Cost Accounting Module 3 - Accounting FOR Materials PDF

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Cost Accounting Module 3 - Accounting FOR Materials Lecture Notes...

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MODULE 3 – ACCOUNTING FOR MATERIALS AE212: Cost Accounting And Control MATERIALS COST AND CONTROL Control of production cost refers to seeing to it that the different elements incurred, in total and per unit, are in accordance with plans and adopting prompt remedial measures in case there are deviations. Effective control of the elements of production cost maximizes manufacturing efficiency, reduces unit costs and enables management to attain desired inventory levels. The control of materials cost requires the use of estimates of materials, in total and per unit, like in a production budget; the use of forms for internal control like purchase requisition, purchase order, receiving report, materials requisition, materials ledger cards, returned materials report, scrap report and the like. Functions relating to materials may be divided into: a. Purchasing and Receiving b. Storing and Issuing c. Accounting and Valuation PURCHASING AND RECEIVING The procurement of materials is the job of the purchasing department usually headed by the purchasing agent. The purchasing department should first receive a purchase requisition usually from production department heads or supervisors that serves as an authority for procurement of a specified quantity and type of materials and/or supplies. The purchasing agent should have knowledge about the different sources of their materials and supplies and the corresponding purchase prices and terms to be able to choose the best company to deal with. PURCHASE REQUISITION The purchase requisition may originate from anyone of the following: 1. Materials custodian/warehouseman 2. Materials ledger clerk 3. Department head 4. Supervisor 5. Head of the engineering department The purchase requisition serves two purposes: [1] to notify the purchasing department that a need exists for materials; and [2] to fix responsibility for the purchase request. It usually contains information such as the quantity, description, and sometimes even the unit price of the materials being requisitioned. The purchase requisition is made at least in duplicate The duplicate copy remains with the requesting employee and the original copy is sent to the purchasing department which will serve as a basis or authority to make a purchase order.

PURCHASE ORDER The purchase order, usually signed by the purchasing agent, serves as a written authorization for the vendor/supplier to deliver the specified quantity and type of materials described therein at the designated time and place. In some cases, when purchase orders are made through other forms of communication such as by telephone, fax, email, etc., the purchase order is still sent to the supplier and serves as a confirmation and as a source document for the vendor as well as the purchasing company.

The Purchase Order is usually prepared in five (5) copies to be distributed as follows: 1. Vendor - As an authority to deliver the goods 2. Accounting department - To be used in verifying the vendor’s invoice preparatory to processing the voucher for the payment of the purchase 3. Materials ledger clerk - As a notification that the materials requested are on order 4. Receiving department - As authorization to accept an incoming delivery/ shipment 5. Purchasing dept - As file copy RECEIVING REPORT The receiving department’s function is to accept the deliveries of materials from the supplier, to unpack them, check on the actual quantities received compared with the vendor’s packing lists. It also compares the type and the quantities received with those specified in the purchase order to determine if there is any discrepancy. In this process, the receiving department will also be able to discover goods received that are damaged while in transit. The next step done by the receiving department is to make a receiving report. This form shows the purchase order number, the account number to be charged, the name of the supplier, details regarding the shipment, the quantity and the detailed description of the goods received. It may also provide space where the result of the inspection is written like when there are discrepancies noted such as when the quantity or the type of goods received are not those specified 1

in the purchase order. The quantity received maybe more or less than those ordered, or the nature and quality of those received are different from those specified in the purchase order. The receiving report is usually prepared in four (4) copies, one copy for each of the following: 1. Accounting dept - As notification that the materials ordered have been received 2. Purchasing dept - To supply information about the shipment which might be useful in evaluating the vendor’s performance in sending the materials on schedule 3. Materials dept - Where the receiving report will be checked against the quantities actually delivered to the storeroom 4. Receiving dept - As file copy

INVOICE APPROVAL AND VOUCHERING By the time materials reach the receiving department, the company usually will have received the invoice from the vendor. This invoice and a copy of the purchase order are filed in the accounting department. When the receiving report with its inspection report arrives, the receiving report and the invoice are compared to see that materials received meet purchase order specifications as to items, quantities, prices, price extensions, discount and credit terms, shipping instructions, and other possible conditions. If the invoice is found to be correct or has been adjusted because of rejects as noted in the inspection report, the invoice clerk approves it, attaches it to the purchase order and the receiving report, and sends these papers to another clerk for the preparation of the voucher. This comparison contributes to the effective internal control over materials, since the company avoids paying for materials it did not actually receive. The payment voucher prepared by the accounting department is sent to the treasurer / cash department, which issues check to the vendor. CORRECTING INVOICES When the purchase order, receiving report and invoices are compared, various adjustments or errors may be discovered. Errors normally encountered are the following: a. Some of the materials ordered are not received and are not entered on the invoice. In this case no adjustment is necessary, and the invoice may be approved for immediate payment. On the purchase order the invoice clerk will make a

notation of the quantity received in place of the quantity ordered. If the vendor is out of stock or otherwise unable to deliver specified merchandise, an immediate ordering from other sources may be necessary. b. Quantity received is less than what the invoice shows. In this situation, the shortage is noted and is deducted from the total invoice before payment is approved. A letter or a debit memo is sent to the vendor explaining the shortage is usually in order.

c. The vendor ships a quantity larger than called for on the purchase order. The purchaser may keep the entire shipment and add the excess to the invoice, if not already invoiced; or the excess may be returned or held, pending instructions from the seller. Some companies issue a supplementary purchase order or a credit memo that authorizes the invoice clerk to pay the overshipment. If the purchaser decides to return the excess, a Return Shipping Order (RSO) is prepared. The RSO is an authority to the receiving clerk to return the excess to the vendor. It is usually prepared in duplicate, the original sent to the vendor with the goods and the duplicate as file copy of the receiving department. d. Materials of a wrong size or quality, defective parts, and damaged items are received. If the items are returned, a correction on the invoice should be made before payment is approved. It may be advantageous to keep damaged or defective shipments if the seller makes adequate price concessions, or the items may be held subject to the seller’s instructions e. It may be convenient for a purchaser to pay transportation charges, even though delivered prices are quoted and purchases are not made on this basis (FOB Destination). The amount paid by the purchaser is deducted on the invoice, and the paid freight bill is attached to the invoice as evidence of payment.

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STORING AND ISSUING When materials have been transferred from the receiving department to the materials/stores department, responsibility shifts from the receiving clerk to the storeroom clerk/ storekeeper / warehouseman. Upon receipt of the materials, the storeroom clerk checks the materials with the accompanying receiving report. He then stores the materials in the places indicated by the inventory numbers shown in the receiving report. For better control, each bin, which is a compartment or shelf used as storage place, is provided with bin card / bin tag. BIN CARD A bin card usually shows quantities of each type of material received, issued, and on hand. They are not part of the accounting records as such, but they show the quantities on hand in the storeroom at all times and should agree with the quantities on the materials ledger cards in the accounting department.

Note: RR No. is Receiving Report number; MR No. is Materials Requisition number. Upon storing, the materials are recorded in the bin card by filling out the “Date” and “Received” columns. The “Balance” column is then adjusted for the quantity of materials received and the person storing should sign under the “Signature” column. MATERIALS REQUISITION Issuance of materials is covered by a Materials Requisition (MR) or Stores Requisition. It is a written order to the storekeeper / warehouseman / storeroom clerk to release materials and deliver to the requesting department. The person making the requisition may be a department head, a supervisor, a production control clerk, or a foreman. The form should clearly state the department or job to be charged and is accomplished in four (4) copies, distributed as follows: 1. Accounting dept To Materials Ledger Clerk – as basis for posting on the Materials Ledger Card under “Issued” 2. Accounting dept To the bookkeeper – as basis for recording the issuance of materials 3. Materials dept As authorization to release materials 4. Requesting dept As file copy The storekeeper takes the materials from the bins and records the issue on the bin card under “Issued” column. Upon issuance, he requires the requesting person / receiver to sign all copies of

the MR on the line “Received by and Date Received”. The “Unit Cost” and “Total Cost” columns are left blank by the storekeeper because these shall be filled up by the Materials Ledger Clerk.

Its preparation results in entries in the “Issued” sections of the materials ledger cards and in postings to the job order cost sheets, production reports, or the various expense analysis sheets for individual departments. The physical flow of direct materials from the storeroom to the production department is accounted for as a transfer of cost from Materials to the Work in Process. That is the reason why it is recorded in the cost department as a debit to Work in Process and a credit to Materials. Requisitions are not only used for direct materials issued to the factory. Requisitions are also used in issuing indirect materials or supplies. If the supplies are not used in the factory, supplies are charged to marketing or administrative expense accounts. If used in the factory, then they are charged to the Factory Overhead Control account. Therefore, issuance of such would require a journal entry debiting Factory Overhead Control and credit to Materials. Since more timely information is necessary for product costing and customer billing, requisitions are entered into the job cost sheets at a daily or weekly intervals. Also, because updated general ledger accounts are needed only periodically such as at the end of a month, quarter or a year, for purposes of preparing financial statements, the general journal entries can also be made periodically like monthly or quarterly in summary form. In companies using highly automated accounting system, individual requisitions are recorded electronically in the job cost sheets and in the related subsidiary records. In this way, the records are updated instantly. MATERIALS REQUISITION JOURNAL In as much as many requisitions are made every month, it would be impractical to make a journal entry for each. Instead, they may be summarized monthly so that only one journal entry is made each month for requisitions. Another alternative is the use of a special journal – the Materials Requisition Journal. It facilitates the posting to proper ledger control accounts. This journal is a form of materials summary. At the end 3

of the month, the totals of the various columns are posted directly to the ledger accounts, except for the Sundries column from which items are posted individually.

Materials handling costs, such as purchasing, receiving, unpacking, inspecting, insuring, storing, and general and cost accounting, may also form part of the materials cost. For simplicity, materials are commonly carried at the invoice price paid to the vendor, all acquisition costs are generally charged to factory overhead.

MATERIALS LEDGER CARD When perpetual inventory system is used, it is necessary to maintain a materials ledger card for each type of material. It is a kind of record showing the quantities and prices of materials received, issued, and on hand as of a given date. It is sometimes called the stock ledger card. It serves as a subsidiary ledger for the Materials or Raw Materials account in the general ledger.

RETURNED MATERIALS SLIP This form is used to accompany the return of excess materials to storeroom from production area. This happens when materials issued include allowances for spoilage or when the quantity of the production order is reduced after the materials have been issued.

The columns for cost and unit cost are not filled up. All the copies with the materials are brought to the storeroom. The storekeeper signs along the line “Received by” and thereafter stores the materials in their proper location. He makes the entry in the bin card. The 4th copy is given back to the department returning the materials. The 3rd copy is retained by the storekeeper while the 1st and 2nd copies are sent to the Materials Ledger Clerk for entry in the materials ledger card and the bookkeeper for recording purposes. The “Unit Cost” and “Total Cost” columns are left blank by the storekeeper because these shall be filled up by the Materials Ledger Clerk. ACCOUNTING AND VALUATION

The pro-forma journal entry to record the purchase of materials with terms for discounts is suggested for convenience. The procedure is to record the materials net of the discounts. This is to avoid the inconvenience of recomputing and adjusting the unit costs of the materials in the materials ledger card. Another advantage of the procedure is to call the attention of management for its failure to take advantage of the discounts through the use of the account Purchase Discount Lost if the account is paid beyond the discount period.

The purchase invoice received from the vendor provides base figures for determining the materials cost to be entered in the inventory records. This figure, however, is subject to adjustment. Accounting theory recognizes that charges, such as transportation and insurance, are proper additions to the cost of materials purchases. 4

The procedure suggested in recording freight costs incurred for material purchases treats the freight cost as an item of factory overhead. This approach requires making an estimate of the freight costs that maybe incurred for an accounting period and include it in the computation of the factory overhead rate to be applied to production. Advocates of this method justify it also for simplicity and convenience because the procedure would avoid the possibility of having too many decimal places for the unit costs of materials in the materials ledger card especially when the freight costs are considered insignificant or immaterial in amount. Based on this procedure, the freight in, therefore, is considered one of the costs controlled by the account title Factory Overhead Control. MATERIALS COSTING METHODS When materials are purchased, their quantity and actual costs are entered in the Received section of the materials ledger card. When materials are requisitioned for production, an entry is made under the Issued column of the materials ledger card. In the process of issuing materials for production, problem arises as to how much would be the cost to be assigned to the material issuances. There are different methods of costing materials issued for production. The most common methods are the following: 1. First in, first out method (FIFO)

by dividing the total cost of the materials available by the number of units on hand (in the “Balance” column of the materials ledger card). Issuances are recorded at this price until a new purchase/receipt changes the average cost. To illustrate the materials ledger card under the two (2) methods of costing materials issued, assume the following transactions: May 1 - Beginning balance 600 units at P30 3 - Received 150 units at P40 12 - Received 150 units at P50 14 - Issued 600 units 16 - Received 300 units at P60 22 - Issued 450 units 24 - Returned to storeroom 50 units of those issued on May 14 25 - Received 450 units at P70 30 - Returned to supplier 20 units purchased at P40 per unit 1. First-In, First-Out (FIFO) MATERIALS LEDGER CARD

2. Average cost method These methods relate to assumptions as to flow of costs. The physical flow of units may coincide with the method of cost flow, though such a condition is not a necessary requirement. Although this discussions deals with materials inventory, the same costing methods are also applicable to work in process and finished goods inventory. First-in, First-Out (FIFO). Under this method, cost follows the usual physical flow of the materials. Since the materials purchased first are ordinarily the first to be issued into production, the first or earliest cost recorded for a particular type of materials in its materials ledger card is the first cost taken out. After purchases at this price have been exhausted, units are priced at the latest costs when using FIFO. Proponents of FIFO argue that it is a logical method that produces a realistic valuation of materials inventory. Average Cost. Under this method, the cost is drawn from a common pool made up of several materials acquisition costs. Under moving average method, a new average cost is computed every time a new lot of materials is received and this average cost per unit shall be used to cost all issuances of materials made until another lot is purchased. It is computed

a) Returns to Storeroom. The same price when it was originally issued is used and shall be shown in the original position. b) Return to Supplier. The supplier is charged with the original acquisition cost. However, if the return is made when the “Balance” column of the materials ledger card no longer show the original cost, the entry in the materials ledger card will be the next available price and posted under the “Received” column in negative. The journal entry to record the return to supplier on May 30 is: Vouchers Payable (20 units x P40) 800 Factory Overhead Control (Inventory Adjustment) 400 Materials (20 units x P60) 1,200 c) Total of the Total cost in “Received” column represents the Total Purchases, in the “Issued” column it represents the Cost of Materials 5

Issued, and in the “Balance” column it represents the ending balance of Materials Inventory account. 2. Average Cost MATERIALS LEDGER CARD

a) Moving Average Cost per Unit (MACU) = Total Cost / Quantity = P24,000 / 750 units = P32.00 per unit b) Return to Storeroom is recorded at the original issue price, which is P35. Since the return to storeroom increases the balance, like when purchases are made, this gives rise to an adjustment of the average cost per unit. c) Return to Supplier. The entry in the materials ledger card will be th...