Unit 1, Topic 3: Accounting for Materials

COST ACCOUNTING
& CONTROL
Unit 1, Topic 3: ACCOUNTING FOR MATERIALS
Learning Outcomes: At the end of the unit, you will be able to:
1. Define and explain materials control.
2. Discuss materials control procedures.
3. Describe and explain the forms used in materials control procedures.
4. Describe JUST-IN-TIME materials control and its advantages.
5. Explain how the cost of materials issued is accounted for.
6. Differentiate the accounting for scrap, spoiled goods, & defective
work

Introduction:

Have you ever been to McDonald’s or

Jollibee? Did you ever wonder how they
safeguard and account for their direct
materials? What would happen if they
would run out of chicken, ground beef and
potatoes for the meals, burgers and
fries?
Should it be
better for
them to stock as much as they can?

This module will enhance your know-how regarding the two basic aspects of
materials control: physical control control of and
the investment. After this learning process, I
hope you will be able to grasp
the importance of protecting materials from
misuse or theft. Also, the maintenance of
appropriate levels of inventory to ensure client
satisfaction, sustain fitting market share and,
ultimately, profitability. Finally, you
will be refreshed concerning the suitable
accounting for materials, even scrap
materials, spoiled goods, and defective work.
As such, we will also lay a hand on the just-in-
.
time system.

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 Unit 1, Topic 3: Accounting for Materials

Activating Prior Learning

In the space provided below, you create an illustration of the
internal control process.

Section 1: MATERIALS CONTROL

Learning Objectives:
At the end of this lesson, you will be able to:

a. Define and explain physical control of materials.

b. Define and explain controlling the investment in materials
c. Explain order point
d. Explain economic order quantity (EOQ)
e. Explain materials control procedures in general terms.
f. Cite and describe the documents/forms commonly used in
materials control.

Presentation of Content
WHAT CONSISTS MATERIALS CONTROL?

All procedures and processes that a company implements to secure its

resources is materials control. It has two basic aspects:

 Physical control keeps from wastage or theft.

 Investment control keeps proper quantities of inventory.

PHYSICAL CONTROL

In general, a firm must sustain: limited access, segregation of duties, and

accuracy in recording to effectively control materials.

 Limited Access. Only authorized

staffs should can access materials
storage areas.
 Segregation of duties.
These following
responsibilities should be
segregated: purchasing, receiving,
storage, use, and recording. As
much as possible, no one person
should be assigned to more than
one of these incompatible duties.
 Accuracy in Recording. Accurate recording of purchases and
issuance of materials should be maintained. At least once a month, the

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 Unit 1, Topic 3: Accounting for Materials

record of inventories should be compared with a physical inventory

count.

INVESTMENT CONTROL

Funds invested in inventories tie up a large portion of a firm’s working capital

that’s why the optimum level of inventory should be preserved to ensure
profitability.

The management should contemplate the costs of handling, storage, taxes, and
insurances.

Higher than needed inventory levels may lead to unnecessary loss from
damage, deterioration, and obsolescence. Thus, brilliant decision should be
made regarding:

 when to place an order

 how many units to order each time.

Order Point. A minimum level of inventory should be determined for

each type of raw material, and inventory records should specify the
balance of each type on hand.

A subsidiary ledger must be maintained for each type of inventory. When

the programmed minimum level for an inventory item on hand is reached,
an order should be placed, thus the term order point for this inventory
control technique.

Economic Order Quantity (EOQ). This system indicates the most

economical number of units to be ordered, thus complementing the
technique order point which only indicates the time when to order an item.
To determine the quantity to be ordered, the cost of placing an order and
the cost of carrying inventory in stock must be considered.

 Limitations of Order Point and EOQ. These calculations are based

on estimates of production volume, lead time, and order and
carrying costs, thus, they are really approximations that serve as a
guide to planning and controlling, not a panacea.

WHAT IS MATERIALS CONTROL PROCEDURES?

Materials control procedures generally relate to the following functions:

purchase and receipt, storage, and requisition and consumption of
materials.

Though, obviously you may have noticed that supporting documents are
now in the form of computer records, I still want to show you the original

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 Unit 1, Topic 3: Accounting for Materials

format of the documents generally used in the procurement or purchase of

materials. These forms consist the following:

1. Purchase requisition form - authorizes the purchasing agent to

buy materials needed. Usually, this form originates from the
storeroom keeper or some other staff with similar authority and
responsibility.
2. Purchase order form – details the materials to be purchased,
including price and terms, the date and scheme of transport. It is
prepared by the purchasing agent who sends it to the chosen
vendor.
3. Vendor’s invoice – this should be received from the vendor before
the materials arrive at the factory. It has to be reviewed to ensure
whether or not it conforms to the purchase order form’s
specifications.
4. Receiving report form – it describes in detail the vendor, when
and what materials were received. The receiving clerk prepares this
report after counting and inspecting items received.
5. Debit-credit memorandum – at times, a shipment of materials
does not match the purchase order and the invoice. This should be
communicated to the vendor.
• If quantity received is greater than ordered, (and the
goods will not be returned) a credit memorandum will be
prepared. This increases the amount of payable by the
purchasing company.
• On the other hand, if quantity received is lesser than
ordered, a debit memorandum will be prepared to notify
the vendor of the shortage.

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 Unit 1, Topic 3: Accounting for Materials

SAMPLE FORMS FOR MATERIALS CONTROL PROCEDURES:

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 Unit 1, Topic 3: Accounting for Materials

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 Unit 1, Topic 3: Accounting for Materials

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 Unit 1, Topic 3: Accounting for Materials

JUST-IN-TIME MATERIALS CONTROL

In a just-in-time (JIT) inventory system, materials are brought to the plant

immediately preceding their use in production. It is very common in JIT
manufacturing for a finished product to be shipped to the customer during the
same eight-hour shift that the raw materials used in the product were received
from the supplier. As a result, JIT system significantly reduces inventory
carrying costs.

For JIT to work efficaciously, a high degree of coordination and cooperation

must exist between the supplier and the manufacturer and among
manufacturing work centers.

Just-in-time production procedures originated from the Japanese industry.

Later, it became popular with U.S. fabricators such as Harley-Davidson,
Hewlett-Packard, IBM, and Dell Computer.

Application:
Answer each briefly in the space provided:

1. Imagine you are going to advise a business owner regarding

warehousing techniques. As you learned from our lesson, what
internal controls would you suggest so that he will able to
secure his inventories?

2. In relation to your answer in item 1, would you suggest the

usage of the forms you learned from the materials control
procedures? Explain.

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 Unit 1, Topic 3: Accounting for Materials

3. Do you think we practice JIT inventorying system in the

Philippines? Explain your idea.

Section 2: COST OF MATERIALS ISSUED

Learning Objectives:
At the end of this lesson, you will be able to:

a. Explain the methods to determine the cost of materials

issued.
b. Differentiate FIFO from Moving average method.
c. Discuss the relevance of conducting periodic physical count
and comparing such to the perpetual balances in the stores
ledgers.

Presentation of Content
A vital area of materials accounting is the costing of materials requisitioned
from the warehouse for use in the production. The materials on hand maybe a

mix of items purchased on different dates and at different prices. As a

consequence, there must be difficulty knowing the unit cost of materials put
into production. To solve this issue, quite a few practical methods are
accessible. In this course, I will only introduce them to you briefly because
they are discussed extensively in the intermediate accounting courses.

A. First-In, First-Out Method (FIFO). This method assumes that

materials issued are taken from the oldest materials in inventory.
Hence, the materials are costed at the prices paid for the oldest
materials.

For its simplicity and because it closely parallels the physical flow of
materials, many companies use FIFO.

B. Moving Average Method. This technique assumes that the materials

issued are basically taken from a mixed collection of identical
materials in the warehouse such that there is no need to identify which
material is from the earliest or the latest purchases.

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 Unit 1, Topic 3: Accounting for Materials

A basic requirement of this method is the computation of an average

unit price each time a new batch of material is received. This average
unit price will be used to cost all issues of materials until another batch
is purchased. Since the proliferation of computers, surely this isn’t a
hassle anymore, isn’t it?

C. Last-In, First-Out Method (LIFO). This undertakes that materials

issued for production are the most recently purchased materials.
Accordingly, materials issued are costed at the most recent purchase
prices, and inventories on hand at the end of the period are costed at
prices paid for the earliest purchases.

This method of costing closely approximates the physical flow of

materials in some trades such as the smelting of iron ore where raw
material is stored in mountainous piles. As ore is needed, it is taken
from the pile in such a way that the material being used is the last ore
that have been received. Nevertheless, the application of this method is
now prohibited by accounting standards.

Inventory Verification. The stores ledger provides a perpetual inventory of

the individual items of material in the storeroom - each account shows the
number of units on hand and their cost. From this information, a balance sheet,
an income statement, and a manufacturing statement will be prepared. Yet the
reliability of the inventory totals from these ledgers may be incorrect because
of errors in recording receipts or issues of materials. Thus, materials on hand
should be checked periodically against the individual stores ledger accounts.
This can be done on say a quarterly or monthly basis, whichever is more
applicable. And to ensure imprecision or fraudulence does not happen, the
count should be done by somebody other than the warehouse keeper or the
stores ledger clerk. The count would be summarized in an inventory report.

Application:
Answer each briefly in the space provided:

1. Personally, as a future accountant (or more appropriately, say a

cost accountant), would you rather promote a company to use the
FIFO method rather than the Moving average method as a cost
flow accounting? Please explain your answer.

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 Unit 1, Topic 3: Accounting for Materials

Section 3: SCRAP, SPOILED GOODS, & DEFECTIVE WORK

Learning Objectives:
At the end of this lesson, you will be able to:

a. Differentiate scrap from spoiled goods.

b. Define defective work.
c. Discuss the difference in the accounting for scraps, spoiled
goods and defective work.

Presentation of Content
At times, some units produced are flawed and thus, cannot be sold as regular
items. The controls
over these items is
crucial to inventory
control.

Scrap or waste materials can be inevitable as

natural part of the production process, or they
may be the result of spoiled or defective units
from unnecessary or unavoidable mistakes during
production.

Defective items tend to impair a company’s name that’s why most companies
introduce quality control practices to prevent faulty items from being sold.
Because scrap, spoiled goods, and defective work typically have some value,
each of their costs is accounted for separately.

SCRAP MATERIALS

The expected sales value of the scrap tells the accounting procedures to be
used.

A. Small Value. No entry is made for it until the scrap is sold. Upon sale,
this would the pro-forma entry:

Cash (or Accounts Receivable) ……….. xxx

Scrap Revenue …………………………… xxx

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 Unit 1, Topic 3: Accounting for Materials

The revenue from scrap sales is usually reported as “Other income”

in the income statement. Or, it can be treated as a reduction in
manufacturing costs and credited to Work in Process (if the
specific job it relates to is determinable); as a residual option,
Factory Overhead can be credited.

B. High Value

 An inventory card should be prepared and the scrap transferred to a

controlled materials storage area. If both the quantity and the
market value of the scrap are known, the following journal entries
are recorded:
Scrap Materials. . . . . . ... . . . . . . . . ………. xxx
Scrap Revenue (or WIP or FOH) .. . …….xxx

At the time of sale, this would be the entry:

Cash (or Accounts Receivable) ……….. ..xxx

Scrap Revenue ………………………….. xxx

 If the market value of the scrap is not known, the accounting would
be similar for the scrap with a small value.

SPOILED AND DEFECTIVE WORK.

Spoiled units cannot be economically amended thus they are sold as items of
substandard quality or “seconds.”

The loss associated with spoiled goods may be treated as follows:

A. Part of the cost of the job or department that produced the spoiled
units.
B. Charged to Factory Overhead and allocated among all jobs or
departments.

Generally, Factory Overhead is charged unless the loss can be attributed

from a special order. In both cases, the spoiled goods are recorded in
Spoiled Goods Inventory at the expected sales price.

Defective units have imperfections but they can be corrected such that its
market value is higher than the cost to correct them.

The entries for recording the cost linked with defective work are similar to
those employed in accounting for spoiled work.

There are, however, additional costs for correcting the imperfections on

defective units. For regular products, the additional costs are charged to

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 Unit 1, Topic 3: Accounting for Materials

Factory Overhead. For special orders, the additional costs are charged to the
specific job (WIP) on which the defective work occurs. It is worthy to note,
however: an inventory account is not established for goods classified as
defective these units will be corrected and sold as regular goods.

 Be sure you check the extensive discussion of entries for spoiled and
defective units in the topics Job order costing and Process Costing.

Application: I will test your learning now. True or false.

1. Some scraps are inevitable while others maybe unnecessary.
2. Spoiled units can be mended and sold as first-rate merchandise.

3. To account for small value scraps, no entry is made until the scrap
is paid.
4. A separate inventory card should be maintained for high value
defective units.

Assessment: A 50 items, 50 pts. Graded Multiple Choice Quiz will be

conducted at the end of this unit.

Summary of the Unit:

 Physical Control  JUST-IN-TIME
 Investment Control  First-In, First-Out Method
 Order Point  Moving Average Method
 Economic Order  Inventory Verification
Quantity (EOQ)  Scrap Materials
 Materials Control  Spoiled units
Procedures  Defective Work
Reflection on Learning: Now that you were done with the unit, take time to
internalize what you have assimilated so far by answering these questions:

1. What learning interest you the most in this unit? Why do you
think so?

2. Do you think materials control can be applied in real life? Can

you list some of its significance in your future profession or
business?

3. What topic in the unit you feel most incompetent and desire to
know more?

References:

1. Lanen, Anderson & Maher (2017) Fundamentals of Cost Accounting.

New York, NY: McGraw-Hill Education.
2. Flores, M. (2016) Integrated Cost Accounting Principles and
Applications. Quezon City, PH. REX Book Store Inc.

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 Unit 1, Topic 3: Accounting for Materials

3. Brewer, P., Garrison, R., & Noree, E. (2016) Introduction to

Managerial Accounting. Penn Plaza, New York, NY: McGraw-Hill
Education.
4. De Leon, G. & De Leon, N. (2014) Cost Accounting. C.M. Recto,
Manila, PH. GIC Enterprises & Co., Inc.
5. Horngren, T., Datar, S., & Rajan, M. (2012) Cost Accounting. A
Managerial Emphasis. Upper Saddle River, New Jersey. Pearson
Prentice Hall.

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