Costing and Control
of Materials
Manufacturing Costs
Direct
Materials
Direct
Labor
The Product
Manufacturing
Overhead
Direct Materials
Raw materials that become an integral part of
the product and that can be conveniently
traced directly to it.
Example: A radio installed in an automobile
Direct Labor
Those labor costs that can be easily traced to
individual units of product.
Example: Wages paid to automobile assembly workers
Manufacturing Overhead
Manufacturing costs that cannot be traced
directly to specific units produced.
Examples: Indirect labor and indirect materials
Wages paid to employees
who are not directly
involved in production
work.
Examples: maintenance
workers, janitors and
security guards.
Materials used to support
the production process.
Examples: lubricants and
cleaning supplies used in the
automobile assembly plant.
Classifications of Costs
Manufacturing costs are often
classified as follows:
Direct
Material
Direct
Labor
Prime
Cost
Manufacturing
Overhead
Conversion
Cost
Materials
Materials are the basic input that are transformed
into finished goods in the production process.
Materials costs based on relationship with finished
goods, can be broken down into direct
and indirect costs.
Control of Materials
Accounting for materials in a manufacturing
company usually involves two activities.
(1) Purchase of Materials
(i) Purchase
(2) Issue of Materials
(i) Periodic
Requisition
System
(ii) Purchase order
(ii) Perpetual
(iii) Receiving Materials
System
Inventory
Inventory
1. Purchase Requisition
Purchase is initiated through a purchase requisition.
Avon Company Ltd
Purchase Requisition
Number
Department/Individual making request……………..
Order date …………. Delivery date requested……………..
Quantity
Catalogue number
Description
Approved b y…………………………..
Figure 1: Purchase Requisition
Unit price
Total cost
Total
2. Purchase Order
After the requisition has been approved, the purchasing
department places order.
Avon Company Ltd
(full address)
Purchase Order
Number
Supplier………………….
Order date…………………
Address……………………
Date delivery requested by………………
Delivery terms………………. Payment terms………………..
Quantity
Catalogue number
Description
Approved b y…………………………..
Figure 2: Purchase Order
Unit price
Total cost
Total
3. Receiving of Materials
Quantities and condition on receipt of goods are noted by the
receiving department on a Receiving Report as shown in Figure 3.
Avon Company Ltd
Receiving Report
Number
Supplier ……………….
Purchase order number……………
Date received……………..
Quantity
Catalogue number
Approved signature…………
Figure 3: Receiving Report
Description
Unit price Total
Storing and Issuance
of Materials
The basic accounting records of any inventory system are the
documents required to authorise and record materials movements
in/out of the store, namely, stocks/stores/materials ledger cards,
bin cards and materials requisition note.
Stock/Stores/Materials Ledger Cards
They show quantities on order, expected delivery dates and
quantities reserved/required for work to be processed. They
show the account number; description/type of material;
location; unit measurement; minimum and maximum quantities
to carry; details about the materials received; issued and
balance.
Bin Card
Bin card shows quantities of each type of material
received, issued and on hand.
Avon Company Ltd
Bin Card
Description ……………….
Bin card ………….
Stores ledger number…………
Date received…………………
Code number………….
Unit number ………..
Date
Received
Reference
Figure 4: Bin Card
Issue
Quantity
Reference quantity
Balance Check
quantity
Materials Requisition Note/Form
The issuance of materials is authorised by means of a materials
requisition form prepared by the production
manager/departmental supervisor.
Materials Requisition Form
Date requested ……………..
Department requesting ……………
Requisition number………………..
Quantity
Description
Approved by …………….
Date issued ………….
Issued to ……………
Job number Units cost
Figure 5: Materials Requisition Note
Total
Periodic Inventory System
Periodical inventory system involves physical count
of materials on hand at periodical intervals to
arrive at the ending inventory.
Exhibit 1: Cost of Materials Issued
Materials inventory-opening
+ Purchases
= Materials available for use
– Materials inventory-closing (based on physical count)
= Cost of materials issued
Perpetual Inventory System
Perpetual inventory system shows both cost of
materials issued and ending materials
inventory directly.
Recording/Accounting for
Material Cost
When a perpetual inventory system is used to account for
materials inventory, a subsidiary ledger records
card is maintained.
Inventory Record Card
Item……….
Description…………….
Received
Date
Quantity
Issued
Amount
Date
Figure 6: Inventory Record Card
Balance
Quantity
Amount
Date
Quantity Amount
The use of perpetual inventory system also involves physical count of
materials on hand, at least once a year, in order to check for
possible loss or shrinkage due to theft or spoilage.
If the physical count does not match with the balance in the inventory
record cards, the book figures are adjusted upward/downward to
reflected the actual count.
Journal Entries: The purchase and issue of materials (direct as well indirect)
are journalised as follows:
(i)
When materials are purchased:
Direct Materials Inventory A/c
To Cash/Accounts Payable (credit purchases)
Indirect Material Inventory A/c
To Cash/Accounts Payable A/c (credit purchase)
(ii)
Issue of direct materials for production:
Work-in-process Inventory A/c
To Materials Inventory A/c
(iii) Issue of indirect materials for production:
Factory Overhead Control A/c
To Materials Inventory A/c
Dr
Dr
Dr
Dr
Cost of Inventory
The cost of inventory may be said to be composed of two elements: (i)
Inventory quantities determined on the basis of either physical count or
perpetual inventory records and (ii) Unit cost.
In general, the basis of inventory valuation is the “lower of cost or
market” or more appropriately “the lower of actual cost or replacement
cost.”
Although replacement costs can be estimated for interim periods, and
adjustments made later on to reflect the conditions at the close of the
year, the market value can be known with certainty only at the close of
the accounting period.
As regards the actual cost, there are several elements associated with
it. They are: (i) Invoice cost, (ii) Freight charges and costs of buying,
receiving and storing,
cash.
and (iii) Discounts-trade/quantity as well as
Periodic Inventory System
Periodical inventory system involves physical count
of materials on hand at periodical intervals to
arrive at the ending inventory.
Exhibit 1: Cost of Materials Issued
Materials inventory-opening
+ Purchases
= Materials available for use
– Materials inventory-closing (based on physical count)
= Cost of materials issued
Methods of Inventory
The proper costing of inventory is important from
the point of view of the income determination
and asset measurement. The important
inventory costing methods are:
Simple
Average
Weighted
Average
Method
Specific
Identification
FIFO
Method
LIFO
Method
Specific Identification
This method entails keeping a record of the purchase price of
each specific unit and the quantity of specific units used.
Cost of materials used is computed by multiplying the
quantity used by the specific price of each material.
Cost of Materials Available for Use
(-) Ending Materials Inventory
= Cost of Materials Issued
XX
(XX)
XX
Specific Identification
Example No. (6): Page 207
Materials Available for Use:
Date
1/1
3/2
7/11
10/6
Units purchased
×
Cost Per Unit
2,500
×
$ 53
3,275
$ 54.5
2,320
$ 57
1,905
$ 56
Cost Materials Available for Use
=
Total
=
=
=
=
$ 132,500
$ 178, 487.5
$ 132,240
$ 106,680
$ 549,907.5
Specific Identification
Ending Materials Inventory:
Date
Units
purchased
-
Units
Issued
=
Units on
Hand
×
Cost Per Unit
Ending
Inventory
1/1
2/3
11/7
2,500
-
0
=
2,500
×
$ 53
$ 132,500
3,275
-
2,950 (9/5)
=
325
×
$ 54.5
$ 17,712.5
2,320
-
1,525 (1/9)
=
795
×
$ 57
$ 45,315
6/10
1,905
-
1,150
(17/12)
=
755
×
$ 56
$ 42,280
Total Ending Materials Inventory
$ 237,807.5
Specific Identification
Cost of Materials Issued:
Date
9/5
1/9
17/12
Units Issued
×
Cost Per Unit
2,950
×
$ 54.5
1,525
×
$ 57
1,150
×
$ 56
Cost of Materials Issued
Cost of Materials Available for Use
(-) Ending Materials Inventory
= Cost of Materials Issued
=
=
=
=
Total
$ 160,775
$ 86,925
$ 64,400
$ 312,100
$ 549,907.5
($ 237,807.5)
$ 312,100
Simple Average
 The various purchase prices are added together and their
sum is divided by the total number of purchases to arrive at
the average cost per unit.
 Beginning Inventory is treated as a purchase.
Average Cost Per Unit= Sum of Purchase Prices ÷ Total Numbers of Purchase
Date
1/1
2/3
11/7
6/10
Sum of Cost Per Unit
Cost Per Unit
$ 53
$ 54.5
$ 57
$ 56
$ 220.5
Simple Average Cost=$ 220.5 ÷ 4 =$ 55.125
Note: “Beginning Inventory Treated as Purchase”.
Simple Average
A. Ending Materials Inventory
Number of Units in Ending Materials Inventory X Simple Average Cost =
Ending Materials Inventory
XX Units* X $ XX
$ XX
Beginning Inventory
(+) Purchases
Materials Available for use
(-) Materials Issued
Number of Units in Ending Materials Inventory*
A. Cost of Materials Issued
Units Issued X Simple Average Cost =
Cost of Materials Issued
XX Units X $ XX
XX
XX
XX
XX
XX
$ XX
Simple Average
A. Ending Materials Inventory
Number of Units in Ending Materials Inventory X Simple Average Cost =
Ending Materials Inventory
4,375* × $ 55.125
$ 241,171.87
Beginning Inventory
(+) Purchases= (3,275 + 2,320 + 1,905)
Materials Available for use
(-) Materials Issued= (2,950 + 1,525 + 1,150)
Number of Units in Ending Materials Inventory*
A. Cost of Materials Issued
Units Issued X Simple Average Cost =
Cost of Materials Issued
5,625 Units × $ 55.125
2,500
7,500
10,000
5,625
4,375
$ 310,078.12
Weighted Average Method
According to the Weighted Average Method, the weighted
average price of purchases and inventory is taken as the
basis for determining the cost of the inventory.
Steps:
 each purchase price × quantity of units in each purchase.
 WA unit cost= Total cost of purchased units ÷ Total number of units
available for use.
 Ending Inventory= Number of Units in Ending Materials Inventory ×
Weighted Average Cost
 Cost of Materials Issued= Units Issued ×Weighted Average Cost.
 Cost of materials Available for use= Ending Inventory + Cost of
Materials Issued.
Weighted Average Method
Date
1-Jan
2-Mar
11-Jul
6-Oct
Total
Units Purchased
Cost Per Unit
Total
2,500
$ 53
$ 132,500
3,275
$ 54.5
$ 178,487.5
2,320
$ 57
$ 132,240
1,905
$ 56
$ 106,680
10,000 Units
$ 549,907.5
Weighted Average Cost =$549,907.5+$10000= $ 54.99
A. Ending Materials Inventory
Number of Units in Ending Materials Inventory X Weighted Average Cost =
Ending Materials Inventory
4375 Units X $ 54.99
$ 240,581
A. Cost of Materials Issued
Units Issued X Weighted Average Cost =
Cost of Materials Issued
5625 Units X $ 54.99
$ 309,318
FIFO Method
The FIFO method assumes that the inventory is consumed
in chronological order, that is, items received first are
deemed to have been issued/consumed first
and priced accordingly.
 This method assumes that the first stock to be
received is the first to be sold.
 The cost of materials used is based on the oldest
prices.
 The closing stock is valued at the most recent
prices.
FIFO Method
FIFO Method
Ending Materials Inventory = 4,375 units
Date
6-Oct
11-Jul
2-Mar
Total
Unit Purchased
1905
2320
150 (3,275)
4375 units
Cost Per Unit
$ 56
$ 57
$ 54.5
×
×
×
=
=
=
Total
$ 106,680
$ 132,240
$ 8,175
$ 247,095
=
=
Total
$ 132,500
$ 170,312.5
$ 302,812.5
Ending Materials Inventory
Cost of materials issued = 5,625 units
Date
1-Jan
2-Mar
Total
Unit Purchased
2,500
3,125 (3,275)
5,625 units
Cost Per Unit
×
$ 53
×
$ 54.5
Cost of Materials Issued
LIFO Method
The LIFO method is based on the assumption that the cost of
inventory is computed on the basis of the inverse sequence
of receipts.
 This method assumes that the last stock to be
received is the first to be sold.
 Therefore, the cost of materials used is based on
the most recent prices.
 The closing stock is valued at the oldest prices.
LIFO Method
LIFO Method
Ending Materials Inventory= 4,375 units
Date
Unit Purchased
Cost Per Unit
1-Jan
2,500
$ 53
2-Mar
1,875 (3,275)
$ 54.5
Total
4,375 units
Ending Materials Inventory
Total
$ 132,500
$ 102,187.5
$ 234,687.5
Cost of Materials Issued= 5625 units
Date
Unit Purchased
Cost Per Unit
6-Oct
1,905
$ 56
11-Jul
2,320
$ 57
2-Mar
1,400 (3,275)
$ 54.5
Total
5625 units
Cost of Materials Issued
Total
$ 106,680
$ 132,240
$ 76,300
$ 315,220
LCM Rule



Assets are generally stated in the financial
statements according to the cost principle.
However, in case of inventory, cost principle
is abandoned and lower of cost or market
(LCM) rule takes its place. This rule states
that inventory should be measured at the
lower of:
Cost; or
Market Value
LCM Rule
Adjustment (11/7):
Materials inventory before LCM adjustments
$ 57
(-) Materials inventory after LCM adjustments
$ (56)
= Difference
$1
= $ 1 × 795 units
$ 795
Specific Identification
Adjustments = (795 units X $ 1) =
Ending Materials Inventory before LCM adjustments.
(-) Adjustments
Adjusted Ending Materials Inventory
Specific Identification
Adjustments = (795 units X $ 1) =
Cost of Materials Issued before LCM Adjustments.
(+) Adjustments
Adjusted Cost of materials Issued
$ 795
$237,807.5
($795)
$237,012.5
$795
$312,100
$795
$312,895
LCM Rule
Simple Average Cost
Since the simple Average cost is less than replacement cost,
no adjustments is necessary for the LCM rule.
Weighted Average Cost
Since the Weighted Average cost is less than replacement
cost, no adjustments is necessary for the LCM rule.
LCM Rule
Adjustment (11/7):
Materials inventory before LCM adjustments
$ 57
(-) Materials inventory after LCM adjustments
$ (56)
= Difference
$1
= $ 1 × 2,320 units
$ 2,320
FIFO
Adjustments = (2,320units X $ 1) =
Ending Materials Inventory before LCM adjustments.
(-) Adjustments
Adjusted Ending Materials Inventory
FIFO
Adjustments = (2,320 units X $ 1) =
Cost of Materials Issued before LCM Adjustments.
(+) Adjustments
Adjusted Cost of materials Issued
$ 2,320
$247,095
($2,320)
$244,775
$2,320
$302,812.5
$2,320
$305,132.5
LCM Rule
LIFO:
Since the unit cost of ending materials is less than
replacement cost, no adjustments is needed for the LCM
rule.