CHAPTER 2 –

ACCOUNTING FOR
RAW MATERIALS
Perpetual Materials Inventory System
• The perpetual inventory system requires the need to maintain stock
cards for each type of materials to show the summary of the inflow,
outflow and balance of raw materials in quantity and in peso
amount.

• Under this system, the movement of raw materials is summarized in

a Raw Materials Inventory account making it easier for a company
to determine the amount of inventory on hand at any given time.

• This system however necessitates the physical counting of raw

materials at least once a year to confirm the balance reflected in the
material stock cards and in the Raw Materials Inventory account.
Periodic Inventory System

• Under periodic inventory system, there is no need to

maintain a stock card for the raw materials.

• A physical count is made periodically which is near

the end of a period to determine the units on hand.

• The raw materials issued are the residual amount

after deducting the physical inventory counted from
goods available for sale.
Basic Transactions Associated with Raw Materials (Perpetual Inventory
System)

• The cost of raw materials is debited to Raw Materials Inventory

when the materials are received. This account is debited for the
invoice cost and freight costs chargeable to the purchaser.

• It is credited for purchase discounts taken and purchase returns

and allowances.

• Upon receipt of the materials, the inventory clerk updates the

inventory ledger card or stock card. After all postings have been
made, the balance in the Raw Materials Inventory account (ledger
balance) should equal the sum of the balances in the raw materials
ledger card.
Basic Transactions Associated with Raw Materials (Perpetual
Inventory System)

Entry to record the purchase of raw materials: 000

Raw Materials Inventory 000
Accounts payable in Cash
An entry in the material stock card is required.

• If the materials purchased are for a specific job, the cost is charged directly
to a work in process account.

Work in process 000

Accounts payable/ Cash 000
Freight In or transportation costs.

Perpetual Inventory System

• Freight in or transportation costs of raw materials purchased is a
product costs.
• Under the perpetual inventory system, the freight is charged to Raw
Materials accounts.
• In this case, the total costs of raw materials purchased include the
invoice price plus the freight.
• In recording the purchase in the inventory stock card, the freight cost is
proportionately assigned to each material, using different basis like units
purchased, invoice costs or weighted costs resulting to an adjustment in
the unit costs.
• The cost of raw materials issued already includes part of the freight
costs.
Freight In or Transportation Costs
Periodic Inventory System
• On the other hand, if the method of accounting for inventories is
the periodic inventory method, the freight cost is charged to a
separate account, Freight In and record only the invoice cost in
Purchases account.

• When raw materials are issued, separate calculation is made to

apportion the freight in costs to issued and unissued raw materials.
The amount allocated to the raw materials is debited to Work in
Process account together with the invoice price.
Basic Transactions Associated with Raw Materials (Perpetual
Inventory System) (Con.)

• Illustration. Dolby Manufacturing Company purchased the following raw

materials from X Company, terms 2/10 , n/30.

Units Weight U/C

Raw Materials A 1,000 1.5 P5.00 P 5,000
Raw Materials B 1,000 2.0 20.00 20,000
Total P 25,000

• Paid P800 for transportation costs of the above purchased.

• Required: Determined the amount to be charged to Raw Materials Inventory

account under perpetual and periodic inventory system if freight is allocated
to be the units purchased based on: (a) invoice costs; (b) units purchased;
(c) weighted units
 Basic Transactions Associated with Raw Materials
(Perpetual Inventory System) (Con.)

(a) Freight is allocated based on invoice costs

Perpetual Inventory System Periodic Inventory System

Raw Material – A 5,160 Purchase 25,000

Raw Material – B 20,640 Acct Payable 25,000
Accounts Payable 25,000 Freight in 800
Cash 800 Cash 800

Invoice costs: Allocation:

Material A P5,000 Mat A 5/25*800 P160
Material B 20,000 Mat B 20/25*800 640
Total P25,000 Total freight P800

Amount Charged to:

Material A 5,000 + 160 P5,160
Material B 20,000 + 640 20,640
Basic Transactions Associated with Raw Materials
(Perpetual Inventory System) (Con.)

(b) Freight is allocated based on units purchased.

Units Allocation:
Material A 1,000 Mat A (50% x 800) P400
Material B 1,000 Mat B (50% x 800) 400
Total 2,000 Total freight P800

(c) Freight is allocated based on weighted units

Weighted Units Allocation:
Material A (1,000*1.5) 1,500 Mat A 1,500/3,500*800 P 343
Material B (1,000*2) 2,000 Mat B 2,000/3,500*800 457
Total 3,500 Total freight P800
Inventory Stock Card
• The stock card is to record the movement of the inventory.
• The beginning balanced is entered first under balance column.
• Entries in this stock card are made in chronological order (according to
date of occurrence).
• After proper posting has been made on purchases and issuances, the card
shows the balance of the inventory in units and in peso values at a given
period.

Item: Raw Material A

Receipts Issuances Balance

Date Units UC Amount Units UC COS Units UC Amount

Issuance of Raw Materials
• Raw materials are transferred from the warehouse to the
production department.

• A material requisition form completed by the production supervisor

is the basis of the raw material inventory clerk for the release of the
materials.

• A copy of the material requisition form goes to the accounting

department as basis for recording the issuance and for entering the
direct material cost to the individual jobs in process.
Entry to record the issuance 000
Work in process (direct materials) 000
Manufacturing overhead (indirect materials) 000
Raw materials Inventory
Issuance of Raw Materials (Con.)
• Materials Requisition Form. This form serves as the basis of recording the
issuance of raw materials.

MRF No. __________________________ Date _____________________________

Job No. to be charged _______________ Department _______________________

Items Quantity Units Unit Cost Amount

Requested by: _____________________ Received by: _______________________

Approved by: ______________________ Released by: _______________________
Issuance of Raw Materials (Con.)

Returns of excess raw materials to the storeroom

Raw Materials Inventory 000
Work in process – DM 000
Manufacturing Overhead 000

Returns of raw materials to the supplier

Accounts Payable or Cash 000
Raw Materials Inventory 000
Scrap Materials
• Scrap materials are defective materials or leftover materials in production.

• Scrap includes fillings or excessive trimmings of materials after the

manufacturing operation; defective materials not suitable for manufacturing
operations; and broken parts of materials as a result of employee error or
machine breakdown that causes the product in a poor quality condition.

• If these materials can be traced to a specific job, the market value of the
scrap materials is debited to Scrap Materials and credited to Work in
Process.

• If the scrap recovered cannot be traced to a specific job, the market value is
credited to Miscellaneous Revenue instead of Work in Process.
Methods of accounting for scrap materials
1. Reduction of the cost of specific products which were produced

2. Reduction of the cost of production in general

3. Recognizing as other revenue for the market value of the scrap

4. Recognizing as sales revenue for the market value of the scrap

Inventory Valuation Methods

• The most common methods of valuing raw materials

are:
a. FIFO (first in, first out)
b. Average cost (moving average – perpetual ;
weighted average - periodic)
Inventory Valuation Methods

FIFO

• Under FIFO method, raw materials inventory is

reported at latest cost while the raw materials issued
is reported at earliest cost.

• In a period of rising prices, this method will yield a

higher gross profit because the cost of goods sold is
assigned lower cost.
Illustration: Costing of raw materials inventory,
FIFO
• Below are transactions regarding one of the raw materials of Moonlight
Company:
July 1 Balance, 800 units @ P98
2 Purchased 1,000 units as P100 per unit.
3 Issued 1,000 units to Dept. 1
5 Purchased 1,500 units at P105 per unit
7 Purchased 500 units @ P110
8 Issued 1,200 units to Dept. 2
10 Purchased 500 units @ P108
15 Purchased 800 units @ P105
20 Issued 2,000 units to Dept. 1

• Required:
1. Post the transactions to Raw Materials Ledger card using (a) FIFO
and (b) Moving Average and Weighted Average
2. Compute the amount of Raw Materials Inventory and Raw
Materials used
Solution: (1) Posting to the materials
ledger card.
1. A FIFO METHOD

Item: Raw Materials A

Receipts Issuances Balances
Date Units Unit Total Units Unit Total Units Unit Total
Cost Cost Cost Costs Cost Cost
Jul 1 800 98 78,400
2 1,000 100 100,000 800 98
1,000 100
3 800 98 78,400 800 100 80,000
200 100 20,000
1,000
5 1,500 105 157,500 800 100 80,000
1,500 105 157,500
Solution: (1) Posting to the materials
ledger card. (Con.)
7 500 110 55,000 800 100 80,000
1,500 105 157,500
500 110 55,000
8 800 100 80,000 1,100 105 115,500
400 105 42,000 500 110 55,000
1,200
10 500 108 54,000 1,100 105 115,500
500 110 55,000
500 108 54,000
15 800 105 84,000 1,100 105 115, 500
500 110 55,000
500 108 54,000
800 105 84,000
20 1,100 105 115,500
500 110 55,000 100 108 10,800
400 108 43,200 800 105 84,000
900 94,800
Solution: (1) Posting to the materials
ledger card. (Con.)
• Under FIFO method of costing, stocks acquired earlier are issued first to
production.

• The computation of raw materials available for use, raw materials used
and raw materials inventory is as follows:

Units UC Amount
Inventory, July Purchases: 800 98 P 78,400
July 2 1,000 100 100,000
5 1,500 105 157,500
7 500 110 55,000
10 500 108 54,000
15 800 105 84,000
Raw Materials available 5,100 P528,900
Solution: (1) Posting to the materials
ledger card. (Con.)
Less: Issuance
July 3 (1,000) (P98,400)
8 (1,200) (122,000)
20 (2,000)
Raw Materials issued (4,200) (213,700)
Raw Materials inventory
900 P434,100
P94,800

• The raw materials inventory of 900 units with a total cost of

P94,800 is composed of:
100 units @ 108 P 10,800
800 units @ 105 84,000
Total 900 units P 94,800
1. B Moving Average Method (Perpetual
Inventory)
• Item: Raw Materials A
Receipts Issuance Balance
Date Units UC Total Units UC Total
Units UC Total
July 1 800 98.00 78,400
2 1,000 100 100,000 800 98.00 78,400
1,000 100.00 100,000
1,800 99.11 178,400
3 1,000 99.11 99.110 800 99.11 79,288
5 1,500 105 157,500 800 99.11 79,288
1,500 105.00 157,500
2,300 102.95 236,788
7 500 110 55,000 2,300 102.95 236,788
500 110.00 55,000
2,800 104.21 291,788
8 1,200 104.21 125,052 1,600 104.21 166,736
1. B Moving Average Method (Con.)
10 500 108 54,000 1,600 104.21 166,736
500 108.00 54,000
2,100 105.11 220,736
15 800 105 84,000 2,100 105.11 220,736
800 105.00 84,000
2,900 105.08 304,736
20 2,000 105.08 210,160 900 105.08 94,572

• Under the moving average method, the total cost of inventory is divided by the
total units to arrive at the average unit cost.

• This procedure is repeated every time raw materials are acquired and returned to
the supplier. Cost of raw materials issued is based on the latest average unit cost.

• The computation of raw materials available for use, raw materials used and raw
materials inventory is as follows:
1. B Moving Average Method (Con.)
Units UC Total
Inventory, July Purchases: 800 98 P 78,400
July 2 1,000 100 100,000
5 1,500 105 157,500
7 500 110 55,000
10 500 108 54,000
15 105 84,000
Raw Materials available 800
5,100 P528,900

Less: Issuance
July 3 (1,000) 99.11 (P 99,110)
8 (1,200) 104.21 (125,052)
20 (2,000) 105.08 (210,160)
Raw Materials issued (4,200) (P434,322)
Raw Materials Inventory P 94,578
900
1. B Weighted Average Method (Periodic)
• Under periodic inventory system, there is no need to maintain a
stock card for the raw materials.

• A physical count is made periodically which is near the end of a

period to determine the units on hand.

• A weighted average unit cost is computed based from the raw

materials available for use during the period. This is used to
compute for costing the raw materials issued and raw materials on
hand.

• The raw materials on hand and the raw materials used is computed
as follows:
1. B Weighted Average Method (Con.)

Units UC Total
Inventory, July Purchases: 800 98 P 78,400
July 2 1,000 100 100,000
5 1,500 105 157,500
7 500 110 55,000
10 500 108 54,000
15 105 84,000
Raw Materials available 800 103.71 P528,900
Units on hand (900 x 103.71) 5,100 93,339
Raw material used (4,200 x 103.71) P435,561
900
4,200
Economic Order Quantity (EOQ)
The Traditional Inventory Model

• Small and medium scale business have its largest investment in

inventory. But an investment in inventory is not profitable because
peso spent return nothing until the inventory is sold.

• Business should maintain enough inventories to meet customer

orders, but not so much that storage costs and inventory
investments are excessive.

• The EOQ model is designed to help the production manager

determines the amount of stock to be purchased every time an
order is made or to produce with each production run to minimize
total inventory costs.
Economic Order Quantity (EOQ) (Con.)
The Traditional Inventory Model

• EOQ is the order size for an inventory item that result

in the lowest total inventory costs for a period.

• The lowest total cost for an inventory occurs when

the size of an inventory order is large enough so that
the cost of ordering that quantity of inventory is
equal to the cost of carrying it.
(Heitger, at al)
Economic Order Quantity (EOQ) (Con.)
The Traditional Inventory Model
1. Carrying cost which include costs of storage, insurance, inventory
taxes, obsolescence, spoilage and pilferage, opportunity cost of funds
tied up with the inventory and handling costs.
• The carrying cost is larger for large amount of inventory.

2. Ordering costs which include costs of placing and receiving orders like
cost of processing documents, insurance for shipments, and unloading
costs.
• The costs of ordering inventory are the same whether small quantity or
big quantity of inventory is ordered.
• If small quantity is ordered the ordering cost on per unit basis is higher
whereas, if large quantity of inventory is ordered, the ordering cost per
unit is lower.
• The sum of carrying costs and ordering of any given quantity of
inventory is the total cost of inventory for that order size.
Economic Order Quantity (EOQ) (Con.)
The Traditional Inventory Model

• If the raw materials are internally produced, the two costs

associated with these materials are (1) set up costs and (2) carrying
costs.

• Set up costs include costs of preparing equipment and facilities so

they can be used to produce a particular component.

• Examples are wages of idled production workers, cost of idled

production facilities (lost of income) and the costs of test runs, like
labor, materials, and overhead.
Solving for EOQ
• 
• The Economic Order Quantity answers two questions.

• First, how many units should be ordered? Second, when should these
units be ordered?

• The formula to compute EOQ is:

EOQ = 
Example: Annual units required............................... 4,800
Ordering P 30 / order
costs........................................... P 1.25
Carrying costs per unit..............................
Solving for EOQ (Con.)
• 

EOQ = 
= 480

• How many orders are made each year?

No. of orders = = 10 orders

Solving for EOQ (Con.)
• What is the frequency of placing an order?

Time to order = 360 days / 10 = 36 days

• This means that the company should make an order of

480 units every 36 days.

• The cost of ordering

Total ordering = No. of orders per year x cost per order

= 10 x 30
= P300
Solving for EOQ (Con.)
• The cost of carrying the inventory
Average inventory = EOQ / 2 (this represent the average
inventory on hand assuming that the
inventory is used evenly throughout the
year.

Carrying cost = Average inventory x carrying cost per unit

= 480 / 2 x 1.25
= P300.00

• Total Inventory Costs

Total inventory costs = Carrying costs + ordering costs
= P300 + P300
= P600
The Reorder Point
• The assumption that raw materials arrive all at once is not
always true. The timing of purchase is very critical element of
material planning.

• The EOQ model helps the management decide how much to

order at a time. In the above example, no mentioned is made
about possible delays in the delivery of the materials ordered.

• In materials management, the lead time is very significant.

This is the time span from date an order is placed to date of
actual receipt.
The Reorder Point (Con.)
• To serve as insurance against possible delay, the company should maintain
enough materials during the waiting period.

• The Reorder Point is the point in time a new order should be placed.
Let us assume that:
Lead time......................................................... 15 days
Daily requirement........................................... 13.33 units
Reorder point.................................................. 200 units

• The company will placed an order once the stock on hand has reached the
200 units level.

• At this level, the company is assured that it has enough raw materials to
use during the 15 days lead time.
Reorder point = Daily usage x lead time
Stock outs and safety stocks
• Raw materials must be properly managed to avoid stock out or
holding of excessive inventories.

• Stock out occurs when a company does not have materials to issue
when needed and this will result to disruption of production
schedules and most often, loss of customer if orders are not delivered
on time.

• Manufacturing companies cannot afford to have excessive inventories

of raw materials because it will increase carrying costs such as
storage, insurance, obsolescence or spoilage.

• Material requirement must be planned, so that, the right quantity of

materials will be ordered at the right time interval at a very least cost.
Stock outs and safety stocks (Con.)
• Because of the difficulty to forecast lead time, manufacturing
companies must maintain buffer stocks or safety stocks above the
required inventory as protection for possible stock outs.

• The safety stock level maybe determine by considering the

maximum daily usage and the average daily usage.

• Once the safety stock is determine, the reorder point can be

computed as:
Example: Maximum daily usage............................... 50 units
Average daily usage.................................. 40 units
Lead 18 days
time...................................................
Stock outs and safety stocks (Con.)
• The safety stock is computed as:
Maximum daily usage.................................. 50
Less: Average daily usage............................ 40
Difference..................................................... 10
Multiply by lead 18
time.................................... 180 units
Safety stock..................................................

• The reorder point can now be computed as:

Safety stock.................................................. 180
Plus: usage during lead 720
time........................ 900 units
Reorder point...............................................

Reorder point = Daily usage x lead time + safety stocks

Reference:
• Rante, G.A. (2016). Cost Accounting. Millenium Books, Inc.