ACCOUNTING FOR MATERIALS

A. Requirements essential to an effective internal control system for materials:

1. to maintain a minimum inventory or investment ( cash outlay ) in materials and supplies.
2. materials of the desired quantity and quality should be available when needed for efficient and uninterrupted operations.
3. materials should be purchased only when need arises,in economical quantities at most favorable price and approved by authorized officers.
4. materials should be checked and received by authorized personnel if they are in good condition.
5. payment of materials purchased should be properly checked and approved.
6. issuance of materials should be properly authorized and accounted for..
7. materials should be handled and under the responsibility of authorized personnel in charge.

BASIC ASPECTS OF MATERIAL CONTROL

1. Physical Control
2. Control of the investment ( cash outlay ) in materials.

* Physical control of materials:

1. Effective internal control of materials.
a. a system of authorization and approval
b. segregation of duties and responsibilities
1. requisition/purchasing
2. custody
3. recording
c. surprise audit should be made regularly.

* Controlling the investment ( cash outlay ) in materials.

1. Economic Order Quantity :EOQ" Model also known as Square Root Rule ,
( SRR ), Economic Lot Size ( ELS ), Economic Batch Size ( EBS ) refers to the
units of materials that should be purchased to minimized total relevant inventory costs.
Total relevant inventory costs include the sum of ordering costs and carrying costs.
Formula: ( refer to the textbook )
Example: Given: Annual demand or requirement = 24,000 units
Ordering Costs = Php 750.00
Carrying cost per unit = Php 4.00
Answer: EOQ = 3,000 units (pls. refer to textbook for solutions.)

a. Ordering Costs - cost of placing and receiving an order.

Cost per order = total ordering cost/ number of orders
Total Ordering Costs = Cost per order x number of orders
Number of orders = Annual demand/Order Size ( or EOQ )
Illustration:
Diane Garment Mfg. Co. expects to use 10,000 meters of cotton cloth per month in 2016.
In 2015, the total ordering costs amounted to P 20,000.00 for a total of 40 orders. It is expected
that prices in 2016 would be 10% higher than that of 2015. Compute the expected ordering costs
 in 2016 if the company orders in batch of 12,000 meters nad 24,000 meters.

Solutions:
Annual demand = 10,000 meters x 12 mos.
= 120,000 meters
Expected cost per order in 2016
Cost per order = P20,000.00/40 x 110%
= P 550.00
Total ordering costs based on the 12,000 meters or 24,000 meters order sizes.
Order size 12,000 meters 24,000 meters
Annual demand 120,000 mts. 120,000 mts.
Number of orders:
120,000/12,000 10
120,000/24,000 5
x x
Cost per order P 550.00 P 550.00
Total Ordering costs P5,500.00 P2,750.00

b. Carrying Costs - are those costs incurred in maintaining or storing inventories.

Carrying cost per unit = total carrying costs/average inventory
Total carrying costs = Carrying costs per unit x average inventory
Average inventory = EOQ (or order size) /2
also;
Carrying cost per unit = unit cost x carrying cost ratio
Carrying cost ratio = carrying cost per unit/unit cost

Illustration:
In 2018, Asmirah Mfg. Company incurred a total of P 400,000.00 for materials inventory carying costs
with an average materials inventory of 200,000 units. What would be the total carrying costs in 2019 if the
order size is 500,000 units or 900,000 units, assuming the company does not maintain safety stock quantity.

Solution:
Order sizes 500,000 units 900,000 units
Carrying cost per unit:
( P 400,000.00/200,000 units ) P 2.00 P 2.00
Average Inventory:
( 500,000 units/2 ) 250,000 units
( 900,000 units/2 ) 450,000 units
Total Carrying costs P500,000.00 P 900,000.00

2. Reorder Point ( ROP ) - sometimes called as Lead Time Quantity, refers to the inventory level where a purchase order
should be placed. Once an Economic Order Quantity has been determined, management should decide when to place an order
whether at reorder point or at revised reorder point.
Reorder point = average daily usage x average lead time
Revised reorder point = Lead time quantity x safety stock
Lead time quantity = average daily usage x average lead time
Safety Stock Quantity = safety stock (in usage) + safety stock (in time)
Safety stock (in usage) = ( maximum daily usage - average daily usage ) x average lead time
Safety stock ( in time ) = ( maximum lead time - average lead time ) x average daily usage
Maximum Inventory level = Safety Stock quantity + Order Size ( EOQ )
Average usage = Annual demand/ working days in a year
Lead time refers to the period between the placement of the order andthe receipt of materials ordered.
Lead time quantity refers to average daily usage during the lead time period.
Average usage refers to average daily usage of inventory during the period ( annual demand/working days in a year ).
Safety stock refers to additional inventory as a cushion against possible stock outs, unforseen events such as surge
in demand or a longer-than-usual lead time. Safety stock is also known as buffer stock.

Illustration:
Marilyn Products Company has the following production data:
Annual requirements = 80,000 units
Number of working days = 320 days
Average leadtime = 10 days
Maximum lead time = 16 days
Maximum daily usage = 300 units
Economic OrderQuantity = 5,000 units

Solution:
a. Reorder point = average daily usage x average lead time
= 250 units x 10 days
= 2,500 units
Average daily usage = annual demand/ working days in a year
= 80,000 units/320 days
= 250 units
Lead time quantity = average daily usage x average lead time
= 250 units x 10 days
= 2,500 units
Safety stock quantity = safety stock quantity (in usage) + safety stock quantity (in time)
= 500 units + 1,500 units
= 2,000 units
Safety stock quantity (in usage) =( maximum daily usage - average daily usage) x average lead time.
= ( 300 units - 250 units ) x 10 days
= 50 units x 10 days
= 500 units
Safety stock quantity (in time) = = ( maximum lead time - average lead time ) x average daily usage
 = ( 16 days - 10 days ) x 250 units
= 6 days x 250 units
= 1,500 units
Total Safety Stock Quantity = 2,000 units.

b. Revised Reorder Point = lead time quantity + safety stock quantity

= 2,500 units + 2,000 units
= 4,500 units

3. Minimum- Maximum method - the minimum-maximum method sets the limits in inventory balances. Here the minimum
inventroy level serves as the reorder point. It includes the average quantity to be used, from the time an order is placed up
to the time the materials are received ( i.e. lead time ). The safety stock quantity is also included to minimize the occurrence
of stock out. The maximum inventory level is the sum of safety stock quantity and the order size.

Illustration:
Minimum inventory level (reorder point) = 4,500 units
Maximum inventory level = safety stock quantity + economic order quantity
= 2,000 units + 5,000 units
= 7,000 units

4. The two (2) bin system - Materials are stored in bins, or specific stocking area. Two (2) bins are used, one bin contains the quantities
the quantities to be used from the date the materials are received up to the time an order is to be placed, and the other bin contains the
the quantities to be used during the waiting time ( or lead time ) plus the safety stock. Once the first bin is consumed, an order fro two (2) bins is automatically placed
Or simply two bins equally full of stock are used; when one bin becomes empty an order for stock (1bin) is placed. This should arrive before the second bin is emptied.
In minimum-maximum method or two bin system, while monitoring costs of stocks are low, average stock levels are probably higher than necessary.
5. The ABC classification - the ABCmodel or selective control model classifies invnetories into three classes, A, B and C. Class A includes the high value items, Class B, the
average value items and Class C the low value items. Relevant principles and practices with regard to these inventory classes are summarized as follows:

Inventory Class
A B C
Cost or Price high value average value low value
Quality of internal control very strict relatively strict strict
Inventory movement/sale slow moving relatively fast fast moving
Inventory turnover low average high
Quality of staff/manpower best available average fair
Quality of records error-free highly reliable reliable
Replacement or reorder time can be long average soonest possible
Level of safety stock low average high

The ABC classification model is related to Pareto's law or the 80-20 rule.That is, 80% of the inventory value are grouped in class A, hgh value invnetory
classification,and the remaining 20% are grouped in class B and class C classifications or it may also be 80% of the inventory value are groued in class B ad C
and the remaining 20% in class A.
* Innovative Inventory and Production Management
Traditional inventory Model or sometimes called the just-in-case system maintained large amounts of the three types of inventories to act as buffers so that operations can proceed
smoothly just in case there are unanticipated interruptions.

Just-in-time management is a managerial strategy applied in manufacturing which invloves having the right materilas of right quality and quantity in the right place and at the right time.
It has the objective of eliminating idle resources throughout the company. It is the anti-thesis of just-in-case management which calls for stocks to be held (buffer stocks) in case something
goes wrong.
The ultimate aims of JIT can be expressed as follows:
Materials purchased/ordered JIT to produce parts
Materials received JIT to go into production
Parts are completed JIT for sub-assemblies
Sub-assemblies ready JIT for final assembly
Finished products manufactured JIT to be shipped to customers/for sale

METHODS OF COSTING MATERIALS INVENTORY

1. First-in, First-out method (FIFO)

2. Weighted average method
a. Simple weighted average
b. Moving average
3. Specific Identification method

First-in, First-out (FIFO)

Under this method, cost follows the usual physical flow of materilas. The cost of materials purchased first is the first cost to be issued into production
The first (or earliest) cost recorded for a particular type of materials in its stock card or sunsidiary ledger is the first cost taken out.
Weighted Average Method
a. Simple weighted average method - used for periodic inventory system. This method is based on the assumption that units issued in particular accounting
period (usually 1 month ) should be charge at an average cost, such average being computed by the totla amount of purchases divided by the total number of units acquired.
The inventory at the end is computed by by multiplying the weighted average cost per unit by the units on hand.
b.Moving average method -is used for perpetual inventory system. Under a moving average method, a new average is computed after each purchase of materials by dividing the
total cost of materials available by the number of units then on hand. Issuance is recorded at this latest average cost until a new purchase changes the average cost.
Specific Identification method
Under this method it requires a detailed physical count, each item used or sold and each item remaining in the inventory is identified.
The cost of specific materials that are used during the period is included in the cost of goods manufactured for that period and the cost
of specific remaining materials on hand at the end of a period is included in the ending materials inventory of that period.
The cost of specific finished goods that are sold during a period is included in the cost of goods sold for that period and the cost of specific
remaining finished goods on hand at the end of a period is included in the ending finished goods inventory of that period.