ACCOUNTING OF MATERIALS
- Materials can be classified as either direct materials or indirect materials.
- Direct materials can be directly attributed to a unit of production, or a specific job, or a
service provided directly to a customer.
- Indirect materials cannot be directly attributed to a unit of production.
- Cost of direct material can be charged directly to the cost unit that uses the materials.
- Costs of indirect materials are charged to the cost centre that requisitions them from
the stores department and uses them.
- Procedures and documentation for materials:
o The stores department is responsible for the receipt, storage and issue of
materials.
STORES DEPT PRN PURCHASING
MRN DEPT
(Goods Received
Note)
USER DEPT 1
Purchase Order
Materials Transfer Note Purchase Order
USER DEPT 2 Delivery Note
ACCOUNTS
SUPPLIER Invoice
o A bin card system – a bin card is kept for each item of inventory. A bin card is used to
record the quantities only of inventory received and issued and the current inventory
balance.
o An inventory ledger system – it records both the quantity and value of items received
into stores, issued from stores and the current balance held in stores.
Compiled by Enos Chiyongwe FCCA FZICA – 0977456212
Page 1
- Pricing Methods
- A business might use any of several valuation methods for pricing stores issued. Three such
methods are:
o First in first out (FIFO)
It is assumed that materials are issued from stores in the order in which they are
received.
Each successive consignment into stores is exhausted before charging issues
from stores at the next price.
Advantages
It is a logical pricing method which probably represents what is
physically happening: in practice the oldest inventory is likely to be used
first.
It is easy to understand and explain to managers.
The inventory valuation can be near to a valuation based on
replacement cost.
Disadvantages
FIFO can be cumbersome to operate because of the need to identify
each batch of material separately.
Managers may find it difficult to compare costs and make decisions
when they are charged with varying prices for the same materials.
In a period of high inflation, inventory issue prices will lag behind
current market value.
o Last in first out (LIFO)
It is assumed that materials issued from stores are the units that were acquired
the most recently of those still remaining in inventory.
When the prices are rising, using LIFO the total value of materials issued will be
more than under FIFO and the closing inventory value less than FIFO.
Advantages
Compiled by Enos Chiyongwe FCCA FZICA – 0977456212
Page 2
Inventories are issued at a price which is close to current market value
Managers are continually aware of recent costs when making decisions,
because the costs being charged to their department or product will be
current costs.
Disadvantages
The method can be cumbersome to operate because it sometimes
results in several batches being only part-used in the inventory records
before another batch is received.
LIFO is often the opposite to what is physically happening and can
therefore be difficult to explain to managers.
As with FIFO, decision making can be difficult because of the variations
in prices.
o Weighted Average cost (AVCO)
All quantities of an item of inventory are valued at a weighted average cost. An
average cost is calculated each time that there is a new delivery into stores.
Using this method, the total value of materials issued and the closing inventory
value are between the FIFO and LIFO valuations.
Weighted average price = Value of opening stock + Value of new receipt
Qty of opening stock + Qty of new receipt
Advantages
o Fluctuations in prices are smoothed out, making it easier to use the
data for decision making.
o It is easier to administer than FIFO and LIFO, because there is no need
to identify each batch separately.
Disadvantages
o The resulting issue price is rarely an actual price that has been paid, and
can run to several decimal places.
o Prices tend to lag a little behind current market values when there is
gradual inflation.
o Periodic Weighted Average
Using this method the cost of issues cannot be calculated until the end of the
period.
Compiled by Enos Chiyongwe FCCA FZICA – 0977456212
Page 3
Periodic average price = Cost of Opn stock + Cost of all receipts in the period
Units in Opening inventory + Units received
- Inventory losses and waste
o Wastage is usually measured as a percentage of the quantities of materials input.
o Wastage expected is normal whereas the unexpected is abnormal.
Input – Wastage = Output
Input = Output X 100%
(100% - wastage rate percentage)
Example : In a production process, there is usually a wastage rate of 5% of input. Materials cost $8
per kilogram. The required output is 1,520 kilograms. What quantity of input materials should be
required, and what will they cost?
o Unexpected wastage could be caused by the following:
If labour is less experienced than expected and make more mistakes when using
the material
If a machine is old or poorly maintained and there are more breakdowns and
errors than expected
If the production process has changed
If the estimate of the control rate for wastage was too low.
- Material Inventory control
o Stocktake: is the counting and recording of the physical quantities of each item of
inventory.
o Periodic stocktake is carried out at a specific time, for example at the end of the
accounting year.
o Continuous stocktake involves checking items on a rotating basis.
o Inventory is held so that sales can be made and profits can be earned. The objective of
an inventory policy should be to minimise the total annual costs associated with
inventory.
o The total costs associated with inventory include the following costs: purchases costs,
inventory holding costs, inventory ordering costs and stockout costs.
o Buffer inventory (safety inventory) is a basic level of inventory held to cover
unexpected demand or uncertainty of lead time for the item of inventory.
Compiled by Enos Chiyongwe FCCA FZICA – 0977456212
Page 4
o Economic order quantity (EOQ) is the order quantity for an item of inventory that will
minimise the combined costs of ordering and holding inventory over a given period of
time.
o Assumptions made in EOQ:
There should be no stockout of the item.
There is no buffer inventory (buffer stock).
A new delivery of the inventory item is received from the supplier at the exact
time that existing inventory runs out.
The inventory item is used up at an even and predictable rate over time.
The delivery lead time from the supplier is predictable and reliable.
o EOQ = √2CoD/Ch
Co is the cost of placing an order of the inventory item
Ch is the annual cost of holding one unit of the inventory for one year
D is the annual demand for the inventory item
Q is the order quantity
Order costs = XC
Where Q: Quantity ordered
C: Cost per order
D: Demand per annum
Holding costs = Order Qty/2
Total holding costs = X Cost of holding one unit.
o Inventory Levels
The re-order level is the level of inventory at which a fresh order is placed with a
supplier.
Lead time is the gap that arises between an order being placed and its eventual
delivery.
Re-order level = Maximum lead time X Maximum demand
Where safety stock is required :
Re-order level = Safety stock + (lead time X demand)
Minimum Inventory level = Re-order level - (Ave. lead time X Ave. demand)
Maximum Inventory level = Re-order Qty + Re-order level - (Minimum
demand X Minimum lead time)
Compiled by Enos Chiyongwe FCCA FZICA – 0977456212
Page 5
