Temu 8 CH 4 Akt Bi Cost Acct Modul 2020

Ch 4 – 8th week
Cost
Accounting
Tim Dosen FEB -2020

Chapter 4
STOCK CONTROL
CONTENTS
4.1 Stage 1 studies 4/2
4.2 Introduction 4/2
4.3 Controlling stock 4/4
4.3.1 Introduction 4/4
4.3.2 The ordering procedure 4/5
4.3.3 The purchasing procedure 4/6
4.3.4 The receiving procedure 4/7
4.3.5 The stores procedure 4/7
4.3.6 The accounting procedure 4/9
4.4 The stores function 4/10
4.4.1 Introduction 4/10
4.4.2 Stores organisation 4/10
4.4.3 Stock levels and statistical techniques 4/11
4.4.4 Stocktaking 4/15
4.5 Material pricing 4/16
4.5.1 The problem 4/16
4.5.2 First-in, first out method (FIFO) 4/16
4.5.3 Last-in, first-out (LIFO) 4/18
4.5.4 Periodic simple average (PSA) 4/19
4.5.5 Periodic weighted average (PWA) 4/19
4.5.6 Cumulative weighted average (CWA) 4/20
4.5.7 Standard price 4/21
4.5.8 Replacement cost 4/21
4.5.9 Other methods 4/22
4.5.10 Selection of a method 4/23
4.5.11 A calculative example 4/24
4.6 Just-in-time-procedures 4/27
4.7 Backflush costing 4/28
4.8 Throughput accounting 4/31
4.9 Summary 4/35
Self-test Questions 4/36
Tutorial Questions 4/37
Further Reading 4/38
This chapter deals mainly with the problems associated with the control and
pricing of materials. As we saw in Chapter 1, the total production cost of a
particular unit comprises the direct costs associated with manufacturing that unit
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Chapter 4 / Stock Control
plus a share of production and non-production overhead. Direct costs consist of

direct materials, direct labour, and other direct expenses. By definition such costs
are relatively easy to identify with particular units, although this does not
necessarily mean that they are easy to control. In the case of materials, two
significant issues arise: (1) their procurement and storage; and (2) the issue and
pricing of them to production. These two issues form the basis of this chapter.
Learning Objectives
After studying this chapter you should be able to:
explain the nature and importance of materials in cost determination

describe the essentials of an effective stock control system
outline the operational procedures involved in stores management
discuss the advantages and disadvantages of the main material pricing
methods
assess the importance of just-in-time procedures, backflush costing, and
throughput accounting.
4.1 Stage 1 studies

Your Stage 1 studies involved a brief introduction to ‘accounting for material
costs’ (see Introduction to Management Accounting, Chapter 2, Section 2.3).
This chapter builds on the knowledge you gained during your study of that
module, but we also cover ‘material pricing’ which was only mentioned in
passing at Stage 1. We also assess the importance that modern production
methods have had on stock control procedures, and again this topic was barely
touched upon at Stage 1.
Activity 1
Refer to your Stage 1 manual (Introduction to Management Accounting). Read

Chapter 2, Section 2.3 and then make some notes about the main points. Read
Sections 4.2, 4.3 and 4.4 in this chapter, then compare your notes with what you
have just read.
♦
4.2 Introduction
In this chapter we are going to concentrate on the planning and control aspects of
materials (or inventories as they are sometimes called).
In manufacturing entities, materials form an important part of the total production
cost of a particular unit. By materials we mean those elements or substances
which are used in the manufacture of a par-ticular unit. In manufacturing a car,
for example, we will use raw materials (e.g. metal and wood) and component
parts (such as lights and mirrors). However, an entity will normally hold in store
at any one
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time not just raw materials and component parts, but also other types of materials
such as ‘consumables’ (e.g. cleaning materials), units in intermediate stages of
production (known as work-in-progress), bal-ances on long-term contract work
(e.g. expenses incurred to date in building a bridge), and finished goods (such as
cars ready for sale to customers).
Activity 2
Write down what you think is meant by the term ‘materials’. Refer to a good
dictionary (such as the Oxford English dictionary), and then compare your
definition with the dictionary definition.
♦
All of these types of materials need to be stored and safe-guarded. The provision
of adequate storage facilities can be expensive, and looking after them and their
contents can also involve substantial expenditure. Hence an entity will want to
ensure that it retains sufficient stocks to meet its operational and customer
requirements so that it does not run short of any particular item. However, it will
not want to keep stocks at levels beyond what it needs, partly because they will
be expensive to store and partly because they may be subject to various losses
(such as evaporation, misappropriation, obsolescence, and wastage).
A particular unit may receive either a direct material charge or an indi-rect one. If
we are able to identify such a cost easily and economically with a particular unit,
we will classify this cost as a direct material cost. If it is difficult to identify
easily and economically with a particular unit, it will be treated as part of
overheads, and the particular unit will hence be charged with its share of indirect
material costs. However, you will recall from your Stage 1 studies that it is not
always as easy as that. Some costs may be easy to identify with a particular cost
centre, but difficult to identify with a particular unit. We may, for example, be
making some furniture. It will probably be relatively easy to identity the wood
and metal used in making the furniture with a particular cost centre and with
particular units. However, while it may be easy to charge cost centres with the
cost of nuts and bolts that they requisition, it probably would not be easy or
economic to charge individual units with the cost of each nut or bolt used in the
manufacture of (say) a chair or a table.
As far as the control of materials is concerned, the distinction between direct and
indirect is not particularly significant, as the procedures adopted apply to all
materials irrespective of whether they are treated as direct or indirect product
costs.
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4.3 Controlling stock
4.3.1 Introduction
There are three main objectives of stock control (1) to be able to supply to the
production process the required level of stock of an appropriate quality as and
when required; (2) to have efficient and effective procedures for the ordering and
storage of materials; and (3) to have appropriate stock recording procedures.
In order to meet these objectives, the overall control procedures them-selves also
revolve round three basic requirements: (1) the managers involved in stock
control must be given clearly delineated areas of responsibility; (2) only a limited
number of designated individuals should be allowed to activate certain decisions;
and (3) all actions and decisions taken by individuals should be required to be
documented on official stationery. Only purchasing officers, for example, should
have the authority to order goods from a supplier, and such orders should always
be documented on the company’s specially designed ‘purchase order’ form. With
large companies, the documentary system will now almost certainly be
computerised. The basic principles will still be the same, however, as those for a
manual system which we describe below (see also Figure 4.1).
DEPARTMENTAL STORES STOCK PRODUCTION

MANAGERS MANAGER CONTROL CONTROL
ORDER INITIATION
PURCHASING
RECEIPT OF GOODS
STOREKEEPING
ISSUE OF GOODS
ACCOUNTING
Figure 4.1 The main stages of material control
As can be seen from Figure 4.1, stock control involves six main stages:
the initiation of an order; (2) the purchasing of the required mat-erials; (3) the
receipt of the materials into store; (4) store keeping; (5)
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the issuing of goods to production; and (6) the accounting procedures. In

outlining the stock control procedure we will assume that we are dealing with a
large manufacturing company, that the company has a cost centre structure
comprising both production and service cost centres, and that the service cost
centres include separate purchasing, receiving, and stores departments.
4.3.2 The ordering procedure
An order may be initiated by a particular department or cost centre requisitioning

the stores for some materials. This would normally be made on a Material
Requisition Note (see Figure 4.2).
MATERIAL REQUISITION
JOB REQUIRED FOR: NO:

DEPARTMENT:
DATE REQUIRED: DATE:
QUANTITY DESCRIPTION CODE NO. WEIGHT RATE (£) NOTES
BIN NO. REQUISITIONED BY:

STORES LEDGER FOLIO:
STOREKEEPER: APPROVED BY:
PRICED BY:
Figure 4.2 Material requisition note
A materials requisition form authorises the stores manager to issue materials to

the requisitioning department. It would normally be signed by the departmental
foreman (or the departmental manager in the case of a particularly large order). If
the material is not in stock or if there is only a small amount left, the stores
manager will then submit a purchase requisition (see Figure 4.3) to the
purchasing department.
A purchase requisition may also be initiated by the production con-troller (a

manager responsible for planning and controlling the manu-facturing process),
the stock controller or the stores manager himself (if some stock appears to be
getting low, for example).
Three copies of a purchase requisition would normally be raised: one would go to
the purchasing department, one would go to production control department, and
one would be retained in the department initiating the requisition.
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PURCHASE REQUISITION
DATE: NO:
QUANTITY CODE DESCRIPTION STOCK CODE PURCHASE SUPPLIER

NO. ORDER NO.
REQUISITIONED BY: AUTHORISED SIGNATURE:
LATEST DATE REQUIRED: APPROVED BY:
Figure 4.3 Purchase requisition note
4.3.3 The purchasing procedure
The arrangement for the purchase of goods will vary from company to company
depending upon the company’s location, size and the complexity of its
operations. Purchasing is a specialised activity. Some companies may centralise
all of their purchasing procedures, while other will operate on a decentralised
basis.
Centralised purchasing departments have a number of advantages, e.g. a cohesive
purchasing policy can be instituted, specialist staff can be recruited, standardised
materials are easier to purchase, and more favourable discount arrangements may
be made with suppliers. By contrast, centralisation can lead to delays in
purchasing procedures, there is the loss of a close personal contact among staff,
and it can be tedious and time-consuming for departments to deal with a
centralised department if they are located some distance from it.
Upon receipt of a purchase requisition, the purchasing department will seek out
suitable suppliers (or an order may be placed with a regular supplier). They then
may ask such suppliers to submit a tender for a specific order. The tender will
include the price, the quantity, and the delivery date. Once a number of tenders
have been received, the purchasing department will select the most appropriate
one. The ten-der accepted will not necessarily be the lowest quoted price,
because other factors (such as the security of supply) may be more important
than price. An order will then be placed with that supplier using a Purchase Order
(see Figure 4.4).
At least three copies of a purchase order would normally be prepared. One would
go to the supplier, one to the receiving department, and one to the accounting
department.
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PURCHASE ORDER
TO: NO:
FROM: ORDERED BY:
OUR REF: DATE:

Please supply, in accordance with the instructions listed below, the following:
PARTICULARS PRICE PER DELIVERY

£
DELIVERY::
TERMS: FOR ........................ LTD
Figure 4.4 Purchase order
4.3.4 The receiving procedure
The company would expect the supplier to despatch the order on or before the
agreed date. When the materials arrive at the company’s premises, the procedure
would be for them to be checked against the delivery note (or despatch note)
which will have accompanied the materials despatched by the supplier, and
against a copy of the purchase order. Details of the materials received and a
Goods Received Note (GRN) would then be prepared (see Figure 4.5).
A copy of the GRN will be supplied to the purchasing department, the initiating
department, the stores department, the receiving department, and the accounting
department. A GRN shows details of the type and quantity of goods received. It
confirms that goods that have been ordered have actually been received by the
company, and that they have been delivered strictly in accordance with the
purchase order.
4.3.5 The stores procedure
Under this heading we will consider two stages: the receipt of goods into store
and the issue of them to production.
Once the goods have been received and inspected they can be trans-ferred to the
Stores Department. They then become the responsibility of the Stores Manager.
A record will be kept of goods or materials taken into store. Depending upon
their nature, they may be stored on shelves, in bins or some other form of
container. Details of goods received and issued to production will normally be
entered on a Bin Card (or its equivalent), an example of which is shown in Figure
4.6).
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GOODS RECEIVED NOTE
DATE: NO:
TIME:
OUR ORDER NO.:
SUPPLIER:
SUPPLIER’S ADVICE NOTE NO.:
GOODS QUANTITY
CARRIER: RECEIVED BY: GOODS INSPECTION REPORT:
PURCHASE PROGRESS BIN NO.: STORES INVOICE ACCOUNT

REQUISITION CHART LEDGER NO.: REFERENCE
NO.:
Figure 4.5 Goods received note
Details will also be entered on a Stock Record Card (see Figure 4.7), and in the
Stores Ledger (see Figure 4.8).
BIN CARD
DESCRIPTION: BIN NO:
LOCATION: CODE NO:
RECEIPTS ISSUES STOCK

DATE G.R. QUANTITY DATE REQUISITION QUANTITY BALANCE
NOTE NO.
Figure 4.6 Bin card
The Bin Card only records physical movement of stock. The Stock Record Card
contains more information, such as an order placed, and the free stock balance
(i.e. the actual physical stock plus orders placed less unfulfilled requirements),
while the Stores Ledger includes details about the price paid for each batch of
goods received and their total value.
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STOCK RECORD CARD
CODE: MAXIMUM LEVEL:

STORES LOCATION: MINIMUM LEVEL:
DESCRIPTION: RE-ORDER LEVEL:
RE-ORDER QUANTITY:
RECEIPTS ISSUES Physical ALLOCATIONS ORDERS FREE

STOCK
Date Ref Qty Price Date Ref Qty Price stock Date Ref Qty Date Ref Qty BALANCE
Figure 4.7 Stock record card
MATERIAL: MAXIMUM:
CODE: MINIMUM:
RECEIPTS ISSUES STOCK

Unit Stores Unit Unit
DATE GRN Qty price Amount requ. Qty price Amount Qty price Amount
NO. £ £ No. £ £ £ £
Figure 4.8 Example of a folio in a stores ledger
The various items of stock will almost certainly be given a code number
(especially if the system is computerised). The use of a coding system helps to
increase the efficiency of the stock control system. It also avoids confusion, e.g.
over items that are very similar, and it reduces the amount of administrative and
clerical work involved keeping stock records.
Once the materials are in stock, then they can be issued in accordance with the
requests of other departments. We will be returning to have a more detailed look
at the stores procedure in the next section.
4.3.6 The accounting procedure
The supplier would normally send an invoice to the company, and the purchasing
department would then check it against the purchase order and the GRN. Once
the details have been confirmed, it can be
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passed to the Accounting Department. The invoice will once again be checked,
and then arrangements made to settle it by the due date. Thereafter, the respective
ledger accounts would be written up.
Activity 3
Try and get hold of actual examples of the following documents: purchase order,
goods received note, bin card, and stock record card. If you work for a company,
you might contact the accountant to see if he will let you have a copy of each type
of document. Alternatively, you might know someone who works for a company
who would be willing to obtain examples for you.
♦
4.4 The stores function
4.4.1 Introduction
It will be obvious from the outline described in the above section that the stores
department plays a very important part in the overall stock control system. The
basic function of the stores department is, of course, to supply to other
departments the materials that they require at the time that they require them and
of the right quality. In order to fulfil this function the stores department needs to
have (1) a convenient location, (2) have sufficient space to store all the stock
required, (3) the facilities to store the stock safely and securely, (4) a manageable
system for the ordering, receiving, storage and issue of stock, and (5) a recording
system that provides sufficient information for the stores manager to be able to
control stock levels that can be matched with the level of physical stocks.
In this section we examine some of these features in a little more detail.
4.4.2 Stores organisation
A large company will almost certainly have to make a policy decision over the
location of its stores function. In essence, it has three options:
it can centralise its stores keeping function; (2) it can maintain a central store
but operate with a number of sub-stores; or (3) it can run a decentralised
storekeeping system.
In general, experience indicates that the more personnel who have responsibility
for a certain function the more difficult it becomes to control that function.
Ideally, therefore, in order to maximise con-trol, a company will want to ensure
that all its storekeeping activities are not fragmented, i.e. they should be
centralised. In practice, how-ever, this may not always be practical. A large
company, for example, may operate on several sites, and it may be highly
inconvenient and
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time-consuming to operate from just one central store. In such cir-cumstances, it

may be impossible to centralise all the store-keeping activities.
Nonetheless, centralised store-keeping has a number of advantages.

These may be summarised as follows.
Advantages of adopting a centralised store-keeping system

There will be less duplication of physical resources, such as land, buildings,
and equipment.
Greater financial resources will be available to invest in laying out the stores
more effectively, more up to date equipment can be installed, and more
sophisticated security arrangements can be employed.
Fewer personnel will need to be employed, and they can become more
familiar with the entire range of stock, while at the same time being able to
specialise in various aspects of stores management.
Greater supervision of staff is possible.
Clerical and recording costs can be reduced.
Lower levels of stock may need to be carried, and there is less danger of it
becoming wasted or obsolete.
Stock-taking is easier to arrange and to operate.
While there are considerable advantages in operating a centralised store keeping

system, there are, however a number of disadvantages. These may be
summarised as follows.
Disadvantages of a centralised store keeping system

Transport costs may be increased.
Departments that are some distance from a centralised store may find that
delays and errors occur.
If long delays occur before some departmental orders are supplied there may
be stoppages to production.
There is a greater risk of stock losses if all stocks are located centrally owing
to such factors as fire and theft.
There may be a loss of local knowledge and expertise.
4.4.3 Stock levels and statistical techniques
At some stage the stores manager will have to determine whether to place an
order to replace some goods that have been in stock. A decision to re-order may
be done on a casual basis based on instinct,
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knowledge and experience, or it may be triggered by the adoption of a number of

statistical techniques.
The Stores Manager will be conscious that there is a need to balance the amount
held in stock against likely production requirements. He will also have to take
account of the time it normally takes between placing an order and the actual
receipt of the order into stores. Indeed, it could be very expensive for the
company in terms of production delays if manufacturing operations were
disrupted because of a short-age of materials. This is particularly the case in
industries that operate a continuous 24 hour operating process (like glass
manufacturing), because once production ceases there are often considerable
technical problems to overcome before production can resume satisfactorily.
On the other hand, while the storage of stock can be an expensive business, so
too can the placing of an order. Storage requires appro-priate premises and
facilities. Staff have to be employed. The stock has to be made secure and it has
to be insured. Furthermore, the cost of purchasing the stock has to be financed
(perhaps by bank borrow-ing). Ordering can also be expensive. Specialist staff
may need to be employed, and the receipt of small orders on a frequent basis can
also be very expensive.
The Stores Manager may, therefore, adopt some statistical techniques in order to
help him control stock levels and to offer some guidance to ordering policy. The
main techniques are discussed in the following sub-sections.
4.4.3.1 Reorder level
The reorder level indicates when an order should be place with a supplier. It will
normally lie between the maximum level and the minimum stock levels. The
reorder level may be calculated as follows:
Maximum usage × maximum lead time
The maximum usage is an estimate of the maximum amount of stock that would
ever be required at any one time. The estimate is based on experience. The
maximum lead time is the maximum amount of time that it takes between placing
an order with a supplier and the receipt of that order into stores. Once again the
estimate will be based on experience.
4.4.3.2 Minimum level
The minimum level of stock is an estimate of the absolute minimum below which
stock would not be allowed to fall. However, it would not normally be the case
that stocks would be reduced to their mini-mum levels. Stock would be reordered
well before such an eventuality occurred, otherwise there would be a risk that
insufficient material would be available for production. It would be more
appropriate to
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regard the minimum stock level, therefore, more as a buffer or as a safety stock
level.
The minimum stock level may be calculated as follows:
Reorder level − average usage in the average lead time
4.4.3.3 Economic order quantity
The reorder quantity is the amount of stock ordered whenever a new order is
placed. This may be based on the economic order quantity (EOQ). The EOQ
attempts to achieve a balance between the cost of ordering goods and the cost of
storing them. A large order will reduce the number of orders placed (making it
cheaper to place an order), but more storage space may be required to
accommodate the receipt of large orders (making it more expensive to store the
stock). The EOQ may be calculated statistically as shown below:
2CoD
Ch
where: Co = the cost of ordering goods from a supplier
D = the demand for the goods during a particular period
Ch = the holding cost of the unit during the period
This formula is based on a number of assumptions which may not always apply
in practice. The main assumptions may be summarised as follows.
Meaningful order costs and stock holding costs can both be calcu-lated.
Order costs and stock holding costs are constant.

Orders are not received in batches.
An estimate can made of the demand for the stock.
It is clear from the above summary that the main problem that arises from the use
of the EOQ is the difficulty in calculating the ordering and the stock holding
costs. Nevertheless, the EOQ is a useful guide for the stores manager, but it
should be viewed in precisely that light, i.e. it is only a guide. It should not be
adhered to rigidly without regard to the Stores Manager’s personal experience
and knowledge of what actually happens in practice.
4.4.3.4 Maximum level
The maximum stock level is the absolute maximum amount of stock beyond
which stocks should not be allowed to rise. The level will be based on likely
production demands, the reorder level, the amount ordered, and the amount of
time between ordering and receiving the goods. It may be calculated as follows:
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Reorder level + reorder quantity − (minimum usage × minimum lead time)
Activity 4
Go back and have a look at the various formulae listed above. Consider them
together. Do they make sense? Is there any logic to them?
♦
4.4.3.5 A calculative example
In this section we illustrate the use of the statistical techniques described above in
the form of a comprehensive example. The details are contained in Exhibit 4.1.
Exhibit 4.1: Shirley Ltd
The Stores Manager of Shirley Ltd has been supplied with the following infor-
mation relating to Pex, a raw material which is one of the main ingredients used in
the manufacture of the company’s major product:
Maximum usage per day: 1000 units
Minimum usage per day: 200 units
Average usage per day: 600 units
Reorder period: 30 to 36 days
Annual forecasted demand: 135 000 units
Cost of placing an order: £900
Cost of holding stock per unit: £3
Required:
Calculate the following stock levels:
reorder level;
minimum level;
economic order quantity; and

maximum level.
Solution to Shirley Ltd
1 Reorder level
Maximum usage × maximum lead time = 1000 × 36 = 36 000 units
2 Minimum level
Reorder level−average usage in the average lead time = 36 000 −(600×33∗)

= 36 000 − 19 800 = 16 200 units ∗ (30 + 36)/2
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3 Economic order quantity
× Ch × × 3
2 Co D = 2 900 × 135 000 = 9000 units
4 Maximum level
(Reorder level + EOQ∗) − (minimum usage in minimum lead time) = (36 000 +
9000) − (200 × 30) = 45 000 − 6000 = 39 000 units
∗ i.e. the reorder quantity
Tutorial notes
Based on the data given in the question, the Stores Manager of Shirley Ltd
should ensure that the maximum quantity of Pex in store amounts to no more
than 39 000 units. When the stock level falls to 36 000 units he should place an
order for 9000 units. With minimum usage the 36 000 units in stock would last for
180 days, but if the usage was at its maximum there would be sufficient stock for
36 days. This is the maximum lead time, so the stores would always be able to
cope with the likely maximum demand for units of Pex.
4.4.4 Stocktaking
A stocktake can be a very boring experience, as anyone who has taken part in one
will be able to tell you. It involves counting every item in the store, recording the
results on stock sheets (containing a description of each item of stock and the
physical quantity held in store), and then comparing the results with the stores
ledger accounts. Any material differences will then be investigated and action
taken to tighten up the security of the stores if stock appears to have
‘disappeared’ without any apparent cause, e.g. through evaporation, the breaking
up of large batches of materials, or through natural wastage. It might be difficult
for you to imagine the tedium of such an exercise, but just think how laborious it
might be for you to count every item of stock in your local newsagents shop.
Then try and imagine the same exercise for a large company. Nonetheless, and
notwithstanding the tedium involved, a stocktake is an important part of the
overall control procedure, and it also is important when preparing the financial
accounts.
Some companies may only conduct a periodic stocktake, i.e. at the end of a
designated period such as the end of the financial year. However, large
companies might arrange their stocktaking procedures on a continuous basis
because there might be too much to do if it was attempted all at once. A
continuous stocktake involves doing a stocktake of selected items on an ongoing
basis so that over a period of time all items of stock will have been checked. This
saves time at the end of the financial year, it avoids having to do the count at
great speed, specialist staff can be employed, and discrepancies come to light
much sooner than is the case with a periodic stocktake.
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The adoption of a perpetual inventory system for recording stock (i.e. receipts
and issues of stock are entered in the accounts after each transaction)
complements a continuous stocktaking system because the physical count can
always be compared with an up-to-date record in the ledger system. Otherwise,
once a stocktake has been undertaken there may be a delay before the result can
be checked against the book entries.
4.5 Material pricing
4.5.1 The problem
Another important function of the Stores Manager will be to ensure that materials
are priced out to production at an appropriate amount. This might not appear to
be a major problem given that direct materials are those that are easy and
economic to identify with specific jobs or processes. In this context, however, we
are referring to the physical identification of materials with jobs or processes, and
not necessarily the value of them.
If it is possible to identify the physical stock with a particular job or process, the
charge to production may be based on the actual cost of materials purchased.
This method is known as the specific identification method, and in such
circumstances no overwhelming problem arises in adopting it.
The problem of pricing arises in those circumstances where stocks are purchased
in batches, and where the cost of each batch may vary. If old and new stock is
stored together there may also be a problems in distinguishing the old stock from
the new. Liquids, for example, may be stored in tanks (as may grains in silos or
vats), and any new stock of liquid may be just tipped into the tank which will
normally contain some previously purchased liquid. The new liquid becomes
indistinguishable from the old liquid. Thus when some liquid is drawn off for
issue to production, it is impossible to know which is old liquid and which is new
liquid as the old and new have been mixed together. This means that it is also
impossible to price the issue of the mixed liquid on the basis of old and new
prices. Hence in such circumstances it is necessary to estimate the charge to
production, and a number of methods have been devised to cope with the
problem.
We deal with some of the main methods in the following sub-sections.
4.5.2 First-in, first out method (FIFO)
It is important that when dealing with the pricing problem the phys-ical issue of
materials to production is distinguished from the pricing problem. Wherever
possible, of course, the oldest goods in store will be issued first to production,
followed by the next oldest and so on. However, as we explained above, in the
case of certain types of stock
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(such as grains and liquids), this may not always be possible and a mix of old and
new stock may be issued to production. An estimate then has to be made of the
price to be charged to production for the material issued.
Irrespective of the impossibility of physically distinguishing old stock from new

stock it seems logical to use old prices first followed by the new prices. This is
known as the first-in, first-out method (FIFO). Once a batch of good purchased at
a certain price appears to have been used in production, the next batch (or part
batch) will be charged out at the next oldest price. Remember that each price is
used only up to the amount of goods purchased at that price. If we purchase 100
units at £1 per unit, for example, followed by another purchase of 200 units at £2
per unit, then assuming we issue 150 units to production, 100 units will be
charged out at £1 per unit and 50 units at £2 per unit (a total of £300) i.e. we do
not charge out all of the 150 units at £1 each. Thereafter, if (say) another 25 units
are issued to production they will be charged out at £2 each (i.e. a total of £50 or
25 × £2).
The FIFO method has a number of advantages and disadvantages which are
summarised below.
Advantages
FIFO appears to complement the physical issue of materials. The method
gives a false impression, of course, because for pricing purposes old and new
stock cannot be physically separated.
There is some logic in using the oldest prices first.
The stores ledger account is arithmetically self-balancing as aver-ages or
estimates of prices are not adopted..
As prices are based on actual cost (and not on an estimate or a value), no
balances arise which have to be written off to the profit and loss account.
The closing stock value tends to be close to current economic values since
normally it will have been recently purchased.
Statement of Standard Accounting Practice (SSAP) 9 permits it to be used
for financial accounting purposes in the United King-dom (you may well be
familiar with this point because it is also included in your Financial
Reporting module). This means that duplication is avoided if the same
method is also used for man-agement accounting purposes.
Within the United Kingdom it is allowable for tax purposes.
Disadvantages
It is arithmetically cumbersome to calculate, especially if there are numerous
receipts of goods which are taken into stock at varying prices.
4/17
It is difficult to make cost comparisons between jobs because the charge to

production may depend upon the accidental timing of when material was
issued to one job compared to the issue to another job.
The charge to production relates to out-of-date prices as the oldest prices are
used first.
During periods of inflation production costs are understated as older prices
will be less than newer prices. This means that prof-its tend to be overstated.
The reverse applies during periods of deflation: production costs are
overstated and profits understated.
4.5.3 Last-in, first-out (LIFO)
The LIFO method is similar to the FIFO method except that the latest prices paid
for materials taken into store are used first, followed by the next latest price, and
so on. Suppose, for example, that 100 units were first taken into stock and the
price paid for each unit was £1. A further purchase was made of 200 units at £2
per unit. Thereafter 150 units were issued to production. Using the LIFO method,
the charge to production would be £300 (150 units × £2). If this was followed by
a further issued to production of 100 units, the charge would be £150 [(50 units ×
£2) + (50 units × £1)]. In other words, once we appear to have charged out all of
the 200 units purchased at £2 each, we do not use that price again, and we have
to go back to the earlier price (unless in the meantime another batch has been
purchased at a new price).
The main advantages and disadvantages of LIFO may be summarised as follows:
Advantages
As LIFO uses actual prices paid, the stores ledger account is self-balancing.
This means that no balancing figure has to be written off to the profit and
loss account.
The charge to production will be closer to current economic values because
the latest prices paid for materials are being adopted.
In times of rising prices (i.e. inflation), there will be a higher charge to
production and a lower value for closing stocks. This will have the effect of
reducing the amount of profit earned by each job, thereby acting as a hedge
against inflation. The opposite will apply if prices are falling (i.e. if there is a
deflationary period).
Disadvantages
The method is arithmetically cumbersome to operate, especially if there are a
large number of batches of goods taken into store and they have all been
purchased at different prices.
4/18
The charge to production for similar jobs being undertaken at the same time
may vary because one job was in the queue before another job when it came
to requisitioning materials.
The closing stock value will be based on out-of-date prices because the
oldest prices will have been used in the valuation.
SSAP 9 does not accept this method for financial accounting purposes.
Although it could be used in management accounting reports, this would
mean that there would be extra clerical effort involved in producing two
stock valuation figures.
It is not allowable for tax purposes in the United Kingdom.
4.5.4 Periodic simple average (PSA)
One of the simplest pricing methods to adopt is that known as the periodic simple
average methods. The opening stock price is added to all the prices paid for
batches of goods purchased during a particular period (say a month), and then
divided by the number of prices in the total. Suppose, for example, that during
May a company purchases three lots of goods at £1, £2, and £3 per unit
respectively. The issue of good to production during May will, therefore, be
charged out at £2
per unit (£1+2+3 ).
3
There are two main problems with this method.
Issues to production cannot be charged out until the end of the period. This
may cause a delay in invoicing a customer, and this could lead to cash flow
problems.
As no account is taken of the quantity of goods purchased in any one batch,
this may give undue weighting to small (or large) batch quantities purchased
at unrepresentative prices. This problem can be avoided by using a periodic
weighted average price.
4.5.5 Periodic weighted average (PWA)
The periodic weighted average method is very similar to the PSA method, except
that account is taken of the amount of materials pur-chases. For example,
suppose in May 100 units were purchased at £2 per unit, and 50 units at £3 per
unit. The period weighted average price for May would be £2.33 [(£200 + 150) /
(100 + 50)]. Note that the periodic simple average price would be £2.50 (£2+2£3 ).
Assuming that the defined period of time was (say) a month, the PWA would be
calculated for the month based on the quantity and value of the opening stock
plus all purchased made in that month. Hence like the PSA method only one
purchase price would be used to charge out all issues to production during that
particular month.
The main advantage of the PWA method is that once the price for the period has
been calculated, then that price is held for that entire
4/19
period and all issues to production are charged out using that same price for that
period. However, it has the disadvantage that the price can only be calculated at
the end of the period when all the prices and quantities are known. Thus once
again there may be some delay in invoicing customers, and this might have a
possible impact on the organisation’s ability to finance its activities.
4.5.6 Cumulative weighted average (CWA)
Unlike the PSA and PWA methods, the cumulative weighted average method
allows for varying batch sizes and it also enables goods to be priced when they
are charged to production. This means that there should be no undue delay in
invoicing customers.
A simple example will illustrate how the method works. Suppose that 100 units
were taken into stock at £1 per unit, followed by a further 200 units at £2 per
unit. The cumulative weighted price would be £1.67 [(100 units × £1) + (200 ×
£2) = £500 ÷ 300(100 + 200)]. Hence a transfer to production of 150 units would
then be charged out at £250 (150 × £1.67). However, this price per unit will
change each time that a new batch of goods is taken into stock at a new price.
This might suggest that it could become a cumbersome method to adopt, but if a
stores ledger account is used which provides columns for the total quantity of
stock and for its value, it is a relatively easy method to operate. In order to
calculate a new issue price all that is necessary is to divide the total value of
materials in stock by the total quantity. CWA has the following advantages and
disadvantages:
Advantages
The price charged to production reflects a balance between the quantity of
materials in stock and the price paid per unit.
It is easy to apply, especially if a stores ledger account is used.
It smoothes out the prices paid for different batches of goods i.e. the price
being used to charge goods to production is not distorted by uneven levels of
materials purchased at varying prices.
Charges to production and the value placed on closing stock reflect the
smoothing out of any erratic fluctuations in prices paid for materials.
CWA gradually absorbs price changes taking place over a period of time.
Cost comparisons between jobs are easier and fairer because the prices
adopted do not depend on the accidental timing of being first in the queue
when requisitioning materials.
As it is an actual cost method (i.e. one not based on values) no unrealised
stock gains or losses occur.
4/20
It is acceptable under SSAP 9 requirements and for tax purposes within the
United Kingdom.
Disadvantages
The CWA price may not necessarily reflect any price that has actually been
paid because it is an average price.
It lags behind current economic prices.
Some arithmetical adjustment caused by rounding may have a marginal
effect on the closing stock value.
4.5.7 Standard price
Instead of using one of the cost methods described above, it may be possible to
use a standard cost, that is, a price that the entity expects to pay for materials that
it purchases. Although this method would normally be used as part of an overall
standard costing system, it can still be used on its own for pricing purposes.
As with all the other methods, it has a number of advantages and disadvantages.
Advantages
Once determined, a standard cost is very easy to apply to each issue of stock
to production.
It holds good for a specific period of time.
It is possible to make a fair comparison between the costs of different jobs.
Disadvantages
It is not easy to determine an accurate standard cost.
It is not an actual cost method, so balancing items may appear in the stores
ledger account. These will have to be written off to the profit and loss
account.
4.5.8 Replacement cost
The replacement cost method uses the price which would have to be paid for
materials issued to production if they were being purchased at the time they were
being issued to production. Like the standard cost method, it is very easy to apply
(assuming that information can be readily obtained about changes in the current
cost of purchasing similar materials). This method would also be normally
incorporated into a system of replacement accounting, although it can be used in
isolation. Unlike the standard cost method, however, it is likely that current
prices will change fairly frequently, thereby requiring frequent
4/21
changes to be made issue prices. In summary, its advantages and disadvantages

are as follows.
Advantages
It may be possible to hold the replacement cost stable over a reasonable
period of time depending upon how current prices change.
It is very easy to apply once a replacement price has been obtained.

The prices charged to production reflect current economic condi-tions.
Disadvantages
It is very difficult to determine an accurate replacement cost.
As it is not an actual cost method, profits and losses may arise in the stores
ledger account. These will have to be written off to the profit and loss
account.
It is difficult to make fair comparisons between different jobs.
It is not acceptable for tax purposes within the United Kingdom.
4.5.9 Other methods
There are two other methods that are similar to FIFO and LIFO, although they
are both very rare in practice. It is not surprising, therefore, that they are not even
mentioned in many conventional management accounting textbooks. One is
called HIFO (highest-in, first-out), and the other NIFO (next-in, first-out).
If HIFO is adopted, the highest price actually paid during a period would be
selected as the price to use in charging out all issues to production during that
period. Its advantages are as follows.
As only one price is used, it is easy to apply.

There is no balance to write off to the profit and loss account as it is an
actual cost method.
Much fairer comparisons can be made between different jobs.
During inflationary periods there is less danger of overstating prof-its
because the highest prices are used to charge out materials to production.
Its major disadvantage is that it may not reflect current economic conditions.
The NIFO method uses the price which the entity has agreed to pay for the next
order. It is easy to operate, no balancing items occur, and like
4/22
HIFO it will provide a hedge against inflation. The NIFO price may be very
similar to the replacement price, although it is possible that current market prices
may have changed since an order was placed.
Another pricing method which is similar to the periodic simple average method
discussed earlier is the cumulative simple average (CSA) price. As was pointed
out, one of the disadvantages of the PSA method is that a delay can occur before
customers are invoiced. This problems could be solved by using a cumulative
simple average price. Thus each time another batch of materials was purchased a
new average price would be calculated. It is very similar, therefore, to the CWA
method, except that the amount or the weights of different purchases are not
taken into account.
One problem is that it can be difficult to calculate because when a batch

purchased at a certain price appears to have been issued to production (based on
a comparison of cumulative receipts and issues), that price is dropped from the
calculation. Such information can be incorporated into the stores ledger, but it
would be easy to use the CWA method which would then avoid the weighting
problem.
You may also come across another method known as the base stock method. This
is perhaps a misnomer, because it is not an actual method. It works by keeping
the very first purchase of stock at its original price. The original stock is then
treated as a buffer or base stock, and in all subsequent stock valuations it will be
included at its original value. Any issues to production would be charged out
using one of the methods described above.
4.5.10 Selection of a method
If you had to advise management which of the above pricing methods to adopt,
you may find yourself in somewhat of a quandary. However, depending which
country you work in, some methods may rule them-selves out automatically on
legal and professional accounting grounds, e.g. LIFO in the United Kingdom.
Generally speaking, however, the practical choices lay between FIFO and either
CWA or PWA. PWA is probably less desirable than CWA because of the time
delay before it can be calculated. Both the CSA and PSA cost methods have the
major disadvantage that they do not take into account the quantity of material
purchased. The standard cost method is generally acceptable provided that
sufficiently reliable information can be obtained about the likely cost of materials
that the entity may need to purchase. The replacement cost method is likely to be
used only if a current cost system of accounting is adopted.
Assuming that it is not possible to use the specific identification method,

therefore, the selection of an appropriate method would appear to be a choice
between FIFO, CWA, and standard cost. How-ever, before finally determining
which you would recommend, you are advised to check the precise legal and
professional requirements that apply in the country in which you are working.
4/23
We will now have a look at an example which will explain in detail how some of
the main pricing methods may be applied in practice.
4.5.11 A calculative example
In this section we will illustrate the use of the main material pricing methods
discussed in the previous section. We do so in Exhibit 4.2.
Exhibit 4.2: Joyce Ltd
Joyce Ltd had the following transactions relating to production material AB1 for
the month of April 19X4:
Date Description Units Price per unit (£)
1 April Opening stock 45 10
6 April Purchases 70 12
10 April Issues to 30
production
production
production
production
Required:
Using the following methods of pricing the issue of materials to production,

calculate the value of the closing stock of AB1 as at 30 April 19X4:
first-in, first out (FIFO);
last-in, first out (LIFO);

cumulative weighted average (CWA);
periodic simple average (PSA); and

periodic weighted average (PWA).
Assuming that the total sales revenue for completed units of AB1 for April
19X4 was £4000 and the other production costs involved totalled £500,
calculate Joyce’s gross profit using each of the above stock pricing methods.
4/24
Solution to Joyce Ltd.
1 Calculation of closing stock value

Date Receipts Issues Stock
April Quantity Price Value Quantity Price Value Quantity Value
£ £ £ £ £
(a) FIFO
1 45 450
6 70 12 840 115 1290
10 30 10 300 85 990
13 15 15 225 100 1215
17 40 15 @£10 450 60 765
25 @ £12
20 100 14 1 400 160 2 165
22 90 45 @ £12 1 185 70 980
15 @ £15
30 @ £14
24 40 14 560 30 420
27 80 17 1 360 110 1 780
3 825 2 495
(b) LIFO
1 45 450
6 70 12 840 115 1 290
10 30 12 360 85 930
13 15 15 225 100 1 155
17 40 15 @ £15 525 60 630
25 @ £12
20 100 14 1 400 160 2 030
22 90 14 1 260 70 770
24 40 10 @ £14 470 30 300
15 @ £12
15 @ £10
27 80 17 1 360 110 1 660
3 825 2 615
(c) CWA
1 45 450
6 70 12 840 115 1 290
10 30 £1290/115 337 85 953
= £11.22
13 15 15 225 100 1 178
17 40 £1178/100 471 60 707
= £11.78
20 100 14 1 400 160 2 107
22 90 £2107/160 1 185 70 922
= £13.17
24 40 13.17 527 30 395
27 80 17 1 360 110 1 755
3 825 2 520
4/25
(d) Periodic simple average

Purchases £
1) 1.4.X4 10
2) 6.4.X4 12
3) 13.4.X4 15
4) 20.4X4 14
5) 27.4.X4 17
68
5
= 13.60
Issues to production 200 (30 + 40 + 90 + 40) × £13.60 = £2720 (Opening stock +
purchases) − issues to production = closing stock value

(£450 + 3825) − 2720 = £1555
Periodic weighted average
Opening stock + purchases during April

Opening stock units + units purchased during April
£450 + 840 + 225 + 1400 + 1360 4275
= = = £13.79
45+70+15+100+80 310
Issues to production = 200 × £13.79 = £2758
Closing stock value = (opening stock + purchases) − issues to production = (£450 +
3825) − 2758 = £1517
2 Calculation of gross profit

FIFO LIFO CWA PSA PWA
£ £ £ £ £
Sales revenue 4000 4000 4000 4000 4000
Direct materials (2495) (2615) (2520) (2720) (2758)

Other costs (500) (500) (500) (500) (500)
(2995) (3115) (3020) (3220) (3258)
Gross profit 1005 885 980 780 742
Tutorial notes
The data given in the question indicate that the price of AB1 is rising. As can be
seen above, therefore, by using the FIFO method of pricing, the gross profit is
higher than by using LIFO. As might be expected, by using CWA, the gross profit
lies somewhere between the FIFO and LIFO methods. In this example, the
periodic simple average method and the periodic weighted average methods both
result in a much lower level of gross profit than is the case with FIFO, LIFO and
CWA.
4/26
4.6 Just-in-time-procedures
Since the 1980’s many large companies throughout the world (partic-ularly in
Japan) have adopted what has come to be called just-in-time (JIT) procedures for
their production processes. The basic concept is very simple. Instead of
producing finished goods for stock which the company eventually hopes to sell
(referred to as the push-through system of manufacturing), the idea is that goods
should be produced only when there is a customer for them, i.e. manufacturing
should be based on demand-pull. In essence, therefore, goods are produced only
when a customer is signed up for them, and individual cost centres within the
company only work on goods or components when they are needed. In other
words, neither the company as a whole, nor individual units within it,
manufacture units for stock.
JIT requires that the work-place itself and the work done within it is redesigned
on fairly unconventional lines. Thus instead of having (say) an assembly cost
centre, a fitting cost centre, and a finishing cost centre where a unit in process
flows in sequence from one cost centre to the other, the work may be organised
in ‘cells’. The cells will be based on the different types of machinery or
equipment used in manufacturing a particular product. One important feature of
the system is that work will not be undertaken simply to keep the staff busy: if
there is currently no demand for the product, then it will not be manufactured. By
contrast, if there is a definite order for the product then the system operates so
that the order is delivered on time as agreed with the customer.
You may now have begun to see the implications of JIT as far as stock control
and pricing are concerned. If the purchasing procedures are also based on JIT
principles, then materials will be purchased only when required. In theory, when
they are needed for a particular job, an order will be placed with a specified
supplier and that supplier will be so reliable that the materials will be delivered
just when they are to be used in production. This procedure eliminates the
necessity to have an elaborate purchasing, receiving and storage system. Indeed,
the stores function becomes downgraded to a very low level of impor-tance, and
hence the control of materials also becomes a relatively unimportant activity. In
effect, when the material is needed, the com-pany telephones the supplier and the
material arrives (perhaps within the hour) just when it is required. It is delivered
straight through to the production process.
The pricing problem is also virtually eliminated because material is only ordered
for specific jobs, and hence the price of such material can easily be identified
with such jobs.
In order for JIT purchasing procedures to work, there has to be a very close
relationship between the company and its suppliers. Any delay in receiving an
order placed for immediate usage, or any material received that is not of the right
quantity or quality, causes enormous
4/27
problems in fulfilling the customer’s orders on time (especially as is often the

case, customers are promised extremely short lead times between order and
delivery). Nonetheless, there are substantial qual-itative benefits, such as better
supplier and customer relations, and a more flexible work-force. The cost savings
include lower ordering, receiving and storage costs, less risk of obsolescence and
waste, and reduced administration and recording costs.
It should be stressed that JIT procedures are still at an early stage of

development. They have yet to be introduced on any scale into small companies,
and so the twin problems of control and pricing outlined so far in this chapter are
still pertinent.
4.7 Backflush costing

The introduction of JIT procedures means that much less emphasis needs to be
placed on stock control and valuation. Since stock is ordered and delivered
straight to production as and when it is required in order to meet customers’
specific orders, there will also be much less need to manufacture units for stock
in case there is an expected demand from a potential customer. All of this means
that along with stock,work in progress may also be almost entirely eliminated
from the system.
The impact of JIT has, therefore, resulted in a review of conventional accounting

procedures. It has been suggested that as a result of the virtual elimination of
work in progress, there is no need to cost it since any remaining WIP will be
relatively insignificant. This argument has led to a new form of costing called
backflush costing.
The basic idea of backflush accounting is very simple. It revolves round two
concepts: (1) do not cost work in progress; and (2) only cost units of production
when they have become finished goods. However, a decision has to be taken at
what point in the production cycle the finished goods should be costed.These
points are known as trigger points, and there are three main options:
Trigger point 1
Cost when the finished goods have been completed. This is the easiest and
simplest version of backflush costing. It is suitable for use when the
production process is based on JIT procedures.
Trigger point 2
Cost when (a) the materials have been purchased; and (b) the finished goods
have been completed. This option is suitable for use when the organisation
holds minimal work in progress since the costs attached to the units will be
very similar to those obtained using a more conventional costing system.
4/28
Trigger point 3
Cost when (a) the materials have been purchased; and (b) the finished goods
have been sold. In effect, this option mirrors another new type of costing
system known as throughput accounting which we will be examining in the
next section. There are two main advantages of adopting a trigger point at
this stage: (1) there is less incentive for managers to build up stocks; and (2)
it focuses their attention on the importance of selling the units they produce.
We illustrate the effect on the relevant accounts by using each of the above three
trigger points in Exhibit 4.3.
Exhibit 4.3: Backflush Costing Using Three Trigger Points
The following data relate to Meadows Ltd for the month of April 19X4:
Data for April 19X4
Raw material purchases £1600
Conversion costs (direct labour + overheads) £1050
Finished goods manufactured 500 units
Sales 400 units
Standard material cost per unit £3
Standard conversion cost per unit £2
Note: There were no opening stocks of raw materials, WIP or finished goods.
Required:
Show extracts from the following accounts using trigger points when: (1) finished
goods are completed; (2) materials are purchased and finished goods are
completed; and (3) when materials are purchased and the finished goods are
sold:
raw materials stock account;

conversion cost account;
finished goods account; and

cost of goods sold account.
4/29
Solution to Meadows Ltd.
1 Trigger point: Finished goods completed

Raw materials stock account: not required
Conversion cost account
£ £
Cash/creditors 1050 Finished goods (500 × £2) 1000
Cost of goods (balance written off) 50
1050 1050
(c) Finished goods stock account

£ £
Standard material cost (500 × £3) 1500 Cost of goods sold [£400 × (£3 + 2)] 2000
Conversion costs 1000 Balance c/d 500
2500 2500
Balance b/d 500
(d) Cost of goods sold account

£ £
Finished goods stock 2000
2 Trigger point: Material purchased and finished goods completed

(a) Raw material stock account
£ £
Cash/creditors 1600 Finished goods stock (500 × £3) 1500
Balance c/d 100
1600 1600
Balance b/d 100
(b) Conversion cost

£ £
Cash/creditors 1050 Finished goods (500 × £2) 1000
Cost of goods (balance written off) 50
1050 1050
Balance b/d 50
(c) Finished goods stock

£ £
Raw material stock 1500 Cost of goods sold 2000
Conversion costs 1000 Balance c/d 500
2500 2500
Balance c/d 500
(d) Cost of goods sold account

£ £
Finished goods stock 2000
4/30
3 Trigger point: Material purchased and finished goods sold

(a) Raw materials stock account
£ £
Cash/creditors 1600 Cost of goods sold (400 × £3) 1200
Balance c/d 400
1600 1600
Balance b/d 400
(b) Conversion cost account

£ £
Cash/creditors 1050 Cost of goods sold (400 × £2) 800
Balance c/d 250
1050 1050
Balance b/d 250
Finished goods account not required
Cost of goods sold account

£ £
Raw materials stock 1200
Conversion cost 800
2000
Tutorial notes
The balance on the conversion account will be written off to the cost of goods
sold at the end of the designated costing period. This may be at the end of
each month, each quarter, or at the end of the financial year.
Note that the cost of goods sold is identical regardless of when the trigger
point is determined.
All three methods involve using the budgeted or the standard cost for
recording the various transactions.
It is clear that backflush costing does not adhere to the conventional method of
costing products. This means that its adoption could be in conflict with the
external financial reporting requirements, and extra work may be necessary at the
end of the financial year in order to com-ply with statutory and professional
requirements. However, it could be argued that backflush costing is justifiable in
such circumstances if its use enables managers (1) to concentrate on sales; and
(2) to use resources much more effectively and efficiently.
4.8 Throughput accounting

We indicated in the last section that as far as backflush costing is concerned, the
use of trigger point three (at the time of material purchases and when the goods
are sold) is tantamount to the adoption of what is known as throughput
accounting (TA)
4/31
This form of accounting is still at an early stage of development. It revolves

round the recognition that, in order to maximise profitability, it is vital that stocks
are turned into finished goods and then sold as quickly as possible. Thus, like
backflush costing, the concept is very closed associated with a JIT environment.
The accounting procedures are quite straight forward. They involve reporting
revenues and costs on the basis of throughput contribution. Throughput
contribution is the difference between sales revenue and direct material cost. An
example of a throughput accounting report is illustrated in Exhibit 4.4.
Exhibit 4.4: Example of a Throughput Accounting Report
£
Sales revenue 3000
Direct materials (1400)
Throughput contribution 1600
Direct labour (300)
Direct expenses (50)
Manufacturing overhead (600)
Administration overhead (250)
Research and development overhead (50)
Selling and distribution overhead (100)
(1350)
Operating profit 250
Tutorial notes
As can be seen from Exhibit 4.4, the presentation of a throughput accounting

report is very similar to that of a marginal cost report. A marginal cost report
discloses the ‘contribution’, the contribution being the difference between sales
revenue and the variable cost of sales. The contribution is then reduced by all the
fixed cost in order to arrive at net profit. Throughput contribution is the difference
between sales revenue and direct material costs (which almost certainly are
variable costs). The net profit is then the difference between the throughput
contribution and all other costs (i.e. irrespective of whether they are direct or
indirect, or fixed or variable costs).
The use of throughput accounting has also given rise to the adoption of a specific
accounting ratio known as the throughput ratio (the TA ratio). Before we deal
with the TA ratio it would be helpful first outline the circumstances which have
brought about throughput accounting.
During the 1980s many companies throughout the world (especially in North
America and Japan) began to re-examine their production processes in an attempt
to maintain and increase their profitability. It was realised that the traditional
approach to manufacturing was to determine production requirements on
estimated demand, i.e. based on the budgeted sales, a certain level of activity
during the budget period would be required to be achieved by the production
process.
4/32
This level of activity was then reported to production managers and each cost
centre manager was expected to achieve it. However, basing specific activities
throughout the factory on a budgeted sales could cause problems because
experience indicated that various constraints would always occur in the factory.
Such constraints are known as bottlenecks, and these constraints cause work in
progress to build up in some cost centres with the result that subsequent
operations or processes cannot cope with the inputs being fed to them. We will
illustrate the point with an example (see also Figure 4.9). Two cost centres (A
and B) supply parts to a third cost centre (C). C does not have the capacity to deal
with all the parts being supplied by A and B because its total machine hours
available are restricted. Nonetheless, A and B continue to make parts, and they
then have to store those parts which C cannot cope with. Such parts are recorded
as work in progress.
600 PROCESS 200 UNITS

UNITS A
100 COMPLETED
WORK IN PROGRESS ASSEMBLY
(400 UNITS)
UNITS (MAXIMUM)
200 PROCESS 100 UNITS

UNITS B
WORK IN PROGRESS
(100 UNITS)
Constraints:
Assembly’s maximum production is 100 units.
Assembly requires two units from process A for every one from process B.
Figure 4.9 The effect of a bottleneck
A and B continue to manufacture parts even if they are only for stock, partly
because the employees are not paid to be idle, and partly because their
performance is measured on what they produce. No one worries, therefore, that
many of the parts that they are making are not sold: it is sufficient for A and B to
be seen to be making them. But what is the point if they are not being sold? The
answer to this question is ‘not much’ but it is only recently that the question has
been seriously addressed. Hence the development of a ‘throughput’ approach.
The identification of manufacturing bottlenecks, and the attempts made to

eliminate them is referred to as the theory of constraints
4/33
(TOC). The theory suggests that there is no point in manufacturing for stock if
there are bottlenecks somewhere within the system. Cost centres should only
manufacture the number of units that a particular bottleneck can accommodate.
This means that some cost centres may remain idle until the bottleneck is
eliminated. There should, of course, always be a constant and detailed
investigation into identifying poten-tial bottlenecks with the intention of
eliminating them immediately (perhaps by purchasing an extra machine), but in
the meantime the bottleneck activity would determine the activity level. In other
words, a bottleneck is similar to a limiting (or key factor) that you will have
come across in your marginal costing studies in Stage 1. Apart from the
throughput accounting report, there is also another close similar-ity between
marginal costing and TA. Just as with marginal costing when there is a limiting
factor, (i.e. you would choose that unit which produces the maximum
contribution per unit of limiting factor), so a similar exercise is carried out in TA.
The exercise involves calculating what we referred to earlier as the TA ratio. The
basic idea is very simple. In order to increase profitability, throughput theory
indicates that raw materials should be turned into sales as efficiently and
effectively as possible. Stock (of what ever type) is a drain on the organisation’s
resources, and the amount must be minimised. The TA ratio helps to emphasise
the importance of throughput. It is calculated as follows:
Return per factory hour

Throughput accounting (TA) ratio =
Cost per factory hour
The return per factory hour is calculated by dividing the throughput contribution
per unit made by a bottleneck activity (i.e. the sales revenue less the direct
material cost) for every hour that it spends in the bottleneck area. The cost per
factory hour is obtained by dividing the total factory cost (which does not include
direct materials) by the total hours available in the bottleneck area. Exhibit 4.5
shows how the ratio is calculated.
Exhibit 4.5: Calculation of a Throughput Accounting Ratio
In a particular production process, Machine K2 has proved to be a bottleneck as it

has a maximum capacity of 1000 hours per period. The total factory cost
(excluding direct materials) for a particular period is £6000. K requires 3 machine
hours of K2. Its selling price is £36 per unit and the direct material cost is £9 per
unit.
Required:
Calculate the throughput accounting ratio.
4/34
Solution to Exhibit 4.5
Return per manufacturing hour =
Sales revenue less direct material cost £36 − 9

= = £9
K2 machine hours 3
Cost per factory hour =
Total factory cost £6000

= = £6
Total K2 machine time available 1000
TA ratio =
Return per factory hour £9

= = £1.5
Cost per factory hour 6
Tutorial notes
The exhibit shows only one unit (K). However, the K2’s TA ratio would be
compared with the TA ratio for other units, and production would then be
concentrated on those units that had the highest TA ratios. This again illustrates
the point that TA is very similar to the calculation of limiting factors in traditional
marginal costing. The only real difference is that in calculating ‘contribution’, TA
restricts the definition of variable cost to direct materials only, whereas all variable
costs are included in marginal costing.
The useful of TA clearly depends on the acceptance of ‘throughput’ as a practical

concept in the manufacturing processing. There is no doubt that holding high
levels of stock can be extremely expensive, and that it would appear sensible for
a company to minimise its stock levels. JIT procedures rely on stock being
supplied of the right quality and quantity just when it is needed in production.
The emphasis on turning stock into immediate sales complements those
procedures. However, the theory of constraints with its emphasis on maximising
production on the capacity of identified bottlenecks does require a fundamental
change in approach and attitude. Most managers are not programmed into
believing that in certain circumstances, ‘idle time’ is acceptable because their
basic training has been to ensure its elimination.
It remains to be seen, therefore, whether the theory of constraints becomes much

more widely accepted in practice. If it does, then the accountant’s traditional
approach to costing may also need a funda-mental shift in emphasis.
4.9 Summary
In this chapter, we have outlined a system for stock control. In the first part of the
chapter we have emphasised that the control of such a system primarily depends
upon personnel being authorised to carry out certain functions, and the recording
of any action or decision that
4/35
they take. In the second part of the chapter, we have dealt with the complex
problem of attaching a price to goods transferred to production (or other
services). This is a most important task for the accountant, and it links with the
overall problem of building up the total cost of a job or a process.
We have also reviewed some changes that are taking place in produc-tion
processes, such as just-in-time procedures and the emphasis on throughput. When
JIT is applied to stocks, the control and pricing of them become much less
significant. Similarly, the concept of through-put requires changes to traditional
management accounting practices. The changes required are at an early stage of
development, but inter-esting possibilities are backflush costing and throughput
accounting. As yet, however, these two developments have not yet been widely
incorporated into practice.
In the next four chapters, we turn to some traditional costing tech-niques. In

Chapter 5 we take a more general look at what accountants call absorption
costing, while in Chapter 6, 7 and 8 we examine some costing methods that relate
to specific industries and organisations.
Self-test Questions
What are the three main objectives of stock control?
List five main stages in the material control process
What is a purchase order?
What is a goods received note?
What purpose does a bin card serve?
What is a stock record card?
What main columns would you expect to find in a stores ledger account?
List three main advantages and three main disadvantages of a centralised

storekeeping system.
What is a materials requisition note?
What are the formulae for each of the following stock control statistical
techniques: (1) reorder level; (2) minimum level; (3) economic order quantity;
(4) maximum level?
What five main assumptions are adopted in using the economic order
quantity formula (EOQ)?
What is a perpetual inventory system?
4/36
What benefits are to be obtained by adopting a continuous stocktaking

system?
List ten material pricing methods.
Which three material pricing methods are generally acceptable?
What is the impact of profit during inflationary conditions of using a stock

pricing method that (a) reflects economic conditions: and (b) is based on
historical conditions?
Describe briefly the impact of just-in-time procedures on stock control.
What is backflush accounting?
Assess the impact of the theory of constraints on accounting practice.
Describe what is meant by the throughput accounting ratio.
Tutorial Questions
4.1 Outline the main requirements of an effective and efficient stock control
system.
4.2 ‘In order to achieve the maximum control over stock it is essential to have a
centralised store system.’ Discuss.
4.3 Assess the relevance and importance of backflush costing.
4.4 It has been suggested that throughput accounting is just a fashionable

devised by accountants to keep them employed. How far do you agree with
this assertion?
4.5 You are presented with the following stock data for April 19X4 relating to raw
material K2 which Colley Ltd uses in its manufacturing process:
Maximum usage: 1600 kg per day
Minimum usage: 400 kg per day
Average usage: 1200 kg per day
Annual demand: 250 000 kg
Cost of placing an order: £600
Lead time: 20 to 24 days
Holding cost per kg: £2
Required:
Calculate the reorder level, the minimum stock level, the economic order
quantity, and the maximum stock level of K2; and
state what problems there are in determining the economic order

quantity.
4/37
4.6 The following information relates to the acquisition and issue of material TRG1
by Manon Ltd, a small manufacturing company, for the three months to 31
March 19X4:
Date Purchases Price per kg Issues
kg £ kg
6.1.X4 1000 30
20.1.X4 2000 40
31.1.X4 1500
12.2.X4 4000 45
7.3.X4 4500
25.3.X4 1000 50
31.3.X4 500
Note: There were 500 kg of TRG1 in stock at 1 January 19X4 which had
been purchased at £35 per kg.
Required:
Calculate the closing stock value of TRG1 at 31 March 19X4 using each
of the following material pricing methods:
first-in, first out (FIFO);
last-in, first-out (LIFO);
cumulative weighted average (CWA);
periodic simple average (CSA); and
periodic weighted average (PWA).
examine the effect on gross profit of using the above pricing methods
during a period when prices are rising.
Further Reading
The texts that are referred to in the following section contain material which will
not be examined. The intention in providing the list is to enable students who
wish to pursue any area of the course for their own purposes to do so.
Foster, G. and C.T. Horngren (1988), ‘Cost accounting and cost

management in a JIT environment’, Journal of Cost Management for the
Manufacturing Industry, Winter, pp. 4−14.
Galloway, D. and D. Waldron (1988 and 1989), ‘Throughput accounting −
The need for a new language for manufacturing’, Management Accounting
(UK), Vol. 66, No. 10, November, pp. 34−35; Vol. 66, No.11, December
1988, pp. 34−35; Vol.67, No.1, January 1989, pp. 32−33; Vol. 67, No.2,
February 1989, 41.
Goldratt, E.M. and J. Cox (1993), The Goal, 2nd edit. Aldershot: Gower.
4/38
Horngren, C.T., G. Foster and S.M. Datar (1997), Cost Accounting A

Managerial Emphasis, Chapters 19 , 20 and 21. Upper Saddle River:
Prentice−Hall.
Tanaka, M., T. Yoshikawa, J. Innes, and F Mitchell (1993), Con-temporary
Cost Management, Chapter 10. London: Chapman & Hall.
Appendix 1
ANSWERS TO TUTORIAL QUESTIONS
Chapter 4
4.1 Many companies, especially manufacturing companies, invest heavily in raw
materials and other stocks, and these may form a high proportion of their
total costs. Hence if there is little control over stocks, there is a danger that
duplicate and unnecessary expensive purchases may be made, stocks may
deteriorate or dis-appear, and too much (or two little) stock may be held in
store. All of these factors may result in a company investing wastefully in a
key element of its cost. A rigid stock control system is vital, therefore, and it
will range from physical control to documentary control. It is convenient to
discuss these two aspects of control under a number of headings.
Authorisation
A system of responsibility accounting is recommended whereby managers
are given specific responsibility for activities within
Appendix 1 / Answers to Tutorial Questions
clearly designated boundaries. In a relatively large organisation, this almost

certainly means that there will be a separate purchas-ing department, a
separate receipt of goods department, a sepa-rate stores department, and
separate production and administrative units. This means that unless the
authorisation to purchase goods is strictly limited, scores of managers may
have the authority to order goods. If an organisation has a purchasing
department, all purchasing requests should be routed through that
department, and each request would be put in writing. A separate purchas-
ing function not only helps to achieve greater control, but it allows experts to
specialise in different aspects of purchasing. This means that experts can
drive harder bargains both in terms of price and quality.
Once a request has been made to purchase some goods (and assuming that
they are not in store or already on order), the pur-chasing department will
select and place an order with a suitable supplier, once again in writing.
Receipts of goods
The organisation would expect a supplier to deliver the order on time. When
the goods arrive, they should be physically inspected and checked against a
copy of the purchase order and a goods received note. Thereafter they can
then be transferred to stores.
Physical control
After the receipt and inspection stage the goods should be trans-ferred to a
safe and secure environment, i.e. an environment where the goods will not
deteriorate and where unauthorised appropri-ations cannot be made. This
may mean keeping all goods in a centralised store, although this is not
always practical in a large and diversified organisation. After being
inspected once again before being stored, the goods should be checked
against a copy of the purchase order and the goods received note. They will
then be transferred to a part of the stores set aside for those types of goods. A
record of the type and quantity may be made on a bin card (or its equivalent)
although sometimes all the details are only kept in the stores ledger. The
stores ledger will also include the value of the goods
Goods should only be issued to production or other departments upon the

receipt of a materials requisition, the amount issued then being entered on
the bin card and in the stores ledger along with the value (using an
appropriate pricing method).
At regular intervals (i.e. at least once a year) a physical stock check should
be made in the stores, and the physical quantities checked against the
documentary records. In some cases, the job may be too big to do all at once,
so the stock check may be done on a continuous sectional basis so that by
the end of the financial year all sections have been checked at least once.
Any discrepancies between the physical check and the documentary records
would
A1/32
need to be investigated. If there is no obvious reason why there was a

discrepancy, the entire documentary and physical control procedures would
need to be re-examined in order to establish where there are possible weak
links.
Whether a system is effective (i.e. the extent to which it achieves its goals)
will depend, of course, on what the goals are. Almost certainly they will be
framed round a desire ‘to provide the right type of goods at the time that they
are wanted at the cheapest possible price and at the lowest minimum cost’.
Efficiency will be measured by what cost is put into the system for what is
got out of it. Thus it would be possible, for example, to keep large amounts
of stock in store so that the production units were never kept waiting for
supplies. Keeping large amounts of goods in store can be expensive,
however, so that cost has to be balances against the cost of much more
frequent ordering with the possibility that there could be a delay in receiving
some vital supplies.
In summary, the costs of controlling stock (which may be very high) have to
balanced against the benefits of having a well controlled system.. In some
circumstances this could mean that control is relaxed, e.g. some production
managers may be allowed to place minor orders because otherwise the
system becomes too bureau-cratic and expensive to operate.
4.2 In theory a centralised store keeping system should help to achieve maximum
control over the receipt and issue of goods into and out of store. The more
people that are involved in such activity, the greater the chance that
something will go wrong. However, it may not always be practicable
(especially in geographically dispersed organisations) to operate a central
stores system. Nonetheless, a number of advantages and disadvantages of
having such a sys-tem can be identified and these have to be balanced in
order to determine what is best for a particular organisation. The various
advantages and disadvantages may be summarised as follows:
Advantages
Less investment. As a result of scale benefits, fewer resources may need
to be invested in building, plant and machinery and personnel, any
surplus released then perhaps being able to be invested in more
sophisticated equipment.
Reduced bureaucracy. Communication between personnel is easier if
they are located on one site.
Lower stocks. A lower level of total stock may be needed, and the
duplication of stock items is avoided.
Specialisation. Staff can specialise in the various types of goods and
they can become experts in the suitability of them for various purposes.
Control. It is much easier to control the physical security of stock if they

are located centrally.The same point applies to staff activities.
A1/33
Stock taking. This is much easier to organise and control where there is
only one store.
Disadvantages
Site difficulties. If the organisation operates on several sites, a
centralised store-keeping system can be very inconvenient. Delays may
occur in servicing the various sites, and a general break down in
communications is not unknown.
Local knowledge. Stores that operate in different geographical areas can
recognise much more easily the requirements of local managers, and
staff may be able to specialise much more in what is needed by
personnel with whom they are in close contact.
Transport costs Greater transport costs may be involved in delivering

goods to a central store and then having to issue them to distant sites.
The decision to centralise or decentralise the store keeping func-tion is a

balance between the respective costs and benefits, and these will clearly vary
for different organisations.
4.3 In recent years various new production methods have gained favour in
industry, among them, just-in-time (JIT) procedures. The basic idea of JIT is
that goods should only be produced when they are wanted by customers, and
there is no need to produce goods that are just going to go into stores. It
follows from this concept that it is possible to adopt JIT procedures for
stock: stock will only be ordered when it is needed for production. Indeed, in
theory it would only be ordered and delivered straight into production at the
precise time that it was required. Hence, once again, there would be no need
to keep any goods in stock.
JIT procedures have encouraged some accountants to argue that the old
method of costing the production of goods needs to be replaced by a costing
system that recognises new production and processing procedures. One new
method that has been suggested is that of backflush accounting. The idea is
that goods would only be costed when they are actually transferred to
finished stock. They would not, therefore, have costs attached to them as
they proceed through the production process. It follows that there would be
no need to value work in progress. The total cost of finished goods would be
exactly the same as it would be if traditional methods of costing were
adopted. However, the system would be somewhat simplified. A customer
would place an order (there would be no question of delivering it from
stock), it would be manufactured, it would be transferred to finished goods,
and only at that point would it be costed (although the proponents of
backflush costing accept that there are different trigger points when it may
be costed).
There is much to be said for this form of costing provided that it supports a
JIT system. That system may not always work in
A1/34
practice, because it depends upon customers being prepared to wait while

their order is processed, although there are at present many instances of
where customers expect to place an order and to have to wait for completion,
e.g. in custom tailoring. This means that it can be identified and costed
separately, and that may mean that the costs attached to it are more accurate.
There is also a clear advantage in not having resources tied up in work in
progress, and the difficult problem of having to cost it at the year end.
The difficulty for many organisations is that they cannot operate on an order
system and have to produce for stock, thereby requiring the value of work in
progress to be estimated. Nonetheless, the idea of only producing to order is
attractive and if it becomes more wide-spread then costing methods will
have to be adapted to suit new manufacturing systems.
4.4 Throughput accounting is a new branch of accounting which like backflush

accounting has been developed as a result of the intro-duction of just-in-time
procedures. The emphasis on throughput accounting is to draw attention to
the contribution made to turn-ing raw materials into sales as quickly as
possible. Hence reports would be prepared for management which show
throughput con-tribution, i.e. sales revenues less direct material costs. This
is very similar to the approach adopted in marginal costing, except that the
total variable cost is deducted from the sales revenue instead of just direct
material cost.
Throughput accounting avoids the problem inherent in marginal costing of

having to analyse total cost between fixed and variable costs. In throughput
costing the remaining costs are deducted from the throughput contribution
and while these may be analysed into their various elements, the distinction
is not particularly important. The technique is, therefore, very easy to adopt
and to understand, and it does emphasise the importance of turning round
raw mat-erials as fast as possible in order to increase the contribution and
hence profit. Other costs, of course, will still need to be controlled, and there
is a danger that not enough attention will be given to them if too much
emphasis is placed on the throughput contribu-tion and the throughput ratio.
The throughput ratio is a measure of the sales return per factory hour after
deducting direct material costs in relation to the factory cost per hour, i.e.
the contribution made towards direct labour and all other factory costs apart
from direct materials.
The statement in the question is highly provocative. The main role of a

management accountant is to provide a service to man-agement. If that
service is not required then the role becomes redundant. However, given that
management accountants play a useful part in assisting managers to operate
more effectively and efficiently, they have a duty in a rapidly changing
world to adapt their techniques to suit new circumstances. Thus costing
methods that were devised to suit industrial conditions in Victorian time,
A1/35
are not necessarily appropriate in high technology industries of the 21st

century. Such methods need to be adapted and to be changed.
This might have the accidental benefit that it helps to secure the employment
of accountants, but if the costs of doing so outweigh the benefits, senior
management will soon dispense with their services.
4.5 Colley Limited

(a) Reorder level
Maximum usage × maximum lead time = 1 600 kg × 24 days = 38 400 kg
Minimum level
Reorder level − average usage in the average lead time

38 400 − (1 200 × 22†)
38 400 − 26 400
12 000 kg
†(20 + 24)/2 = 22
Economic order quantity
2CoD = 2 × 600 × 250 000 = 12 250 kg

Ch 2
Maximum level
Reorder level + Reorder quantity (EOQ) − minimum usage

in minimum lead time = 38 400 + 12 250 − (400 kg × 20 days) = 42 650 kg
The following problems arise in determining the economic order

quantity:
1 It is not easy to estimate the cost of placing an order.
2 It is also difficult to estimate the holding cost of a particular item
3 The holding cost may not always be constant.

4 Safety stocks are ignored, and it cannot always be assumed that they
will remain at the same level irrespective of the order quantity
5 The formula assumes that the average balance of stock will be equal to
one half of the order quantity.
6 The demand for the stock may be difficult to establish 7 Orders
are sometimes received in batches.
Highlighting these problems helps to make the point that the EOQ
formula is only meant to be a guide to decision-making, and it should
not be applied mechanistically.
A1/36
4.6 Manon Limited

1
First-in, first-out
Calculation of closing stock amount:
Kg
Opening stock 500
Receipts (1 000 + 2 000 + 4 000 + 1 000) 8 000
8 500
Issues (1 500 + 4 500 + 500) 6 500
Closing stock 2 000
(1 000 kg × £45) = 45 000 + 50 000(1 000 kg × £50)

Total = £95 000
Last-in, first-out
(500 × £50) = 25 000 + 30 000(1 000 kg × £30) + 17 500(500 kg × £35)

total = £72 500
Cumulative weighted average

Date Quantity Cumulative Value Cumulative value Weighted
quantity average
price per kg
kg kg £ £ £
1.1.X4 500 500 17 500 17 500 35.00
6.1.X4 1 000 1 500 30 000 47 500 31.67
20.1.X4 2 000 3 500 80 000 127 500 36.43
31.1.X4 (1 500) 2 000 (54 645) 72 855 36.43
12.2.X4 4 000 6 000 180 000 252 855 42.14
7.3.X4 (4 500) 1 500 (189 630) 63 225 42.15
25.3.X4 1 000 2 500 50 000 113 225 45.29
31.3.X4 (500) 2 000 (22 645) 90 580 45.29
Periodic simple average
Average price = £35 + 30 + 40 + 45 + 50 = £200 /5 = £40 × issues of 6 500 = £260 000
Closing stock = £357 500 − 260 000 = £97 500
A1/37
Periodic weighted average

Receipts Price per kg Value
kg £ £
1.1.X4 500 35.00 17 500

6.1.X4 1 000 30.00 30 000
20.1.X4 2 000 40.00 80 000
31.1.X4
12.2.X4 4 000 45.00 180 000
7.3.X4
25.3.X4 1 000 50.00 50 000
31.3.X4
8 500 200.00 357 500
Opening stock value + total value of receipts

= £357 500/8 500 = £42.06
Opening stock units + total unit receipts
Issues = 6 500 × £42.06 = £273 390
Closing stock = Opening stock + receipts

= £357 500 less issues of 273 390 = £84 110
In order to illustrate the impact of FIFO and LIFO on profit assume that
sales for the quarter to 31 March 19X4 were £400 000.
Trading account for the quarter to 31 March 19X4

FIFO LIFO CWA PSA PWA
£ £ £ £ £
Sales 400 000 400 000 400 000 400 000 400 000
Less: cost of
goods sold
Opening stock 17 500 17 500 17 500 17 500 17 500
Purchases 340 000 340 000 340 000 340 000 340 000
357 500 357 500 357 500 357 500 357 500
Less: closing 95 000 72 500 90 580 97 500 84 110
stock
262 500 285 000 266 920 260 000 273 390
Gross profit 137 500 115 000 133 080 140 000 126 610
Using the data given in the first part of the question the above table
shows quite clearly that by using FIFO during a time of rising prices,
there is a higher amount of gross profit than by using LIFO. This is
because FIFO values closing stock at
A1/38
prices which during a period of inflation would normally be less than

current prices. A higher closing stock value means the opening stock
plus purchases is reduced by a larger amount thus creating a larger gap
between sales revenue and the cost of sales.
As LIFO values issues to production at levels that are closer to current

economic circumstances, the closing stock is valued at older and in
times of inflation cheaper prices. Hence the deduction of the closing
stock value from the total of opening stock plus purchases results in a
higher amount. This means that by using LIFO, the gap between sales
revenue and the cost of goods sold is narrower than is the case with
FIFO, thereby resulting in a lower gross profit.
In times of deflation, of course, the opposite applies: FIFO results in a

lower gross profit and LIFO in a higher one.
As might be expected, the CWA method results in a gross profit
somewhere between that obtained by using FIFO and LIFO, although in
this exhibit the CWA gross profit is much closer to FIFO. The PSA
gross profit is in excess of that obtained by using FIFO, while the PWA
results in a gross profit that is almost exactly half-way between FIFO
and LIFO.

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Ch 4 – 8th week

Tim Dosen FEB -2020

plus a share of production and non-production overhead. Direct costs consist of

After studying this chapter you should be able to:

explain the nature and importance of materials in cost determination

4.1 Stage 1 studies

Refer to your Stage 1 manual (Introduction to Management Accounting). Read

4.3 Controlling stock

DEPARTMENTAL STORES STOCK PRODUCTION

Figure 4.1 The main stages of material control

the issuing of goods to production; and (6) the accounting procedures. In

4.3.2 The ordering procedure

An order may be initiated by a particular department or cost centre requisitioning

JOB REQUIRED FOR: NO:

QUANTITY DESCRIPTION CODE NO. WEIGHT RATE (£) NOTES

BIN NO. REQUISITIONED BY:

Figure 4.2 Material requisition note

A materials requisition form authorises the stores manager to issue materials to

A purchase requisition may also be initiated by the production con-troller (a

QUANTITY CODE DESCRIPTION STOCK CODE PURCHASE SUPPLIER

REQUISITIONED BY: AUTHORISED SIGNATURE:

LATEST DATE REQUIRED: APPROVED BY:

Figure 4.3 Purchase requisition note

4.3.3 The purchasing procedure

OUR REF: DATE:

PARTICULARS PRICE PER DELIVERY

TERMS: FOR ........................ LTD

Figure 4.4 Purchase order

4.3.4 The receiving procedure

4.3.5 The stores procedure

GOODS RECEIVED NOTE

CARRIER: RECEIVED BY: GOODS INSPECTION REPORT:

PURCHASE PROGRESS BIN NO.: STORES INVOICE ACCOUNT

Figure 4.5 Goods received note

DESCRIPTION: BIN NO:

LOCATION: CODE NO:

RECEIPTS ISSUES STOCK

Figure 4.6 Bin card

STOCK RECORD CARD

CODE: MAXIMUM LEVEL:

RECEIPTS ISSUES Physical ALLOCATIONS ORDERS FREE

Figure 4.7 Stock record card

RECEIPTS ISSUES STOCK

Figure 4.8 Example of a folio in a stores ledger

4.3.6 The accounting procedure

4.4 The stores function

In this section we examine some of these features in a little more detail.

4.4.2 Stores organisation

time-consuming to operate from just one central store. In such cir-cumstances, it

Nonetheless, centralised store-keeping has a number of advantages.

Advantages of adopting a centralised store-keeping system

While there are considerable advantages in operating a centralised store keeping

Disadvantages of a centralised store keeping system

4.4.3 Stock levels and statistical techniques

knowledge and experience, or it may be triggered by the adoption of a number of

4.4.3.1 Reorder level

Maximum usage × maximum lead time

4.4.3.2 Minimum level

Reorder level − average usage in the average lead time

4.4.3.3 Economic order quantity

Order costs and stock holding costs are constant.

4.4.3.4 Maximum level

Reorder level + reorder quantity − (minimum usage × minimum lead time)