Controlling and Costing Materials Inventory - 2023.ppt

Cost accounting

1. Controlling and Costing Materials
Inventory

2. Inventory Costing Methods
According to Pedro P. Guerrero, when the
inventory items are few and are not ordinarily
interchangeable, specific identification
technique may be used.
Specific identification of cost means that
specific costs are attributed to identify items of
inventory.¹
_______________________________________
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¹Pedro P. Guerrero, Cost Accounting –Principles and Procedural
Applications, 2018 Edition

3. When there are large numbers of items of
inventory that are usually interchangeable,
perpetual inventory system is usually used.¹
Unit costs and total costs should be computed
each time materials are received and issued.¹

4. The primary basis of inventory valuation is cost.¹
If unit prices vary from one purchase to another,
an assumption should be made about the flow of
costs.¹

5. Three methods to determine the cost of ending
inventory to be reported:
A. First In, First Out (FIFO) method –Under this
method, the first materials purchased (the oldest
or earliest) are the first materials to be used. The
materials on hand are assumed to be the last one
purchased.¹
B. Last In, First Out (LIFO) method –Under this
method, the last materials purchased (the most
recent) are the first materials to be used. The
materials on hand are assumed to be the first one
purchased.¹

6. C. Moving Average Method –In this method all
the costs are commingled and an average cost is
computed with each new purchase and assigned
to materials issued and on hand.¹

7. Illustration: Assume the following transactions
relating to Material IJ-4, ink jet:
May 1 : The beginning balance on hand is 150 units, costing
P150 each.
 6: 150 units are purchased under Purchase Order 08 at
P155 each.
 10: 180 units are issued for use per Requisition 10.
 21: 150 units are purchased on Purchase Order 09 for
P156.
 23: 160 units are issued for use on Requisition 16.
 25: 10 units are returned to the storeroom as noted on
Returned Materials Report 3. These units had been issued on
May 10 for use on Requisition 10.

8. Illustration 4-1: First In, First Out Method
MATERIALSLEDGER CARD
(FIFO Cost Method)
MATERIAL Ink Jet REORDER POINT 150
NUMBER IJ-4 REORDER QUANTITY 150
DATE REF. RECEIVED
UNITS PRICEAMOUNT
ISSUED
UNITS PRICE AMT.
BALANCE
UNITSPRICE AMT.
May1 Bal. 150 150 22.500
6 PO-8 150 155 23,250 150 150 22,500
150 155 23,250
10 R10 150 150 22,500
30 1554,659 120 155 18,600
21 PO-9 150 156 23,400 120 155 18,600
150 156 23,400
23 R16 120 155 18,600
40 156 6,240 110 156 17,160
25 RM3 (10) 155 (1,550) 10 155 1,550
110156 17.,160

9. Arguments In Favor of First In, First Out:
1. It is easier and less costly to use.¹
2. It reflects the actual physical flow of goods.¹
3. The inventory shown in the balance sheet is
more relevant because it includes the most recent
costs.¹

10. Arguments Against the First In, First Out:
1. It does not match current costs against current
sales revenue .¹
2. It can lead to distortions of net income in period
of rising prices.¹

11. Illustration 4-2: LIFO Cost Method
MATERIALS LEDGER CARD
( LIFOCost Method)
MATERIAL Ink Jet REORDER POINT 150
NUMBER IJ-4 REORDER QUANTITY 150
DATE REF. RECEIVED
UNITS PRICEAMOUNT
ISSUED
UNITS PRICE AMOUNT
RECEIVED
UNITS PRICE AMT.
May 1 Bal. 150 150 22,500
6 PO-8 150 155 23,250 150 150 22,500
150 155 23,250
10 R10 150 155 23,250
30 150 4,500 120 150 18,000
21 PO-9 150 156 23,400 120 150 18,000
150 156 23,400
23 R16 150 156 23,400
10 150 1,500 110 150 16,500
25 RM3 (10)150 (1,500) 10 150
110 150 18,000

12. Arguments In Favor of Last In, First Out:
1. Current costs are matched against the current
revenue, because the cost of goods sold contains
the most recent costs.¹

13. Arguments Against Last In, First Out
1. It represents an unrealistic physical flow of
goods.¹

14. Moving Average Method –under this method,
the units and cost of each new purchase are
added to the balances already on hand when the
purchase is received, and a new average cost per
unit is computed.¹

15. Illustration 4-3: Moving Average Method
MATERIALS LEDGER CARD
(Moving Average Method)
MATERIAL Ink Jet REORDERPOINT 150
NUMBER IJ-4 REORDER QUANTITY 150
DATE REF. RECEIVED
UNITS PRICE AMOUNT
ISSUED
UNITS PRICE AMOUNT
BALANCE
UNITS PRICE AMT
May 1 Bal. 150 150 22,500
6 PO-8150 155 23,250 300 152.50 45,750
10 R10 180 152.50 27,450120 152.50 18,300
21 PO-9150 15623,400 270 154.4441,700
23 R16 160 154.44 24,710.40110 154.44
16,989.60
25 RM3 (10) 152.50 ( 1,525 )120 154.29
18,514.60

16. Argument In Favor of the Moving Average
Method –it produces inventory valuation that
approximates current value if there is a rapid
turnover of inventory.¹
Argument Against the Moving Average –there
may be a considerable lag between the current
cost and inventory valuation since the average
unit cost involves early purchases.¹

17. Philippine Accounting Standards (PAS) No. 2
(Inventories) prescribes the use of the FIFO and
the Moving Average Methodsto compute the
cost of inventories.¹
LIFO is no longer permitted under PAS 2.¹

18. Valuation at Cost or Net Realizable
Value
PAS No. 2 provides that inventories shall be
measured at the lower of cost and net
realizable value.¹
Net realizable value (NRV) refers to the
estimated selling price in the ordinary course of
business less the estimated cost of completion
and the estimated cost necessary to make the
sale.¹

19. The rule of cost or net realizable value, whichever
is lower may be applied as follows:
1. Lower of Cost or Net Realizable Value by
Item
2. Lower of Total Cost or Total NRV

20. Lower of Cost or Net Realizable Value by Item:
Under this plan, the cost and the net realizable
value of each item in inventory are determined.¹
The basis of valuation (the lower figure) is
identified for each item and is multiplied by the
quantity on hand to obtain the value of the lower
of cost or NRV.¹
The lower valuation for each item is used to
compute the value of the inventory as a whole.¹

21.  Cost NRV Valuation
Lower of Cost
Description Quantity per Unit per Unit Basis
or NRV
Material X 100 P100 P110 Cost
P10,000
Material Y 200 150 120 NRV
24,000
Inventory Valuation
P34,000

22. Lower of Total or Total NRV:
This method pertains to the calculation of the
total cost and the total NRV of the entire
inventory.¹
The lowerof the total is used as inventory
valuation.¹

23.  Cost NRV Total
Total
Description Quantity per Unit per Unit Cost
NRV
Material X 100 P100 P110 P10,000
P11,000
Material Y 200 150 120 30,000
24,000
 P40,000
P35,000
Inventory Valuation
P35,000

24. Application of the Rule of Cost or Net Realizable
Value Whichever is Lower
To adjust inventory to lower value, two
approaches may be used when perpetual
inventory records are kept:
1. Each materials ledger card is adjusted to show
the new unit values.¹
2. A valuation account is set up to reduce the total
value of the inventory to net realizable value. The
individual materials ledger cards are not changed
and continue to reflect cost.¹

25. Under the first approach, each materials ledger
card is adjusted according to the lower of cost or
NRV.¹
The loss is recorded by a general journal entry
debiting Loss on Inventory Write Down and
crediting Materials.¹
This method results in an increase on the cost
of goods sold for the difference between the
cost and the NRV and does not show the
inventory loss as a separate item on the income
statement.¹

26. Under the second approach, the inventory is
recorded at cost and any loss on inventory write
down is accounted for separately by debiting
Loss on Inventory Write Down and crediting a
valuation account Allowance for Inventory
Write Downs.¹
In subsequent years, the allowance account is
adjusted upward or downward depending on the
difference between the cost and net realizable
value of the inventory at year end.¹

27. Illustration 4-4: (Second Approach)
To illustrate, assume the following data for 2017,
the first year of operations and 2018:
 Dec. 31, 2017
Dec. 31, 2018
Inventory at Cost, per Materials Ledger Card P360,000
P420,000
Inventory at Net Realizable Value 348,000
416,000

28. Adjusting Entry to Set Up the Valuation
Account:
2017
Dec. 31 Loss on Inventory Write Down
12,000
 Allowance for Inventory Write Down
12,000
 To record loss resulting from
decline
 in NRV of inventory.

29. Income Statement Presentation:
Finished Goods Inventory. Jan. 1
Pxxx
Cost of Goods Manufactured (at cost)
xxx
Total Goods Available for Sale
P xxx
Finished Goods Inventory, Dec. 31
xxx
Cost of Goods Soldbefore Inventory Write Down
xxx
Add: Loss on Inventory Write Down
xxx

30. Balance Sheet Presentation:
Inventory, at cost P xxx
Less: Allowance for Inventory Write Down xxx
Inventory, at lower of cost or NRV
P xxx

31. Adjusting Entry to Record Recovery from
Inventory Write Down:
2018
Dec. 31 Allowance for Inventory Write Down 8,000
 Recovery from Inventory Write Down
8,000
 To record recovery resulting from adjustment
 of allowance account.

32. Income Statement Presentation:
Finished Goods Inventory, Jan. 1 P
xxx
Cost of Goods Manufactured (at cost)
xxx
Total Goods Available for Sale
xxx
Finished Goods Inventory, Dec. 31
xxx
Cost of Goods Sold Before Recovery from
Inventory Write Down
xxx
Less: Recovery from Inventory Write Down
xxx

33. Periodic Physical Inventory
Differences may occur between the quantity of a
material on hand and the quantity shown on the
material ledger card.
A physical inventory can be performed in one of
two ways:
1. At the end of an accounting period, all
production is halted and the employees count and
tally the materials on hand.¹
2. Only a few materials are counted each day. A
schedule is made so that all materials will be
inventoried at least once each year.¹

34. Adjustment of Inventory Shortage and
Overage
1. Materials ledger cards are corrected. A
shortage is recorded by an entry under Issued
column. The cost is computed using the costing
method (FIFO, LIFO, or moving average) as if the
missing materials were being charge out on a
requisition on the closing date. An overage is
entered under the Received column of the
material ledger card using the cost of the last
issue of that material.¹
2. Prepare entry to adjust accounts for the net
shortage or overage. Net inventory shortage as a
result of the physical count is adjusted by a debit
to Manufacturing Overhead Control and a credit
to Materials account.¹

35. Reasons for Inventory Shortages and
Overages
1. Failure to post receipts and or issues.¹
2. Errors in posting.
3. Errors in recognizing the correct cutoff dates.¹
4. Spoilage as a result of poor storage
conditions.¹
5. Losses due to theft of materials by employees.¹
6. Losses arising from theft by outsiders owing to
inadequate plant protections.¹

36. Disclaimer: This power point presentation is
for classroom discussion only. Not for
publication.
SOURCE AND REFERENCE:
Pedro P. Guerrero, Cost Accounting –
Principles and Procedural Applications, 2018
Edition

37. End of Presentation