LESSON 3

ELEMENTS OF PRODUCT COST

MATERIALS
ENGINEERING AND PLANNING DEPARTMENT
- Determine the cycle of operation to be performed and
establishes the materials needed for each step of the cycle
PRODUCTION BUDGET AND MASTER PLAN
- Materials needed for the production of the product

PROCESS OF OBTAINING MATERIALS

PURCHASES REQUISITION FORM

- It is a document sent to the purchasing department and
usually that originates from storeroom staff, materials
record clerk, a research engineering, or other department
employee or supervisor who needs materials
PURCHASE ORDER
- It is an authorization signed by the purchasing agent sent to
a vendor (supplier) to supply goods at the agreed price
specification, terms, and conditions of the product and at a
specified time and place of delivery
RECEIVING REPORT
- It is a document prepared by the receiving department that
shows the purchase order number, the account number to
be charged, the name of the vendor (supplier), the details
 relating to transportation and the quantity and type of goods
received
MATERIAL REQUISITION FORM
- It is a document authorizing the material storekeeper to
deliver material to the department presenting the requisition
form
BILL OF MATERIALS
- It is a list of materials needed to produce a product
RETURN MATERIALS REPORT
- It is a document prepared when some materials requisitioned
were not used in the production and are returned to the
materials storeroom staff
DEBIT OR CREDIT MEMORANDUM
- It is a document prepared when the type, quantity, quality of
goods ordered differs from the goods shipped by the
supplier and an adjustment must be made to the supplier’s
invoice

PROCUREMENT / PUCHASING DEPARTMENT

- Responsible for the purchases of materials and supplies
- Headed by purchasing manager
- Has the authority to purchase materials needed by different
company’s department in correct quantities, standard,
proper time at the lowest possible price

MAIN FUNCTION
- To receive purchase requisition from any department
- To purchase the materials and services at the right pace,
right supplier, right specification, right quantity at the right
time
- Request proposals from different suppliers
- Negotiate with the supplier
- Prepare purchase order
- Follows up the delivery
- Handle paperwork’s involved I purchasing and delivery of
materials
- Coordinates with the receiving and accounts payable
department to ensure the materials needed were delivered,
received in full and are being paid on time
- To ensure that the staff members of the purchasing
department comply with the company policies by following
the proper procedures for the purchase, budget approval,
 and ensure that it is in accordance with overall purchasing
policy of the company

MATERIAL CONTROL SYSTEM

- Systematic control over purchasing, handling, storing and
use of materials to minimize wastes, loss of materials from
the time it is received, store and issued and operational
inefficiencies

OBJECTIVE
o To allow uninterrupted production
o To have the required quality of materials
o To minimize wastage, spoilage and defective goods
o To assign responsibility
o To maintain the cost of materials at a minimum and
maximum level
o To purchase materials at the minimum price
o To provide information to the company

BASIC ASPECT
o Physical and operational aspect
▪ Limit the access to materials
▪ Proper segregation of duties and responsibilities
▪ Accuracy in recording
▪ Contril of investment in materials
o Control of investment of materials aspect
▪ Material planning – focuses on quantity materials
purchases and timing of its purchased

ESSENTIAL OF MATERIALS CONTROL

1. Cooperation and coordination of different department
2. Good storage facilities
3. Proper checking and accounting of materials (standard
form)
4. Proper records of different materials
5. Centralized purchasing department
6. Proper inspection of materials when they are received
7. Proper segregation of duties and responsibilities
8. The quantity of materials to be ordered should be
planned
CONTROL SYSTEM
o Order cycling method – materials on hand are revied
on periodic cycle and orders are placed to maintain the
desired level of inventory (this method is applicable
for companies that maintain big and slow selling
products such as appliance and furniture)
o ABC analysis – materials are categorized as follows
(1) small and less costly materials; (2) somewhat
larger and more costly; (3) very large and expensive
materials. It helps the company to determine how
much time it needs for reordering material bases on its
category (this method is applicable for companies
such as supermarkets, wholesalers)
o Two bin system - this method divides the materials
into two bins; one bin is used for normal operation and
the other bin is used for backup purpose only
(appropriate for companies who sell non-perishable
goods such as books, tools, supplies)
o Minimum and maximum system – it is the simpliest
method to manage the inventory. The company will
only set the minimum and maximum level of
inventory on hand. When the inventory level has
reached the minimum level an order will be placed to
reach the maximum level (appropriate for companies
that sell perishable, small and inexpensive items)
o Automatic order system – an order is placed
automatically when the level of inventory reaches the
pre-determined order point
MATERIAL RESOURCE PLANNING (MRP) - is a
system that helps manufacturers plan and control the
resources needed to make products. It's a software-based
system that helps ensure the right materials are available in
the right quantities at the right time
o INVENTORY: MRP tracks inventory levels and
availability
o DEMAND: MRP uses demand forecasts to predict
how much product will be needed
o PRODUCTION SCHEDULE: MRP creates a
production schedule that tells when to order materials
and make products
o PURCHASING: MRP helps manage the purchasing
 of raw materials
o DELIERY: MRP manages delivery timing to ensure
products are available for consumers

BENEFITS:
▪ Improved productivity: MRP helps manufacturers
meet demand and improve overall productivity
▪ Reduced downtime: MRP helps manufacturers
avoid stockouts and production delays
▪ Improved customer service: MRP helps
manufacturers adapt to demand variations to
maintain high levels of customer service
▪ Reduced costs: MRP helps manufacturers
minimize material and labor costs

CHALLENGES
▪ MRP requires accurate and up-to-date data
▪ Changes in material specifications or availability
can cause production delays

ORDER POINT
- Will trigger the placement of a purchase order for additional
units of materials
- Helps the company to minimize the amount of investment in
its material inventory
- Formula: order point = (usage x lead time) x safety stock
FACTORS IN DETERMINATION OF ORDER POINT
o USAGE - It refers to quantity of materials used each
day
o LEAD TIME - It refers to the estimated time in days
to place an order of materials up to its receipts
o SAFETY STOCK - It refers to the estimated quantity
of materials maintained to avoid running out of stock
(stockout)

FORMULAS:
o SAFETY STOCK = (maximum daily usage – average
daily usage) x lead time
o REORDER POINT = (lead time x average daily
usage) + safety stock
o NORMAL MAXIMUM INVENTORY = order point
 – (average daily use x lead time) + order quantity
o ABSOLUTE MAXIMUM INVENTORY = order
point – (minimum daily use x lead time) + order
quantity

ECONOMIC ORDER QUANTITY (EOQ)

o It is an equation which determine the optimum
purchase order of inventory at a minimized cost

ORDERING COST
- Are cost that are incurred in having an additional inventory
that includes freight costs, salary of the staff in the
purchasing, receiving, inspection and recording department,
cost of paper form, communication cost to place and order
to supplier, receiving report. Inspection cost, cost of
accounting and payment to vendor
CARRYING COST
- Are cost that are incurred in maintaining the inventory, it
includes handling and storage cost, interest, insurance,
property taxes, loss due to spoilage, theft deterioration,
recording the inventory, and opportunity cost of capital tied
up in inventory
REASONS FOR CARRYING COSTS:
1. To balance set up and carrying cost
2. To satisfy customer demand
3. To avoid stock outs and shutting down the production
facilities
4. To take advantage of discount
5. To hedge against future price increases

FORMULAS:
o NUMBER ORDER PER YEAR / ANNUAL ORDER
COST = annual quantity / EOQ.
o TOTAL ORDERING COST = cost per order x
number of orders
o AVERAGE INVENTORY = order size / 2
o TOTAL CARRYING COST - average inventory x
carrying cost per order
METHODS OF COSTING MATERIALS
PAS 2. Paragraph 6 provides that inventories shall include
1. Assets held for sale in the ordinary course of
business (Finished Goods)
2. Assets in the production process for sale in the
ordinary course of business (Work in Process)
3. Materials or supplies to be consumed in the
production process or in the rendering of service
(Materials)

o SERVICE PROVIDER INVENTORIES include the

cost of service such as labor and other cost of
personnel directly engaged in providing services
(including supervisory salary and attributable
overhead)
o MERCHANDISING COMPANY INVENTORY
would be goods purchase and held for resale
o A MANUFACTURING COMPANY inventories
include raw materials, work in process, and finished
goods inventory

ACCOUNTING FOR INVENTORIES

PERIODIC INVENTORY SYSTEM
▪ This system does not keep real time record of
inventory in stocks or goods sold to customer and
the company will do periodic physical inventory
count on hand from time to time
PERPETUAL INVENTORY SYSTEM
▪ This system continuously update the balance of its
inventory by maintaining an inventory ledger
card (stock card)
ACCOUNTING FOR INVENTORY WRITEDOWN
o Inventory should be carried at cost or net realizable
value which ever is lower
1. DIRECT METHOD - each material ledger card is
adjusted at the lower cost or net realizable value. The
difference between the cost of inventory and its net
realizable value is known as Loss on inventory write-down
(decrease the cost of goods sold)
2. ALLOWANCE METHOD - loss on inventory write
down is debited and credit Allowance for inventory write-
down for any decrease in value of inventory

COST OF INVENTORY
o COST OF INVENTORY - should include all cost of
purchases, net of trade discount received (but
including non-refundable taxes, freight and handling
cost) and other cost incurred in bringing the
inventories to their present location and condition.
Except:
1. Abnormal amount of wasted materials, labor
and overhead
2. Storage cost of finished goods except storage
cost of goods in process are part of the inventory
3. Administrative and Selling cost

INVENTORY COUNT
o The following items should be noted when doing the
inventory count
Included:
▪ Materials in transit purchased FOB shipping point
▪ Finished goods in transit sold FOB destination
▪ Finished goods out on consignment
Excluded:
▪ Materials in transit purchased FOB destination.
▪ Finished goods in transit sold FOB shipping point
▪ Finished goods accepted on consignment

TRADE DISCOUNT
o Deducted from the list price or catalog in to arrive at
the invoice price
o Encourage the buyer of goods to purchase more
because of the markdown on the list price
o No accounting entry for trade discount
CASH DISCOUNT
o Deducted from the invoice price when payment is
made within the discount period
o Its purpose is to encourage prompt payment so that
buyers can avail of the discount
o Cash discount is recorded as purchase discount on the
books of the buyer (gross or net method) and sales
discount in the books of the seller
ELEMENTS OF COST
L4 LABOR
Primary objective of management
- To efficiently utilize its human resources as economically as
possible

CONTROLING LABOR COST

- Recording the number of hours used in total and by job
- Recording the quantity produced by workers
- Analyzing the hours used by employees to determine how
time is to be charged
- Allocation of payroll costs to jobs and factory overhead
accounts
- Preparation of the payroll, including computation and
recording of the employees' gross earnings, deductions and
net earnings
LABOR COST ACCOUNTING AND CONTROL
- Correct timekeeping
- Strict control on labor management
- Analysis of time in terms of department, operation and
production orders
- Improvement in the method of production

REASON FOR PROPER USE OF LABOR COST

- It has a significant effect on the growth, profitability of the
company
- Labor productivity significantly influences the conversion
cost per unit
- It is one major cost element in the manufacturing operation
- It is more difficult to control compared to material cost
because of human involvement
- It is affected by government policy and trade unions
- It is not subject to any technical limitations which restrict
productivity
- It is affected by inefficiency on the growth, ineffective
supervision, idle time, high rate of labor turnover, attitude
of workers towards work, dissatisfaction of workers
CLASSIFICATION OF LABOR
- DIRECT LABOR Is a payroll cost that are paid to workers
who are directly engaged in the conversion process of raw
materials to finished goods
 - INDIRECT LABOR - Is any payroll cost that are paid to a
worker that supports the production process, and which are
not directly involved in the conversion of raw materials
into finished product
- LABOR OVERHEAD - WAITING TIME OR IDLE TIME
cost of non productive hours or direct labor caused by lack
of work, waiting for materials delay from scheduling,
machine breakdown and machine set up
- MAKE UP PAY - When payments to an employee are based
solely on the number of units produced, the employee is
said to be paid at a "piecework rate"
- OVERTIME PREMIUM represent amount paid in excess of
regular rate to employees working in excess of 8 hours in a
day or working during holidays or their rest day. Charged to
factory overhead.
- SHIFT PREMIUM extra pay to work during less desirable
evening shift (2 pm to 10 pm) or night shift (10 pm to 6 am
). Charged to factory overhead
- EMPLOYERS PAYROLL TAXES is the amount remitted to
different government agencies for SSS premiums,
PhilHealth contributions and pag ibig contributions.
Charged to factory overhead
GROSS EARNINGS AND DEDUCTIONS
GROSS EARNINGS OF EMPLOYEES:
1. WAGES-gross earnings of an employee who is paid
by the hour for only the actual hours worked
2. SALARIES - gross earnings of an employee who is
paid a flat amount per week or month regardless of the
hours worked in a period.
3. GROSS EARNINGS - the compensation of an
employee and includes regular pay and overtime premiums

PAYROLL DEDUCTIONS:
1. EMPLOYEE'S INCOME TAX - the amount of tax
to be withheld each period depends on the following:
a) Amount of the employee's earnings
b) Frequency of the payroll period
c) Classification of the taxpayer
2. SOCIAL SECURITY SYSTEM PREMIUM-levied
against both the employer and the employee (based on table
provided).
3. PHILHEALTH CONTRIBUTION levied against
 both the employer and the employee in equal amounts
(based on table provided)
4. PAGIBIG CONTRIBUTION -levied against both
the employer and the employee (based on table provided).

DEPARTMENT RESPONSIBLE FOR LABOR COST

CONTROL
1. Personal department
o Responsible for the planning, recruitment and firing
of the labor force.
o It is one who provides training and seminars and place
people to job for which they are suited
o It is also responsible for carrying out the labor
policies laid down by the top management
2. Engineering and work study department
o Responsible for maintaining control over working
conditions and production technique/ plan and
specification for each job, process, and operations.
o It includes preparation of plan for each job and
process, maintaining efficient working conditions,
conducting time and motion study, merit rating, setting
time wages system and conducting research work
3. Time keeping department
o The department is responsible for the accumulation of
the total hours worked spent by each worker on a job,
product and processes.
o TWO IMPORTANT ACTIVITY
a) Time keeping
▪ TIME KEEPING - MANUAL METHOD -
Involves recording the total number hours each
worker spent in carrying out the job.
TWO TIME KEEPING METHODS
a) ATTENDANCE REGISTER METHOD - A
logbook or time register book is maintained by the
timekeeper.
b) TOKEN OR DISC METHOD is this method a
token or a disc is given to each worker bearing his /
her identification number (placed on hooks on a
board at the entrance of the factory

▪ TIME KEEPING - MECHANICAL METHOD

 a ) TIME RECORDING CLOCKS - under this
method
each worker is given timecard (arranged
alphabetically) and insert to time clocks upon
entrance and departure.
b) DIAL TIME RECORDS- A machine is used
known as dial time recorder to register
automatically the time in and time out of the
workers
c) KEY RECORDED SYSTEM given a key each
worker is

b) Time booking
▪ Refers to the analysis of time of each worker in
terms of department, operation, process or jobs.
▪ It is essential in determining the cost of each job,
operation or process; proper utilization of
worker's time, assigning the overhead cost to
units and effective cost control and cost
reduction.
4. Payroll department
o This department is responsible for the computation of
the total gross earnings including the amount of
payroll deductions (withholding taxes, SSS,
PhilHealth, PAGIBIG Contributions of each worker ,
preparation of payroll/ wages of all workers and
maintain the payroll records
5. Cost accounting department
o This department is responsible in collecting,
classifying and assigning all cost to jobs, products and
processes

ACCOUNTING SYSTEM AND WAGE PLAN

PAYROLL ACCOUNTING SYSTEM
o TIME TICKETS, TIMECARDS, ETC. – Records the
hours worked or units produced by each employee in
total and by job, operations and process
o COST LEDGER – Analyze the hours worked by
workers to determine how labor time as charged
o PAYROLL SUMMARY AND LABOR COST
SUMMARY – Charge payroll time to jobs, operations,
 processes and factory overhead
o DISBURSEMENT VOUCHER AND PAYROLL
SLIPS – Prepare the payroll
o RECEIVING REPORT – Payment or settlement of
wages and salary

TYPES OF WAGE PLAN

1. Time Based Wage Plan (hourly and salary wages)
o Under this plan wages are determined on the basis of
time worked spent by workers irrespective of the
quality of work done
o It is calculated by multiplying the hourly rate of the
worker by the number of time spent
o Formula: Wage number of time worked X rate per
hour
o Advantages:
▪ Simple and economical to use
▪ Give a sense of security because they will know
that they are paid based on the time spent in the
factory regardless of efficiency and they can
easily understand how their wages are computed
▪ Control materials wastages as the job is not done
in a hurry
o Disadvantages:
▪ Production suffer because workers are not time
pressured
▪ No additional incentive for workers to achieve
production efficiency because they are paid based
on the time spent
▪ It decrease the morale of other workers who work
efficiently than others
2. Piece Based Wage Plan (Commission and Per-Unit Pay)
o Under this plan, wages are determined on the basis of
output produced by the workers without considering
the time spent in performing the job.
o It is calculated by multiplying the number of units of
the worker by the specific rate per unit
o Formula: Wage Units Produced X rate per hour
o Advantages:
▪ It provides incentive to workers who produce
more
 ▪ It is a fair wage plan because efficient workers are
rewarded and inefficient workers get less
o Disadvantages:
▪ It increases clerical cost because this plan needs an
up-to-date records of output produce by each
worker
▪ More workers feel tired because they exerted lots
of effort to produce more so that they will earn
more
▪ Quality may be sacrificed in order to maximize
quantity
3. Modified Based Wage Plan (Hybrid Models and
Adjustable Rates)
o This is a combination of time wage plan and piece
wage plan
o Each worker is paid based on a minimum hourly rate
regardless if an established quota of production is not
met.
o Workers are given a bonus for the additional piece of
output if they exceeded the established quota
4. Bonus or Incentive Schemes (Performance Bonuses and
Profit Sharing)
o This wage payment is also known as premium bonus
plan
o It is given to increase production
o TWO TYPES
▪ Individual Incentive Plan - under this scheme
remuneration will be based on the performance of
individual workers
▪ Group Incentive Plan - under this scheme,
remuneration is based on the productivity of the
group or entire work force of the organizations
Which wage payment plan should be implemented?
o Time-Based Plan
▪ Suitable for jobs with consistent hours and tasks.
o Piece-Based Plan
▪ Ideal for jobs with measurable output.
o Modified-Based Plan
▪ Balances time and output for flexibility.
o Bonus/Incentive Schemes
▪ Encourages performance through additional
 rewards.

ACCOUNTING FOR LABOR

LABOR TIME LOSSES
o IDLE TIME - it is the time wasted in which workers
spend their time without giving any production caused
by non-availability of materials, inefficient
supervision machine breakdown, power interruption
o TYPES OF IDLE TIME
1. Normal Idle time - it is the time wasted in which
workers which is inherent in production or cannot be
avoided
2. Abnormal Idle time refers to the loss of time due
abnormal reason such as power failure

ACCOUNTING FOR OVERTIME PREMIUM

- CHARGED TO SPECIFIC JOB
o If the workers are called to work for rush order upon
specific request of a customer with knowledge that
overtime is required to finish the job
o Work in process XXX
Estimated XXX
- CHARGED TO MANUFACTURING OVERHEAD
CONTROL
o If the job is a regular order which cannot be
completed in the regular working hours the overtime
premium is charged to Factory Overhead Control
Account
o Factory Overhead control XXX
Estimated XXX
OTHER LABOR RELATED COSTS CHARGED TO
FACTORY OVERHEAD
- SSS, PhilHealth and PAGIBIG contribution of the employer
- Fringe benefit such as sick leave with pay, holiday, vacation
pay, health insurance, pension payments, hospitalization,
benefits
- Shift Premium pay - cost of labor paid to workers who work
on an evening shift (Night Differential)
- Incentive plans