Cost Accounting and Control

Marian G. Magcalas, CPA, MBA

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 TABLE OF CONTENTS
Page
Module 5. Job Order Costing 87
Introduction 87
Learning Outcomes 88
Lesson1. Job Order Costing and Process Costing 88
Lesson 2. Elements of Product Cost in Job Order Costing 90
Lesson 3. Use of Predetermined Factory Overhead Rate 91
Lesson 4. Major Source Documents for Job Order Costing 93
Lesson 5. Accounting Procedures for Materials 96
Lesson 6. Accounting Procedures For Labor 98
Lesson 7. Accounting for Factory Overhead 100
Assessment Task 5 106
Summary 114
References 116
Module 6. Materials Management and Control 117
Introduction 117
Learning Outcomes 118
Lesson 1. Types of Materials 118
Lesson 2. Material Control 118
Lesson 3. Purchasing Control 121
Lesson 4. Purchase Procedure 122
Lesson 5. Inventory Model 128
Assessment Task 6 131
Summary 132
References 133

Module 7: Methods of Costing Materials 134

Introduction 134
Learning Outcomes 135
Lesson 1. Valuation of Incoming Materials 135
Lesson 2. Cost Flow Assumptions 136
Lesson 3. Inventory Systems 137
Lesson 4. Periodic FIFO 138
Lesson 5. Periodic Average 139
Lesson 6. Perpetual FIFO 140
Lesson 7. Perpetual Average 141
Lesson 8. Specific Identification 143
Lesson 9. Spoiled Goods 143
Lesson 10. Defective products 147
Lesson 11. Scrap 148
Lesson 12. Waste 150
Assessment Task 152
Summary 154
References 155

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 MODULE 5
JOB ORDER COSTING

Introduction

The job order cost procedure keeps the costs of various jobs or contracts separate during
their manufacture of construction. The method is applicable to job order work in factories,
workshops, and repair shops as well as to work by builders, construction engineers,
shipbuilders, and printers. The cost unit is the job, the work order, or the contract, and the
records will show the cost of each. The method presupposes the possibility of physically

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identifying the jobs produced and of charging each with its own cost (De Leon, N., De Leon,
E.D., & De Leon, G.M., 2019)

Learning Outcomes

At the end of this module, students should be able to:

1. Define job order costing and identify the types of industries that would be most to
use this system.
2. Demonstrate the mechanics of a job order costing system.
3. Differentiate among the forms used in the purchase and issuance of materials
such as a purchase requisition, a purchase order, a receiving report, and a
materials requisition.
4. Prepare a job order cost sheet.

Lesson 1. Job Order Costing and Process Costing

(Mejorada, 2006)

Cost accumulation may be by products, departments or processes. In other words, it

may be a job order costing or by process costing.

Job Order Costing

This refers to the costing procedure whereby costs are accumulated by products (or
by jobs). It is adopted for products (or groups of products) that can be physically identified
9or are heterogeneous) so that they can be charged with their respective costs. The cost
unit is the job (or work) order or the contract for such job. Examples of products using job
order costing are houses, boats, pianos, radios, automobiles, and furniture.

Process Costing
This refers to the costing procedure whereby costs are accumulated by departments
or processes. This is adopted for products manufactured under conditions of continuous

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processing so that they are not distinguishable from one another (or are homogeneous).
Examples of these products are beverages, flour, chemicals, and minerals.

The differences between job order costing and process costing may be summarized
as follows:

Job Order Costing Process Costing

Nature of products Heterogeneous Homogeneous
Cost accumulation By job orders By departments or processes
Reporting By job orders By departments or processe
When is unit cost computed? Upon completion End of costing period
(usually a month)
Unit cost computation:
Production costs per job Departmental costs
Number of units Equivalent units of production
Subsidiary records for work
in process Job order cost sheets Cost of production reports
(or departmental cost sheets)

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 Figure 5.1. Comparison of Job Order Costing and Process Costing
(Business-accounting.net, n.d.)
Lesson 2. Elements of Product Cost in Job Order Costing
(Mejorada, 2006)

The elements of product cost are materials cost, labor cost and factory overhead.
For job order costing, materials and labor costs refer to direct materials cost and direct labor
cost, respectively.

Direct materials cost

This refers to those items that form part of the finished product and
which can be measured and directly charged to the product.
Direct labor cost
This refers to cost of labor expended in the manufacture dof a product
and which can be directly charged to the product.
Factory overhead
This is also known as manufacturing expense or burden, It refers to
the indirect element of cost. It includes all manufacturing costs not classified

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 as direct materials or as direct labor. Indirect materials are those needed for
the completion of the product but the consumption of which with regard to the
product is either so small or allocation would be too complex so that for
convenience, it is treated as an indirect product cost. Indirect labor refers to
cost of manpower which cannot be identified as pertaining to a particular
product.

Figure 5.2. Job Order Cost System (Chegg.Study, n.d.)

Lesson 3. Use of Predetermined Factory Overhead Rate

(Mejorada, 2006)

The prime costs (direct materials and direct labor) are charged directly to jobs while
factory overhead, being the indirect cost, needs to be allocated yet.

Accumulation of factory overhead is generally completed only after the end of the
accounting period, that is, after all adjusting entries are made. Inasmuch as prompt cost
information is required, factory overhead is preferably charged to production at a
predetermined rate.

The predetermined factory overhead rate is based on estimated or budgeted factory

overhead for an accounting period and the budgeted base. The bases used in the allocation
are: direct labor hours, machine hours, direct labor cost, materials cost and units of production.

Using direct labor cost as the base, the formula is as follows:

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 Factory = Budgeted or estimated factory overhead
Overhead rate Budgeted or estimated direct labor cost

Example: Estimated factory overhead for 21B is P60,000, and estimated total direct labor cost
for all jobs to be processed is P120,000. Job orders no. 001, for 500 pairs of shoes, is
completed with direct materials cost of P25,000 and direct labor cost of P20,000.

The factory overhead rate must be 50% of direct labor cost arrived at as follows:

Factory overhead rate = P60,000 = 50% of direct labor cost

P120,000

The cost of Job Order 001 and per pair of shoes are arrived at as follows:

Job 001
Direct materials P25,000
Direct labor 20,000
Factory overhead applied
(50% x P20,000) 10,000
Total production cost P55,000

Cost of pair of shoes

(P55,000/500 pairs) P 110

With prompt information on unit cost, the company can set its selling price by adding the
desired margin. Without the predetermined factory overhead rate, the selling price will not
be able to be determined properly and a loss may possibly be incurred.

Lesson 4. Major Source Documents for Job Order Costing

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 (De Leon et al., 2019)

Job-Order Cost Sheet

a. These records accumulate product costs of specific units or small batches of
units for both product costing and control purposes.
b. The file of job-order sheets for uncompleted jobs serves as a perpetual book
inventory and the subsidiary ledger for Work in Process Control.
c. A separate cost sheet is prepared for each job.

Figure 5.3. Job-order-cost sheet (Slideshare.net, n.d.)

Materials Stockcard
a. These records are the perpetual book inventory of costs and quantities of
materials on hand.

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 b. The file of materials stockcards for unused materials is the subsidiary ledger for
Materials Control.
c. A separate stockcard is prepared for each type of material on hand.

Figure 5.4. Materials stock card/ledger card (Slideplayer.com, 2015)

Finished Goods Stockcard

a. These records are the perpetual book inventory of costs and quantities of
completed goods held for sale.
b. The file of finished goods stockcards for unsold goods is the subsidiary ledger of
Finished Goods Control.

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 Figure 5.5. Finished goods stock card (Slideplayer.com, n.d.)

Factory Overhead Control Cost Record

a. These records accumulate detailed manufacturing overhead costs by
department.
b. The file of these records for the accounting period is the subsidiary ledger for
Factory Overhead Control.

Materials Requisition, Time Ticket and Clock Card

a. As the source document for charging costs to jobs and department.
b. To aid in fixing responsibility for control and usage of materials and labor.

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Lesson 5. Accounting Procedures for Materials
(De Leon et al., 2019)

Procedures that affect the materials account involve the:

1. Purchase of materials and supplies.

2. Issuance of materials and supplies.
- Direct materials
- Indirect materials and supplies

Recording the purchase of materials.

A copy of materials requisitions prepared by employees and duly authorized and

approved will be given to the storekeeper, which will serve as the basis for the materials to
be issued.

The entry to record the purchase of materials is:

Materials xxxx
Accounts Payable xxxx

(Under the periodic system, Purchases is debited).

Materials is posted in the Material Control account and at the same time
posted under the Received section in the individual materials ledger card/stockcard.
A separate card is used for each material item, showing quantity received, unit cost,
and total amount.

The entry to record the return of materials to vendor is:

Accounts payable xxxx

Materials xxxx

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 An entry is made on the stock card under the Received section enclosed in
parenthesis to indicate reduction in quantity.

Recording the issuance of materials.

The entry to record the issuance of direct materials is:

Work in process xxxx

Materials xxxx

An entry is made on the stock card under the Issued section and also on the
Job-order cost sheet- Materials.

The entry to record the issuance of indirect materials is:

Factory overhead control xxxx

Materials xxxx

An entry is made on the stock card under the Issued section and also on the
overhead analysis sheet.

The material control account may be summarized as follows:

MATERIALS

1.Inventory beginning 1. Cost of direct materials issued

2. Purchase of materials 2. Cost of indirect materials issued
3.Freight-in (using direct charging) 3. Cost of materials returned to supplier
4.Cost of materials returned from
factory

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 The balance of the Materials Account represents the Materials inventory at
the end of the period under consideration. The amount should be equal to the total of
the schedule of balances of all materials stock cards.

Lesson 6. Accounting Procedures for Labor (De Leon et al., 2019)

The accounting procedures for labor may be divided into two distinct phases:

1. Collection of payroll data, computation of earnings, calculation of payroll

taxes, and payment of wages.
2. Distribution and allocation of labor costs to jobs, departments, and other
cost classifications.

In most factories, clock cards/time records are used to record the days or hours
worked by each employee. They are used as the basis in computing the gross
earnings of employees who are paid hourly wages.

In addition to these clock cards, time tickets are prepared for each worker to
determine the time spent for each job as basis in determining the amount to be
charged to direct labor cost and indirect labor cost.

The time ticket for various jobs are sorted, priced, and summarized, and the
time ticket hours should be reconciled with the clock card hours.

At regular intervals, usually daily or weekly, the labor time and labor cost for
each job are entered on the job order cost sheets. For each payroll period- weekly,
every two weeks, or monthly- the summary of employees’ earnings and the liability for
payment is journalized and posted to the general ledger.

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 The entry to record the payroll and the incurrence of liability is:

Payroll xxxx
Withholding Tax Payable xxxx
SSS Premium Payable xxxx
Philhealth Contribution Payable xxxx
Accrued Factory Payroll xxxx
The entry to record the distribution of payroll is:

Work in process xxxx

Factory Overhead Control xxxx
Payroll xxxx
An entry is made on the cost sheet under the labor section.

The entry to record the payment of payroll is:

Accrued Factory Payroll xxxx

Cash xxxx

The Work in process account is used to charge the jobs with the direct labor
cost. Factory overhead control is charged for the indirect labor cost incurred. The tax
withheld is computed based on the table provided with Bureau of Internal Revenue.
For the SSS Premiums and Philhealth Contributions, the table is provided by the Social
Security System.

The clearing account for the total wages due to the factory personnel is the
payroll account summarized as follows:

PAYROLL

1. Total wages and salaries 1. Total payroll during the payroll period
2. Factory personnel during the at the same time debiting work in

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 payroll period process for direct labor and overhead
for indirect labor.

The account used to accumulate the liability for payroll or factory overhead is the
Accrued Factory Payroll summarized as follows.

ACCRUED FACTORY PAYROLL

1. Total amount of wages paid to 1. Beginning balance

personnel at the time crediting
accounts payable or cash.
2.Total amount of wages and salaries due
to factory personnel at the same time
debiting payroll.

Lesson 7. Accounting for Factory Overhead (De Leon et al., 2019)

There are two accounts used:

1. Factory overhead control
2. Factory overhead applied

Factory overhead control is used to accumulate actual overhead incurred, while

factory overhead applied is used to accumulate estimated factory overhead applied to
production.

For factory overhead applied to production, a predetermined rate is used and this is
computed using any of the following as a base:

- Units of production
- Direct material cost

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 - Direct labor hours
- Direct labor cost
- Machine hours

The predetermined factory rate computed may be used for all departments in the
company (blanket rate) or a rate may be computed for each department to fit the natures of
the operations of the department (departmentalized rate). Estimated factory overhead
(Factory overhead applied) is used even if there is actual factory overhead because at the
time the overhead is needed for costing of jobs completed, the actual overhead is not yet
available (the actual will be known only at the end of the month).

As items in the factory overhead control account are incurred, the Factory Overhead
Control account is debited. The applied factory overhead entered on the job-order cost
sheet for each job is the basis for the following entry:

Work in process xxxxx

Applied Factory Overhead xxxxx

An entry is made of the cost sheet – factory overhead section.

Some actual overhead costs, such as indirect materials, indirect labor, and payroll
taxes are debited to Factory Overhead Control as they are incurred. Other overhead costs,
such as depreciation and expired insurance are debited to Factory Overhead Control when
adjusting entries are recorded.

The controlling account for accumulating the indirect charges incurred in production is:

MANUFACTURING OVERHEAD CONTROL

1. Indirect materials and supplies 1. Total debit footing at the end of

Issued from the warehouse at the accounting period when closing the
same time crediting materials books.

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 2. Indirect labor at the same time
crediting payroll.
3. Indirect expenses purchased from
outsiders.
4. Cost of other indirect expenses incurred
by the company.

Manufacturing overhead applied- account used for accumulating the total overhead charged
to production during the period.

MANUFACTURING OVERHEAD APPLIED

1. Total credit footings at the end of the 1. Cost of overhead allocated to

accounting period upon closing production and computed by of the
books. multiplying the actual factor being
used during the period by the
predetermined rate, at the same time
debiting work in process.

Over/under applied overhead- the difference between the actual overhead incurred and the
applied overhead.
OVER/UNDER APPLIED OVERHEAD
1. Difference between the actual 1. Difference between the actual
manufacturing overhead and the manufacturing overhead and the
applied overhead when actual is more applied overhead when the applied is
than the applied. more than the actual.

The closing of the Factory Overhead Control account and the Factory Overhead Applied
account may be done at the end of the month or at the end of they year. If the closing is to
be done monthly, the following are the entries:

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End of the month:
Factory overhead applied xxxx
Under/over applied overhead xxxx
Factory overhead control xxxx

End of the year:

Cost of Goods sold xxxx
Under/over applied overhead xxxx

Accounts used in Job-Order Costing:

Work in process- controlling account used to record the flow of the elements of cost
through the factory during a given period of time.

Finished Goods- a controlling account used to record the flow of the cost of goods
completed and transferred to the finished goods storeroom during the
period.
Cost of Goods sold- an account used to accumulate the cost of finished good disposed
through the sale to customers.

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Figure 5.6. Flow of the elements of Costs (Martin, n.d.)

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 Figure 5.7. Job-Order Costing flow of the Elements of Costs (Chegg.com, n.d.)

Assessment Tasks

1. Two basic costing systems for assigning costs to products or services are job order
and process costing. These two costing systems are usually viewed as being on
opposite ends of a spectrum. The fundamental criterion employed to determine
whether job costing or process costing should be employed is:
a. Proportion of direct (traceable) costs expended to produce the product or service.

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 b. Number of cost pools employed to allocate the indirect costs to the product or
service.
c. Type of bases used in allocating the indirect cost pools to the product or service.
d. The nature and amount of the product or service brought to the market place for
customer consumption.

2. In a manufacturing environment, the job order costing system and process cost
system differ in the way
a. Costs are assigned to production runs and the number of units for which costs
are averaged.
b. Orders are taken and the number of units in the orders.
c. Product profitability is determined and compared with planned costs.
d. Processes can be accomplished and the number of production runs that may be
performed in a year.

3. There are several alternative denominator measures for applying overhead. Which is
not commonly used?
a. Direct labor hours
b. Direct labor costs
c. Machine hours
d. Sales value of product produced

4. When the amount of overapplied factory overhead is significant, the entry to close
overapplied factory overhead will most likely require
a. A debit to cost of goods sold
b. Debits to cost of goods sold, finished goods inventory, and work in process
inventory
c. A credit to cost of goods sold
d. Credits to cost of goods sold, finished goods inventory, and work in process
inventory.

5. Under job order cost accumulation, the factory overhead control account controls
a. Factory overhead analysis sheets

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 b. Job order cost sheets
c. Cost reports by processes
d. Material inventories

6. Supplies needed for use in the factory are issued on the basis of
a. Job cost sheets
b. Material requisitions
c. Time tickets
d. Factory overhead analysis sheets

7. In job order costing, when materials are returned to the storekeeper that were
previously issued to the factory for cleaning supplies, the journal entry should be
made to
a. Materials
Factory overhead

b. Materials
Work in process
c. Purchase returns
Work in process

d. Factory overhead
Work in process

8. In traditional job order cost system, the issuances of supplies to a production

department increases
a. Stores control
b. Work in process control
c. Factory overhead control
d. Factory overhead applied

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9. In a job order cost system, the use of direct materials previously purchased usually
recorded as an increase in
a. Work in process control
b. Factory overhead control
c. Factory overhead applied
d. Stores control

10. In a job order cost system, direct labor costs usually are recorded initially as an
increase in
a. Factory overhead applied
b. Factory overhead control
c. Finished goods control
d. Work in process control

11. In a job order cost system, the application of factory overhead is usually reflected in
the general ledger as an increase in
a. Factory overhead control
b. Finished goods control
c. Work in process control
d. Cost of goods sold

12. A direct labor overtime premium should be charged to a specific job when the
overtime is caused by the
a. Increased overall level of activity
b. Customer’s requirement for early completion of the job
c. Management’s failure to include the job in the production schedule
d. Management’s requirement that the job be completed before the annual factory
vacation closure.

13. Under a job order cost system, the peso amount of the general ledger entry involved
in the transfer of inventory from work in process to finished goods is the sum of costs
charged to all jobs
a. Started in process during the period

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 b. In process during the period
c. Completed and sold during the period
d. Completed during the period.

14. In job order cost system, payroll taxes paid by the employer for factory employees
are usually accounted for as
a. Direct labor
b. Factory overhead
c. Indirect labor
d. Administrative costs

15. In a job order cost system, factory (manufacturing overhead) is

Indirect cost of jobs A necessary element of Production

a. No No
b. No Yes
c. Yes Yes
d. Yes No

16. When a manufacturing company has a highly automated plant producing many
different products, probably the most appropriate basis for applying factory overhead
costs to work in process is
a. Units processed
b. Machine hours
c. Direct labor hours
d. Direct labor costs

17. The logical explanation for an entry that included a debit to Overhead control and a
credit to Prepaid Insurance is
a. The insurance company sent the company a refund of its policy premium
b. Overhead for insurance was applied to production
c. Insurance for production equipment expired.
d. Insurance was paid on production equipment.

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18. Overapplied factory overhead would result if
a. The plant were operated at less than normal capacity.
b. Factory overhead costs incurred were less than costs charged to production.
c. Factory overhead costs incurred were unreasonably large in relation to units
produced.
d. Factory overhead costs incurred were greater than costs charged to production.

19. In service businesses using job order costing, the most commonly used base for
applying overhead to jobs is
a. Machine hours.
b. Direct materials consumed
c. Direct labor costs
d. Meals, travel and entertainment

20. In service businesses using job order costing, the hourly rate used to charge costs to
a job usually includes
a. Both labor and overhead cost
b. Labor cost only
c. Overhead cost only
d. Labor, overhead and miscellaneous costs.

21. The Watkins Company estimated Department A’s overhead at P255,000 for the
period based on an estimated volume of 100,000 direct labor hours. At the end of the
period, the factory overhead control account for Department A had a balance of
P265,500; actual direct labor hours were 105,000. What was the over or
underapplied overhead for the period?

a. 2,250 b. (2,250) c. 15,000 d. (15,000)

22. Cherokee Co. applied factory overhead on the basis of direct labor hours. Budget
and actual data for direct labor and overhead for the year are as follows:

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 Budget Actual
Direct labor hours 600,000 650,000
Factory overhead costs P720,000 P760,000
The factory overhead for Cherokee for the year is

a. Overapplied by P20,000
b. Overapplied by P40,000
c. Underapplied by P20,000
d. Underapplied by P40,000

23. During the current accounting period, a manufacturing company purchased P70,000
of raw materials, of which P50,000 of direct materials and P5,000 of indirect
materials were used in production. The company also incurred P45,000 of total labor
costs and P20,000 of other factory overhead costs. An analysis of work in process
control revealed P40,000 of direct labor costs. Based upon the above information,
what is the total amount accumulated in the factory overhead control account?

a. 25,000 b. 30,000 c. 45,000 d. 50,000

24. Application rates for factory overhead best reflect anticipated fluctuation in sales over
a cycle of years when they are computed under the concept of
a. Maximum capacity
b. Normal capacity
c. Practical capacity
d. Expected actual capacity

25. Worley Company has underapplied overhead of P45,000 for the year. Before
disposition of underapplied overhead, selected year-end balances from Worley’s
accounting records were

Sales 1,200,000
Cost of goods sold 720,000
Direct materials inventory 36,000

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 Work in process inventory 54,000
Finished goods inventory 90,000

Under Worley’s cost accounting system, over or underapplied overhead is assigned

to appropriate inventories and cost of goods sold based on year-end balances. In its
year-en income statement, Worley should report cost of goods sold of

a. 682,500 b. 684,000 c. 757,500 d. 765,000

26. Carley Products has no work in process or finished goods inventories at the close of
business on December 31. The balances of Carley’s account as of December 31,
are as follows:

Cost of goods sold 2,040,000

Selling and administrative expenses 900,000
Sales 3,600,000
Factory overhead control 700,000
Factory overhead applied 648,000

Carley Products’ pretax income for the year is

a. 608,000 b. 660,000 c. 712,000 d. 52,000

Baker Company has two departments (Processing and Packaging) and uses a job order
costing system. Baker applied overhead in Processing based on machine hours and on
direct labor cost in Packaging. The following information is available for July.

Processing Packaging
Machine hours 2,500 1,000
Direct labor cost P 44,500 P 23,000
Applied overhead 55,000 51,750

27. What is the overhead application rate per machine hour for Processing?

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 a. 22.00 b. 1.24 c. 17.80 d. 0.81

28. What is the overhead application for Packaging?

a. 23.00 b. 51.75 c. 2.25 d. 0.44

29. Following are Mill co.’s production costs for October:

Direct materials 100,000

Direct labor 90,000
Factory overhead 4,000
What amount of cost should be traced to specific products in the production
process?

a. 194,000 b. 190,000 c. 100,000 d. 90,000

30. Rumours Co. applies factory overhead as follows:

Department Per Machine hour

Fabricating 7.75
Spreading 15.10
Gossiping 2.125

Actual machine hours are: 19,000 hours for Fabricating, 27,500 hours for Spreading
and 5,500 hours for Gossiping. If the actual factory overhead expenses for the period
is P574,375, how much is over(under)applied factory overhead?

a. (11,875.00) b. (23,562.50) c. (187.50) d. (76,125.00)

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 Summary

Cost accumulation may be by products, departments or processes. In other words, it

may be a job order costing or by process costing.

Job Order Costing refers to the costing procedure whereby costs are accumulated by
products (or by jobs). It is adopted for products (or groups of products) that can be physically
identified 9or are heterogeneous) so that they can be charged with their respective costs. The
cost unit is the job (or work) order or the contract for such job. Examples of products using job
order costing are houses, boats, pianos, radios, automobiles, and furniture.

Process Costing refers to the costing procedure whereby costs are accumulated by
departments or processes. This is adopted for products manufactured under conditions of
continuous processing so that they are not distinguishable from one another (or are
homogeneous). Examples of these products are beverages, flour, chemicals, and minerals.

The elements of product cost are materials cost, labor cost and factory overhead. For
job order costing, materials and labor costs refer to direct materials cost and direct labor cost,
respectively. Direct materials cost refers to those items that form part of the finished product
and which can be measured and directly charged to the product. Direct labor cost refers to
cost of labor expended in the manufacture dof a product and which can be directly charged
to the product. Factory overhead is also known as manufacturing expense or burden, It refers
to the indirect element of cost. It includes all manufacturing costs not classified as direct
materials or as direct labor. Indirect materials are those needed for the completion of the
product but the consumption of which with regard to the product is either so small or allocation
would be too complex so that for convenience, it is treated as an indirect product cost. Indirect
labor refers to cost of manpower which cannot be identified as pertaining to a particular
product.

Major source documents for Job Order Costing are: Job-Order Cost Sheet, Materials
Stockcard, Finished Goods Stockcard, Factory Overhead Control Cost Record, Materials
Requisition, Time Ticket and Clock Card.

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 Procedures that affect the materials account involve the: purchase of materials and
supplies, and issuance of materials and supplies.

The accounting procedures for labor may be divided into two distinct phases: collection
of payroll data, computation of earnings, calculation of payroll taxes, and payment of wages,
and distribution and allocation of labor costs to jobs, departments, and other cost
classifications.

`There are two accounts used for the accounting of Factory overhead: factory
overhead control, and factory overhead applied. Factory overhead control is used to
accumulate actual overhead incurred, while factory overhead applied is used to accumulate
estimated factory overhead applied to production.

References

Chegg.com. (n.d.). Job-Order Costing. https://www.chegg.com/homework-help/questions-

and-answers/ob-order-costing-job-order-costing-system-used-company-produces-product-
provides-service-u-q29430230

De Leon, G. M. Jr., De Leon E. D., De Leon, N. D. (2019). Cost Accounting and Control.
Manila City, Phils. GIC Enterprises & Co., Inc.

Galbreath, S.C., Caldwell, C.W., Booker, J.A., Rooney, C.J. (2015). Job Order Cost
Accounting. https://slideplayer.com/slide/15028020/

Karolinski, N., Bradford, M. (n.d.). Job Order Cost System.

https://slideplayer.com/slide/6065836/

Martin, J.R. (n.d.). Job Order Costing. https://maaw.info/JobOrderCostMain.htm

Mejorada, N. D. (2006). Cost Accounting. Quezon City. Goodwill Trading Co., Inc.

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 MODULE 6
MATERIALS MANAGEMENT AND CONTROL

Introduction (Guerrero, 2014)

In a manufacturing business, the cost of raw materials is a major part of the total
manufacturing cost of each product. Rigid controls over raw materials are necessary not only
to guard against theft but also to minimize waste and misuse from causes such as
maintenance of excessive inventories, over issuance, deterioration, spoilage and
obsolescence of materials. Certain requirements essential to an effective internal control
system for materials will be discussed in this module.

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 Learning Outcomes
At the end of this module, students should be able to:
1. Differentiate among the forms used in the purchase and issuance of
materials such as purchase requisition, a purchase order, a receiving
report, and a materials requisition.
2. Distinguish among the common control procedures used to assist
management in keeping inventory costs to a minimum.

Lesson 1. Types of Materials

(Ottuparammal, Shameera, & Jahfarali, n.d.)

The materials are a major part of the total cost of producing a product and are one of
the most important assets in majority of the business enterprises. Hence the total cost of a
product can be controlled and reduced by efficiently using materials.

The materials are of two types, namely:

(i) Direct materials: The materials which can be easily identified and
attributable to the individual units being manufactured are known as direct materials.
These materials also form part of finished products. All costs which are incurred to
obtain direct materials are known as direct material costs.
(ii) Indirect materials: Indirect materials, on the other hand, are those
materials which are of small value such as nuts, pins, screws, etc. and do not
physically form part of the finished product. Costs associated with indirect materials
are known as indirect material costs.

Factory supplies, office supplies and selling supplies are generally termed as stores.

Lesson 2. Material Control (CBSEAcademic, 2018)

Material Control is a system which ensures the provision of the right quantity of
material lof the right quality, at the right time with a minimum amount of investment. It is a
systematic control over the procurement, storage, and usage of materials so as to maintain
an even flow of materials and at the same time avoiding excessive investment in inventories.

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The essentials of a good system of material control include scheduling the requirements of
purchasing, receiving, inspecting, maintaining stock records and material accounting and
recording. In fact, Material control is a matter of coordination among the purchase department,
receiving and inspection department, store keeping department, product control department
and stock Control department. The success of a business concern largely depends upon the
efficiency of its Material Control System.

Objectives of Material Control:

1. Continuous supply of materials for uninterrupted flow of production: Situation of

production stoppage due to materials running out of stock should be avoided. Such production
stoppage is very costly in terms of overheads, denial of sales or panic purchases.
2. Optimum investment in materials: Excessive investments due to over stocking of
materials reduce profitability of the business as it locks large capital without any returns as
well as increased storage cost.
3. Economy in purchasing: Material should be purchased at the lowest possible cost
without sacrificing the quality, regularity, and dependability of supplies.
4. Strict quality control: There should be a strict system of quality control. The order of
supplies of right quality of raw materials should be authorized. Material should be tested at
the time of their receipt and a report should be generated initialed by the person who has
tested them for fixing responsibility.
5. Minimum handling cost and time: Material should be stored at such a place and in
such manner, that:

- Material can be located at ease

- Made available to the user departments with least efforts
- Time consumed in tracing material and making them reach the user
department should be the least.
6. Control on payment for materials: Ensure that no payment is made for materials
not ordered though received, or for material not received or for materials of defective quality.
7. Authorized issues: Ensure that no issue from the store takes place without a
proper authorization. The store keeper has to be made accountable for all issues.

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 8. Minimize wastages: Minimizing wastages in handling at the time of receipt of
materials in stores, during their issues and during use in the user department. Norms should
be fixed for wastages at each stage and wastages above the norms should be investigated.
9. Control on the pilferages and leakages and other losses: A system should be put
in place to ensure that pilferages of material do not take place. Special control is required to
be put in place for material prone to pilferage.
10. Detect the slow moving and fast moving materials: The system should detect, on
a regular basis, the items of material which are slow moving and items which are not moving
at all. This will help in regulating further purchases of such materials and prevent losses. Many
times, disposal of non-moving items is better than keeping them in sores and incurring storage
cost.
11. Control on misappropriations: Ensure that no misappropriation of materials take
place as once leakages develop in the system, they tend to become recurring in nature.
12. Regular and dependable information about materials: There should be regular and
dependable record of information of each type of material- the stock position, minimum level,
maximum level, special problems with respect of certain materials and the list of dependable
suppliers. This will help in placing order of the right quantity at the right time and to the right
supplier.

Essentials of Sound Material Control System

1. Organization for Material Control: There should be a proper coordination and
internal check between sales, production, purchases, receiving, testing, and storage and
issue functions.
2. Material Planning: Material requirement should be determined in advance. Through
the adoption of perpetual inventory system, the quantity of material in hand and its value is
always available, which helps in avoiding the situation of over and under stocking.
3. Material Purchasing and Receiving: Exploration of different sources of materials
and its reliable suppliers should be regularly reviewed and revised. A proper system should
be laid down for comparing quotations, receiving and inspection of materials and testing the
quality of materials received.
4. Storage of Material: Location and layout of the stores should be such that the time
and transportation cost involved in receiving and issue of materials to the users is least. It
should facilitate strict control on the stores by adopting perpetual inventory Bin card system.

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 5. Issue of Material: Materials should be issued only against a proper Material
Requisition slip. Surplus material, if any, should only be returned to the Stores department
and direct transfer of surplus material from one job to another should be discouraged.
6. Material Accounting and Reporting: A complete record of all purchases, issues,
returns, transfers and losses of material should be prepared and an efficient system of internal
audit should be established.

Lesson 3. Purchasing Control (Ottuparammal et al., n.d.)

Wrong purchases increase the cost of materials, store equipments and the finished
goods. Hence it is imperative that purchases should be effectively, efficiently and
economically performed.

Dr. Walther defines scientific purchasing as the “Procurement by purchase of the

proper materials, machinery, equipment and supplies of stores used in the manufacture of a
product, adapted to marketing in the proper quantity and quality at the proper time and the
lowest price consistent with the quality desired”.

The major objectives of scientific purchasing it to purchase the right quantity at the
best price, materials purchased should suit the objective, production should not be held up,
unnecessarily capital should not be locked up in stores, best quality of materials should be
purchased and company’s competitive position and its reputation for fairness and integrity
should be safeguarded. Only scientific purchasing will help in achieving the above objectives.
With proper plans, materials can be purchased at a lower price than competitors, turnover of
investment in inventories can be high, purchasing department can advise regarding substitute
materials, new products, change in trends, creating goodwill etc.

Methods of Purchasing
Purchasing can be broadly classified as centralized and localized purchasing.

(a) Centralized Purchasing: In a large organization, manufacturing units are many. In

such cases centralized purchasing is beneficial. The advantages of centralized
purchasing are:

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 1. Specialized and expert knowledge is available.
2. Advantages arise due to bulk purchases.
3. The cost of purchasing can be reduced and selling price can be lowered.
4. As there is good knowledge of market conditions, greater control can be
exercised.
5. When materials have to be imported, it is advantageous to centralize the
buying.
6. Economy and ease in compilation and consultation of results.
7. It can take advantage of market changes.
8. Investment in inventories can be reduced.
9. Other advantages include undivided responsibility, consistent buying
policies. Factors to be considered when decision regarding centralization has
to be taken are geographical separation of plants, homogeneity of products,
type of material bought, location of supplies etc.

(b) Decentralization of Purchases: The advantages of localized purchasing or

decentralization of purchases are:
1. Each plant may have its own particular need. This can be given special
attention.
2. Direct contact can be established with suppliers.
3. The time lag between indenting and receiving materials can be reduced.
4. Technical requirements of each plant can be ascertained.

Lesson 4. Purchase Procedure (Ottuparammal et al., n.d.)

Purchase requisition
The initiation of purchase begins with the receipt of purchase requirement/ requisition
slip by the purchase department from either the stores department for regular stocks items or
by the departmental head for specialized materials. The purchase requisition is the formal
request made by the stores or the user department to the purchase department. This
requisition contains complete details such as the date of making the request, the quantity,
quality, any specific characteristic of material demanded, code number of material required,
the latest date by which material should be available etc.

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 The purchase requisition has to be prepared in triplicate- one copy has to be sent to
the purchase department for initiating the purchase procedure, second to the costing
department and the third copy is retained by the department initiating the purchase requisition.

Figure 6.1. Purchase requisition form (Sampletemplates.com, n.d.)

Exploring the supply sources and selection of supplier:

On the receipt of purchase requirement/requisition, the purchase department would

invite tenders or quotations for the supply of goods. After the receipt of quotations, the
purchase department will make the schedule of quotations for the selection of a supplier,
keeping in mind all the required considerations such as price, quality, and terms of payment,
reliability of supplier, mode and time of delivery.

Purchase Order

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 Having selected the supplier, the next step is placing a formal purchase order i.e.
The written authorization to the vendor to supply specific quantity and quality of materials at
stipulated terms and at the time and place mentioned. It is to be signed by the purchase
manager.

Figure 6.2. Purchase order (Vertex42.com, n.d.)

Receiving of Materials

The work of unpacking the goods and their verification is performed by the receiving
department. The receiving clerks verify the contents of the packages with the consignment
notes sent by the suppliers in triplicate along with the packages. He enters the date of receipts,
quantity received by him and the condition of goods in the material received report. The
original copy of consignment note along with material received report in duplicate is sent to
the stores department. Five copies of Material received report are generally prepared. The
original is sent to the purchasing department as a proof that the goods ordered have been
received. Three copies are sent to the stores/ production department along with the materials.

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Stores /production department sends one copy each to the receiving department and to the
accounts departments. One copy is retained for the future reference.

Inspection of Materials
The inspection department will confirm that whether the goods have been received as
per the specification mentioned in the purchase order or not. It may also send samples for
laboratory test, if necessary. It submits its reports of Inspection and testing in triplicate. The
original is sent to the purchasing department and second to the stores or production
department and third is retained by the department for future reference.

Storage of Materials
After the purchase process has been completed and materials have reached the
stores it is necessary to ensure that these are efficiently stored. The store keeper should
accept the materials only after verifying the material received with consignment note, material
received report and inspection report.

Classification and Codification:

Classification is the process of arranging items in groups and sub groups according to
common characteristics. Materials should be classified according to the nature (subjective
Classification) or the purpose to be fulfilled (objective classification). The subjective
classification is useful for identification, storage, ordering and accounting of materials. The
objective classification is useful for costing purposes.

Classification and codification go together. Classification is the first step and

Codification is the next step. Codification is the process of assigning a symbol or number to
different items of material falling in different groups and subgroups. A code has been defined
as a system of symbols designed to be applied to a classified set of items. Classification
facilitates identification of items on the basis of description while coding is the process of
assigning symbol or code number on the basis of classification. Code is shorter, precise and
substitute for long and imprecise description.

The codification can be as per any of the three methods.

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 a) Alphabetical
b) Numerical
c) Alphabetical cum Numerical

Bins and Racks:

The store should be divided into several sections for particular types of material. Each
section should have various suitable containers for keeping different variety of that material.
Such containers or place are called as bins or racks. Each bin or rack is properly numbered
and indexed for easy identification. The floor plan also exhibit at the entrance of store room
for ready location of various sections and corresponding bins. The card is hung outside each
bin and whenever the material is received or issued, entry is made in the card by the store
keeper and correspondingly the balance is shown after every transaction. Thus, bin card
consist of three columns only and gives the ready reference for finding the balance of material
available at any point of time.

Figure 6.3. Bin Card (Keydifferences.com, n.d.)

Stores Ledger:

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 The cost office maintains a store ledger in which separate card is maintained for each
type of raw material and spare parts in the store. Stores ledger gives the same information as
is available in the bin cards except that it gives the monetary information also, such as the
rate, amount of receipts, issues and the balance of materials. So the stores ledger account
has three broad sections – receipts with quantity, rate and amount, issues with quantity, rate
and amount and balance with quantity, rate and amount. Sometimes it also consists of a fourth
section-for material ordered. This column enables the planning of production without
unnecessary reference to other books and accounts.

Figure 6. 4. Stores ledger (Keydifferences.com, n.d.)

Distinction between Bin card and stores ledger:

1. Bin Card contains only quantitative record of receipt, issue and balance of different
materialswhile stores ledger records both quantities and value of materials.
2. Bin card is maintained by the store keeper in the stores department while the
stores ledger is maintained by the cost clerk in the costing department.
3. Posting in the bin card is made simultaneously with the receipt and issue of
materials while the in the stores ledger, it is made after the transaction.
4. Bin card is not a basic accounting record while stores ledger is a basic accounting
record.

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 5. Inter department transfer or inter job transfer are only recorded in the stores ledger
and not in the bin card.

Lesson 5. Inventory Model (Kumar, 2008)

Economic Order Quantity (EOQ)

Inventory models deal with idle resources like men, machines, money and materials.
EOQ aims to minimize and balance the following costs:

1. How much to order (purchase or produce)

- Inventory carrying costs
- Ordering or acquisition costs

As the order quantity increases, the inventory

carrying costs increases while ordering cost
decreases.
Order quantity means the quantity produced or
procured during one production cyle.
2. When to order (lead time)

EOQ can be determined by two methods:

1. Tabulation method
2. Algebraic method

Tabulation (Trial and Error) Method

1. Select the number of possible lot sizes to purchase.
2. Determine average inventory carrying cost for the lot purchased.
3. Determine the total ordering cost for the orders placed.
4. Determine the total cost for each lot size chosen which is the summation
of inventory carrying cost and ordering cost.
5. Select the ordering quantity, which minimizes the total cost.

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 Algebraic method

2CN
EOQ = K

EOQ = Economic order quantity

C = cost of placing an order
N = number of units required annually
K = carrying cost per unit of inventory

Order point
Once the economic order quantity has been determined, management
must decide when to place the order. The order point must be established. If
the lead time and the inventory usage rate are known, determination of the
order point is easy.
Lead time is the period between the placement of the order and the
receipt of materials ordered.
Inventory usage rate is the quantity of materials used in production over
a period of time.
The order point should be where the inventory level reaches the
number of units that would be consumed during the lead time.

Illustrative Problem: (Rashidjaved, 2019)

The John Equipment company estimates its carrying cost at 15% and its ordering cost
at $90 per order. The estimated annual requirement is 78,000 units at a price of $4 per unit.

Required:
(i). What is the most economical no. of units to order?
(ii). No. of orders to be placed in a year.
(iii). About how often will an order need to be placed?

Solution
(i). Economical No. or Units to Order:
Annual requirement = 48,000 units

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Ordering cost = $9 per order
Carrying cost = 15% of per-unit cost.
Per unit cost = $4 per unit

(ii). No. of orders to be placed in a year:

= Annual requirement / EOQ
= 48,000 units / 1,200 units
= 40 orders
(iii). About how often will an order need to be placed (i.e. frequency of orders):
Frequency of orders = No. of days in one year / No. of orders
= 360 days / 40 orders
= 9 days

Assessment Task

State whether each of the following statement is True or False:

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1. Material Control relates to Direct Material only and not to consumable stores.
2. Control on Materials has no effect on overhead cost.
3. Inefficiencies and frauds relating to Materials have an impact on organizational
environment.
4. Material Control involves Control over entire material cycle.
5. Procedure, documentation and systems for Material Control may be different in different
organization.
6. Direct Material cost can be identified with a cost center.
7. Cost of Indirect Material is to be treated as overheads.
8. Material Control helps in reconciling the conflicting objectives of purchase department and
finance department.
9. Material control does not work on material handling cost but only on the material
purchase cost.
10. Material control is a matter of coordination of purchase, receiving, inspection, store
keeping, production control and stock control department.
11. At EOQ total storage cost is equal to the total ordering cost
12. With increase in ordering cost, EOQ will go up.
13. With decrease in storage cost, EOQ will come down.
14. Reorder will lie between minimum and Maximum level.
15. Larger the no. of orders, lower will be the storage cost.
16. Re-order level means the quantity to be ordered.
17. The Economic order quantity means the reorder quantity.
18. Ordering Cost includes the cost of goods also.
19. Bill of Material and Material requisition are same.
20. Either of Material Received note or Material Inspection note is to be prepared.

Summary

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 The materials are a major part of the total cost of producing a product and are one of
the most important assets in majority of the business enterprises. Hence the total cost of a
product can be controlled and reduced by efficiently using materials.

The materials are of two types, namely:

(i) Direct materials: The materials which can be easily identified and attributable
to the individual units being manufactured are known as direct materials. These
materials also form part of finished products. All costs which are incurred to obtain
direct materials are known as direct material costs.
(ii) Indirect materials: Indirect materials, on the other hand, are those materials
which are of small value such as nuts, pins, screws, etc. and do not physically form
part of the finished product. Costs associated with indirect materials are known as
indirect material costs.

Material Control is a system which ensures the provision of the right quantity of
material lof the right quality, at the right time with a minimum amount of investment. It is a
systematic control over the procurement, storage, and usage of materials so as to maintain
an even flow of materials and at the same time avoiding excessive investment in inventories.
The essentials of a good system of material control include scheduling the requirements of
purchasing, receiving, inspecting, maintaining stock records and material accounting and
recording.

Economic Order Quantity is an inventory model that aims to minimize and balance
the following costs ordering and carrying costs of materials, and also determines the right time
to order or the lead time of ordering. EOQ can be determined by two methods: Tabulation
method, and Algebraic method.

References

133
Cbseacademic. (2018). Cost Accounting Class XI.
http://cbseacademic.nic.in/web_material/Curriculum/Vocational/2018/Accounting%20and%2
0Taxation/Cost%20Accounting%20class%20XI.pdf

Keydifferences.com. (n.d.). Difference between Bin Card and Stores Ledger.

https://keydifferences.com/difference-between-bin-card-and-stores-ledger.html

Kumar, S. A., Suresh N. (2008). Production and Operations Management. Second Edition.
New Delhi, India. New Age International (P) Limited, Publishers

Ottuparammal, V., Shameera K., Jahfarali, T.H. (n.d.). Cost Accounting. India. University of
Calicut.

Rashidjaved. (2019). Economic Order Quantity (EOQ) Practical Problems and Solutions.
https://www.playaccounting.com/exp-ca/m-costing/economic-order-quantity-eoq-practical-
problems-and-solutions/

Sampletemplates.com. (n.d.). Requisition Form. https://www.sampletemplates.com/sample-

forms/free-requisition-form.html

Walther, L. M., Scousen, C. J. (2009). Managerial and Cost Accounting.

http://cool4ed.calstate.edu/bitstream/handle/10211.3/180408/managerial-and-cost-
accounting.pdf?sequence=1

Vertex42.com. (n.d.). Purchase Order. https://www.vertex42.com/ExcelTemplates/excel-

purchase-order.html

MODULE 7

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 METHODS OF COSTING MATERIALS

Introduction (De Leon et al., 2019)

The main objective of cost accounting is to produce accurate and meaningful figures
for the goods manufactured and sold which are to be used by management for control,
analysis and for the determination of the operating income. The more common methods of
costing materials issued and finished goods sold will be discussed in this module.

Learning Outcomes
At the end of this module, students should be able to:

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 1. Distinguish between the periodic and perpetual cost accumulation systems
used to account for materials issued to production and for ending materials
inventory.
2. Understand the need to value the incoming materials and not necessarily
to be taken at a purchase price only.
3. Understand the problem of costing of issues of materials and hence the
various methods of costing materials.
4. Explain the impact of various methods of costing issues on the cost of
production and valuation of ending inventory.

Lesson 1. Valuation of Incoming Materials (Cbseacademic, 2018)

The receipt of materials means incoming materials meant for conversion into final
product. The incoming materials are to be valued at invoice price subject to trade or quantity
discount plus all expenses incurred up to the point of placing materials in a condition suitable
for issuance from the stores.

These Expenses includes:

- Transportation including cartage expenses.
- Receiving unpacking and inspecting costs.
- Insurance and storage costs.
- Accounting and purchasing costs.

The basic cost of Materials is to be adjusted upwards considering the cost of

containers and the discount availed. The supplier of materials may charge separately for the
containers that he has used for supplying materials. In case these containers are not
returnable, their cost must be added to the cost of materials received. If the containers are
returnable at a price less than the cost charged the difference must be charged to the cost of
material received. In case they are to be returned at full cost charged their cost should not be
added to the cost of incoming materials. Sales Tax, excise duty, custom duty, Insurance etc.
are to be added to the purchase price.
The cost of material is to be adjusted with respect to discount too. Discount is of three
types:

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 Trade Discount:It refers to allowance which is permitted by the vendor to a purchaser
who must resell the articles. The allowance is permitted to compensate the purchaser for
storage, bulk breaking and delivering small quantities.

Quantity Discount: Such discount is allowed by the supplier to the buyer to encourage
him to place large orders. Both trade and quantity discounts should be taken into account
while valuing the incoming materials.

Cash Discount:Such discount is allowed by the vendor to the buyer to encourage him
to make prompt payment of invoice. It is given only when the debtor gives the payment within
the stipulated period. As it is a financial incentive, it is not to be included in valuing the
incoming cost of materials.

Lesson 2. Cost Flow Assumptions (Averkamp, n.d.)

If the Corner Shelf Bookstore sells only one of the five books, which cost should Corner
Shelf report as the cost of goods sold? Should it select $85, $87, $89, $89, $90, or an average
of the five amounts? A related question is which cost should Corner Shelf report as inventory
on its balance sheet for the four books that have not been sold?

Accounting rules allow the bookstore to move the cost from inventory to the cost of goods
sold by using one of two cost flows:
1. First In, First Out (FIFO)

2. Average

Note that these are cost flow assumptions. This means that the order in which costs are
removed from inventory can be different from the order in which the goods are physically
removed from inventory. In other words, Corner Shelf could sell the book that was on hand at
December 31, 2019 but could remove from inventory the $90 cost of the book purchased in
December 2020 (if it elects the LIFO cost flow assumption).
Lesson 3. Inventory Systems (Averkamp, n.d.)

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 Each of the three cost flow assumptions listed above can be used in either of two
systems (or methods) of inventory:

A. Periodic
B. Perpetual

A. Periodic inventory system.

Under this system the amount appearing in the Inventory account is not
updated when purchases of merchandise are made from suppliers. Rather, the
Inventory account is commonly updated or adjusted only once—at the end of
the year. During the year the Inventory account will likely show only the cost of
inventory at the end of the previous year.
Under the periodic inventory system, purchases of merchandise are
recorded in one or more Purchases accounts. At the end of the year the
Purchases account(s) are closed and the Inventory account is adjusted to
equal the cost of the merchandise actually on hand at the end of the year.
Under the periodic system there is no Cost of Goods Sold account to be
updated when a sale of merchandise occurs.
In short, under the periodic inventory system there is no way to tell from
the general ledger accounts the amount of inventory or the cost of goods sold.

B. Perpetual inventory system.

Under this system the Inventory account is continuously updated. The
Inventory account is increased with the cost of merchandise purchased from
suppliers and it is reduced by the cost of merchandise that has been sold to
customers. (The Purchases account(s) do not exist.)
Under the perpetual system there is a Cost of Goods Sold account that is
debited at the time of each sale for the cost of the merchandise that was sold. Under
the perpetual system a sale of merchandise will result in two journal entries: one to
record the sale and the cash or accounts receivable, and one to reduce inventory and
to increase cost of goods sold.

Inventory Systems and Cost Flows Combined

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 The combination of the three cost flow assumptions and the two inventory systems
results in four available options when accounting for the cost of inventory and calculating the
cost of goods sold:

A1. Periodic FIFO

A2. Periodic Average
B1. Perpetual FIFO
B2. Perpetual Average

Lesson 4. Periodic FIFO (Averkamp, n.d.)

"Periodic" means that the Inventory account is not routinely updated during the
accounting period. Instead, the cost of merchandise purchased from suppliers is debited to
an account called Purchases. At the end of the accounting year the Inventory account is
adjusted to equal the cost of the merchandise that has not been sold. The cost of goods sold
that will be reported on the income statement will be computed by taking the cost of the goods
purchased and subtracting the increase in inventory (or adding the decrease in inventory).

"FIFO" is an acronym for First In, First Out. Under the FIFO cost flow assumption, the
first (oldest) costs are the first ones to leave inventory and become the cost of goods sold on
the income statement. The last (or recent) costs will be reported as inventory on the balance
sheet.

Remember that the costs can flow differently than the goods. If the Corner Shelf
Bookstore uses FIFO, the owner may sell the newest book to a customer, but is allowed to
report the cost of goods sold as $85 (the first, oldest cost).

Let's illustrate periodic FIFO with the amounts from the Corner Shelf Bookstore:

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 Figure 7.1. Periodic FIFO (Accounting Coach, n.d.)

As before, we need to account for the total goods available for sale (5 books at a cost
of $440). Under FIFO we assign the first cost of $85 to the one book that was sold. The
remaining $355 ($440 - $85) is assigned to inventory. The $355 of inventory costs consists of
$87 + $89 + $89 + $90. The $85 cost assigned to the book sold is permanently gone from
inventory.

If Corner Shelf Bookstore sells the textbook for $110, its gross profit under periodic
FIFO will be $25 ($110 - $85). If the costs of textbooks continue to increase, FIFO will always
result in more profit than other cost flows, because the first cost is always lower.

Lesson 5. Periodic Average (Averkamp, n.d.)

Under "periodic" the Inventory account is not updated and purchases of merchandise
are recorded in an account called Purchases. Under this cost flow assumption an average
cost is calculated using the total goods available for sale (cost from the beginning inventory
plus the costs of all subsequent purchases made during the entire year). In other words, the
periodic average cost is calculated after the year is over—after all the purchases of the year
have occurred. This average cost is then applied to the units sold during the year as well as
to the units in inventory at the end of the year.
As you can see, our facts remain the same-there are 5 books available for sale for the year
2020 and the cost of the goods available is $440. The weighted average cost of the books
is $88 ($440 of cost of goods available ÷ 5 books available) and it is used for both the cost of
goods sold and for the cost of the books in inventory.

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 Figure 7.2. Periodic Average

Since the bookstore sold only one book, the cost of goods sold is $88 (1 x $88). The
four books still on hand are reported at $352 (4 x $88) of cost in the Inventory account. The
total of the cost of goods sold plus the cost of the inventory should equal the total cost of
goods available ($88 + $352 = $440).

If Corner Shelf Bookstore sells the textbook for $110, its gross profit under the periodic
average method will be $22 ($110 - $88). This gross profit is between the $25 computed under
periodic FIFO and the $20 computed under periodic LIFO.

Lesson 6. Perpetual FIFO (Averkamp, n.d.)

Under the perpetual system the Inventory account is constantly (or perpetually)
changing. When a retailer purchases merchandise, the retailer debits its Inventory account for
the cost; when the retailer sells the merchandise to its customers its Inventory account is
credited and its Cost of Goods Sold account is debited for the cost of the goods sold. Rather
than staying dormant as it does with the periodic method, the Inventory account balance is
continuously updated.
Under the perpetual system, two transactions are recorded when merchandise is sold:
(1) the sales amount is debited to Accounts Receivable or Cash and is credited
to Sales, and
(2) the cost of the merchandise sold is debited to Cost of Goods Sold and is credited
to Inventory. (Note: Under the periodic system the second entry is not made.)

With perpetual FIFO, the first (or oldest) costs are the first moved from the Inventory
account and debited to the Cost of Goods Sold account. The end result under perpetual FIFO

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is the same as under periodic FIFO. In other words, the first costs are the same whether you
move the cost out of inventory with each sale (perpetual) or whether you wait until the year is
over (periodic).

Lesson 7. Perpetual Average (Averkamp, n.d.)

Under the perpetual system the Inventory account is constantly (or perpetually)
changing. When a retailer purchases merchandise, the costs are debited to its Inventory
account; when the retailer sells the merchandise to its customers the Inventory account is
credited and the Cost of Goods Sold account is debited for the cost of the goods sold. Rather
than staying dormant as it does with the periodic method, the Inventory account balance
under the perpetual average is changing whenever a purchase or sale occurs.

Under the perpetual system, two sets of entries are made whenever merchandise is
sold:
(1) the sales amount is debited to Accounts Receivable or Cash and is credited to
Sales, and
(2) the cost of the merchandise sold is debited to Cost of Goods Sold and is credited
to Inventory. (Note: Under the periodic system the second entry is not made.)

Under the perpetual system, "average" means the average cost of the items in
inventory as of the date of the sale. This average cost is multiplied by the number of units sold
and is removed from the Inventory account and debited to the Cost of Goods Sold account.
We use the average as of the time of the sale because this is a perpetual method. (Note:
Under the periodic system we wait until the year is over before computing the average cost.)
Let's use the same example again for the Corner Shelf Bookstore:

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 Figure 7.3. Average Perpetual

Let's assume that after Corner Shelf makes its second purchase, Corner Shelf sells
one book. This means the average cost at the time of the sale was $87.50 ([$85 + $87 + $89
+ $89] ÷ 4]). Because this is a perpetual average, a journal entry must be made at the time of
the sale for $87.50. The $87.50 (the average cost at the time of the sale) is credited to
Inventory and is debited to Cost of Goods Sold. After the sale of one unit, three units remain
in inventory and the balance in the Inventory account will be $262.50 (3 books at an average
cost of $87.50).

After Corner Shelf makes its third purchase, the average cost per unit will change
to $88.125 ([$262.50 + $90] ÷ 4). As you can see, the average cost moved from $87.50 to
$88.125—this is why the perpetual average method is sometimes referred to as the moving
average method. The Inventory balance is $352.50 (4 books with an average cost of $88.125
each).

Lesson 8. Specific Identification (Averkamp, n.d.)

In addition to the four cost flow assumptions presented, businesses have another
option: expense to the cost of goods sold the specific cost of the specific item sold.
For example, Gold Dealer, Inc. has an inventory of gold and each nugget has an
identification number and the cost of the nugget. When Gold Dealer sells a nugget, it can
expense to the cost of goods sold the exact cost of the specific nugget sold. The cost of the
other nuggets will remain in inventory.

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Lesson 9. Spoiled Goods (Malik, 2010)

Cost accounting should provide product costs and cost control information. In the case
of spoilage, the first requirement is to know the nature and cause of the spoiled units.
The second requirement, the accounting problem is to record the cost of spoiled units and to
accumulate spoilage costs and report them to responsible personnel for corrective actions.
Attaining the degree of materials and machine precision and the perfection of
labor performance necessary to eliminate spoiled units entirely would involve costs far in
excess of a normal or tolerable level of spoilage. If spoilage is normal and happens at any
time and at any stage of the productive process, its cost should be treated as factory
overhead, included in the predetermined factory overhead rate, and prorated
overall production of a period. If, on the other hand, normal spoilage is caused by exacting
specifications, difficult processing, or other unusual and unexpected factors, the spoilage cost
should be charged to that order. In either cause, the cost of abnormal spoilage should be
charged to factory overhead.

EXAMPLE:

Spoiled materials charged to total production:

The Nevada Products company has a monthly capacity to manufacture 125,000 three
inch coil springs for use in mechanical brakes. Production is scheduled in response to orders
received. Spoilage is caused by a variety of unpredictable factors and averages $0.05 per
spring. During November, 100,000 springs were produced with a materials cost of $40 per
unit, a labor cost of $50 per unit, and factory overhead charged to production at a rate of 150%
of the direct labor cost. This rate is based an estimate that includes $0.05 per spring for
spoilage. The entry to record work put into production during the month is:

Work in process Materials40,000 Dr.

Work in process Labor50,000 Dr.
Work in process Factory overhead 75,000 Dr.

Materials 40,000 Cr.

Payroll 50,000 Cr.
Applied Factory overhead 75,000 Cr.

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 On the last working day of the month, the entry days production of 4000 units are
spoiled due to improper heat treatment; however, theses units can be sold for $50 each in the
second hand market. To record this normal loss on spoiled goods and the possible resale
value, the entry that charges all production during the period with proportionate share of the
spoilage is:

Spoiled Goods2,000 Dr.

Factory Overhead Control 4,600 Dr.

Work in process Materials 1,600 Cr.

Work in process Labor 2,000 Cr.
Work in process Factory overhead 3,000 Cr.

The materials, labor, and factory overhead in the spoiled units reduced by
the recovery or sales value of these units ($1,600 materials+ $2000 labor + $3,000 factory
overhead – $2000 cost recovery = $4,600 spoilage loss) is relocated or transferred from work
in process to factory overhead control. Each of the 96,000 good units produced during the
month has a charged in cost of $0.05 for spoilage (96,000 × $0.05 = $4,800); the actual
spoilage during the period is $4,600.
The good units produced during the week are on the order where spoilage did occur
carry a cost of $0.40 for materials, $0.5 for labor, and $0.75 for overhead because spoilage is
charged to all production--not to the lot or order which happens to be in process at the time of
spoilage. In other words, the $165,000 monthly production cost less the $6,600 credit resulting
from spoiled units levels $158,400 to be divide by the 996,000 good units manufactured during
the month at a cost of $1.65 per good unit. The entry transferring the good units to finished
goods is:

Finished Goods 158,400 Dr.

Work in process Materials 38,400 Cr.

Work in process Labor 48,000 Cr.
Work in process Factory overhead 72,000 Cr.

During the month, the amounts charged to factory overhead control represent the
depreciation, insurance, taxes, indirect materials and indirect labor actually experienced,

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along with the $4,600 spoilage cost. All production during the month is charged with overhead
of $0.75 per unit. Over head analysis reveals a $200 favorable variance ($4,600 actual minus
$4,800 applied) attributable to the spoilage units. Any difference between the price when the
inventory was recorded and the price realized at the time of sale would be a plus or minus
adjustment to factory overhead control (loss on spoiled goods).
For effective cost control normal spoilage rates and amounts should be established for each
department and for each type of class of materials. Weakly or monthly spoilage reports similar
to the scrap report illustrated on scrap and waste page.

Spoiled materials charged to a particular job:

The Nevada Products Company has contract to manufacture 10,000 heavy duty coil
springs for the Tri-state Supply Company. This order requires a steel wire that is harder and
slightly heavier than stock normally used, but the production process, as well as labor time
and overhead factors, is identical with the standard product. Materials cost for each of these
springs is $0.60 this special order requires exacting specifications, and normal spoilage is to
be charged to the order. The $0.050 per unit spoilage factor is now eliminated from the
overhead rate, and 140% of direct labor cost, and $0.70 per unit, is the rate used on this job.
The order is put into production the first day of December, and sampling during the first hour
of production indicates that eleven units of production are required to secure ten good springs.
Entries to record costs placed into production for 11,000 units are:

Work in process Materials6,600 Dr.

Work in process Labor5,500 Dr.
Work in process Factory overhead 7,700 Dr.

Materials 6,600 Cr.

Payroll 5,500 Cr.
Applied Factory overhead 7,700 Cr.

One thousand units did not meet specifications and are spoiled but can be sold as seconds
for $0.45 per unit. The entry to record the spoilage is:

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Spoiled Goods 450 Dr.

Work in process Materials 150 Cr.

Work in process Labor 125 Cr.
Work in process Factory overhead 175 Cr.

$450 / $1,800 cost of 1,000 units

= 25%
($6,600 Materials / $19,800 Total job cost) × $450 Sales recovery
($5,500 Labor / $19,800 Total job cost) × $450 Sales recovery
($7,700 Overhead / $19,800 Total job cost) × $450 Sales recovery

The entry transferring the completed order to Finished Goods would be:
Finished Goods $19,350 Dr.

Work in process Materials $6,450 Cr.

Work in process Labor $5,375 Cr.
Work in process Factory overhead $7,525 Cr.

The net result of this treatment is to charge the spoilage loss of $1,350 ($1,800 less $450 cost
recovery) to 10,000 good units that are delivered at the original contract price. The unit cost
of completed springs is $1,935 ($19,350 / 10000 units).
Any difference between the price when the inventory was recorded and the price realized at
the time of sale should be an adjustment to work in process, finished goods, or cost of goods
sold, depending on the completion status of the particular job order. as an expedient, the
difference might be closed to factory overhead control.

Lesson 10. Defective products (Lodha, n.d.)

Defective products or units are those which do not meet with dimensional or quality standards
and are reworked for rectification of defects by application of material, labour and/or
processing and salvaged to the point of either standard product or substandard product to be
sold as seconds. Therefore, defectives are that portion which can be rectified at some extra
cost of re-operation.

Defectives may arise due to the following reasons:

1. Sub-standard materials.

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2. Poor workmanship.
3. Poor maintenance of machines.
4. Wrong tool setting.
5. Faulty design of products.
6. Bad supervision
7. Careless inspection
8. Poor working conditions.
9. Lack of control, such as humidity, furnace temperature, etc.
10. Excessive short runs.

Defectives are bad products which are not totally spoiled and can be rectified or restored to
original or near-original condition at some extra cost or re-operation. The additional cost of
rectifying the defectives is added to the total cost and the quantity of defectives rectified is
added to the quantity of good output because defective units rectified can be sold as
“seconds”.
Following methods may be adopted for the treatment of this cost:
1. If the defective production is identified with a specific job or department, the cost of
rectification is charged to that specific job or department.
2. If the defective production is not identified with a particular job or department, the cost
of rectification is added to general factory overhead.
3. If the defective production is due to abnormal reasons, the rectification cost is
transferred to costing profit and loss account.

Lesson 11. Scrap (Lodha, n.d.)

Scrap is discarded material having some values. It represents fragments or remnants

of material that are left from certain type of manufacture. It is a material loss but has small
value without further processing. Examples of scrap are available in operations like turning,
boring, punching, sawing, shavings, moulding, etc. from metals on which machine operations
are carried out; saw dust and trimmings in the timber industry; dead heads and bottom ends
in foundries; and cuttings, pieces and splits in leather industry. Such scrap can be solid
because it can be used by other industries by melting in furnaces. Scrap is always physically
available unlike waste which may or may not be physically present in the form of a residue.

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Thus scrap is always visible whereas waste may or may not be visible. Further, waste may
not have any value whereas scrap must necessarily have a value.

There are three types of scrap, namely:

(a) Legitimate scrap,
(b) Administrative scrap,
(c) Defective scrap.

Legitimate scrap arises due to the nature of operation like turning, boring, punching etc. as
discussed above. This type of scrap can be pre-determined and efforts should be made that
it should not be more than the pre-determined quantity.
Administrative scrap arises due to administrative action, such as, a change in the method of
production.
Defective scrap arises because of use of inferior quality of material or bad workmanship or
defective machines. Such type of scrap is abnormal because it arises due to abnormal
reasons.

The useful methods for the treatment of scrap are as follows:

1. If realisable value of normal scrap is insignificant (i.e., legitimate scrap and
administrative scrap) it may be credited to Profit and Loss Account like other income. This
method of treatment of scrap is suitable when the scrap is of very little value and when the
market for it is uncertain. This method is known as treatment by neglect.
This method is not suitable for effective control over scrap because detailed records of scrap
are not kept and scrap cost is not shown as an element of cost in the cost sheet. Scrap which
is not sold and is in stock is valued at nil for balance sheet purposes and thus vitiates the
valuation of closing stock.
Accounting of scrap by this method is also inaccurate as there is a time lag between the sales
and the production. There is also a possibility that scrap may arise in one period but may be
accounted (i.e., sold) in another period and thus distorts the profits of two periods.

2. The sale value of scrap may be deducted from the cost of materials consumed or
factory overhead. This method is suitable when several production orders are commenced at

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a time and it is not possible to find scrap for each other. This method is, however, not effective
in controlling scrap arising in different processes, jobs or orders.
When overheads are absorbed on the basis of pre-determined rates, it is more appropriate to
credit an estimated allowance for the scrap instead of the amount of actual scrap.
The journal entries for recording the scrap are:
(i) Dr. Scrap Account (with an estimated allowance) Cr. Factory Overhead Control
Account
(ii) Dr. Cash/Debtors (Amount realised on sale) Cr. Scrap Account.

Profit or loss on sale of scrap may be transferred to the Profit and Loss Account at the
end of the year. When scrap is sold on a day-to-day basis and no stock is maintained, the
journal entry is: Dr. Cash/Debtors Account (with realisable value) Cr. Factory Overhead
Control Account

3. The scrap may be assigned a cost if it can be related to the job which yielded the
scrap. It will help in giving reasonable credit to the jobs which yielded scraps. This method of
treatment is suitable when scraps from the various jobs widely differ in nature.

4. It is possible that scrap arising in one job may be used in another job. In such a
case material transfer note for transfer of scrap from one job to another job should be prepared
and credit should be given to the job where scrap arises and debit should be given to the job
for the amount of scrap transferred to it.
Sometimes, scrap may be returned to stores when some further processing has to be done
before that can be utilised for other jobs. Job returning the scrap is credited with the value of
the scrap returned to stores.

5. When the actual scrap is in excess of the pre-determined quantity (i.e., normal
quantity), the cost of the excess scrap is transferred to Costing Profit and Loss Account after
deducting there-from the sale proceeds of such excess scrap. The valuation of excess scrap
is done in the same way as the valuation of abnormal waste is done.

6. The cost of defective scraps after deduction there-from the sale a proceeds of such
scrap is transferred to Costing Profit and Loss Account because it is an abnormal loss.

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Lesson 12. Waste (Lodha, n.d.)

Waste is defined as discarded substances having no values. In many industries, some

waste is inevitable. Such waste may arise due to the inherent nature of materials, chemical
reaction, evaporation, drying, sublimation of goods etc. Waste can also be in the form of
smoke, gas, slag or dust which arises in the course of a manufacturing process.
Waste may be invisible or visible. The former type of waste (i.e., waste due to drying,
evaporation etc.) is invisible whereas the latter type of waste (i.e., gas, smoke, slag etc.) is
visible. Waste has practically no measureable value. Rather in some industries, the waste
instead of realizing any value creates a problem for its disposal incurring further costs. The
waste may be normal and abnormal from the point of view of treatment in costing.

Normal Waste
It is the loss which is unavoidable on account of inherent nature of material. Some
materials such as liquid materials lose their weight due to evaporation. Similarly, there are
some materials (i.e. coal) which are wasted due to loading and unloading. Materials may be
wasted due to breaking the bulk into smaller parts.
Normal waste is unavoidable and as such may be reduced to some extent if there is
strict control but cannot be totally eliminated. Such loss can be estimated in advance on the
basis of past experience or chemical data. As waste has practically no value, its treatment in
costing is relatively simple. The normal process loss is recorded only in terms of quantity.

The effect of such waste is to reduce the quantity of output and to calculate the cost
per unit of the output; the total cost is distributed over the quantity of input less the quantity
of normal waste shown as follows:

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Thus, the cost of normal waste is recovered from the good output because it is a principle of
costing that all normal expenses which are necessarily to be incurred should be included in
the cost of production.

Abnormal Waste:
Any loss caused by unexpected or abnormal conditions such as sub-standard
materials, carelessness, accident etc. or loss in excess of the margin anticipated for normal
process loss should be regarded as abnormal waste.

The value of abnormal loss is calculated with the help of the following formula:

All cases of abnormal waste should be thoroughly investigated and steps taken to
prevent their recurrence in future. Responsibility for abnormal wastage should be fixed on
purchasing, storage, production and inspection staff to maintain standards. Abnormal waste
should not be allowed to affect the cost of production as it is caused by abnormal or
unexpected conditions.

Such loss representing the cost of materials, labour and overhead incurred on the
wastage should he transferred to Profit and Loss Account (Costing Profit and Loss Account
where no integral system of accounting is maintained) and not added to the cost of production
so as to make meaningful comparison of costs of production of different periods.

Assessment Task

Unscramble the letters to reveal the correct answer:

152
1. Inventory is reported as a _________ asset. RNREUCT

2. Inventory is often reported at the _______ of cost or net

WRELO
realizable value.

3. FIFO and LIFO are examples of cost flow

APINSMOTSUS
________________.

4. Under this inventory system the balance in the Inventory

LEAPUETRP
account changes with each sale.

5. Under this inventory system the balance in the Inventory

RECIOPID
account does not change with each sale.

6. A ___________ will report raw materials, work-in-process,

FNCREMTARAUU
and finished goods inventory.

7. The freight cost on inventory items that are purchased

HIGNPSPI
FOB __________ point will be an inventoriable cost.

8. There will be no freight-in on goods purchased FOB

OSIATDNNETI
_______________.

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9. The annual cost of goods sold divided by the average
EVNUROTR
inventory balances is the inventory ______________ ratio.

10. The expected selling price in the ordinary course of

business minus the estimated costs of completion, disposal, ZBEIARLELA
and transportation is the net ___________ value.

Problem solving:

Compute for the ending inventory and cost of goods sold using the following systems:

a. Periodic inventory, FIFO

b. Periodic inventory, weighted average
c. Perpetual inventory, FIFO
d. Perpetual inventory, moving average

Date Units Cost

August 1 Inventory 20,000 P36.00

7 Purchase 30,000 37.20
12 Sale 36,000
21 Purchase 48,000 38.00
22 Sale 38,000
29 Purchase 16,000 38.60

Summary

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 The main objective of cost accounting is to produce accurate and meaningful figures
for the goods manufactured and sold which are to be used by management for control,
analysis and for the determination of the operating income.

The receipt of materials means incoming materials meant for conversion into final
product. The incoming materials are to be valued at invoice price subject to trade or quantity
discount plus all expenses incurred up to the point of placing materials in a condition suitable
for issuance from the stores.
Two systems (or methods) of inventory are Periodic and Perpetual Inventory Systems.
Under the periodic system the amount appearing in the Inventory account is not updated
when purchases of merchandise are made from suppliers. Rather, the Inventory account is
commonly updated or adjusted only once—at the end of the year. Under the periodic inventory
system, purchases of merchandise are recorded in one or more Purchases accounts.

Under the perpetual system the Inventory account is continuously updated. The
Inventory account is increased with the cost of merchandise purchased from suppliers and it
is reduced by the cost of merchandise that has been sold to customers. (The Purchases
account(s) do not exist.) Under the perpetual system there is a Cost of Goods Sold account
that is debited at the time of each sale for the cost of the merchandise that was sold. Under
the perpetual system a sale of merchandise will result in two journal entries: one to record the
sale and the cash or accounts receivable, and one to reduce inventory and to increase cost
of goods sold.

The combination of the two cost flow assumptions and the two inventory systems
results in four available options when accounting for the cost of inventory and calculating the
cost of goods sold: Periodic FIFO, Periodic Average, Perpetual FIFO, and Perpetual Average.

References

Averkamp, H. (n.d.). Inventory and Cost of Goods Sold.

https://www.accountingcoach.com/inventory-and-cost-of-goods-sold

155
Cbseacademic. (2018). Cost Accounting Class XI.
http://cbseacademic.nic.in/web_material/Curriculum/Vocational/2018/Accounting

De Leon, G. M. Jr., De Leon E. D., De Leon, N. D. (2019)Cost Accounting and Control. Manila
City, Phils. GIC Enterprises & Co., Inc.

Lodha, A. (n.d.). Material Losses: Waste, Scrap, Defectives and Spoilage.

https://www.yourarticlelibrary.com/cost-accounting/material-control/material-losses-waste-
scrap-defectives-and-spoilage/55398

Malik, S. (2010). Cost Accounting Procedure for Spoiled Goods.

http://costaccounting786.blogspot.com/2010/08/cost-accounting-procedure-for-spoiled.html

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