Chapter 2 - Purchasing Materials

Materials Control

Requirements for an effective internal control for materials:

1. Materials of the desired quality must be available when needed.¹

2. Correct quantities and types of materials must be on hand at the right time for production to
proceed on schedule.¹
3. Materials must be purchased at the most favorable prices.¹
4. Materials must be protected from loss or theft.¹
5. Risks of spoilage and obsolescence must be minimized.¹
6. Cost of materials handling and storage must be kept to a minimum.¹

According to Pedro P. Guerrero, modern systems of inventory control include the following features:
1. Physical safeguards for receiving, storing, and issuing materials.¹
2. Formal procedures for ordering and paying for materials.¹
3. Perpetual inventory system to provide an ongoing record of the quantity and value of each type
of materials received and issued and the balance on hand.¹

Organization for Control

To secure the advantages of specialization and know how, the functions related to materials acquisition
and use are usually subdivided into the following departments:
1. Purchasing Department – this department is charged with the responsibility of placing orders for
materials with reliable suppliers, at the right time and at the right place.¹
2. Receiving Department – this department is charged with the inspection of incoming shipments
and verification of the quantities received on order.¹
3. Storeroom (stockroom) – this department is responsible for protecting materials against physical
deterioration and ensuring that stocks are properly issued.¹
4. Accounting Department – this department records all transactions in the accounts after
documentary evidences have been supplied by other departments.¹
5. Cash Department – this department pays all invoices after approval by the accounting
department.¹

Materials Purchasing Procedures

The responsibility for purchasing materials is given to the purchasing agent. He must buy materials in
correct quantities, at the proper time, and at the lowest price. He keeps informed various sources of
supply, negotiates purchase contracts, prepares purchase orders, and follows up deliveries. The routine
work begins with the receipt of a purchase requisition.¹

¹ Pedro P. Guerrero, Cost Accounting – Principles and Procedural Applications, 2018 Edition
Reorder Point
To determine when an item has reached a level at which it should be reordered, the following factors
should be considered:
1. The frequency at which the materials is used.¹
2. The length of time it takes for the material to be delivered from the supplier after an order has
been placed. (lead time)¹
3. The minimum level of materials that should be maintained to ensure that the company does not
run out of materials. (safety stock)¹

Reorder Point = Lead time + Safety Stock

Economic Order Quantity (EOQ)

Economic order quantity reflects the quantity necessary to get the best price while keeping inventory at
an appropriate level to ensure uninterrupted production.¹

EOQ = √ 2 x annual requirements x cost of an order / Cost to carry a single item

Purchase Requisition
Once the materials reach the reorder point, the storeroom supervisor completes a purchase requisition
requesting that materials be ordered.¹
A purchase requisition is a properly approved, written request for materials and is prepared in
duplicate. The original copy is sent to the purchasing department as a request for the materials. The
duplicate is retained in the storeroom.¹

Purchase Order
When the purchasing department receives the purchase requisition, source of supply must be selected.
In choosing the supplier, the purchasing agent considers factors such as dependability, quality of
material, delivery date, and price.¹
After choosing the supplier, the purchasing agent prepares a purchase order. The purchase order is
prepared in copies to be distributed as follows:
1. Suppliers – as an authority to deliver the materials¹
2. Storeroom – as a notification that the materials requested are on order¹
3. Receiving Department – as an authorization to accept an incoming shipment¹
4. Purchasing Department – 2 copies for file¹
Receiving Report
The receiving clerk, upon receipt of the materials, takes out his copy of the purchase order and
compares its contents with the shipment. After counting and inspecting the materials, the clerk
prepares a receiving report.¹
The receiving report shows all the details of the shipment, including comments on the condition of the
materials received.¹
The receiving report is usually prepared in quadruplicate. The original and one copy are sent to the
purchasing department, where they are compared with the purchase order and the supplier’s invoice.
Once copy accompanies the materials to the storeroom for comparison with the purchase order and
entry in the storeroom records. The storeroom supervisor signs the final copy to confirm that the
materials have reached the storeroom. This copy is kept in the receiving clerk’s permanent file.¹
The storeroom clerk records the receipt of materials in a subsidiary ledger, the material ledger, by
making an entry on the appropriate materials ledger card.¹

Comparing Documents
When the invoice is received from the supplier, it is sent to the purchasing department. The purchasing
department compares the supplier’s invoice (purchase invoice) with the purchase order and receiving
report to make sure that:¹
1. Materials ordered have been received in good condition and those listed only on the invoice.¹
2. Terms, unit prices, shipping charges, and other details are in accordance with order
specifications.¹
3. Computations are correct.¹
If all documents are in order, the purchase invoice, receiving report, and the purchase order are stapled
and filed in a completed purchase folder arranged alphabetically by supplier. A check voucher also called
disbursement voucher is prepared with supporting documents attached to it. Once approved, the
voucher is sent to the accounting department for recording.¹

Recording the Voucher

When the voucher and supporting documents reach the accounting department, the voucher clerk
checks all the documents if they are properly approved and signed. In verifying the account distribution
against the purchase order, the voucher clerk enters the purchase in the voucher register. ¹
The purchase of direct materials or indirect materials is entered as debit in the Raw Materials column
and as a credit in the Vouchers Payable column.¹
After the entry is made in the voucher register, the voucher is sent to the cash department for filing in
the unpaid vouchers file.¹

Paying the Voucher

Before the due date, the voucher is removed from the unpaid vouchers file. A staff in the Cash
Department prepares a check for the amount in the voucher. The check is recorded in the check
register. The voucher is marked “Paid” by using a rubber stamp and enters the check number and date
paid on the voucher. The check is sent to the supplier, and the voucher is returned to the voucher clerk.
The voucher, with invoice, and other supporting documents is filed in the paid vouchers file.¹
Summary of Procedures and Principles
The following are the summarized procedures and principles of purchasing materials:
1. Materials must be carefully controlled to protect the company’s large investment in materials
and to maintain enough materials on hand to meet production requirements.¹
2. Materials should be purchased in correct quantities, at the proper time, and at the most
economical cost to the company. Purchasing procedures are performed by the purchasing
agent.¹
3. The purchasing cycle consists of the following steps:¹
a. A purchase requisition is prepared by the storeroom supervisor or the production manager.
b. A purchase order is issued.
c. When materials are received from the supplier, payment of the bill should be authorized.
d. The purchase is recorded in the voucher register.
e. A check in payment of the invoice is issued and recorded in the check voucher.
4. All purchasing procedures must reflect the following principles of internal control:¹
a. Request for purchases must be made only by authorized persons.
b. Purchase orders must be properly approved.
c. All materials received must be carefully counted and inspected.
d. Payment should be made only upon proper approval.
e. Purchasing responsibilities should involve different persons, so that the risk of fraud or error
is reduced.
5. Special procedures can be used for handling damaged, lost, or defective materials, and for
shortages and overages in shipment.¹
6. Many of the procedures in the purchasing cycle can be handled electronically.¹

Control Procedures
The level of raw materials inventory is based on scheduled production, which in turn is based on sales
forecasts. Five control procedures are commonly used as follows:
1. Order Cycling – Materials are reviewed on a regular cycle, and orders are placed to maintain a
desired inventory level.¹
2. Min-max method – Minimum and maximum inventory levels are determined. Reordering is
done when the minimum level is reached.¹
3. Two-bin method – This is used for inexpensive items. When the first bin is empty, an order is
placed. The second bin provides coverage until the order is received.¹
4. ABC plan – This is used with a wide variety of items having different values. The more expensive
items receive more frequent review and closer monitoring.¹
A items – most expensive items, usually few on hand.
B items – moderately priced items and moderate quantity on hand.
C items – inexpensive items, generally kept in large quantities.
5. Automatic order system – an order is automatically placed when the inventory reaches a
predetermined level. This system works best when used with a computer.¹
SOURCE AND REFERENCE: Pedro P. Guerrero, Cost Accounting – Principles and Procedural
Applications – 2018 Edition