Cost Accumulation for Inventory Valuation

and Profit Measurement

Accounting for Direct Costs
 Accounting for direct costs

Can be classified into two categories:

1.Labour
o accumulation of labour costs
o recording procedures

2.Materials
omaterials control procedures
oEstablishing optimal stock level
oMaterials requisition
 Accounting for Labour costs

1. Payroll accounting
- concerned with recording the amount due to employees,
inland revenue, pension funds, etc.
o financial accounting function – payment due & reporting
purposes

2. Labour cost accounting

- allocates costs to cost objects (e.g. products/services,
individual customers’ orders, overhead accounts).
o time sheets/job cards as source documents
o Records production or operation-based employees
 Materials recording procedure

Involves the following stages:

1. Storage of materials
2. Purchase of materials
3. Receipt of materials
4. Issue of materials
5. Assigning the cost of materials to cost objects
 Pricing the issue of raw materials

1. The issue of raw materials involves:

reducing the value of raw material stocks

recording the cost of the materials issued to the appropriate job or
overhead account.

2. Difficulty arises in determining which costs should be assigned to

material issues.
Example
1 February : 1000 units purchased at RM1 per unit
1 March : 1000 units purchased at RM2 per unit
30 March : 1000 units sold at RM4 per unit

Three alternative issue prices:

First-in-first-out (FIFO) =RM1.00 per unit
Last in-first out (LIFO) = RM2.00 per unit
Average cost =RM1.50 per unit

A summary of the transactions

Raw materials Gross
Sales Cost of sales closing stock profit
RM RM RM RM
FIFO 4000 1000 x RM1.00 =1000 1000 x RM2.00 =2000 3000
LIFO 4000 1000 x RM2.00 =2000 1000 x RM1.00 =1000 2000
Average
cost 4000 1000 x RM1.50 =1500 1000 x RM1.50 =1500 2500
Planning and control of stocks

1.Relevant costs required for determining EOQ

Holding costs
Ordering costs

2. Holding costs
Opportunity cost of investment in stocks
Incremental insurance costs
Incremental warehouse and storage costs
Incremental material handling costs
Costs of deterioration and obsolete stocks

3. Ordering costs
Incremental clerical costs of preparing a purchase order, receiving
deliveries and paying invoices.
Economic order quantity graph
Determining when to place the order

1. Assume: Ann. DD=6000 units; 50wks a yr; EOQ = 600 units;

Usage per wk = 120 units
With an EOQ of 600 units, orders will be placed at five-weekly
intervals.

However: IF Lead time = 2 wks;

2. Re-order point = 2 weeks x120 units =240 units.
Quantity discounts
Assume purchase cost = RM7 per unit
Annual Demand = 9000 units
Holding cost = RM4 per unit
Cost per order = RM5
A quantity discount of 3% is available for orders in
excess of 1000 units.

Decision: How much should the company order?

Stock Control Systems (concepts ONLY)

 ABC Classification method

 MRP I & MRP II
 JIT
Controlling stocks using ABC classification methods

1. Estimate total purchase cost for each item of stock for the
period.

2. Each item is then grouped in decreasing order of annual

purchase cost:
A items = top 10% of items in stock
B items = next 20% of items
C items = bottom 70% of items

3. It is normal for between 10% and 15% of items in stock to

account for between 70% and 80% of the total value of
purchases. Therefore, the greatest degree of control should be
exerted over the A items.
4. Other factors to be considered

• Shortage of future supplies.

• Future price increases.
• Obsolescence.
• Assumption of constant demand is questionable where an item is
used in several different products or assemblies and demand varies
throughout the period. May not be consistent with MRP systems.
Materials Requirement Planning (MRP I)

 Computerized system for planning the production and the

acquisition of materials.

 It recognizes that the demand for materials is dependent

upon the demand for assemblies of which they are a part and
that the replenishment of stocks cannot be planned
independently of each other.

 Operating an MRP system involves:

• a master production schedule
• a bills of material file
• an inventory file
• a master parts file
4. MRP involves a time-phased schedule of planned order releases of
lower-level items for purchasing and manufacturing.
Manufacturing Resource Planning (MRP II)

 Improvisation/extension of MRP I

manage all manufacturing resources (mats, lab, machines).

Just-in-time systems
1. Elimination of non-value-added activities
•Many activities add cost but no value to the product
• The aim of JIT is to convert raw materials to finished products with lead
times equal to processing times.

2. Change in factory layout

• Move from batch production to cellular flowliness of dissimilar machines
(products grouped into families of different products or components).
• Pull systems (instead of a push system) used, with material movements
minimalized.
• Considered more beneficial to absorb short-run idle time rather than
adding to inventory.
3. Zero defects
• Emphasis on preventive maintenance and ‘doing the job
right first time’.

4. Batch sizes of one

• The aim is to reduce set-up times, batch sizes and
throughput times, thus minimizing stocks.

5. JIT purchasing arrangements

• More frequent deliveries of material that immediately
precede their use.