Management Accounting
Chapter No. 02
Ordering and accounting for Inventory
Management Accounting
Page_3
Chapter No. 02 Ordering and Accounting for Inventory
Chapter learning objectives
Upon completion of this chapter you will be able to:
•describe, for a manufacturing business, the different procedures and documents necessary for
the ordering, receiving and issuing of materials from inventory
•interpret the entries and balances in the material inventory account for a manufacturing business
•describe the control procedures that can be used in a manufacturing business to monitor phyi
cal and ‘book’ inventory and to minimize discrepancies and losses.
1) Accounting procedures for ordering and issuing inventory
Accounting and control procedures for ordering and issuing inventory include the following
Functions:
• ordering
• purchasing
• receiving
• issuing
• Storing and stocktaking.
Ordering, purchasing and receiving inventory
The procedures for ordering, purchasing and receiving materials are as follows.
Explanation:
When a department requires new materials, Purchase requisition is completed (including
authorization by the relevant manager) and sent to purchasing department.
On receipt of a properly authorization, the purchasing department will select a supplier
and create an order on Purchase order form.
The purchase order form is sent to supplier and copies are also sent to the accounts
department and the goods receiving department.
On receipt of the goods, the receiving department will check the goods against the
relevant purchase order, and check the delivery note which accompanies the goods, full
details of the goods are then entered into a goods received Not(GRN)
A copy of the GRN is attached to the relevant purchase order and they are both sent to
the purchasing department where they are approved, the purchase invoice can be paid.
Source person: Mr. Kamran Khan
M.Com, B.Com, D.Com…
MIHE
Mashal Institute of Higher Education
Management Accounting
Page_4
Department requires
new material
Purchase requisition
Purchasing Department
Purchase order
Copy
Supplier
Copy
Goods receiving
department (Store)
Account Department
Supplier
Receipts
Goods Receiving
Department
Goods with delivery note
Purchasing Department
Goods received note
Source person: Mr. Kamran Khan
M.Com, B.Com, D.Com…
MIHE
Mashal Institute of Higher Education
Management Accounting
Page_5
Topic: Accounting for inventory- the material inventory account
Material inventory account:
Materials held in store are assets and are recorded in the balance sheet of a company.
Accounting transactions relating to materials are recorded in the material inventory
account.
Material inventory account
Debit entries reflect an increase in
credit entries reflect a decrease in inventory
Inventory


Purchase
Return to stores
- issues to production
- return to suppliers
Inventory Valuation:






When inventory is received into store from different suppliers and at different
prices every week. It is important that it is valued in consistent way so that closing
inventory values and issued from stores can be valued accurately.
You are probably aware that inventory is usually valued at the lower of cost and
NRV (net realizable value). However, various methods are used to value closing
inventory and issued from stores in management accounting.
There are three main inventory valuation methods.
 FIFO
 LIFO
 Weighted average cost.
FIFO- First in first out FIFO assumes that materials are issued out of stock in the
order in which they were delivered into inventory.
Last in last out-LIFO assumes that materials are issued out of inventory in the
reverse order to which they were delivered into the inventory.
Weighted average cost-AVCO values all items of inventory and issued at an
average price. The average price is calculated after each receipt of goods. The
average price is calculated by dividing the total purchase cost to date by total units
received to date.
Source person: Mr. Kamran Khan
M.Com, B.Com, D.Com…
MIHE
Mashal Institute of Higher Education
Management Accounting
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FIFO method:
An example: ABC company cost flow as per the year is as following.
ABC Company
Cost Flows
Date
Jan 1
Apr 15
Aug 24
Nov 27
Explanation
Beginning Inventory
Purchase
Purchase
Purchase
Total units available for sale
Units at the ending inventory
Units sold
units unit cost Total cost
100
$10
$1000
200
11
2200
300
12
3600
400
13
5200
1000
450
550
12000
On November 30th, 550 units were sold/ issued.
The cost of goods sold/issued formula in a periodic system is:
(Beginning inventory + Purchases) - Ending inventory = Cost of Goods sold.
As per the ABC Company we can calculate the cost of goods sold by pricing the 550 units sold
using the pricing of the first 550 units acquired.
Note: that of the 300 units purchased on August 24, only 250 units are assumed sold/issued.
To find out the cost of goods sold:
Solution as per FIFO method:
Date
Units
unit cost
Total cost
Jan 1
100
$10
$1000
Apr 15
200
11
2200
Aug 24
250
12
3000
Total
550
6200
So $6200 is the “cost of goods sold” of 550 units sold as per FIFO method. And the cost of
closing inventory is $5800.
Source person: Mr. Kamran Khan
M.Com, B.Com, D.Com…
MIHE
Mashal Institute of Higher Education
Management Accounting
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Recording materials with FIFO Method
Material Ledger
Card
Received
Rate Amount Qty
Date
Jan 01..
April 15
Description
Balance b/d
purchased
Qty
200
11
2200
Aug.24
purchased
300
12
3600
Nov. 27
purchased
400
13
5200
Nov.30
Issued
100
200
250
Issued
Rate Amount Qty
100
100
200
100
200
300
100
200
300
400
10
1000
50
11
2200
400
12
3000
Balance
Rate Amount-$
10
1000
10
1000
11
2200= 3200
10
1000
11
2200
12
3600 = 6800
10
1000
11
2200
12
3600
13
5200 = 12000
12
600
13
5200 = 5800
LAST-IN, FIRST-OUT (LIFO) Method:
Date
Nov 27
Aug 24
Total
Units
400
150
550
unit cost
$13
12
Total cost
$5200
1800
7000
As per using LIFO method the cost of goods sold for 550 units is $7000.
Source person: Mr. Kamran Khan
M.Com, B.Com, D.Com…
MIHE
Mashal Institute of Higher Education
Management Accounting
Page_8
Recording materials with LIFO Method
Material Ledger
Card
Received
Rate Amount Qty
Date
Description
Jan 01.. Balance b/d
April 15 purchased
Qty
200
11
2200
Aug.24
purchased
300
12
3600
Nov. 27 purchased
400
13
5200
Nov.30
Issued
400
150
Issued
Rate Amount Qty
100
100
200
100
200
300
100
200
300
400
13
5200
100
12
1800
200
150
Balance
Rate Amount-$
10
1000
10
1000
11
2200= 3200
10
1000
11
2200
12
3600 = 6800
10
1000
11
2200
12
3600
13
5200 = 12000
10
1000
11
2200
12
1800 = 5000
Average-Cost method:
Recording materials with Average Method
Material Ledger Card
Received
Rate Amount Qty
2200
Qty
100
300
Balance
Rate
Amount-$
10
1000
10.667 3200
12
3600
600
11.333 6800
13
5200
1000
12
12000
450
12
5400
Date
Jan 01...
April 15
Description
Balance b/d
purchased
Qty
200
11
Aug.24
purchased
300
Nov. 27
purchased
400
Nov.30
Issued
Source person: Mr. Kamran Khan
M.Com, B.Com, D.Com…
550
Issued
Rate Amount
12
6600
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Mashal Institute of Higher Education
Management Accounting
Cost of Goods
Available
÷
For sale
$12000
÷
Page_9
Total Units
Available
for sale
1000
=
=
Weighted
Average
Unit Cost
$12
As per Average method the cost of goods sold for 550 units is (550×$12= $6600).
Now what is the impact of Each and every method used on the financial statement/income
statement and Tax Effects of cost flow methods?
NOTE: to understand why companies might choose a particular cost flow methods. Let’s
examine the affects of the different cost flow assumptions on the financial statement of ABC&
co, we assume that ABC & co sold its 550 units for $ 11500, and had operating expenses of
$2000 and it is subject to an income tax of 30%.
ABC Company
Income statement
FIFO
LIFO
$11500
$11500
1000
1000
11000
11000
12000
12000
(5800)
(5000)
(6200)
(7000)
5300
4500
(2000)
(2000)
3300
2500
(990)
(750)
2310
1750
Sales revenue
Beginning inventory
Purchases
Cost of goods available for sales
Ending inventory
Cost of Goods sold
Gross Profit
Less: Operating Expenses
Income before income tax
Income Tax expenses (30%)
Net income
Self Test Question 1:
XYZ Company cost flow as per the year of 2012 as following.
Average-cost
$11500
1000
11000
12000
(5400)
(6600)
4900
(2000)
2900
(870)
2303
Date
Jan1
Jan 15
Mar 20
July 24
Nov
Explanation
units
unit cost
Total cost
Beginning inventory
150
$9
$1350
Purchase
200
10
2000
Purchase
250
12
3000
Purchase
200
14
2800
Purchase
300
15
4500
Total units available for sale 1100
13650
Ending inventory
450
Units sold
650
Req: Calculate Cost of goods sold as per FIFO, LIFO and Average cost methods?
Source person: Mr. Kamran Khan
M.Com, B.Com, D.Com…
MIHE
Mashal Institute of Higher Education
Management Accounting
Page_10
Self Test Question 2:
Coca cola company cost flows as per the year so 2011 was as follow.
Date
Jan 1
Apr 14
May 16
Sep 12
Dec 10
Explanation
Beginning inventory
Purchase
Purchase
Purchase
Purchase
Total units available for sale
Ending inventory
Units sold
units
200
250
300
200
400
1350
500
850
unit cost
$12
14
15
18
20
Total cost
$2400
3500
4500
3600
8000
22,000
Req:
01. Calculate the cost of goods sold and ending inventory as per FIFO, LIFO and
Average methods
02. Also show the impact on the income statement of using each method of cost
flows if the 850 units are sold on $30,000 and the operating expenses are for the
company is $7,000 and are subject to 25% of income tax?
Source person: Mr. Kamran Khan
M.Com, B.Com, D.Com…
MIHE
Mashal Institute of Higher Education
Management Accounting
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Exercises:
1. Material costing methods. The Meltzer Company made the following material
purchases and issues during January 2013.
Inventory:
January 1.
500 units @2.4
Receipts:
January 6.
200
@2.5
10.
400
@2.6
25.
500
@2.8
Issues:
January 15.
27.
560
500
Required: the cost of material consumed and the cost assigned to the inventory at the end
of the month, using a perpetual inventory system, by
a. FIFO
b. LIFO
c. Average
Now find out the gross profit and the net profit if net sales in each case are $100000 and
income tax rate is 10%?
2. The following information is to be used in costing inventory August 31:
August 1. Beginning inventory balance: 800 units @6
5. Purchased 200 units @7
9. Purchased 200 units @8
16. Issued 400 units
24. Purchased 300 units @9
27. Issued 500 units
Required: the cost of material consumed and the cost assigned to the inventory at the end
of the month, using a perpetual inventory system, by
a. FIFO
b. LIFO
c. Average
Source person: Mr. Kamran Khan
M.Com, B.Com, D.Com…
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Mashal Institute of Higher Education
Management Accounting
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3. Ledger accounts for materials cost flows: During one week of operations, a materials
ledger card reflected the following transactions.
1st day
beginning inventory: 1400 units @4.60
2nd
received 1000 units @4.80
3rd
issued 800 units
4th
issued 800 units
5th
received 1200 units @5.00
6th
issued 800 units
Other costs for the week were direct labor; $4800, and factory overhead, $4360, 1700 units of
product were completed, and 1500 were sold. There was no beginning inventory of finished
goods and no work in process over the week.
Required: 1. ledger accounts for Materials, Work in process, Finish goods, and cost of goods
sold using (a) FIFO, (b) LIFO
2. The final inventory by the LIFO costing method if inventory is taken at the end of the week.
4. Correcting perpetual inventory cards: The following differences were reported in reconciling
physical inventories and with the material ledger cards.
S.No. Physical Inventory Material Ledger Balance
Reason
1.
2000 Units
2100 units
2.
500 Units
400 Units
3.
1000 gals
1030 gals
The shrinkage is a normal condition of
storage and issue of this material.
Average cost is @30 per gallon.
4.
900 lbs
930 lbs
Shortage due to negligence, average cost
per pound $10.
Negligence to record an issue of direct
material with cost @2.
A purchase of 100 units on credit is not
recorded, cost was $3.
Requirement: 1) A separate Journal Entry for each transaction.
2) The procedure necessary to correct or adjust the material ledger card for each difference.
Source person: Mr. Kamran Khan
M.Com, B.Com, D.Com…
MIHE
Mashal Institute of Higher Education
Management Accounting
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5. Lower of Cost or Market Inventory Valuation: Moore Corporation has the following data
about its I-Pod products.
Product-A
Product-B
Historical cost------------------------- $17.00
$45.00
Replacement cost--------------------- 15.00
46.00
Estimated cost to dispose-------------5.00
26.00
Estimated sales price------------------30.00
100.00
Requirement: The unit value to be assigned in costing the ending inventory of the products,
using the lower of cost or market.
6. Inventory valuation-AICPA Rule: The data about a product of Mishigun Parts Company is as
under:
Situations
1
2
3
4
5
Cost------------------
$100 100
100
40
100
Net realizable value
80
80
80
80
80
Net realizable value less normal profit
50
50
50
50
50
Market (replacement cost)
60
90
40
30
110
Requirement: The unit value to be assigned in costing the ending inventory of the products,
using the AICPA Rule.
Source person: Mr. Kamran Khan
M.Com, B.Com, D.Com…
MIHE
Mashal Institute of Higher Education