MATERIALS COST
LEARNING OBJECTIVE
- MATERIALS COST CLASSIFICATION
- STORE, PROCEDURE AND DOCUMENTATION FOR MATERIALS
- PRICING ISSUES OF MATERIALS
- BOOKKEEPING ENTRIES
1. MATERIALS COST CLASSIFICATION
Types of Inventory: raw materials, work in progress (WIP), finished goods.
Direct materials are the materials that can be directly attributed to a unit of production, or a specific job, or a service provided directly to a customer.
Indirect Materials are other materials that cannot be directly attributed to a unit of production. e.g. oil because it cannot be directly attributed to each unit of finished product.
2. STORE, PROCEDURE AND DOCUMENTATION FOR MATERIALS
The stores department is responsible for the receipt, storage and issue of materials and recording of raw materials.
- Receipt of materials into store: received from suppliers, then goods are checked whether ordered, correct quantity, correct quality and in good condition or not.
- Materials must be stored until required by user department
- Issue of materials from store: when cost centres require materials, they submit a requisition for the materials to the store department.
- Recording receipts and issues (take place on bin card recorded in quantities of material): the stores department monitor the quantities, the safety and security of the physical inventory. The costing department is responsible for recording the cost of materials ( direct and indirect) from store.
It is useful to have an overview of the departments involved in the purchasing process.
Stores department : notifies the purchasing department of the need to buy materials, using a purchase requisition/inventory recorder form.
Purchasing department: orders goods from external supplier using a purchase order.
External supplier: delivers goods to the stores department. The goods are accompanied by a delivery note. The external supplier also sends a purchase invoice to the accounts department, asking for payment for the goods.
Stores department: raises goods received note (GRN) from the delivery note details. The goods received note is used to update the inventory records with the quantities of goods received.
Costing department: the costing department records the cost of the materials received, using the delivery note and purchase invoice details.
Summary of Documents Used:
- Purchase Requisition
- Purchase order
- Delivery note
- Goods received note
- Purchase invoice
- Materials requisition note
- Materials returned note
- Bind card
3. PRICING ISSUES OF MATERIALS
Cost = price (excluding any sales tax) + carriage inwards cost – trade discount.
We do not try to identify what the specific units actually did cost, so might use of several valuation methods as follows.
- First in first out (FIFO)
- Last in first out (LIFO)
- Weighted average cost (AVCO)
Example:
In November 1,000 tons of inventory item 1234 were purchased:
3 November 400 tons at $60 per ton
11 November 300 tons at $70 per ton
21 November 300 tons at $80 per ton
During the same period four materials requisitions were completed for 200 tons each, on 5,14,22 and 27 November.
First In First Out (FIFO) Method:
The stores ledger account for inventory item 1234 is summarised below.
Material issued is $53,000 and the value of closing inventory is $16,000.
Last In First Out (LIFO) Method:
The stores ledger card for inventory item 1234 is summarised below.
Material issued is $57,000 and the value of closing inventory is $12,000. when prices are rising this will always be the case.
Weighted Average Cost (AVCO) Method:
Weighted average cost is calculated each time that there is a new delivery into stores.
Weighted average price =
(inventory value of items in stores + purchase cost of units received)/(Quantity already in stores + Quantity received)
Value of materials issued is $54,400 and the closing inventory is $14,600. these figures are between the FIFO and LIFO.
Periodic Weighted Average Cost Method:
Period weighted average price= ( cost of opening inventory + cost of all receipts in the period)/(units in opening inventory + units received)
Periodic weighted average price = (400×60+300×70+300×80)/(400+300+300)=$69 per unit.
4. BOOKKEEPING ENTRIES
There is an account for each item of inventory in the inventory control system, but in the cost ledger accounting system, there is an inventory control account for all items of inventory in total.
Dr. Material A……………………x
Cr. Cash/payable ……………….x
Inventory Ledger control account = inventory ledger account Material A + inventory ledger account Material B + Inventory ledger account Material C
Issue for material:
Dr. work-in-progress (WIP)/production overhead/other account…….x
Cr. Material A…………………………………………………………………………………..x