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RAW MATERIALS INVENTORY SYSTEM

A periodic or perpetual inventory system may be used to account for the issued materials in the production and the
ending materials inventory.

Perpetual Inventory System requires the need to maintain stock cards for each type of material to show the summary
of the inflow, outflow, and balance of raw materials in quantity and Peso amount. Under this system, the movement of
raw materials is summarized in the “Raw Materials Inventory” account to make it easier to determine the amount of
inventory on hand at any given time. However, this system necessitates the physical counting of raw materials at least
once a year to verify the balance reflected in the material stock cards and the Raw Materials Inventory account.

 Inventory Stock Card – This is used to record the movement of the inventory. The beginning balance is
entered first under the balance column. Entries in this card are chronologically arranged according to the date of
occurrence. After posting the purchases and issuance of materials, this card shows the inventory balance in units
and Peso values at a given period.

ITEM: Raw Material A

Receipts Issuances Balance
DATE Units Unit Cost Amount Units Unit Cost COS Units Unit Cost Amount

Materials Requisition Form – serves as the basis for recording the issuance of raw materials

MRF NO.: DATE:

JOB NO.: DEPARTMENT:
Items Quantity Units Unit Cost Amount

Requested by: Received by:

Approved by: Released by:

The periodic inventory system does not need to maintain a stock card for the raw materials. A physical count is
made periodically near the end of a period to determine the units on hand. The latest purchases are usually left in the
warehouse. The raw materials issued are the residual amount after deducting the physical inventory counted from goods
available for sale.

BASIC TRANSACTIONS

The following are the basic transactions associated with raw materials using a perpetual inventory system:

Purchase of Raw Materials. The cost of raw materials is debited to the 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 balance in the raw materials ledger card.

Entry to record the purchase of raw materials:

Raw Materials Inventory XXX

Accounts Payable or Cash XXX
An entry in the material stock card is required.

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

Work in Process XXX

Accounts Payable or Cash XXX

Freight In or Transportation Costs. This is a product cost. Under the Perpetual Inventory System, the freight is
charged to the Raw Materials account. In this case, the total costs of purchased raw materials in the inventory stock card,
including the freight cost, are proportionately assigned to each material. Different basis can be used like units purchased,
invoice costs, or weighted costs resulting in an adjustment in the unit cost. The cost of raw materials issued already
includes part of the freight costs.

On the other hand, if the periodic inventory method is used, record only the invoice cost in the Purchases account
while the freight cost is charged to a separate account, Freight In. When raw materials are issued, a 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 the Work in Process account and the invoice price.

Example: Dolby Surrounds Company purchased the following raw materials from Ex Company, terms 2/10, n/30.
Units Weight U/C
Raw Materials A 1,000 1.5 P 5.00 P 5,000
Raw Materials B 1,000 2.0 P 20.00 P 20,000
TOTAL P
25,000

Paid P800 for transportation costs of the above purchase. Determine the amount to be charged to the Raw Materials
Inventory account under perpetual and periodic inventory systems if freight is allocated to the units purchased based on:
(a) invoice costs; (b) units purchased; and (c) weighted units.

(a) Freight is allocated based on invoice costs.

PERPETUAL INVENTORY SYSTEM PERIODIC INVENTORY SYSTEM

Purchases 25,000
Raw Materials A 5,160 Accounts Payable 25,000
Raw Materials B 20,640
Accounts Payable 25,800 Freight in 800
Cash 800

Invoice Costs Allocation Amount charged

Raw Materials A P 5,000 5/25 x 800 = P 160 5,000 + 160 = P 5,160
Raw Materials B P 20,000 20/25 x 800 = P 640 20,000 + 800 = P 20,640
TOTAL P 25,000 P 800 P 25,800

(b) Freight is allocated based on units purchased.

Units Allocation Amount charged

Raw Materials A 1,000 50% x 800 = P 400 5,000 + 400 = P 5,400
Raw Materials B 1,000 50% x 800 = P 400 20,000 + 400 = P 20,400
TOTAL 2,000 P 800 P 25,800

(c) Freight is allocated based on weighted units.

Weighted Units Allocation Amount charged
Raw Materials A 1,000 x 1.5 = 1,500 1,500/3,500 x 800 = P 343 5,000 + 343 = P 5,343
Raw Materials B 1,000 x 2.0 = 2,000 2,000/3,500 x 800 = P 457 20,000 + 457 = P 20,457
TOTAL 3,500 P 800 P 25,800

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Issuance of Raw Materials. From the warehouse, the raw materials were transferred to the production department.
The production supervisor's completed materials requisition form is the basis of the raw materials inventory clerk for the
release of the materials. A copy of the materials requisition form goes to the cost accounting department to record the
issuance and enter the direct material cost to the individual jobs in the process.

Entry to record the issuance follows:

Work in Process (Direct Materials) XXX

Manufacturing Overhead (Indirect Materials) XXX
Raw Materials Inventory XXX

Returns of Excess Raw Materials to the Storeroom

Raw Materials Inventory XXX

Work in Process (Direct Materials) XXX
Manufacturing Overhead XXX

Returns of Raw Materials to the Supplier

Accounts Payable or Cash XXX

Raw Materials Inventory XXX

INVENTORY VALUATION METHODS

The two (2) most common methods of valuing raw materials are First-in, First-out (FIFO), and Moving Average.

First-in, First-out (FIFO). Under this method, raw materials inventory is reported at the latest cost, while the Cost of
Goods Sold (COGS) is reported at the earliest cost. This method will yield a higher gross profit in a period of rising
prices because the COGS is assigned lower cost.

Moving Average. Under this method, the total inventory cost is divided by the total units to arrive at the average unit
cost. This procedure is repeated every time raw materials are acquired.

ILLUSTRATION: The following are the transactions regarding one of the raw materials of Moonlight Company:

July 1 Balance, 800 units @ P98 per unit REQUIRED:

2 Purchased 1,000 units @ P100 per unit
a. Post the transactions to Raw Materials Ledger
3 Issued 1,000 units to Department 1.
5 Purchased 1,500 units @ P105 per unit. card using (a) FIFO and (b) Moving Average
7 Purchased 500 units @ P110 per unit. and compute the amount of Raw Materials
8 Issued 1,200 units to Department 2. Inventory and Raw Materials used under the
10 Purchased 500 units @ P108 per unit. perpetual inventory method of costing.
15 Purchased 800 units @ P105 per unit.
20 Issued 2,000 units to Department 1.

(a) FIFO Method

ITEM: Raw Material A

Receipts Issuances Balance
DATE Units Unit Cost Amount Units Unit Cost COS Units Unit Cost Amount
JUL. 01 800 98 78,400
800 98 78,400
02 1,000 100 100,000 1,000 100 100,000

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ITEM: Raw Material A

Receipts Issuances Balance
DATE Units Unit Cost Amount Units Unit Cost COS Units Unit Cost Amount
800 98 78,400
03 200 100 20,000 800 100 80,000
800 100 80,000
05 1,500 105 157,500 1,500 105 157,500
800 100 80,000
07 500 110 55,000 1,500 105 157,500
500 110 55,000
800 100 80,000 1,100 105 115,500
08 400 105 42,000 500 110 55,000
1,100 105 115,500
10 500 108 54,000 500 110 55,000
500 108 54,000
1,100 105 115,500
500 110 55,000
15 800 105 84,000 500 108 54,000
800 105 84,000
1,100 105 115,500
100 108 10,800
20 500 110 55,000
400 108 43,200 800 105 84,000
900 94,800

The computation of raw materials available for use, raw materials used, and raw materials inventory:

Units Unit Cost Amount

Inventory, July 800 98 78,400
ADD: Purchases
July 02 1,000 100 100,000
05 1,500 105 157,500
07 500 110 55,000
10 500 108 54,000
15 800 105 84,000
Raw Materials available 5,100 528,900
LESS: Issuance
July 03 1,000 98,400
08 1,200 122,000
20 2,000 213,700
Raw Materials issued 4,200 434,100
RAW MATERIALS INVENTORY 900 94,800

(b) Moving Average

ITEM: Raw Material A

Receipts Issuances Balance
DATE Units Unit Cost Amount Units Unit Cost COS Units Unit Cost Amount
JUL. 01 800 98.00 78,400
800 78,400
02 1,000 100 100,000 1,000 99.11 100,000
1,800 178,400
03 1,000 99.11 99,110 800 99.11 79,288
800 79,288
05 1,500 105 157,500 1,500 102.95 157,500
2,300 236,788

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ITEM: Raw Material A

Receipts Issuances Balance
DATE Units Unit Cost Amount Units Unit Cost COS Units Unit Cost Amount
2,300 236,788
07 500 110 55,000 500 104.21 55,000
2,800 291,788
08 1,200 104.21 125,052 1,600 104.21 166,736
1,600 166,736
10 500 108 54,000 500 105.11 54,000
2,100 220,736
2,100 220,736
15 800 105 84,000 800 105.08 84,000
2,900 304,736
20 2,000 105.08 210,160 900 105.08 94,572

The computation of raw materials available for use, raw materials used, and raw materials inventory:

Units Unit Cost Amount

Inventory, July 800 98 78,400
ADD: Purchases
July 02 1,000 100 100,000
05 1,500 105 157,500
07 500 110 55,000
10 500 108 54,000
15 800 105 84,000
Raw Materials available 5,100 528,900
LESS: Issuance
July 03 1,000 99.11 99,110
08 1,200 104.21 125,052
20 2,000 105.08 210,160
Raw Materials issued 4,200 434,322
RAW MATERIALS INVENTORY 900 94,578

Under the Periodic Inventory System, a stock card for raw materials is not necessary. A physical count is made
periodically near the end of a period to determine the units on hand. The latest purchases are usually left in the
warehouse. The raw materials issued are the residual amount after deducting the physical inventory counted from goods
available for sale. The raw materials on hand and the raw materials used are computed as follows:
Units Unit Cost Amount
Inventory, July 800 98 78,400
ADD: Purchases
July 02 1,000 100 100,000
05 1,500 105 157,500
07 500 110 55,000
10 500 108 54,000
15 800 105 84,000
Raw Materials available 5,100 528,900
LESS: Units on-hand (800@105+100@108) 900 94,800
Raw Materials Used 4,200 434,322

ECONOMIC ORDER QUANTITY (EOQ)

Most businesses have their largest investment in inventory. But an investment in inventory is not profitable because costs
incurred during purchasing will not be covered until the inventory is sold. Enough inventories should be maintained to
meet customer’s orders but not too much storage costs and inventory investments.

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The design of EOQ model is to help the production manager in determining the amount of stock that will be purchased
every time an order is made or produced with each production run in minimizing total inventory costs.

Economic Order Quantity - the order quantity of inventory that minimizes the total cost of inventory management

Two (2) most important categories of inventory costs are ordering costs and carrying costs. Ordering costs are
costs that are incurred on obtaining additional inventories. They include costs incurred on communicating the order,
transportation cost, etc. Carrying costs represent the costs incurred on holding inventory in hand. They include the
opportunity cost of money held up in inventories, storage costs, spoilage costs, etc.

The greater the inventory on hand, the greater the total carrying costs but lower the ordering costs. If a small inventory is
on hand, total carrying costs will be lower but more orders will be placed, thus increasing the total ordering costs. It is the
responsibility of the management to find the proper inventory policy that keeps the total inventory costs (total carrying
cost + total ordering cost) to a minimum.

Solving for EOQ

EOQ answered two (2) questions; First, “How many units should be ordered?”, and second, “When should these units be
ordered?”

FORMULA:

(2)(𝐴𝑛𝑛𝑢𝑎𝑙 𝑢𝑛𝑖𝑡𝑠 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑑)(𝑂𝑟𝑑𝑒𝑟𝑖𝑛𝑔 𝑐𝑜𝑠𝑡)

𝑬𝑶𝑸 = √
𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝑐𝑜𝑠𝑡𝑠 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡

ILLUSTRATION: Assume the following information:

Annual units required 4,800

Ordering costs P30 per order
Carrying costs per unit P1.25

(2)(4,800)(𝑃30)
(2)(𝑎𝑛𝑛𝑢𝑎𝑙 𝑢𝑛𝑖𝑡𝑠 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑑)(𝑂𝑟𝑑𝑒𝑟𝑖𝑛𝑔 𝑐𝑜𝑠𝑡) = 𝑃288,000
= √230,400 = 𝟒𝟖𝟎 units
𝐸𝑂𝑄 = √ 𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝑐𝑜𝑠𝑡𝑠 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 √ 𝑃1.25 = √ 𝑃1.25

How many orders 𝐴𝑛𝑛𝑢𝑎𝑙 𝑢𝑛𝑖𝑡𝑠 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑑 4,800

are made each 𝑁𝑜. 𝑜𝑓 𝑜𝑟𝑑𝑒𝑟𝑠 = = = 10
year? 𝐸𝑂𝑄 480

360 𝑑𝑎𝑦𝑠 360 𝑑𝑎𝑦𝑠

What is the 𝑇𝑖𝑚𝑒 𝑡𝑜 𝑜𝑟𝑑𝑒𝑟 = = = 36 𝑑𝑎𝑦𝑠
frequency of 𝑛𝑜. 𝑜𝑓 𝑜𝑟𝑑𝑒𝑟𝑠 10
placing an order?
This means the company should make an order of 480 units every 36 days.

Ordering Cost 𝑂𝑟𝑑𝑒𝑟𝑖𝑛𝑔 𝐶𝑜𝑠𝑡 = 𝑁𝑜. 𝑜𝑓 𝑜𝑟𝑑𝑒𝑟𝑠 × 𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑜𝑟𝑑𝑒𝑟 = 10 × 30 = 𝑃300

480
Carrying cost 𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝐶𝑜𝑠𝑡 = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 × 𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 = ( ) (1.25) = 𝑃300
2

Total Inventory
𝑇𝑜𝑡𝑎𝑙 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝐶𝑜𝑠𝑡𝑠 = 𝑂𝑟𝑑𝑒𝑟𝑖𝑛𝑔 𝐶𝑜𝑠𝑡 + 𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝐶𝑜𝑠𝑡 = 𝑃300 + 𝑃300 = 𝑃600
Costs

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Reorder Point

The assumption that raw materials will arrive all at once is not always true. Timing of purchase is a very critical element
of material planning. The EOQ model helps the management decide how much to order at a time. Lead time is very
significant in materials management. To serve as insurance against possible delays, the company should maintain enough
materials during the waiting period. The reorder point is when a new order should be placed. Assume the following:
Lead time = 15 days; and daily requirement = 13.33 units.

𝑅𝑒𝑜𝑟𝑑𝑒𝑟 𝑃𝑜𝑖𝑛𝑡 = 𝐷𝑎𝑖𝑙𝑦 𝑈𝑠𝑎𝑔𝑒 × 𝐿𝑒𝑎𝑑 𝑇𝑖𝑚𝑒 = 15 𝑑𝑎𝑦𝑠 × 13.33 𝑢𝑛𝑖𝑡𝑠 = 200 𝑢𝑛𝑖𝑡𝑠

The company will order once the stock on hand has reached 200 units. At this level, the company is assured that it has
enough raw materials to use during the 15 days lead time.

Stock Outs and Safety Stocks

Raw materials must be managed properly to avoid stock outs or holding of excessive inventories. Stock out occurs
when a company does not have materials to issue when needed. This will result in disruption of production schedules
and, most often, loss of customers 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 requirements must be planned so that the correct
quantity of materials will be ordered at the right time interval at the very least cost. Because of the difficulty of
forecasting lead time, manufacturing companies must maintain buffer stocks or safety stocks above the required
inventory to protect against possible stock outs. The safety stock level may be determined by considering the maximum
daily usage and the average daily usage. Once the safety stock is determined, the reorder point can be computed as:

𝑅𝑒𝑜𝑟𝑑𝑒𝑟 𝑃𝑜𝑖𝑛𝑡 = 𝐷𝑎𝑖𝑙𝑦 𝑈𝑠𝑎𝑔𝑒 × 𝐿𝑒𝑎𝑑 𝑇𝑖𝑚𝑒 + 𝑆𝑎𝑓𝑒𝑡𝑦 𝑆𝑡𝑜𝑐𝑘𝑠

Maximum daily usage 50 units

Average daily usage 40 units
Lead time 18 days

The safety stock is computed as: The reorder point can now be computed as:

Maximum daily usage 50 units Safety Stock 180 units

Less: Average daily usage 40 units Add: Usage during lead time (40 x 18) 720 units
Difference 10 units Reorder Point 900 units
Multiplied by: Lead time 18 days
Safety Stock 180 units

References:
de Leon, N. D., & de Leon, Jr., G. M. (2014). Cost accounting. GIC Enterprises & Co., Inc.
Guerrero, P. (2015). Cost accounting: Principles and procedural applications, 2014-2015 Edition. GIC
Enterprises and Co. Inc.
Horngen, C. T., Datar, S. M., & Rajan, M. (2015). Cost accounting: A Managerial emphasis. Pearson Prentice Hall.
Lanen, W. N., Anderson, S. W., & Maher, M. W. (2014). Fundamentals of cost accounting (4th ed.). The
McGraw-Hill Companies, Inc.
Raiborn, C. A., & Kinney, M. R. (2013). Cost accounting. Cengage Learning Asia Pte Ltd (Philippine Branch). Rante,
G. A. (2016). Cost accounting. Millenium Books, Inc.

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