COST ACCOUNTING – MODULE 3 CONTROL PROCEDURES

SYSTEMS OF ACCOUNTING FOR MATERIALS ISSUED TO PRODUCTION AND

ENDING MATERIALS INVENTORY It is of utmost importance that a company has a good system of materials
Either the periodic inventory system or the perpetual inventory system may inventory control. Achievement of good control keeps costs at a minimum
be used to account for materials issued to production and ending materials level and plant production on a smooth uninterrupted schedule. The
inventory. following concepts should be employed in an inventory control system.

ACCOUNTING BY THE PERIODIC INVENTORY SYSTEM 1. Inventory is the result of purchasing raw materials and parts. It is
also the result applying labor and factory overhead to the raw
Under a periodic inventory system, the purchase of direct and materials to produce finished goods
indirect materials is recorded in an account entitled ‘ Purchases. If a 2. Reduction of inventory is the result of normal use and also finding
beginning materials inventory exists , it is recorded in a separate account alternative uses for scrapping unneeded items.
entitled ‘ materials inventory beginning plus purchases will be equal to the 3. Optimum inventory investment is based on quantitative
materials available for use. Ending materials inventory is determined by a techniques , which are designed to minimize the cost of carrying
physical count of the materials on hand at the end of the period. Cost of inventory and the cost of ordering inventory.
materials issued is determined by deducting from the materials available for 4. Efficient purchasing, management and investment in materials
use the materials inventory end. depend on an accurate forecast of sales and resulting production
schedules
Note that under this method the cost of materials issued is not directly 5. Forecasts help determine when to order materials . Controlling
determined, it is indirectly computed by deducting the remaining inventory inventory can be accomplished by scheduling production.
on hand from the total available for use. 6. Inventory control is more than maintaining inventory records.
Control is exercised by people who are making personal judgments
ACCOUNTING BY THE PERPETUAL INVENTORY SYSTEM partially on the basis of past experiences but within the general
framework of organizational objectives and policies to achieve
Under a perpetual inventory system, the purchase of direct and them.
indirect materials is recorded in an account entitled materials inventory, 7. Methods of inventory will vary depending on the cost of the
rather than in a purchase account. The beginning materials inventory is the material and their importance in the manufacturing procedure.
balance of the materials inventory at the end of the previous period. When
materials are issued , the materials inventory account is credited for the COMMONLY USED CONTROL PROCEDURES
cost of direct materials with a corresponding debit in the work in process 1. Order cycling
inventory. Issuance of indirect materials is debited to the factory overhead 2. Min max method
control account . Under the perpetual inventory system , both the cost of 3. Two bin method
materials issued and the ending materials inventory can be directly 4. Automatic order system
ascertained after each transactions. 5. ABC Plan
 ORDER CYCLING – method where materials on hand are reviewed of a computer , it is possible to periodically recomputed the
on a regular or periodic cycle like for example 30 days . The cycle length will optimum investment in inventory and thus revise the quantity to be
differ according to the cycle of materials being reviewed . Essential or purchased.
important materials will have a shorter review cycle than less important
items . At the time of review , an order will be placed to bring the inventory ABC PLAN – method used by companies with a large number of materials ,
at a desired level. A technique often used for small items is the 90-60-30 each one having a different value. The materials control for a high value
days method . When the inventory level drops to a 60 days supply , an order item will naturally be different from the material control for a low value
will be placed for a 30 day supply. item. The ABC plan is a systematic way of grouping materials into separate
classification and determining the degree of control that each group
MIN MAX METHOD – this method is based on the assumption that requires. For example , inexpensive or not critical materials maybe
materials inventory have minimum and maximum levels. Once the specific accounted for by using the min max method. For expensive and critical
minimum and maximum quantities are determined , the minimum quantity materials a more sophisticated method, such as the automatic order system
will represent the order point. When the inventory reaches the minimum may be used.
level , an order is placed to increase the inventory to the maximum level.
Minimum quantities are usually determined to protect the company against MATERIALS CONTROL
stock out. There are two basic concepts of materials control
1. Physical control or safeguarding materials
TWO BIN METHOD – this method is used for materials that are 2. Control of the investment in materials
considered inexpensive and or non essential. The advantage of this method
is that it is simple and requires only a minimum of clerical time. Under this, PHYSICAL CONTROL OF MATERIALS
materials are divided and placed into two separate bins . The quantity of Every business requires a system of internal control that includes
materials that will be used between the time an order is received and the procedures for the safeguarding of assets . Inventories just like cash and
next order is placed will be on the first bin. The second bin will contain the marketable securities , are to be protected from unauthorized use or theft.
quantity of materials that will be used between the ordering and delivery Inventories usually represent significant portion of a manufacturer’s current
plus additional units of safety stock. When the first bin is emptied an order assets and because of this , materials must be controlled from the time the
is placed. The contents of the second bin will contain the quantity of order is placed with the vendor until they shipped to customers in the
materials that will be used until the receipt of the shipment . finished form. In general, effective control of material involves

AUTOMATIC ORDER SYSTEM 1. Limited access

- This method is used by most companies that are computerized. An 2. Segregation of duties
order is automatically placed when the level of the inventory 3. Accuracy in recording
reaches a predetermined order point quantity. Perpetual inventory
record cards are maintained which records purchases and issuance Limited access – only authorized personnel should have access to materials
of the specific materials. When the inventory balance is equal to the storage area. All issuance of materials for use in production and release of
predetermined order point quantity an order is placed. With the use finished goods for shipment should be properly documented and approved.
Segregation of duties – the following functions should be segregated to WEST Company buys all of the materials and supplies from the Ocampo
minimize opportunities for misappropriation of inventories – purchasing , Company and is allowed a trade discount of 10 percent . Purchases during
receiving, storage, use and recording . the month were 400,000 before the discount .

Accuracy in recording – inventory records should permit the determination Entry ;

of inventory quantities on hand upon request , and cost records should Materials 360,000
provide the data for the valuation of inventories for the preparation of Accounts payable 360,000
financial statements .
The most common methods of costing materials issued and finished goods 2. Quantity discounts – represent cost savings for volume purchases.
sold are; Like trade discounts , quantity discounts are not given explicit
1. First in, first out accounting recognition in the books.
2. Average cost
These methods are related to the flow of costs and not necessarily to the 3. Cash discounts – granted to customers to motivate them to pay
actual flow of materials or finished goods. If only the materials were promptly.
acquired at the same cost all year round, then valuation of materials
inventory and will not be a problem because the value can be computed by a. When taken method – purchases and liabilities are recorded at
simply multiplying the units on hand and the unit cost. The same can be gross amounts at the time of purchase . The discount is only
used fro the finished goods because if the units were produced at the same recognized when the account is paid within the discount period.
cost all year round, the value at the end of the period can be computed by b. When not taken method – purchases and liabilities are recorded at
multiplying the finished goods on hand by the cost to produce each unit. net at the time of purchase , when payment is made after the lapse
The different methods are used because the materials are acquired at of the discount period. , the discount not availed of is charged to a
different costs during the year. Average costs for perpetual inventory purchase discount lost account . It is called when not taken method
system refers to moving average and for periodic system – weighted because if the account is paid within the discount period. No
average. purchase discount is recorded and therefore readers of the financial
statements would not know the company has availed of the
MATERIALS ACCOUNTING discount.
1. Discounts – constitute a reduction in the list price c. When offered method- purchases are recorded at net and the
a. Trade discounts – generally give in percentage 15 percent , 20 liability is recorded at gross, the difference charged to an allowance
percent etc. are used to convert single price list into a series of for purchase discount account. When payment is made after the
price lists for different types of middleman. Trade discounts are lapse of the discount period, the discount not availed of is charged
recorded on the books because purchases are recorded on the to the purchase discount lost account
books because purchases are recorded on the books net of Illustrative problem;
discount.
Jose Company purchased materials listed at 40,000 terms 2/15
ILLUSTRATIVE PROBLEM; n/30 on August 1
 Aug. 1 materials 39,200
Assume payments as follows; Allow. For purchase discount 800
Accounts payable 40,000
a. Full payment is made on August 14
b. Full payment is made on August 30 Aug. 14 accounts payable 40,000
Allow. For purchase discount 800
Requirements ; Cash 39,200
Entries to record the purchase and payments assuming
Aug. 30 accounts payable 40,000
1. When taken method is used Purchase discount lost 800
2. When not taken method is used. Allow . for purchase discount 800
3. When offered method is used . Cash 40,000

1. When taken method is used 11. FREIGHT IN

August 1 materials 40,000 1. Direct charging – the freight incurred on the purchase of
Accounts payable 40,000 raw materials is added to the invoice price. The accounts
14 accounts payable 40,000 debited for the freight is materials. The effect is an increase
Purchase discount 800 in the unit cost. If two or more materials are purchased and
Cash 39,200 delivered at the same time , the freight must be allocated
30 accounts payable 40,000 using the following methods.
Cash 40,000
a. Relative peso value method – freight is allocated on the basis of the
2. When not taken method is used peso value of the items purchased. This is used for materials
purchased and expressed in different terms of measurement .
Aug. 01 materials 39,200 b. Relative weight method – freight is allocated on the basis of the
Accounts payable 39,200 weight of the items purchased ,
14 accounts payable 39,200
Cash 39,200 2. Indirect charging – the freight incurred on the purchase of
30 accounts payable 39,200 raw materials is charged to factory overhead control
Purchase discount lost 800 account.
Cash 40,000

3. When offered method is used ;