Controlling and Costing Materials Inventory

Controlling and Costing Materials is the part of

materials management. Effective materials
management is essential in order to :
1. provide the best service to customers,
2. produce at maximum efficiency, and
3. manage inventories at predetermined levels
to stabilize investments in inventories.
Materials Management

The discussion of materials management deals

with:
• Procedures for materials procurement and use.
• Materials costing methods.
• Cost of materials in inventory at the end of a
period.
• Costing procedures for scrap, spoiled goods, and
defective work
• Summary of materials management
Procedures for Materials Procurement and
Use:
Procurement and use of materials usually involves the following
steps:
• Engineering and planning determine the design of the product, the
materials specifications, and the requirements at each stage of
operations. Engineering and planning not only determine  the
maximum and minimum quantities to run and the bill of materials
for given products and quantities but also cooperate in developing
standards where applicable.
• The production budget provides the master plan from which
details concerning materials requirements are eventually
developed.
• The purchase requisition informs the purchasing agent concerning
the quantity and type of materials needed.
 Procedures for Materials Procurement and
• Use
The purchase order contracts for appropriate quantities
to be delivered at specified dates to assure
uninterrupted operations.
• The receiving report certifies quantities received and
may report results of inspection and testing for quality.
• The materials requisition notifies the storeroom or
warehouse to deliver specified time or is the
authorization for the storeroom to issue material to
departments.
• The materials ledger cards record the receipt and the
issuance of each class of materials and provide a
perpetual inventory record.
 Procedures for Materials Procurement and
Use
• Accounting and controlling procedure involved in the
procurement and use of materials.
• To understand the detailed procedure of purchasing,
receiving stocking, and using materials need some link:
• Purchases of productive material.
• Purchases of supplies, services, and repairs.
• Materials purchasing forms.
• Receiving materials
• Cost of acquiring materials.
• Storage and use of materials.
• Issuing and costing materials into production.
• Materials ledger card--perpetual inventory
The material whose cost The material whose
can easily be cost can not be easily
to a particular unit of
identified to a unit of product is
identified
product is called direct called indirect cost. This is
material. Such as all raw not part of finished
material and all the
product but is necessary to
purchased parts of that manufacture it.
product.
 Materials Costing Methods
The ultimate objective in cost accounting is to produce
accurate and meaningful figures. These figures can be used
for purposes of control and analysis and eventually
matched against revenue produced in order to determine
net operating income.
The more common methods of costing materials issued
and inventories are:
• First-in-First-Out (FIFO) Costing Method
• Average Costing Method
• Last-in-First-Out (LIFO) Costing Method
• Other Methods-Month end average cost, last purchase
price or market price at date of issue, and standard cost.
It is an inventory costing method which
assumes that the first items placed
in inventory are the first consumed.
Inventory at the end of a year consists of the
goods most recently placed in inventory.
 It is simple to understand and easy to operate.
 Material cost charged to production represents actual cost.
 In the case of falling prices, the use of this method gives better
results.
 Closing stock of material will be represented very closely
at
current market price.
 It is a logical method because materials are issued in order
of purchases, so materials received first are utilized first.
 This method is useful when transactions are not too many and
prices of materials are fairly steady.
If the prices fluctuate frequently, this method
may lead to clerical error.
In case of fluctuations in prices of materials,
comparison between one job and the other job
becomes difficult.
For pricing rise, the issue price does not reflect
the market price as materials are issued from the
earliest consignments.
 Practice
Question.
ABC Co. has following data available

01-06-2011 Inventory 800 units@Rs.6/unit.

05-06-2011 Purchased 200 units@Rs.7/unit.
08-06-2011 Purchased 200 units@Rs.8/unit
10-06-2011 Issued 700 units to work in Process
11-06-2011 Issued 300 units to work in Process
 ABC Corporation.
Material Costing
ledger Balance
Date Description Quantity Amount Units Amount

01 June Opening balance 800@6/unit 4800 800 4800

05 June Purchases 200@7/unit 1400 1000 6200

08 June Purchases 200@8/unit 1600 1200 7800

10 June Issued 700@6/unit 4200 500 3600

11 June Issued 100@6/unit

2000 200 1600
200@7/unit
LIFO is an inventory costing method which
assumes that the last items placed in inventory
are first consumed during an accounting year.
Inventory at the end of a year consists of the
goods placed in inventory at the beginning of
the year.
 The cost of materials issued will be nearer to the current
market price.
 It enables us to match cost of production with current
sales revenues.
 The use of the method during the period of rising prices
does not reflect undue high profit in the income
statement.
 In the case of falling prices profit tends to rise due to
lower material cost.
 In the period of inflation LIFO will tend to show the
correct profit and thus avoid paying undue taxes to some
extent.
 Calculation under LIFO system becomes complicated
when frequent purchases are made at highly fluctuating
rates.
 Costs of different similar batches of production carried
on at the same time may differ.
 This method of valuation of material is not acceptable to
the income tax authorities.
 The stock in hand is valued at price which does not
reflect current market price.
 Closing stock will be understated or overstated in the
Balance Sheet.
 Practice
Question.
ABC Co. has following data available

01-06-2011 Purchased 100 units@Rs.5/unit

05-06-2011 Purchased 500 units@Rs.8/unit.
06-06-2011 Issued 200 units to work in Process
07-06-2011 Purchased 100 units@Rs.10/unit
08-06-2011 Issued 300 units to work in Process
 ABC Corporation.
Material Costing
Balance
ledger
Date Description Quantity Amount(Rs.) Units
Amount(Rs.)

01-June Purchases 100@Rs5/unit 500 100 500

05-June Purchases 500@Rs8/unit 4000 600 4500

06-June Issued 200@Rs8/unit 1600 400 2900

07-June Purchases 100@Rs10/unit 1000 500 3900

08-June Issued 100@Rs10/unit

200@Rs8/unit 2600 200 1300

Inventory costing method in which
material is issued at average cost is called
weighted average method.
 Practice
Question.
ABC Co. has following data available

01-06-2011 Purchased 100 units@Rs.5/unit

05-06-2011 Purchased 500 units@Rs.8/unit.
06-06-2011 Issued 200 units to work in Process
07-06-2011 Purchased 100 units@Rs.10/unit
08-06-2011 Issued 300 units to work in Process
 ABC Corporation.
Material Costing
ledger Balance
Date Description Quantity Amount(Rs.) Units Amount(Rs.)

01-June Purchases 100@Rs5/unit 500 100 500

05-June Purchases 500@Rs8/unit 4000 600 4500

06-June Issued 200@Rs7.5/unit 1500 400 3000

07-June Purchases 100@Rs10/unit 1000 500 4000

08-June Issued 300@Rs8/unit 2400 200 1600

Cost of Materials in Inventory at the End of a
Period:
When the cost basis is used in costing inventories
for financial statements and income tax returns, the
sum total of the materials ledger cards must agree
with the general ledger materials control account
which, in turn, is the materials inventory figure on
the balance sheet.
Cost of Materials in Inventory at the End of a
Period:
Costing materials issued is the method used for assigning
dollars to inventory.
• Inventory valuation at cost or market whichever is lower
American Institute of Certified Public Accountant
(AICPA) cost or market rules.
• Adjustments for departures from the costing method
used.
• Inventory pricing and interim financial reporting.
• Transfer of materials cost to finished productionPhysical
inventory
• Adjusting Materials Ledger Cards and Accounts to
Conform to Inventory Accounts
Costing procedures for scrap, spoiled goods, and
defective work:
Generally, manufacturing operations cannot escape the
occurrence of certain losses or output reduction due to
scrap, spoilage, or defective work management and the
entire personnel of an organization should cooperate to
reduce such losses to a minimum. As long as they occur,
however, they must be reported and controlled.
• Scrap and waste
• Spoiled goods
• Defective work
 Summary of Materials Management
Materials managers are constantly confronted with these
problems and requirements:
Inventories account for a large portion of the working
capital requirements of most businesses. This fact makes
materials or inventory management a major problem
requiring constant attention by all three management
levels (top, middle and low). At present, the problem of
materials management has become even more acute due
to market conditions and inflation.
 Summary of Materials Management

Effective materials management and materials control is

found in an organization in which individuals have been
vested with responsibility for, and authority over, the
various details of procuring, maintaining, and disposing off
inventory. Such a person or persons must have the ability
to obtain, coordinate, and evaluate the necessary facts and
to take actions when and where needed.