BM2209

KEY ELEMENTS OF COSTING PART 1

Direct and Indirect Materials
Raw materials pertain to goods that are purchased for conversion into finished products.
Materials may be classified as follows:
1. Direct Materials. These materials are easily identifiable with the product and form part of the
finished good. The cost of direct materials is directly charged to the products. Generally, the
following items are included in direct materials:
• All purchased materials.
• All issued materials from stores to departments for a specified order, job, or process.
• All specially purchased materials for a specified order, job, or process.
• All transferred materials from one process to another.
• All materials used for primary packing.
2. Indirect Materials. These materials are used in production but do not form part of the finished
product. The cost of indirect materials is treated as overhead. Examples of indirect materials are
indirect labor, depreciation, utilities, rent, repairs, maintenance, and insurance.
Basic Terms Associated with Raw Materials
The following are the basic terms associated with raw materials:
1. Freight-in or transportation costs. It refers to the shipping costs which must be paid by the
merchandise buyer depending on the agreed payment terms. It is a type of product cost which is
part of the merchandise cost and should be included in inventory if the merchandise has not been
sold. Under the perpetual inventory system charges, the freight to the raw materials inventory
account. In this case, the total costs of raw materials purchased include the invoice price plus the
freight.
On the other hand, the freight costs are charged under periodic inventory to a separate account,
recording only the invoice cost in the purchases account. 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 recorded in the work-in-process account and the invoice
price.
ILLUSTRATION: Dolby Manufacturing Company purchased the following units of flour and wheat for
their pasta production:
Raw Materials Units Weight Transportation Cost per unit Units X Cost per unit
Flour 1,000 1.5 P5.00 P5,000
Wheat 1,000 2.0 20.00 20,000
TOTAL P25,000
KEY POINTS: The total freight-in or transportation costs incurred by Dolby Manufacturing Company
to purchase flour and wheat is P25,000, which is the total cost of each raw material. It is derived from
the number of units purchased and transportation cost per unit.
2. Inventory stock card. It is used to record the movement of inventory. The entries in the stock card
are made in chronological order according to the date of occurrence or purchase of raw materials.
After proper posting on purchases and issuances, the card shows the inventory balance in units and
peso values at a given period.

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3. Materials requisition form. It serves as the basis for recording the issuance of raw materials.
4. Scrap materials. These are the defective or leftover materials in production. Scraps include fillings
or excessive trimmings of materials after manufacturing operations, defective materials unsuitable
for manufacturing operations, and broken parts of materials resulting from employee error or
machine breakdown, which causes poor quality in the product.
Material Costing and Accounting
The following are the different expenditures associated with the total cost of a product:
1. Purchase of item. The actual cost of the goods purchased.
2. Local taxes and duties. The expenses incurred to import the goods from other countries.
3. Inward freight (Freight-in or Transportation Cost). The cost for moving the goods from the source
to the buyer’s place. It involves any transport medium like trucking, shipping, air freight, or train.
4. Cash discount. An additional reduction in the value of an invoice or billing that the seller allows the
buyer to pay in advance than the due date or regular payment scheme.
5. Volume discount. Sellers offer lower product costs to encourage bulk orders.
6. Trade discount. The amount by which a manufacturer reduces the retail price or published rate of a
product and/or other additional cost-saving propositions to increase sales or market share.
7. Rebates and subsidies. The credit back programs of sellers or the government to induce additional
sales or patronization of products with corresponding terms and conditions.
8. Packing expenses. The total cost to pack and secure the goods during the delivery. It entails more
than the goods’ main packaging like boxes or bags individually, as well as the crates, containers, etc.,
to secure all the units ordered.
9. Joint purchase cost. The appropriate reallocation of the total costs to the various materials if they
shared a standard costing like Inward Freight, Discounts, Packaging, etc.
10. Extra/spare parts. The additional costs to consider in purchasing goods is the requirement of extra
parts, accessories, spare parts, supplies, and others to run or use the item accordingly.
11. Cost of containers. A high-cost equipment/packaging to handle the products for bulk and high-
volume goods delivery. It can be returnable/refundable or not, thus should be accounted for if to be
considered or not in cost.
12. Storage cost. The cost for keeping the materials for buffer use or holding.
Inventory Valuation Methods
The following are the most common methods of valuing raw materials inventory under a perpetual
inventory system:
FIFO (First in, first out)
It is a cost flow process wherein the first goods purchased are also the first goods sold. This is based on
the assumption that goods are sold or used in the same chronological order in which they are bought.
Hence, the cost of goods purchased first (first in) is the cost of goods sold first (first out).
ILLUSTRATION:
Below are the purchases and issuance of timber used in the house construction of Moonlight Company:
Date Transaction
July 1 Balance, 800 units at P98
2 Purchased 1,000 units at P100 per unit
3 Issued 1,000 units to Dept. 1
5 Purchased 1,500 units at P105 per unit

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Date Transaction
7 Purchased 500 units at P110
8 Issued 1,200 units to Dept. 2
10 Purchased 500 units at P108
15 Purchased 800 units at 105
20 Issued 2,000 units to Dept. 1
PROCEDURE:
1. Separate purchases from the issuance of raw materials and tabulate the given data as follows:
Units (Timber) Unit Cost
Inventory, July 800 98
Purchases:
July 2 1,000 100
5 1,500 105
7 500 110
10 500 108
15 800 105
Raw Materials Available
Less: Issuance
July 3 (1,000)
8 (1,200)
20 (2,000)
Raw Materials Issued
Raw Materials Inventory
2. Compute the number of inventory purchases by multiplying the number of given units by its
corresponding unit cost. Then, get the sum of the total units and the total amount of units, and input
the result on raw materials available as follows:
Units (Timber) Unit Cost Amount (Units x Unit Cost)
Inventory, July 800 98 P78,400
Purchases:
July 2 1,000 100 100,000
5 1,500 105 157,500
7 500 110 55,000
10 500 108 54,000
15 800 105 84,000
Raw Materials Available 5,100 P528,900
Less: Issuance
July 3 (1,000)
8 (1,200)
20 (2,000)
Raw Materials Issued
Raw Materials Inventory

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3. Compute the amount of raw materials issuance by assessing the required units of issuance for a
particular date of the transaction versus the available number of units in inventory as follows:
Units Unit Cost Inventory Amount (Units x Unit Cost)
Inventory, July 800 98 P78,400
Purchases:
July 2 200 100 20,000
Issuance, July 3 1,000 98,400
*The amount of inventory issuance for July 3 is derived by getting the sum of the total inventory amount
based on the number of required units which is 1,000, and its corresponding unit cost.

Units Unit Cost Inventory Amount (Units x Unit Cost)

Inventory, July 0 0 0
Purchases:
July 2 800 100 80,000
5 400 105 42,000
Issuance, July 8 1,200 122,000
*Inventory issuance for July 8 is derived by getting the sum of the total inventory amount based on the
number of required units which is 1,200, and its corresponding unit cost on the remaining inventory.

Units Unit Cost Inventory Amount (Units x Unit Cost)

Inventory, July 0 0 0
Purchases:
July 2 0 0 0
5 1,100 105 115,500
7 500 110 55,000
10 400 108 43,200
Issuance, July 20 2,000 213,700
*Inventory issuance for July 20 is derived by getting the sum of the total inventory amount based on the
number of required units which is 2,000, and its corresponding unit cost on the remaining inventory.
4. Input the amount of inventory issuance for each date of transaction. Get the sum of total issued units
and the total amount of issued units and input the result on raw materials issued. Then, get the
difference between raw materials available and raw materials issued, and input the result into the
raw materials inventory.
Units (Timber) Unit Cost Amount (Units x Unit Cost)
Inventory, July 800 98 P78,400
Purchases:
July 2 1,000 100 100,000
5 1,500 105 157,500
7 500 110 55,000
10 500 108 54,000
15 800 105 84,000
Raw Materials Available 5,100 P528,900
Less: Issuance
July 3 (1,000) (P98,400)
8 (1,200) (122,000)
20 (2,000) (213,700)

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Units (Timber) Unit Cost Amount (Units x Unit Cost)

Raw Materials Issued (4,200) (P434,100)
Raw Materials Inventory 900 P94,800
5. Present the composition of the remaining raw materials inventory as follows:
100 units at 108 P10,800
800 units at 105 84,000
TOTAL: 900 units P94,800
* After deduction of all unit issuance, the composition of remaining raw materials is
based on the available units in the inventory and their corresponding unit cost.

Average Cost (Moving Average)

This is a cost flow process of recalculating each inventory item after every inventory purchase. The
calculation involves the total cost of each item purchased divided by the number of items in stock. The
cost of ending inventory and the cost of goods sold is then set at the average.
ILLUSTRATION: From the above transaction of Moonlight Company, provide the raw materials available
for use, raw materials used, and raw materials inventory using the moving average method.
PROCEDURE:
1. Apply steps 1-2 of the FIFO costing method and compute the unit cost of each transaction for raw
materials issuance as follows:
Units Unit Cost Inventory Amount (Units x Unit Cost)
Inventory, July 800 98 P78,400
Purchases:
July 2 1,000 100 100,000
Issuance, July 3 1,800 178,400
*The unit cost of raw materials issuance for July 3 is derived by getting the sum of the total amount of
inventory purchases before the issuance date, divided by the total number of units in the inventory.

𝑇𝑜𝑡𝑎𝑙 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 178,400

𝑈𝑛𝑖𝑡 𝑐𝑜𝑠𝑡 = = = 𝟗𝟗. 𝟏𝟏
𝑇𝑜𝑡𝑎𝑙 𝑢𝑛𝑖𝑡𝑠 1,800

Units Unit Cost Inventory Amount (Units x Unit Cost)

Inventory, July 0 0 0
Purchases:
July 2 800 99.11 79,288
5 1,500 105 157,500
7 500 110 55,000
Issuance, July 8 2,800 291,788
*The unit cost of raw materials issuance is derived by assessing the remaining inventory in stocks versus the required
number of units for issuance, which is 2,800. The remaining inventory for the previous issuance shall be multiplied by the
new unit cost based on the previous issuance, which is 99.11. By adding the total amount of inventory divided by the
number of units available in the inventory before the issuance date, we can derive the new unit cost for July 8 transaction.

𝑇𝑜𝑡𝑎𝑙 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 291,788

𝑈𝑛𝑖𝑡 𝑐𝑜𝑠𝑡 = = = 𝟏𝟎𝟒. 𝟐𝟏
𝑇𝑜𝑡𝑎𝑙 𝑢𝑛𝑖𝑡𝑠 2,800

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Units Unit Cost Inventory Amount (Units x Unit Cost)

Inventory, July 0 0 0
Purchases:
July 2 0 0 0
5 1,100 104.21 114,631
7 500 104.21 52,105
10 500 108 54,000
15 800 105 84,000
Issuance, July 20 2,900 304,736
*Issuance was derived by assessing the remaining inventory in stocks versus the required number of units for issuance,
which is 2,900. The remaining inventory for the previous issuance shall be multiplied by the new unit cost based on the
previous issuance, which is 104.21. By adding the total cost of inventory divided by the number of units available in the
inventory before the issuance date, we can derive the new unit cost for July 20 transaction.

𝑇𝑜𝑡𝑎𝑙 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 304,736

𝑈𝑛𝑖𝑡 𝑐𝑜𝑠𝑡 = = = 𝟏𝟎𝟓. 𝟎𝟖
𝑇𝑜𝑡𝑎𝑙 𝑢𝑛𝑖𝑡𝑠 2,900

2. Input the unit costs for each issuance transaction. Multiply the number of required units for issuance
to its corresponding unit cost. Then, get the sum of total issued units and the total amount of issued
units, and input the result on raw materials issued. Now, get the difference between raw materials
available and raw materials issued, and input the result into the raw materials inventory.
Units Unit Cost Amount (Units x Unit Cost)
Inventory, July 800 98 P78,400
Purchases:
July 2 1,000 100 100,000
5 1,500 105 157,500
7 500 110 55,000
10 500 108 54,000
15 800 105 84,000
Raw Materials Available 5,100 P528,900
Less: Issuance
July 3 (1,000) 99.11 (P99,110)
8 (1,200) 104.21 (125,052)
20 (2,000) 105.08 (210,160)
Raw Materials Issued (4,200) (P434,322)
Raw Materials Inventory 900 P94,578
* Under the Moving Average method, the total cost of inventory is divided by the total units to arrive at the
average unit cost. This procedure is repeated every time raw materials are acquired.

References:
AccountingTools. (n.d.). Moving average inventory method. https://www.accountingtools.com/
articles/2017/5/13/moving-average-inventory-method
Investopedia. (n.d.). First in, first out - FIFO. https://www.investopedia.com/terms/f/fifo.asp
Lalitha, R. & Rajasekaran, V. (2010). Costing accounting. Pearson.
Rante, G. A. (2016). Cost accounting. Millenium Books, Inc.

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