Cost Accounting: Materials: Controlling, Costing, and Planning

Cost Accounting
Chapter 9
Materials: Controlling, Costing,
and Planning
Learning Objectives
1. Describe a system of materials procurement and use.
2. Identify the components of the cost of acquiring
materials.
3. Define and calculate economic order quantity.
4. Define and calculate the order point.
5. Define and calculate safety stock.
6. Describe the ABC plan for inventory control.
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whole or in part. 2
Learning Objectives
7. Describe a just-in-time (JIT) production system and
contrast it with traditional production.
8. State the potential effect of JIT on production losses.
9. Describe JIT’s effects on the purchasing function.
10. Inventory Costing Methods under International
Financial Reporting Standard (IFRS)
whole or in part. 3
9-1 Materials Procurement and Use
• The procurement and use of materials usually involve
the following steps:
1. Establishes the bill of materials
2. The production budget provides the master plan from
which details concerning materials requirements are
developed.
3. The purchase requisition informs the purchasing agent
of the quantity and kind of materials needed.
4. The purchase order contracts for quantities to be
delivered.
whole or in part. 4
• The procurement and use of materials usually involve
the following steps:
5. The receiving report certifies quantities received and
may report results of inspection and quality testing.
6. The materials requisition authorizes the storeroom or
warehouse to deliver specified types and quantities of
materials to a given department at a specified time.
7. The materials record cards record each receipt and
issuance of each kind of material and serve as perpetual
inventory records.
whole or in part. 5
• Purchase of Materials
– Purchasing procedures should be in writing, to fix
responsibility and to provide information regarding the
ultimate use of materials ordered.
– The purchasing department
(1) receives purchase requisitions for materials, supplies, and
equipment.
(2) keeps informed concerning sources of supply, prices, and
shipping and delivery schedules.
(3) prepares and places purchase orders.
(4) arranges for reporting among the purchasing, receiving, and
accounting departments.
whole or in part. 6
• Purchase of Materials
– Invoice approval by the purchasing department has the
advantage of centralizing the approval of invoices in the
department.
– Invoice approval by the purchasing department lessens
internal control.
whole or in part. 7
• Purchase of Supplies, Services, and Repairs
– The steps followed in purchasing materials can apply to all
departments and divisions of a business.
whole or in part. 8
• Purchasing Forms
– Purchase Requisition
– Purchase Order
– Electronic Data Interchange
whole or in part. 9
• Receiving
(1) unloads and unpacks incoming materials
(2) compares quantities received with the shipper’s packing list
(3) matches materials received with descriptions on purchase
orders
(4) prepares receiving reports
(5) notifies the purchasing department of discovered
discrepancies
(6) arranges for inspection when necessary
(7) notifies the traffic department and the purchasing
department of any damage in transit
(8) routes accepted materials to the appropriate location
whole or in part. 10
• Receiving
– The receiving report is distributed as follows:
(1) the receiving department keeps one copy and sends
another to the purchasing department as notice of the
materials’ arrival.
(2) all other copies go to the inspection department and are
distributed after inspection. one copy is sent to the
accounting department.
• Invoice Approval and Data Processing
– Invoice approval is important in materials control because
it verifies that the goods have been received as ordered and
that payment can be made.
– The invoice and a copy of the purchase order are filed in
the accounting department.
– The invoice clerk approves it and attaches it to the
purchase order and receiving report for preparation of a
voucher.
EXHIBIT 9-1 Effects of Purchase
Transactions on Accounts
• Cost of Acquiring Materials
– Purchases Discounts.
– Freight-In.
– Applied Acquisition Costs.
• Storage and Use of Materials
– The storekeeper is responsible for safeguarding materials,
placing them in bins or other spaces until needed, and
seeing that all materials taken from the storeroom are
properly requisitioned.
• Issuing and Costing Materials
– Materials Requisition. The materials requisition authorizes
the storekeeper to issue materials.
– Electronic Data Processing for Materials Requisitions.
– Bill of Materials. The bill of materials for a product is a
list of all materials necessary for a typical job or production
run.
• Materials Subsidiary Records
– The approved invoice goes to the materials clerk for entry
in the Received and Inventory sections of materials ledger
records.
– When the storekeeper issues materials, a copy of the
requisition is sent to the materials clerk, who enters the
date, requisition number, lot number, quantity, and cost of
the issued materials in the Issued section of the materials
record.
9-2 Quantitative Models
• Inventories serve as a cushion between production
and consumption of goods.
• Planning Materials Requirements
– Materials planning deals with two fundamental factors the
quantity and the time to purchase. Determination of how
much and when to buy involves two conflicting kinds of
cost—the cost of carrying inventory and the cost of
inadequate carrying.
• Planning Materials Requirements
• Economic Order Quantity
– The economic order quantity (EOQ) is the amount of
inventory ordered at one time that minimizes annual
inventory cost.
– The optimum quantity to order at a given time is
determined by balancing two factors:
(1) the cost of possessing (carrying) materials
(2) the cost of acquiring (ordering) materials.
– The costs of carrying inventory are often expressed as
percentages of the average inventory investment.
– They must be considered in determining order quantities
and order points. These costs include ordering costs.
– Ordering costs include preparing a purchase requisition,
purchase order, and receiving report; handling the
incoming shipment; communicating with the vendor; and
accounting for the shipment and payment.
– Given the terms EOQ, RU, CO, CU, and CC as specified,
the formula is based on the following relationships:
• Economic Order Quantit
– Quantity Discounts.
– Suppose the annual usage of an item is 3,600 units costing
$1 each, with no quantity discount available; the carrying
cost is 20 percent of the average inventory investment; and
the cost to place an order is $10. The EOQ is:
2  3, 600  $10 $72, 000
  360, 000  600 units
$1 20% $.20
25
• Economic Order Quantit
– Quantity Discounts.
• The EOQ Formula and Production Runs
– The EOQ Formula can be used to compute the optimum
size of a production run, in which case CO represents an
estimate of the setup cost, and CU represents the variable
manufacturing cost per unit.
• Determining the Time to Order
– The question is controlled by three factors:
(1) time needed for delivery
(2) rate of inventory usage
(3) safety stock
– To illustrate, assume a company uses an item for which it
places 10 orders per year, the cost of a stockout is $30, the
carrying cost is $.50 per year per unit, and the following
probabilities of a stockout have been estimated for various
levels of safety stock:
– The total carrying cost and stockout cost at each level of
safety stock are determined as follows:
– In this illustration, the optimum level of safety stock is 100

units, because the total stockout and safety stock carrying
cost is minimized at this level.
• Order Point Formula
I + QD = LTQ + SSQ
Where:
I = Inventory balance on hand
QD = Quantities due in (before depletion of I) from orders
previously placed, materials transfers, and returns to stock
LTQ = Lead time quantity, which equals normal lead time in
months, weeks, or days, multiplied by a normal month’s,
week’s or day’s use
SSQ = Safety stock quantity
– If the weekly usage of a stock item is 175 units, and the
lead time is normally four weeks, then the order point is
1,575 units: 700 units usage during normal lead time plus
875 units of safety stock
Figure 9-1 Rate of Usage Known with
Certainty and Lead Time Known but Variable
– If the usage rate is as high as 210 units per week, with lead
time normally four weeks but possibly as long as nine
weeks, then the safety stock is 1,190 units and the order
point 1,890 units
– Assuming a beginning inventory of 2,800 units with no
orders outstanding, the usage, order schedule, and
maximum inventory levels would be:
• Computer Simulation for Materials Requirements
Planning
– Materials requirements planning (MRP) is a computer
simulation for managing materials requirements based on
each product’s bill of materials, inventory status, and
process of manufacture.
9-3 Materials Control
• The control of materials must meet two opposing
needs:
(1) maintenance of an inventory of sufficient size and
diversity for efficient operations.
(2) maintenance of a financially favorable inventory.
• Effective inventory control should:
1. Provide a supply of required materials for efficient,
uninterrupted operations.
2. Provide ample stocks in periods of short supply (seasonal,
cyclical, or strike) and anticipate price changes.
3. Store materials with a minimum of handling time and cost
and protect them from loss by fire, theft, weather, and
damage through handling.
• Effective inventory control should:
4. Keep inactive, surplus, and obsolete items to a minimum
by reporting product changes that affect materials.
5. Assure adequate inventory for prompt delivery to
customers.
6. Maintain the amount of capital invested in inventories at a
level consistent with operating requirements and
management’s plans.
• Materials Control Methods
– The order cycling method or cycle review method
periodically examines the status of quantities of materials
on hand for each item or class.
– The min-max method premise that the quantities of most
stock items are subject to definable limits. A maximum
quantity for each item is established. A minimum level
provides the margin of safety necessary to prevent
stockouts during a reorder cycle.
– Under the two-bin method, each stock item is stored in
two bins, piles, or bundles. The first bin contains enough
stock to satisfy usage that occurs between receipt of an
order and the placing of the next order; the second bin
contains the normal amount used from order data to
delivery data plus the safety stock.
– Selective Control. Also called the ABC plan, the cost
significance of each item is evaluated.
9-4 Just-in-Time
• Just-in-Time (JIT) is a philosophy centered on the
reduction of costs through elimination of inventory.
All materials and components should arrive at a work
station when they are needed—no earlier and no later.
• Eliminates storage and carrying costs.
• Eliminates the cushion against production errors and
imbalances that inventories provide.
• High quality and balanced work loads are required.
9-4 Just-in-Time
• JIT principles are applicable in improving routine
housekeeping
• It is also useful in managing work in an office, a
service business, or a service department of a factory;
in reducing inventory requirements in a factory or
retail store; and in many other aspects of the
operation of a business.
9-4 Just-in-Time
• The most visible aspect of JIT is the effort to reduce
inventories of work in process and raw materials.
• stockless production
• lean production
• zero inventory production (ZIP)
9-4 Just-in-Time
• JIT seeks to reduce inventories because inventories as
wasteful.
• The objective of reducing inventory to zero, is
possible only under the following conditions:
1. Low or insignificant setup (or order) times and costs.
2. Lot sizes equal to one.
3. Minimum and almost instantaneous lead times.
4. Balanced and level work loads.
5. No interruptions due to stockouts, poor quality,
unscheduled equipment downtimes, engineering changes, or
other unplanned changes.
9-4 Just-in-Time
• The continuing reduction of inventories is achieved
by the following process:
1. Inventories are reduced until a problem (bump) is
discovered and identified.
2. Once the problem is defined, the inventory level is
increased to absorb the shock of this bump and to keep
the system operating smoothly.
3. The problem is analyzed and practical ways are
identified to reduce or remove the problem.
9-4 Just-in-Time
• The continuing reduction of inventories is achieved
by the following process:
4. Once the problem is reduced or removed, the inventory
level is reduced until another problem is discovered and
identified.
5. Steps 2 through 4 are repeated until the minimum
possible level of inventories is achieved.
9-4 Just-in-Time
• JIT and Velocity
– A strategic benefit of increased velocity is the reduced time
needed to fill production orders. When velocity is increased
tenfold, the average order is filled in one-tenth the time.
– Velocity improvement can be extended forward to finished goods
inventory and shipping.
– The intent of JIT is to reduce total cycle time.
– Reducing total cycle time means reducing cost and increasing
competitiveness.
– In addition to the effect on inventory carrying costs, a more
important result of a WIP reduction is its effect on production
losses.
9-4 Just-in-Time
• JIT and Production Losses
– At individual work stations in a production line, the impact
of WIP reduction is simple.
– This can have a dramatic effect on production losses.
– These potential advantages include the savings in setup
costs.
– The savings also include improvements in customer
satisfaction from quicker response to orders.
– The possibility that the faster cycle time might permit all
shipments to be made to order.
9-4 Just-in-Time
• JIT and Production Losses
– There are costs to be offset against the savings. These costs
include
(1) handling a larger number of smaller batches of WIP.
(2) the higher probability of shutdowns due to the smaller
safety stock at each work station.
(3) the possibility that setup costs cannot be reduced enough
to offset the larger number of setups performed.
– Many successful JIT implementations dramatically reduce
production losses and contribute to quality improvement.
The reduction of raw materials inventory can also yield
such similar advantages.
9-4 Just-in-Time
• JIT and Purchasing
– The JIT approach to purchasing emphasizes reducing the
number of suppliers and improving the quality of both the
materials and the procurement function.
– To move materials directly from the supplier to the plant
floor with little or no inspection.
– To eliminate storage except for brief periods directly on the
plant floor.
9-4 Just-in-Time
– A single vendor for each material is the ideal.
– A second vendor may be used to ensure sufficient supply in
periods of unusually high demand.
– The goal is long-term vendor relationships.
– Selecting and monitoring vendors requires a system of
vendor performance appraisal that quantitatively rates each
supplier on timely deliveries, quality of materials , and
competitiveness, rather than a subjective approach.
9-4 Just-in-Time
– Well-developed JIT purchasing uses blanket purchase
orders, which are agreements with vendors stating the total
quantities expected to be needed over a period of three or
six months.
– Received materials or their containers can have bar-coded
labels that are read by hand-held or built-in scanners on the
buyer’s assembly line, similar to the scanners at checkout
counters of many retail stores.
9-4 Just-in-Time
• JIT and Factory Organization
– Change from the traditional factory layout to cells or
work cells. A cell is responsible for the entire production
of one product or part, or a family of very similar ones.
– Every worker in the cell is trained to perform multiple
tasks, so labor is easily shifted to the point in the cell where
it is needed.
– Workers can be evaluated and rewarded as a team rather
than as individuals cooperation and self-policing of
problems.
– Other tasks that are normally considered indirect labor are
assigned to cell workers.
9-4 Just-in-Time
– If an entire factory is organized into JIT cells, the result is
the disappearance of not only the traditional producing
departments but most of the service departments as well.
Scheduling, receiving, materials handling,tool storage,
setup, maintenance, repair, in-process inspection, and
finished-goods inspection are all performed by cell labor
rather than by separate service departments.
9-4 Just-in-Time
– The effects of this arrangement on product quality can be
impressive.
– A high degree of empowerment is possible when a cell
team has autonomy over every production step from
receiving to final inspection and performs most of its own
support functions as well.
– A final impact of JIT on factory organization is in floor
space requirements.
9-4 Just-in-Time
• JIT—A Balanced View
– Most of its adopters embrace it only partially.
– Among the reasons are
(1) the time and effort required to convert many suppliers to a JIT
shipping pattern
(2) the difficulty of obtaining shipping at a cost low enough to
justify many small deliveries
(3) the likelihood of occasional shipping delays if suppliers are
hundreds of miles away
(4) the frustrating tendency for a low-cost, allegedly noncritical
part to become critical when it does not arrive on time and an important
customer’s order cannot be finished because there is no safety stock .
Appendix: Inventory Costing Methods
• The more common methods of costing are first in,
first out (fifo) and average cost. Other methods
include market price, last purchase price, and
standard cost.

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– In this illustration, the optimum level of safety stock is 100

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