basics of material accounting. introduction to various concepts and calculations

1. MATEIRAL ACCOUNTING
By S Bhardwaj

2. ELEMENTS OF COST
 Material cost: Direct materials
 Labor cost: Direct labor cost
 Overheads: Indirect material cost, Indirect labor cost and
other overheads.

3. Material cost
 Material is the first and the most important element of
cost. In a manufacturing company, material cost is the
major component of cost. Even a minor change in the
material cost will spell disaster for a manufacturing
concern.Therefore the control of material cost becomes
very important.

4. Types of material
 Materials can be classified into four categories:
 Raw material: basic material supplied in crude form for
production
 Consumable stores such as lubricants, oil, cotton waste, etc
 Tools, pattern, maintanance materials like hammere, screws,
etc
 Components: items that are finished goods but are required
to manufacture another product, eg, typer, batteries, etc

5. Meaning of material control
 A system for checking that a company has enough
materials in stock for its production needs, but is not
storing more than it needs because this would use capital
unnecessarily a system for checking the quality of
materials bought by a company
 “Material control is a systematic control over purchasing,
storing and consumption of materials, so as to maintain a
regular and timely supply of materials, at the same time,
avoiding overstocking.”

6. Meaning of material control
 “Material control refers to the management function
concerned with acquisition, storage, handling and use of
materials so as to minimise wastage and losses, derive
maximum economy and establish responsibility for
various operations through physical checks, record
keeping, accounting and other devices. ”

7. Need/Objectives of Material Control
 To ensure uninterrupted supply of materials to the
production and service departments.
 To prevent overstocking and under stocking
 To ensure effective and economic use of the available
storage space and labor.
 To minimize the cost of storage.
 To identify and locate storage easily as to issue the
materials immediately

8. Need/Objectives of Material Control
 To maintain up to date stores records
 To facilitate stock taking.
 To reduce the risk of spoilage and obsolescence
 To reduce the misappropriation of materials.

9. Essentials of material control
 Materials Planning
 Materials Purchase/Receiving
 Storage
 Materials issue
 Materials Accounting

10. Materials Planning
 It includes:
 Centralized/ decentralized Purchasing
 Classification and codification
 Standardization and simplification
 Types of stores: centralized/de-centralized
 Fixation of levels:
 Reordering level
 Minimum level
 Maximum level
 Danger level
 Economic order quantity

11. Materials Planning
 Selective control through ABC Analysis
 VED analysis
 Perpetual Inventory System

12. Material Purchasing and receiving
 It Includes
 Ascertaining g requirements of materials
 Exploring source of materials
 Quotations
 Selecting best quotations
 Receiving and inspecting the materials
 Checking and passing bills of payment

13. Materials Storing
 It Includes:
 Location and Layout of Stores
 Maintenances of records, Bin cards, store ledgers
 Perpetual Inventory System
 Calculation of InventoryTurnover Ratio to find out the
movement of different materials.

14. Materials Issuing
 It Includes:
 Materials Requisitions
 Bills of Materials
 Materials returned to stores
 Transfer of materials
 Loss of materials
 Surplus of materials
 Methods of pricing and issue

15. Material Accounting
 It Includes:
 Receipt of materials
 Issue of materials
 Losses and surplus of materials

16. Function of Purchase Department
 What to purchase
 When to purchase
 Where to purchase
 How to purchase
 At what price to purchase

17. Procedure followed by purchase department
 Receiving a purchase requisition
 Exploring the source of supply
 Choosing the best supplier
 Preparation and execution of Purchase Order
 Receiving and Inspecting Materials
 Checking and passing of bills for payment.

18. Purchase Requisition
 Document generated by a user department or
storeroom-personnel to notify the purchasing
department of items it needs to order, their quantity, and
the timeframe. It may also contain the authorization to
proceed with the purchase.Also called purchase request
or requisition.
 It is a form used as a formal request to purchase
department to purchase materials it needs.

19. Format of Purchase Requisition

20. Purchase Order
 A purchase order (PO) is a commercial document and
first official offer issued by a buyer to a seller, indicating
types, quantities, and agreed prices for products or
services. It is used to control the purchasing of products
and services from external suppliers.
 It is the document which gives the authority to the
department that will receive the materials and to the
accounting department to accept bills from the supplier.

21. Format of Purchase Order

22. Store Records-BIN CARD
 A document that records the status of a good held in a stock
room.A typical retailing business with a large stock room will
use a bin card to record a running balance of stock on hand, in
addition to information about stock received and notes about
problems associated with that stock item.
 A Bin card makes a record of the receipt and issue of materials
and is kept for each item of stores carried. Receipt and issue
column of the bin card records movement of stores.
 It is placed right next to the specific material.
 It is maintained by the storekeeper and he is responsible for it.
 For each stores, minimum, maximum and ordering quantity is
written in the bin card which helps the storekeeper to control
the stores.

23. Format of BIN Card

24. Stores Ledger
 A Store ledger is a document showing the quantity and
value of materials received, issued and in balance at the
end. One stores ledger is allotted to each component of
material. Entries are made in this ledger by the costing
clerk with reference to goods received note, material
requisition note, material returned note etc.
 It is kept with the costing department and is identical to a
bin card except that the amount/value is also shown here
along with quantity of materials.

25. Stores Ledger Format

26. Stores ledger Vs. Bin Card

27. Bill Of Material
 A Bill of material(BoM) gives a complete list of all the
materials required with quantities for a particular job,
order of process.
 A bill of materials or product structure (sometimes bill of
material, BOM or associated list) is a list of the raw
materials, sub-assemblies, intermediate assemblies, sub-
components, parts, and the quantities of each needed to
manufacture an end product.
 Prepared by production department, it serves the
purpose for materials Requisition.

28. Bills of Materials Format
S.N Descripti
on
Stores
Code No
Quantity
Required
Rate Amount Remarks
1
2
3
4
XYZ COMPANY Ltd
Bill of Materials
Job No. No.
Dept Authorised Date
Drawing Officer
Received By
Store keeper
Priced By
Stores Ledger Folio

29. Material Return Note
 Materials in excess in requirement or defective are
returned back to the stores using a Material return Note.
 It is similar to Material Requisition Note, therefore a
separate colours are used for that

30. Methods of Material Issue Valuation
 Cost Price Method:
 FIRST IN FIRST OUT(FIFO)
 LAST IN FIRST OUT (LIFO)
 AVERAGE COST
 HIGHEST IN FIRST OUT(HIFO)
 INFLATED PRICE
 SPECIFIC PRICE
 BASE STOCK
 Market Price Method
 REPLACEMENT PRICE
 REALISABLEVALUE

31. Methods of Material Issue Valuation
 Standard Price Method
 CURRENT STABDARD PRICE
 BASIC STANDARD PRICE

32. COST PRICE METHOD
 FIFO:
The first in, first out (FIFO) method of inventory
valuation is a cost flow assumption that the first goods
purchased are also the first goods sold. In most companies,
this assumption closely matches the actual flow of goods,
and so is considered the most theoretically correct
inventory valuation method.
In simple words materials received first are issued
first.

33. EXAMPLE FIFO
Mar 1 Beginning Inventory 68 units @ rs15.00 per unit
5 Purchase 140 units @ rs15.50 per unit
9 Sale 94 units @ rs19.00 per unit
11 Purchase 40 units @rs16.00 per unit
16 Purchase 78 units @ rs16.50 per unit
20 Sale 116 units @ rs19.50 per unit
29 Sale 62 units @ rs21.00 per unit
Use the following information to calculate the value of inventory on hand on
Mar 31 and cost of goods sold during March in FIFO periodic inventory system
and under FIFO perpetual inventory system.

34. EXAMPLE FIFO
 Solution: FIFO Periodic
Units Available for
Sale
= 68 + 140 + 40 + 78 = 326
Units Sold = 94 + 116 + 62 = 272
Units in Ending
Inventory
= 326 − 272 = 54
Cost of Goods Sold Units Unit Cost Total
Sales From Mar 1
Inventory
68 15.00 1,020
Sales From Mar 5
Purchase
140 15.50 2,170
Sales From Mar 11
Purchase
40 16.00 640
Sales From Mar 16
Purchase
24 16.50 396
272 4,226
Ending Inventory Units Unit Cost Total
Inventory From Mar
16 Purchase
54 16.50 891

35. EXAMPLE FIFO Perpetual
Date Purchases Sales Balance
Units Unit
Cost
Total Units Unit
Cost
Total Units Unit
Cost
Total
Mar 1 68 15.00 1,020
5 140 15.50 2,170 68 15.00 1,020
140 15.50 2,170
9 68 15.00 1,020 114 15.50 1,767
26 15.50 403
11 40 16.00 640 114 15.50 1,767
40 16.00 640
16 78 16.50 1,287 114 15.50 1,767
40 16.00 640
78 16.50 1,287
20 114 15.50 1,767 38 16.00 608
2 16.00 32 78 16.50 1,287
29 38 16.00 608 54 16.50 891
24 16.50 396

36. ADVANTAGES OF FIFO
Followings are the advantages of FIFO method.
 FIFO method is easy to understand and operate.
 FIFO method is useful where transactions are not
voluminous and prices of materials are falling.
 FIFO method is suitable for bulky materials with high unit
prices.
 FIFO method helps to avoid deterioration and
obsolescence.
 Value of closing stock of materials will reflect the current
market price.

37. DISADVANTAGES OF FIFO
Some disadvantages of FIFO method are as follows.
 FIFO method is improper if many lots are purchased
during the period at different prices.
 The objective of matching current costs with current
revenues can not be achieved under FIFO method.
 If the prices of materials are rising rapidly, the current
production cost may be understated.
 FIFO method overstates profit especially in inflation.

38. LIFO
 LIFO assumes that goods which made their way to
inventory (after purchase, manufacture etc.) later are sold
first and those which are manufactured or acquired early
are sold last.Thus LIFO assigns the cost of newer
inventory to cost of goods sold and cost of older
inventory to ending inventory account.This method is
exactly opposite to first-in, first-out method.

39. LIFO EXAMPLE
 Use LIFO on the following information to calculate the
value of ending inventory and the cost of goods sold of
March.
Mar 1 Beginning Inventory 60 units @ rs15.00
5 Purchase 140 units @rs 15.50
14 Sale 190 units @ rs19.00
27 Purchase 70 units @rs 16.00
29 Sale 30 units @ rs19.50

40. LIFO EXAMPLE
Solution: LIFO Periodic
Units Available for Sale = 60 + 140 + 70 = 270
Units Sold = 190 + 30 = 220
Units in Ending
Inventory
= 270 − 220 = 50
Cost of Goods Sold Units Unit Cost Total
Sales From Mar 27
Inventory
70 16.00 1,120
Sales From Mar 5
Purchase
140 15.50 2,170
Sales From Mar 1
Purchase
10 $15.00 150
220 3440
Ending Inventory Units Unit Cost Total
Inventory From Mar 27
Purchase
50 15.00 750

41. LIFO EXAMPLE Perpetual
Date Purchases Sales Balance
Units Unit
Cost
Total Units Unit
Cost
Total Units Unit
Cost
Total
Mar 1 60 15.00 900
5 140 15.50 2,170 60 15.00 900
140 15.50 2,170
14 140 15.50 2,170 10 15.00 150
50 15.00 750
27 70 16.00 1,190 10 15.00 150
70 16.00 1,120
29 30 16.00 480 10 15.00 150
40 16.00 640
31 10 15.00 150
40 16.00 640

42. ADVANTAGES OF LIFO
 The main advantages of LIFO method are as follows
 LIFO method is appropriate for matching cost and
revenue.
 LIFO method is simple to operate and easy to
understand.
 LIFO method facilitates complete recovery of material
cost.
 LIFO method is most suitable when prices are rising.

43. DISADVANTAGES OF LIFO
The main disadvantages of LIFO method are as follows
 Inventory valuation does not reflect the current prices
and therefore are useless in the context of current
conditions.
 Due to variation of prices, comparison of cost of similar
job is not possible.
 Calculations become complicated and cumbersome when
rates of receipts are highly fluctuating.
 LIFO involves considerable clerical work.

44. To be continued…