University of Luzon

COLLEGE OF ACCOUNTANCY
2nd Semester S.Y. 2021-2022

ACCOUNTING FOR MATERIALS

Materials control includes physical control of materials and control over the investment in
materials. Effective physical control of materials involves limiting the access to stored
materials, segregating the duties of employees who handle materials and materials reports,
and establishing an accurate recording system for materials purchases and issues. Only
authorized personnel should be permitted in material storage areas, and procedures for
moving materials into and out of these areas should be well established. The following
functions of materials control should be segregated to minimize opportunities for employee
misappropriation: purchasing, receiving, storage, use, and recording. To ensure the
accurate recording of purchases and materials issues, inventory records should document the
determination of inventory quantities on hand, and cost records should provide the data
needed to assign a cost to inventories to be used in the preparation of financial statements.
CARE: Custody, Authorization, Recording, Execution

Controlling the materials inventory investment requires analysis and planning to determine
when orders should be placed and the number of units to be ordered. The point at which the
predetermined minimum level of inventory is reached, requiring the item to be ordered, is
called the order point. Calculating the order point is based on the following:
Usage—is the anticipated rate at which the materials will be used.
Lead time—is the estimated time interval between placing the order and receiving the
materials ordered.
Safety stock—is the estimated minimum level of inventory needed to protect against stock-
outs.
The order point can be calculated as follows:
(Expected Daily Usage × Lead Time) + Safety Stock

The optimal quantity of materials to order at one time, called the economic order quantity,
is the order size that minimizes the total costs of placing orders and of carrying inventory in
stock. Order costs include purchasing, receiving and inspection salaries and wages,
communication costs, and record keeping. Carrying costs include storage and handling;
interest, insurance, and property taxes on inventories; and losses due to theft, spoilage, or
obsolescence. Annual order costs decrease when order size increases while annual carrying
costs increase with increases in order size. The economic order quantity formula is:

The economic order quantity is the point where total order costs equal total carrying costs,
unless there is a provision for safety stock.

Materials control personnel include (a) the purchasing agent who is responsible for
purchasing the materials needed at the most economical price; (b) the receiving clerk who is
responsible for supervising incoming shipments of material; (c) the storeroom keeper who is
responsible for storing and maintaining the goods received; and (d) the production
department supervisor who is responsible for supervising the operations of a particular
department and who prepares or approves material requisitions.

The supporting documents used in the procurement process include (a) the purchase
requisition, which is prepared by the storeroom keeper to notify the purchasing agent that
additional materials should be ordered; (b) the purchase order, which is prepared by the
purchasing agent describing the materials ordered, stating terms and prices, and fixing the
date and method of delivery; (c) the vendor’s invoice, which the purchasing agent compares
 University of Luzon
COLLEGE OF ACCOUNTANCY
2nd Semester S.Y. 2021-2022

to the purchase order to verify description of materials, price,

terms of payment, method of shipment, and delivery date; (d) the receiving report, which is
prepared by the receiving clerk who counts and identifies the materials received and records
the shipper, the date of receipt, the materials received, and the number of the purchase order
identifying the shipment; and (e) the debit-credit memorandum, which is prepared when
the type, quantity, or quality of goods ordered differs from that which was shipped and
adjustments must be made to the vendor’s invoice. If goods are to be returned, the purchasing
agent will prepare a return shipping order.

After materials have been ordered, received, and transferred to the storeroom, they must be
protected from unauthorized use. Materials should not be issued from the storeroom without
written authorization in the form of a properly approved materials requisition. The
materials requisition should identify the specific job or department to which the materials are
issued. Occasionally materials are returned to the storeroom because, for example, more
materials were requisitioned than were actually needed for production or perhaps the wrong
type of material was issued. Returned materials should be accompanied by a returned
materials report.

All purchases of material should be recorded in the general ledger as a debit to Materials. The
materials account is a control account supported by a subsidiary materials ledger. The
individual accounts in the materials ledger are designed to show the quantity of each material
on hand and its cost. When materials receipts and issues are posted to the materials ledger
accounts, the balance is extended after each entry so that it may be determined when stock is
falling below minimum requirements. Most companies now have automated inventory
systems that utilize online information processing, such as bar coding and optical scanning
technology, to update inventory records on a “real time” basis.

There are several acceptable ways of assigning costs to materials as they are issued. Under the
first-in, first-out (FIFO) method of costing, the materials issued are costed at the earliest
prices paid for the materials in stock, and the ending inventories are costed at the most recent
purchase prices. Under the moving average method, an average unit price is computed each
time a new lot of materials is received, and the new unit price is used to cost all issues until
another lot is received and a new unit price is computed. In choosing an inventory costing
method, the method selected should accurately reflect the income for the period in terms of
current economic conditions. The FIFO method is simpler and less expensive clerically and
fairly depicts profits under stable price conditions. Many companies have adopted the middle-
of-the-road position represented by the moving average method, especially now that
computer programs do the computations.

All materials issued to production and those returned to stock during a period are recorded on
a summary of materials issued and returned. At the end of the period, the summary
provides the information necessary to record the cost of materials. The total cost of direct
materials requisitioned is recorded by debiting Work in Process and crediting Materials. The
total cost of indirect materials requisitioned is recorded by debiting the appropriate factory
overhead account and crediting materials. Unused materials returned from the factory to the
storeroom are recorded by debiting Materials and crediting Work in Process (direct materials)
or Factory Overhead (indirect materials). Any materials returned to vendors should be
recorded by debiting Accounts Payable and crediting Materials. The balance of the Materials
account may be proven by comparing it to the total of the individual materials ledger account
balances.

Periodically, the materials on hand should be physically counted and compared to the
individual materials ledger accounts by someone other than the storeroom keeper or
materials ledger clerk.
 University of Luzon
COLLEGE OF ACCOUNTANCY
2nd Semester S.Y. 2021-2022

A just-in-time inventory (JIT) system, also known as a lean production system,

significantly reduces inventory-carrying costs by requiring that raw materials be delivered
only when they are ready to be used and by eliminating inventory buffers of raw materials
between manufacturing cells. Many manufacturing functions that were performed in
individual departments in a traditional manufacturing system are combined into work
centers and manufacturing cells in a JIT system. A JIT system can significantly reduce
throughput time, the time that it takes a unit of product to make it through the manufacturing
process, and increase velocity, the speed with which units are produced in the system.
Successful JIT systems require a high degree of coordination with both suppliers and
customers and among work centers.

Scrap or waste materials may result from the production process. If the expected sales
revenue from scrap is small, no entry is made for the scrap material until it is sold. At the time
of sale, Cash or Accounts Receivable is debited and Scrap Revenue, Work in Process, or Factory
Overhead is credited depending on whether or not the scrap can be identified with a specific
job or department. If the revenue from scrap is expected to be substantial and the market
value is known, Scrap Material should be debited and Scrap Revenue should be credited at the
time the scrap is inventoried. Scrap Material is credited when the materials are subsequently
sold.

Spoiled units are imperfect units of the primary product and have a defect that cannot be
economically corrected. The spoiled goods should be recorded in an inventory account at the
expected sales value in one of the two following ways:
Spoiled Goods Inventory XX
Factory Overhead XX
Work in Process XXXX
If charging the unrecovered costs of spoilage to factory overhead.
OR

Spoiled Goods Inventory XX

Work in Process XX
If charging the loss due to spoilage to a specific job.

Defective units have an imperfection that is considered correctable at an additional cost.

When defective work results from regular production, the costs of correcting the defects are
charged to factory overhead, but when defective work results from special orders, the rework
cost is charged to the order. The entries follow:
Factory Overhead XXXX
Materials XX
Payroll XX
Factory Overhead XX
When the cost of the defects results from regularly produced
goods.
OR
Work in Process XXXX
Materials XX
Payroll XX
Factory Overhead XX
When the defects result from a specific order.
 University of Luzon
COLLEGE OF ACCOUNTANCY
2nd Semester S.Y. 2021-2022

Recording materials transactions

Farnsworth Fabricators, Inc. maintains the following accounts in its general ledger: Materials, Work
in Process, Factory Overhead, Accounts Payable, and Cash. The materials account had a debit
balance of P 75,000 and the cash account had a debit balance of P 100,000 on September 1. A
summary of materials transactions for September shows:
a. Materials purchased on account, P 125,500
b. Direct materials issued, P 90,900
c. Direct materials returned to storeroom, P 3,750
d. Indirect materials issued, P 4,850
e. Indirect materials returned to storeroom, P 720
f. Payment of invoices, P 98,250
g. Materials on hand at the end of the month were less than the store’s ledger balance by P 250.

Economic order quantity, order and carrying cost, and order point.
Lopez Co. has the following data available relative to its investment in materials:
Number of units of material used annually 20,000

Number of workdays in a year 250

Cost of placing an order P 20

Annual carrying cost per unit of inventory P5

Instructions:
1. Compute the economic order quantity.
2. Using the above data, compute the order size that results in the minimum total order and
carrying cost by completing the following table. EOQ = 400 units

EOQ =

At EOQ: TOC=TCC

(1) (2) (3) (4) (5) (6)

Order Number Total Average Total Total Order and
Size of Orders Order Cost Inventory Carrying Cost Carrying Costs
100 200 4,000 50 250 4,250
200 100 2,000 100 500 2,500
300 67 1,340 150 750 2,090
400 50 1,000 200 1,000 2,000
500 40 800 250 1,250 2,050
600 33 660 300 1,500 2,160
700 29 580 350 1,750 2,330
800 25 500 400 2,000 2,500
 University of Luzon
COLLEGE OF ACCOUNTANCY
2nd Semester S.Y. 2021-2022

3. If the company requires a safety stock of 200 units and has an anticipated lead time of 5 days,
what is the order point?

If the company requires a safety stock of 200 units and has an anticipated lead time of 5
days, what is the order point?
ROP = (Expected Daily Usage x lead time) + Safety Stocks
ROP = (80units/day x 5days) + 200units
ROP = 400units + 200 units
ROP = 600 units (When to order)
Daily Usage = 20,000 units / 250 working days = 80 units per day

Inventory Costing Methods

Chicago Clay, Inc. makes the following purchases and issues of a new material during March:
March 2 Received 200 lbs. @ P9; total cost, P 1,800.
8 Received 60 lbs. @ P 10; total cost, P 600.
18 Issued 100 lbs.
24 Received 240 lbs. @ P 12; total cost, P 2,880.
31 Issued 200 lbs.

Instructions: Using a perpetual inventory system and the materials ledger cards provided, state
the cost of materials consumed and the cost assigned to the inventory at the end of March.
1. First-in, first-out costing

Received Issued Balance

Date Unit Unit Unit
Quantit Amoun Quantit Amoun Quantit Amoun
y Price t y Price t y Price t

Cost of materials consumed P_______________

Cost assigned to inventory P_______________

2. Moving average method (Round to the nearest cent)

Received Issued Balance

Date Unit Unit Unit
Quantit Amoun Quantit Amoun Quantit Amoun
y Price t y Price t y Price t
 University of Luzon
COLLEGE OF ACCOUNTANCY
2nd Semester S.Y. 2021-2022

Cost of materials consumed P_______________

Cost assigned to inventory P_______________