Notes and Illustrations: Accounting for Materials and Labor

(Concepts)
Accounting for Materials
Materials are raw products that are necessary to produce another product. It is one of the
significant parts of the product in terms of quality and value. It may either be a direct materials
or indirect materials, the former are materials directly traceable to the product, if not traceable,
have significant impact in the total value of the product produced. On the other hand, indirect
materials are the residual definition of direct materials; classified as factory overhead.
Materials are assets, one of the most important assets of the company, and it must be
safeguarded and protected, thus, proper controls and management are necessary. The
management must balance the levels of materials, it should not be over or under the optimal level
of inventories. Not maintaining the proper level may result to overstocking or understocking,
consequently, the company may have losses due to obsolescence or inadequate supply of the
needs of the customers. Materials, likewise, are susceptible to theft, embezzlement, and losses,
so the company must put procedures and strategies on how to protect those from the said
untoward incidents.
Material controls comprise of two aspects: (1) Physical control of materials, and (2)
control of the investment in materials. Physical control includes:
1. Limited access. Only those who are authorized must have access to the
storeroom. All transactions, in and out of the materials, must be properly
documented and recorded.
2. Segregation of duties. Responsible persons must be segregated for the following
functions: purchasing, receiving, storage, use and recording.
3. Accuracy in recording.
Controlling the investment –
In this aspect, our target is to maintain an inventory (materials) level that is sufficient to
produce the needs of the customers for a given period of time. To do this, we will apply some
techniques like EOQ and re-order point. Likewise, different inventory control methods can be
applied to avoid overstocking or understocking of inventories.
(1) Economic Order Quantity (EOQ)
 Defined as level of inventory order that minimizes the total cost associated with
inventory management;
 Formula:
 EOQ =
√ 2 × DxC
H
 Where:
D =annual demand
C = cost per order
H = holding or carrying cost per unit

(2) Re-order Point

 Defined as a point at which an order (equal to the EOQ) should be placed with the
suppliers in order to replenish the current stock equal to the EOQ.
 Formula:
 Reorder point = lead time in days x average daily usage
 Reorder point is the level of inventory that is equal to the consumption during the
lead time.
 Safety stock must also be considered.

EOQ and Re-order Point Application

1. Assuming the following data:
Number of units of materials required annually 10,000
Cost of placing an order P 10.00
Annual carrying cost per unit of inventory P .80

Compute the EOQ.

Solution:

EOQ = 2
√ ( P 10 )( 10,000 )
P .80
EOQ = 500 units
2. Assume that the expected daily usage of an item of materials is 100 units and the anticipated
lead time is 4 days. Compute the re-order point.
Assume the safety stock is E 800 units. Re compute the re-order point.
Solution:
Re-order point = (4 days x 100) + 800 units
= 1,200 units
(3) Inventory Control Methods
 Min max method – An order is placed when the minimum level of stock is reached.
 Two bin system - Two bins are established. First, the larger bin is used when a stock is
purchased; the second bin is used when an order is placed until its actual receipt.
 Order cycling system – A review of the entire inventory is done at regular intervals, i.e.
30, 60,90 days.
 Automatic order system – order is automatically placed when the stock level reaches a
predetermined level.
 ABC system – involves the classification of different types of inventories according to
the type or degree of control required.

Business Papers Used to Support Material Transactions

1. Purchase requisition – used to inform the purchasing department of a need for materials
and supplies.
2. Purchase Orders – used to request to a supplier for specified goods at an agreed upon
price. It also stipulates terms of delivery and terms of payment. This document is the
supplier’s authorization to deliver goods and submit a bill.
3. Receiving Report – when the goods are delivered by the supplier to the customer, the
latter upon checking the goods used this document to list all the goods received from the
former.
4. Material Requisition Slip – used every time the production department needs materials
and supplies from the warehouse.
Note: Try to find a sample of these documents from internet.

Materials Process Flow Chart

Received and stored in

Orders of materials Issuance of materials to
warehouse
(using purhase requisition, production
(purchase orders vs. purchase
purchase orders) (materials requisition slip)
invoice; receiving report)

Recording of Materials
1. Gross method – discussed fully in your financial accounting (Take time to review it).
2. Net method - discussed fully in your financial accounting (Take time to review it).
3. Allowance method – means that the purchases are recorded at net of the cash discount.
Any cash discounts are debited to “allowance for purchase discount.” The amount to
credited is accounts payable at total value of the inventories purchased.
 100,000, 2/10, 1/30, n/60
RMI 100,000
AP 100,000

RMI (100T x 98%) 98,000

AP 98,000
RMI 98,000
Allowance for purchase discount 2,000
AP 100,000
Short Application of Allowance Method
Assume that a certain company purchased materials at a list price of P 300,000 subject to
terms of 2/10, n/30. The entries to record the purchase and subsequent payment are:
To record the purchase:
Raw Materials Inventory 294,000
Allowance for purchase discount 6,000
Accounts payable 300,000

To record the payment (if made within the discount period):

Accounts payable 300,000
Allowance for purchase discount 6,000
Cash 294,000

Inventory Systems and Cost Flow Assumptions

A. Inventory system
1. Periodic inventory system
2. Perpetual inventory system – our focus…

B. Costing methods
1. Specific identification
2. FIFO
3. Average method
 All were discussed already in financial accounting (Also, see notes under Module
(Lesson 1).
Stock Variances
Inventory loss or shortage in inventory occurs when there is evaporation loss or shrinkage,
volume fluctuation due to temperature, pilferage or theft, inaccurate in recording, ending
inventory per records do not correspond with physical count and other instances.
 Inventory loss or shortage is normal (charged to FOH):
Factory overhead control xxx
Raw materials inventory xxx

 Inventory loss or shortage not normal (charged to expense):

Inventory loss or shortage (expense) xxx
Raw materials inventory xxx

Stock Valuation (Review of PAS 2)

Initial valuation – discussed in financial accounting.
 Subsequent valuation – discussed in financial accounting. To reiterate,
 Lower of cost or NRV
 Entries:
Loss on inventory write down xxx
Allowance for inventory write down xxx

 Reversal of the previous allowance is allowed but up to the extent of the original
write –down. Entries:

Allowance for inventory write-down xxx

Recovery from inventory write-down xxx
 The loss on allowance for inventory write down is a deduction from the cost of goods
sold. To wit:
Total goods available for sale P xxx
Finished goods, end (xxx)
Cost of goods sold, unadjusted P xxx
Allowance for inventory write down (xxx)
Cost of goods sold, adjusted P xxx

Note: For your review of the systems and cost flow assumption, you may use the book –
Financial Accounting by Valix.
 Accounting for Labor Cost

Recording of Payroll
Transaction Journal Entries
Incurrence or accrual of payroll Payroll xxx
Withholding taxes payable xxx
SSS contributions payable xxx
Philhealth contributions payable xxx
HDMF contributions payable xxx
Accrued salaries xxx

Note: contributions pertain to employee’s

share

Distribution of payroll to various Work in process inventory xxx

departments
Factory overhead control xxx
Selling expenses xxx
Administrative expenses xxx
Payroll xxx

Accrued salaries xxx

Payment of payroll
Cash xxx

Factory overhead control xxx

Accrual of employer’s share in various
contributions Selling expenses xxx
Administrative expenses xxx
SSS contributions payable xxx
 Philhealth contributions payable xxx
EC contribution payable xxx
HDMF payable xxx
Accrued payroll xxx

Forms and Records

Time-keeping Payroll
Clock cards Payroll records
Time Tickets Employee’s earning records
Production reports Payroll summaries
Labor Control
 Verification of employee information;
 Authorization and verification of any changes in employee records;
 Authorization of overtime work;
 Verification of calculation of incentive scheme;
 Restricting payment of wages to any worker on behalf of the absentee worker;
 Payment of wages thru bank deposits or checks;
 Reconciliation of time reports with the attendance records;
 Segregation of duties between timekeeping and payroll processing.

Labor Efficiency and Productivity

 Work study
 A systematic analysis of human work which consists of method, time, and motion
study in relation to the performance of a job or activity.
 Method study
 Involves the critical analysis and examination of the method of work
performance.
 Time study
 Analysis of time required to perform a give task under normal working
conditions.
 Motion study
 The study of body motions used in performing an operation, with the thought of
improving the operation by eliminating unnecessary motions and simplifying
 necessary motions and then establishing the most favorable motion sequence for
maximum capacity.

Labor Turnover
 Refers to the change in the labor force during a specified period. It represents the
proportion of the employees that leave (e.g. through resignation, dismissal or attrition) to
the number of employees on payroll during the period.
 High labor turnover ratio reflects an increase in cost and decrease in productivity.
 Measuring labor turnover:
 Separation method
 Replacement method
 Flux method

Labor Turnover Measurement

 Separation method
Labor turnover = (no. of separations during the period / Ave. no. of
employees during the period) x 100%
 Replacement method
Labor turnover = (No. of replacements during the period / Ave. no. of
employees during the period) x 100%
 Flux method
Labor turnover = (No. of separations + no. of replacements during the period
/ Ave. no. of employees during the period) x 100%
Avoidable Causes of Labor Turnover
 Dissatisfaction with job or inadequate remuneration;
 Unsatisfactory working conditions and facilities;
 Poor morale and low levels of motivation within the workplace;
 Bad relationship with co-workers/ superiors;
 Lack of employees’ welfare activities;
 Lack of incentive and promotion.

(Application)
Accounting for Materials
1. Allowance Method Application
The following transactions were completed by ABC Company in Dec. 2019.
1. Dec. 9 Purchased materials from Aces Hardware under credit terms of 2/10, n/30.
The list price is P 120,000 less 10%, less 5%.
2. Dec. 10 Purchase materials from King Supplies, P 50,000, 2/10, n/30
3. Dec. 19 Paid the account to Aces Hardware in full.
4. Dec. 26 Purchased merchandise from Tee Song Hardware, P 40,000, 2/10, n/30.
5. Jan. 5 Paid the account to Tee Song Hardware.
6. Jan. 9 Paid the account to King Supplies in full.
Required: Prepare journal entries using the allowance method, under perpetual inventory
system.
Gross Method Net Method Allowance Method
Dec. 9 RMI 102,600 RMI 100,548 RMI 100,548
AP 102,600 AP 100,548 All. For PD 2,052
AP 102,600
Dec. 10 RMI 50,000 RMI 49,000 RMI 49,000
AP 50,000 AP 49,000 All. For PD 1,000
AP 50,000
Dec. 19 AP 102,600 AP 100,548 AP 102,600
RMI 2,052 Cash 100,548 All. For PD 2,052
Cash 100,548 Cash 100,548
Dec. 26 RMI 40,000 RMI 39,200 RMI 39,200
AP 40,000 AP 39,200 All,for PD 800
AP 40,000
Jan. 5 AP 40,000 AP 39,200 AP 40,000
Cash 39,200 Cash 39,200 All, for PD 800
RMI 800 Cash 39,200
Jan. 26 AP 50,000 AP 49,000 AP 50,000
Cash 50,000 PDL 1,000 PDL 1,000
 Cash 50,000 Cash 50,000
All. For PD 1,000

2. Cost Flow Assumptions

The following data are provided to you.

August 1 Inventory 400 units at P P 4,000

10
August 12 Purchases 600 units at P 7,200
12
August 16 Issue 500 units
August 18 Purchase 300 units at P 4,500
15
August 20 Issue 200 units
August 25 Purchase 400 units at P 5,600
14
August 28 Issue 400 units

Requirement: Compute the ending inventory under the following assumptions:

1. FIFO – perpetual/periodic
2. Average method – periodic
3. Average method – perpetual
FIFO:
Ending inventory at units 600 units
Ending inventory at cost:
400 units x 14 P 5,600
200 units x 15 3,000
Total ending inventory P 8,600
Average: periodic
TGAS at cost/TGAS at units = average unit cost
 21,300/1,700 units = 12.53 x 600
Ending inventory at cost = 7,518
Average: Perpetual

August 1 Inventory 400 units P 4,000

at P 10
August 12 Purchases 600 units 7,200 4,000 + 7,200 =
at P 12 11,200/1,000 =
11.2
August 16 Issue 500 units 11.2 x 500 units =
(5,600)
Bal. 500 units Balance: 11,200 –
5,600 = 5,600
August 18 Purchase 300 units at 4,500 4,500 + 5,600 =
P 15 10,100/800 =
12.63
August 20 Issue 200 units 12.63 x 200 =
2,526
Bal. 600 Balance: 10,100 –
2,526 = 7,574
August 25 Purchase 400 units at 5,600 7,574 + 5,600 =
P 14 13,174/1,000 =
13.17
August 28 Issue 400 units 13.17 x 400 =
5,268
Balance: 13,174 –
5,268 = 7,906

3. Stock Variances
Assuming that the company conducted a physical count to determine the accuracy of the
record of inventories. Based on the physical count, the amount of inventory under FIFO
method was P 8,000. After investigation, the variance in the inventory was due to
 evaporation of the materials which is normal considering the nature and type of materials
stored in the warehouse.
Prepare the adjusting entries to record the difference under perpetual inventory system.
Factory overhead control 8,000
RMI inventory 8,000

4. Inventory Valuation
Assume the following data as of December 31:
Cost NRV Credit Balance
(amount per materials (information outside of
(required
ledger card) the acctg. records) allowance)

Cost NRV Credit balance

(ledger) (outside) (Req. all)
December 31, 2013 P 270,000 P 260,000 P 10,000
December 31, 2014 320,000 312,000 8,000
December 31, 2015 285,000 290,000 0

Required: Prepare adjusting entries.

2013: loss on inventory writedown 10,000

Allowance for inventory writedown 10,000

2014 Allowance for inventory writedown 2,000

Recovery of inventory writedown 2,000

2015 Allowance for inventory writedown 8,000

Recovery of inventory writedown 8,000

Material Controls

Ginza Company’s provided the following information for the recent fiscal year:

Annual inventory requirement 4,000 units

Cost per unit (other than carrying and ordering costs) P 90
Cost of placing an order P 250
Carrying cost per unit P 2.00

Determine the EOQ.

 EOQ = square root of 2(4,000) (250)/2
EOQ = 1,000 units

2. Aeon Laketown predicts that 10,000 units of materials will be used during the year. The
expected daily usage is 40 units. The expected lead time is 6 days, and there is a safety stock of
300 units. Aeon expects that the cost of materials will be P 480 per unit. It anticipates that it will
cost P 200 to place each order. The annual carrying costs is P 1.00 per unit.

Required:
a. Calculate the order point.
Order point = average daily usage x lead time
= 40 units x 6 days
= 240 units + 300 units
= 540 units
b. Calculate the economic order quantity.
EOQ = square root (2) (10,000) (200)/1
EOQ = 2,000 units
c. Calculate the total ordering and carrying cost at EOQ point.
Total ordering cost: 200
Total carrying cost: 1 x 2,000 = 2,000
Total cost: 200 + 2,000 = 2,200

Accounting for Labor Cost and Control

1. Recording of Labor Cost

The Ingrid Manufacturing Company pays employees every two weeks. Monday, May 1, is the
beginning of a new payroll period. The following payroll is prepared by the payroll department
and forwarded to accounting for recording:

Payroll Summary
For the Period May 1 – 14

Factory employees Sales and Adm. Emp. Total

Gross Earnings P 100,000 P 30,000 P 130,000
Withholdings and deductions
Income tax 12,000 2,400 14,400
SSS premiums 3,330 950 4,280
Philhealth contributions 375 150 525
Pag-ibig contributions 2,000 600 2,600
Total P 17,705 P 4,100 P 21,805

Net earnings P 82,295 P 25,900 P 108,195

Additional information:
 Of the total amount of factory payroll, P 30,000 pertains to indirect labor.
 Employer’s share are as follows:

SSS Philhealth Pag-ibig Total

Premiums
Factory 5,067 375 2,000 7,442
payroll
Selling and 3,540 150 600 4,290
Adm
Total 8,607 525 2,600 11,732

2. Labor Turnover

Assume the following workers on payroll for 2015:

No. of employees, Jan. 1 2,600
No. of employees, Dec.31 2,800
Employee resignations 50
Employee discharged 140
Employees recruited (of these, 60 workers
were recruited because of leavers and
the rest were recruited due to expansion plans) 450

Compute the labor turnover ratio using three (3) methods.