9/8/2021

ACCOUNTING FOR
MATERIALS

ARNEL N. MORAN

Systems of
Accounting for
Materials

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Periodic Inventory System

A periodic inventory system only updates the
ending inventory balance in the general
ledger when a physical inventory count is
conducted. Since physical inventory counts
are time-consuming, few companies do them
more than once a quarter or year. In the
meantime, the inventory account in the
accounting system continues to show the cost
of the inventory that was recorded as of the
last physical inventory count.

Under the periodic inventory system, all

purchases made between physical inventory
counts are recorded in a purchases account.
When a physical inventory count is done,
the balance in the purchases account is then
shifted into the inventory account, which in
turn is adjusted to match the cost of the
ending inventory.

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The calculation of the cost of goods sold

under the periodic inventory system is:

Beginning inventory + Purchases = Cost of

goods available for sale

Cost of goods available for sale – Ending

inventory = Cost of goods sold

Periodic Inventory System

Advantages and Disadvantages
The periodic inventory system is most useful for
smaller businesses that maintain minimal amounts
of inventory. For them, a physical inventory count
is easy to complete, and they can estimate cost of
goods sold figures for interim periods. However,
there are several problems with the system:
• Minimal information. It does not yield any
information about the cost of goods sold or
ending inventory balances during interim periods
when there has been no physical inventory
count.

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• Estimation errors. You must estimate the cost of

goods sold during interim periods, which will likely
result in a significant adjustment to the actual cost of
goods whenever you eventually complete a physical
inventory count.
• Large adjustments. There is no way to adjust for
obsolete inventory or scrap losses during interim
periods, so there tends to be a significant (and
expensive) adjustment for these issues when a
physical inventory count is eventually completed.
• Not scalable. It is not an adequate system for larger
companies with large inventory investments, given its
high level of inaccuracy at any given point in time
(other than the day when the system is updated with
the latest physical inventory count).

Perpetual Inventory System

Perpetual inventory provides a highly detailed
view of changes in inventory with immediate
reporting of the amount of inventory in stock,
and accurately reflects the level of goods on
hand. Within this system, a company makes no
effort at keeping detailed inventory records of
products on hand; rather, purchases of goods
are recorded as a debit to the inventory
database. Effectively, the cost of goods sold
includes such elements as direct labor and
materials costs and direct factory overhead
costs.

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A perpetual inventory system is superior to

the older periodic inventory system because
it allows for immediate tracking of sales and
inventory levels for individual items, which
helps to prevent stockouts. A perpetual
inventory does not need to be adjusted
manually by the company's accountants,
except to the extent it disagrees with the
physical inventory count due to loss,
breakage or theft.

Material Control Procedures

Material control is a management activity
that administers how the inventory employed
in the production process is procured,
acquired, handled and utilized. It is a
process that requires planning, organization
an auditing of all the elements employed in
certain productive activity.

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The main objectives of material control are: to

maintain an uninterrupted supply of all
elements required for the production process
to run smoothly, to reduce thefts and wastage
through proper storing procedures and to
manage efficient handling, dispensation and
consumption of available materials. This is a
crucial function for companies to reduce their
costs, since it deals with one of the highest
cost centers of any business organization,
which is its productive process.

This function is normally subordinated to a Supply

Chain Management Department, that oversees
processes such as procurement, purchasing,
quality control, inventory and plant management.
Another key function of this activity is to make sure
the quality of the elements is adequate to maintain
the quality of the end product. This should be
managed through previously executed supplier’s
evaluations and quality tests, and afterwards,
through quality checks of delivered goods.
Perhaps the most crucial task of material control is
to supply the required component uninterruptedly,
to avoid delays and unforeseen disturbances to
the productive workflow.

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Commonly used control

procedures
1. Order Cycling
2. Min-Max Method
3. Two-bin Method
4. Automatic Order System
5. ABC Plan

Order Cycling
It is an inventory control method where orders are
periodically placed, but the order quantity is different every
time. The method has the following features:
• An order is periodically placed.
• The order quantity is different every time.
• Even relatively large fluctuations in demand can be
handled properly.
• Even seasonal variation can be handled modestly.
• The inventory volume can be reduced compared with
ordering point system.
• A-group items are usually best for this method.
• Longer lead time is acceptable.
• Longer time for paperwork is needed.

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Min-max Method
The Min/Max inventory ordering method is a basic
reordering mechanism that is supported by many
ERPs and other types of inventory management
software. The “Min” value represents a stock level that
triggers a reorder and the “Max” value represents a
new targeted stock level following the reorder. The
difference between the Max and the Min is frequently
interpreted as the EOQ (Economic Order Quantity).
And while Min/Max inventory planning is quite a crude
method for inventory ordering, Min/Max settings can
be dynamically adjusted to offer better inventory
performance.

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Two-bin Method
Two-bin inventory control is a system used to
determine when items or materials used in
production should be replenished. When items
in the first bin have been depleted, an order is
placed to refill or replace them. The second bin
is then supposed to have enough items to last
until the order for the first bin arrives. In short,
the first bin has a minimum of working stock
and the second bin keeps reserve stock or
remaining material.

The two-bin inventory control method is also

sometimes referred to as kanban, which is
strongly associated with the just-in-time (JIT)
method of a manufacturing process.

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How Two-Bin Inventory Control

Works
Effectively managing stock levels is one of the
biggest challenges that companies face. Not
having enough inventory can result in missing
out on sales opportunities and losing out to
competitors. Holding too much stock, on the
other hand, increases the possibility of
damage, spoilage, theft and falling victim to
shifts in demand. It also means higher storage
costs and delays recouping money from
purchased goods to reinvest in the business.

The two-bin inventory control system is a

basic technique used to ensure that
companies reduce these risks and always
have, more or less, the right level of stock to
meet demand without overdoing it.

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In its simplest form, the process can be broken

down like this:
• The first bin is placed on top or in front of the
second bin
• A reorder card is placed on the bottom of both
bins
• Stock is taken from the more accessible first bin
• When the first bin is empty it is replaced with the
second bin
• The reorder card is used to restock the first bin
• When the ordered stock arrives it is placed in the
empty bin and the process repeats itself.

Automatic Order System

• The Automated Order System, or AOS, is a
computer program that automatically routes orders
to the designated order system, in the case of odd
lot orders, or directly to brokers working on the floor
of an exchange.
• Automated trading systems like AOS have the
capacity to execute orders with both speed and
accuracy. By removing human intervention in this
phase of the order-handling process, these systems
can lower the number of errors. Finally, they're also
able to provide another layer of security against
fraud, thereby helping to control risk too.

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ABC Plan
ABC inventory analysis is a method used to
classify a business’s stock items into three
categories – A, B and C, based on their value
to the business. A items are the most important
in terms of the value they bring a company,
whilst C items are the least valuable. The
objective of ABC inventory analysis is to help
managers focus their time on their most
valuable / important products and adapt their
inventory control policies accordingly.

Order Point
The reorder point (ROP) is the level
of inventory which triggers an action to
replenish that particular inventory stock. It is
a minimum amount of an item which a firm
holds in stock, such that, when stock falls to
this amount, the item must be reordered. It
is normally calculated as the forecast usage
during the replenishment lead time plus
safety stock.

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1. Usage – the anticipated rate at which the materials

will be used.
2. Lead time - the delay applicable for inventory
control purposes. This delay is typically the sum of
the supply delay, that is, the time it takes a supplier
to deliver the goods once an order is placed, and
the reordering delay, which is the time until an
ordering opportunity arises again.
3. Safety Stock - an additional quantity of an item
held by a company in inventory in order to reduce
the risk that the item will be out of stock. Safety
stock acts as a buffer in case the sales of an item
are greater than planned and/or the company's
supplier is unable to deliver additional units at the
expected time.

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Economic Order Quantity (EOQ)

Economic order quantity (EOQ) is the ideal
order quantity a company should purchase
to minimize inventory costs such as holding
costs, shortage costs, and order costs. This
production-scheduling model was developed
in 1913 by Ford W. Harris and has been
refined over time. The formula assumes that
demand, ordering, and holding costs all
remain constant.

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Carrying cost of inventory or

holding cost refers to the total cost of
holding inventory. This includes
warehousing costs such as rent, utilities
and salaries, financial costs such as
opportunity cost, and
inventory costs related to perishability,
shrinkage (leakage) and insurance.

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Documents Used to
Support Material
Transactions

Purchase Requisition Slip

A purchase requisition form is an internal
document that employees use to request the
purchase of a specific item. The employee
describes the product and why it is needed.
This form is then sent to other individuals
and departments within the company for
review and approval.

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Purchase Order
A purchase order (PO) is
a commercial document and first official offer
issued by a buyer to a seller indicating
types, quantities, and agreed prices for
products or services. It is used to control the
purchasing of products and services from
external suppliers.

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Receiving Report
A receiving report is used to document the
contents of a delivery to a business. The
form is filled out by the receiving staff of the
business accepting the delivered goods.

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Material Requisition Slip

A material requisition form lists the items to
be picked from inventory and used in the
production process or in the provision of a
service to a customer, usually for a specific
job.

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Methods of Costing
Materials

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First-in, First-out Method (FIFO)

It is a method used for cost flow assumption
purposes in the cost of goods sold
calculation. The FIFO method assumes that
the oldest products in a company's inventory
have been sold first. The costs paid for
those oldest products are the ones used in
the calculation.

Average Method
The average cost method assigns a cost to
inventory items based on the total cost of
goods purchased or produced in a period
divided by the total number of items
purchased or produced.

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Weighted Average Method

When using the weighted average method,
you divide the cost of goods available for
sale by the number of units available for
sale, which yields the weighted-average cost
per unit. In this calculation, the cost of goods
available for sale is the sum of beginning
inventory and net purchases. This weighted
average figure is then used to assign a cost
to both ending inventory and the COGS.

Moving Average Method

When a perpetual inventory system is used,
a new weighted average unit cost is
calculated every after each new purchase,
and this amount is used to cost each
subsequent issuance until another purchase
is made.

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• Discount – a reduction in a certain price or amount.

• Trade Discount- a deduction from the list price or
catalogue price granted to customers to encourage
purchase of goods or merchandise in big quantities or
volume. This is not recorded or shown in the buyer’s or
seller’s books. Usually stated in a certain percentage.
• Cash Discount – a deduction from the selling price or
purchase price granted to customers to encourage
prompt payment of accounts. This is recorded as
purchase discount in the buyer’s book or sales discount
in the books of the seller. This method of recording cash
discount in the books of the buyer or seller is known as
the Gross Method. Stated in terms such as 2/10, n/30;
3/10,n60

Spoiled Units,
Defective Units,
Scrap Material, and
Waste Material

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Spoilage is unacceptable units of

production that are discarded or are sold for
reduced prices. Spoilage can occur at any
stage of the production process.
Rework is unacceptable units of production
that are subsequently repaired and sold as
acceptable finished goods.
Scrap is material left over when making a
product. It has low sales value when
compared with the sales value of the
product or sales of value of the input
material.

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