Chapter 7

Inventory system
 PERIODIC INVENTORY
 PERPETUAL INVENTORY
PERIODIC INVENTORY SYTEM
 Purchases are record using “ PURCHASE
ACCOUNT”(Expense Method)

 Cost of Goods Sold and Ending Inventory is determined at

the end of each accounting period. based on actual
inventory count.

 No updating of stock cards upon issuance

 Methods involved in computing for the unit cost – Average

Method.
Perpetual INVENTORY SYTEM
➢ Purchases are record using “ Materials Inventory
Account”(Asset Method)

➢ Cost of Goods Sold and Updated Balance of Inventory is

available due to maintenance of stock cards which
involves recording of “INs” and “OUTs

➢ Methods involved in computing for the unit cost – FIFO,

Moving Average
Control procedure
➢ Forecast Sales or expected demand of your product
➢ Determine Production Budget for Materials base on sales forecast
➢ Set the optimum inventory investment that would lower carrying cost
and ordering cost
➢ Analyze cost materiality, usage rate and period of inventory placement
.
➢ Limited access to materials storage areas.
➢ Segregation of functions for executing purchases, recording and
physical access/control.
➢ Review accuracy of recording.
Commonly used control procedures
❖ ORDER CYCLING
❖ MIN-MAX METHOD
❖ TWO-BIN METHOD
❖ AUTOMATIC ORDER SYSTEM
❖ ABC PLAN
Economic order quantity
 Quantity per order which results in
minimum total inventory cost.
Total inventory cost
 Total Inventory Cost = Ordering Cost + Carrying
Cost
ODER CYCLING
➢ SET ORDER CYCLE LENGTH (WEEKLY, 30days,
60days, etc.) according to degree importance of
each type of inventory.

➢ Technique often used for small items is the 90-60-

30 day method. When inventory level drops to a
60-day supply, an order will be placed for a 30-day
supply.
Min-max method
➢ Set the minimum and maximum level of each type
of inventory.
➢ Order will be placed upon reaching the minimum
level that will bring back inventory to maximum
level.
➢ Used for inexpensive items.
Two bin method
➢ Inventory are stocked in two separate bins,
order will be placed once the first bin is
emptied.
➢ Quantity placed on the first bin is equal to
consumption during ordering time until
delivery of such materials.
➢ Second bin – quantity placed on the first
bin + safety stock.
Automatic order system
➢ Computerized inventory system
➢ Order point is set per item in the program,
thus upon reaching such level the program
will automatically prepare a purchase order.
➢ Used for expensive items.
Abc plan
 Is a systematic way of grouping materials
into separate classification and determining
the degree of control that each group
requires.
 A – expensive
 B – not so expensive
 C - inexpensive
Optimum inventory investment
 It requires the analysis of the following factors:
1. Usage of funds
2. Costs of materials handling
3. Storage
4. Insurance against fire, theft or other casualty
5. Loss from damage, deterioration and
obsolescence
Optimum inventory investment
1. When orders should be placed – ORDER
POINT
2. How many units should be ordered - EOQ
ORDER POINT
➢ USAGE – the anticipated rate at which the
materials will be used.
➢ LEAD TIME – the estimated time interval
between the placement of an order and
receipt of the material.
➢ SAFETY STOCK – the estimated minimum
level of inventory needed to protect against
running out of stock.
ORDER POINT
SAFETY
USAGE LEAD TIME STOCKS
(10/DAY) (5DAYS)
(20 UNITS

No. of days
needed to place
an order and
receipt of such
order
ECONOMIC ORDER QUANTITY
 Formula Method

2(Cost per order)(number of units required annually)

Carrying cost per unit
ECONOMIC ORDER QUANTITY
Tabular Method Or Carrying Cost
Page 179 – De Leon
 Given
 Number of units of materials required annually 10,000
 Cost of placing an order P10.00
 Annual carrying cost per unit of inventory P 0.80
 EOQ = 2(10)(10,000)
P0.80

 EOQ=500units
Accounting for Discounts
 Trade Discounts – purchases are recorded net of trade
discounts, granted on the spot upon purchase.( Ex.
Compute for trade discount of 20%,10% and 5% of
P100,000 purchases) Ans: P 68,400
 Quantity Discounts – same with trade discounts
 Cash Discounts – granted to customers to motivate
them to pay promptly. Discount is conditional.
Types of Cash Discounts
 When taken method
 When not taken method
 When offered method
 Payment after the discount period
When taken Method When not taken Method When offered/Allow Method
Purchases (dr)– gross amt Purchases(dr) – net amount Purchases(dr) – net amount
Note: Note: Note:
Allow. for Purchase Disc. (dr) – Allow. for Purchase Disc. (dr) – no Allowance for Purchase Discount
no set up set up (dr) – recorded

A/P (cr)– at gross amount A/P(cr) – at net amount A/P (cr)– at gross amou

When taken Method When not taken Method When offered Method

A/P(dr)– gross amt A/P (dr) – net amount A/P (dr) – at gross amount

Cash (cr)– at net amount Cash(cr) – at net amount Cash (cr)– at net amount

Purchase Disc. (cr) – Allow. for Pur.

discount amount Disc.(Cr) – to
close the acct.
When taken Method When not taken Method When offered Method
A/P(dr)– gross amt A/P (dr) – net amount A/P (dr) – at gross amount
Purchase Discount Lost (dr) Purchase Disc. Lost (dr)
Cash (cr)– at gross amount Cash(cr) – at gross amount Cash (cr)– at gross amount
Allow. for Pur. Disc.(Cr) -
– to close
the acct.
Example: Dated Dec 1, 2014, Jen Co. purchased materials originally priced at P
100,000 with the following discount
(A)Trade Discount of 20%,10%,5%
(B) Quantity Discount of of 10% B) P61,560
(C)Cash Discount with terms, 10/15, n/30
base on 3 methods : (1) full payt made on Dec 14 (2) full pay’t made on Dec 30,
2014.

When Taken method

Dec 1 Materials 61,560
A/P 61,560
Dec 14 A/P 61,560
Purchase Discount 6,156
Cash 55,404
If
Dec 30 A/P 61,560
Cash 61,560
Example: Dated Dec 1, 2014, Jen Co. purchased materials originally priced at P
100,000 with the following discount
(A)Trade Discount of 20%,10%,5% B) P61,560
(B) Quantity Discount of of 10%
(C)Cash Discount with terms, 10/15, n/30
base on 3 methods : (1) full payt made on Dec 14 (2) full pay’t made on Dec 30,
2014.

When Not Taken Method

Dec 1 Materials 55, 404
A/P 55, 404
Dec 14 A/P 55, 404
Cash 55, 404

If
Dec 30 A/P 55, 404.00
Purchase Discount Lost 5,540.40
(Add to Materials Purchases in COGS
statement)
Cash 61, 560
Example: Dated Dec 1, 2014, Jen Co. purchased materials originally priced at P
100,000 with the following discount
(A)Trade Discount of 20%,10%,5% B) P61,560
(B) Quantity Discount of of 10%
(C)Cash Discount with terms, 10/15, n/30
base on 3 methods : (1) full payt made on Dec 14 (2) full pay’t made on Dec 30,
2014.
When offered Method
Dec 1 Materials 55, 404
Allowance for Pur. Discount 5,540.40
A/P 61, 560
Dec 14 A/P 61, 560
Allowance for Pur. Discount 5,540.40
If Cash 55,404.00
Dec 30 A/P 61,560
Purchase Discount Lost 5,540.40
(Add to Materials Purchases in COGS
statement)
Cash 61, 560
Allowance for Pur. Disc. 5, 540.40
Freight-in
Direct Charging Indirect charging
 Freight cost is added to  Freight cost is debited to
Materials inventory Account Factory Overhead Control
Two Methods of allocating Freight-
in under Direct Charging
 RELATIVE PESO VALUE METHOD
Share in Freight per item=
Freight Cost/ total group item cost x per item cost

 RELATIVE WEIGHT METHOD

Share in Freight per item=
Freight Cost / Total Weight x weight per item
Accounting for
 Spoiled Units
 Defective Units
 Scrap materials
 Waste materials
Two methods for accounting
spoiled, defective, and scrap
materials
 Charged to specific job – spoilage, defects and scraps
are traceable to specific job or product. Debited to
“Work in Process account”. Beyond normal limits.

 Charged to all production – account being debited “

Factory overhead control “. Or within normal limits
 ACCOUNTING FOR SCRAP WORK
 Scrap consists of recyclable
materials left over from product
manufacturing and
consumption, such as parts of
vehicles, building supplies, and
surplus materials. Unlike
waste, scrap has monetary
value, especially recovered Scrap Materials may be accounted
metals, and non-metallic • Charged to Specific Job
materials are also recovered • Charged to All Production
for recycling. • As Other Income
(Scrap Sales - usually recognized at the
point of sale)
ACCOUNTING FOR
MATERIALS

• The purpose of materials accounting is to provide a summary from
the general ledger of the total cost of materials purchased and used in
manufacturing.

• All materials issued during the month and materials returned to stock
are recorded on a summary of materials issued and returned form OR
commonly called materials requisition form.
SPOILED, DEFECTIVE WORK, SCRAP,
and Waste Materials
 Spoiled work has imperfections that cannot be economically corrected.
The loss can be treated as part of the Cost of the Job (Chargeable to
Specific Job) or charge to Factory Overhead (Chargeable to all
productions).
 Defective work has imperfections that are correctable. The extra costs
are either charged to the job (Chargeable to Specific Job) or charged to
Factory Overhead (Chargeable to all productions).
 Scrap consists of recyclable materials left over from product
manufacturing and consumption, such as parts of vehicles, building
supplies and surplus materials Unlike waste, scrap has monetary value,
especially recovered metals, and non-metallic materials are also
recovered for recycling.
 Waste materials do not affect the number of units, also it can either be
charged to all production or to specific job. Disposal costs for waste
materials will increase the production costs.
Charged to specific job(beyond normal limit)
Spoiled Units Defective Units Scrap Materials Waste
Materia
ls
Taken out of
Yes No Yes Yes
the production
Total units Decrease in Same number
Same Same
produced -end total units of units
Unit cost It will It will Decrease in Increase i
increase increase unit cost if unit cost
cost/unit cost/unit scrap as a value
JE WIP xx WIP xx
To record add'l costs Materials xx Materials xx
Payroll xx Payroll xx
FOH-A xx FOH-A xx
(FOH-A, no added (FOH-A, no
allowance for spoilage) added allowance for
defective units)

Journal entries JE when taken-out For add’l work Scrap Materials xx WIP
Spoiled Goods xx WIP xx WIP xx
WIP xx
A/P
Materials xx
*Value
Payoll xx
Spoiled Goods=at sold
amt. FOH-A xx
WIP = value of spoiled
goods
 Charged to all production(w/in normal limit)
Spoiled Units Defective Units Scrap Materials Waste
Materials

Taken out of the Yes No Yes Yes

production
Total units Decrease in Same number
Same Same
produced -end total units of units
Unit cost –before It will not It will Same cost/unit Same
accounting of over and increase cost/ not increase cos even scrap as a
under applied overhead unit t/unit cost/unit
value
JE WIP xx WIP xx
Materials xx Materials xx
To record Payroll xx
add'l costs Payroll xx
FOH-A xx
FOH-A xx (FOH-A with allowance for
(FOH-A with allowance for defective units)
spoilage)

JE JE when taken-out of JE For add’l work JE to record Scrap

the production FOH-C xx
Spoiled Goods xx
FOH-C
Mat xx Scrap Materials xx
FOH-C xx FOH-C xx A/P
Payoll xx
WIP xx FOH-A(cr) xx
*Value
100% cost of Spoiled Goods=at sold amt. If FOH-C is already closed
WIP = total unit cost of
spoiled units good units x spoiled units
Scrap Materials(dr)