COST ACCOUNTING TECHNIQUES (PART B1)

Accounting for materials.

Materials make up a large part of the total cost of production of goods and services.
It is therefore essential that materials are properly accounted for and safeguarded.
Inventory Control
Inventory control involves ordering, purchasing, receiving into store, issuing them
to production department and controlling inventory levels.
Classification of inventories
1. Raw materials
2. Work-in-progress
3. Parts/Components/Consumables
4. Finished Goods
Ordering, receipt and issue of raw materials.
Movement of materials in an organization must be properly documented using the
appropriate documents such as a purchase requisition note, purchase order, goods
received note (GRN), material requisition note, material transfer note and material
returned note.
1. Purchase requisition note. This is sent by the production department to the
purchasing department authorizing the purchase department to place an
order.
2. Quotations. Quotations are obtained by the purchasing department from the
selected suppliers. Quotations will among other things indicate the type and
prices of materials to be ordered by the purchasing department.
3. Purchasing order. This is a document prepared by the purchasing
department and sent to a selected supplier(s). A copy of this document is
sent to the accounts department.
4. Delivery note. This note normally accompanies the goods supplied. The store
keeper will have to sign the delivery note to confirm the correctness of the
items supplied by the supplier. The signed delivery note is then given to the
carrier.

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 5. Goods received note (GRN). Once the delivery note is accepted by the store
keeper, the store keeper prepares the goods received note. A copy of the
goods received note is given to the Accounts department which compares
the goods received note to the purchase order. Once the Accountant or the
accounts department is satisfied with the two documents, payment process
is initiated to effect payment for the goods.
6. Material requisition note. It takes records of materials issued to the
production department.
7. Materials transfer note. Where materials are issued to a particular job but
are transferred to another job, materials transfer note should be raised. It
shows the transferee and the transferor jobs and the description of the
materials.
8. Bin card. It is a document used to record the receipts, issues and transfer of
materials. It is held by the store keeping department. The Bin card only
records materials in units and shows the levels but NOT the values of
materials.
9. Stores ledger. The stores ledger records receipts, issues and stock balances
at any point in time. It records both quantities and values of material at any
point in time.
10. Free inventory. It refers to inventories available for future use. It is
calculated as:
Free inventory = materials in inventory
+ materials ordered from suppliers
- Materials requisitioned but not yet issued.
Question 1
A wholesaler has 8,450 units outstanding for part X100 on existing customer’s
order; there are 3925 units in inventory and the calculated free inventory is 5525
units. How many units does the wholesaler has on order with his supplier?
This question would be solved in class.
Objectives of storing materials.
1. To assist in the easy identification of materials.
2. To assist in the easy location of the materials.
3. It enhances issues and receipts of materials.
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 4. To protect materials from damage.
5. It ensures the efficient and effective use of the storage space.
6. It ensures the maintenance of correct stock levels.
Assignment 1
State 5 reasons for coding materials held in store.
Stock taking/ count
Stock taking or count involves the physical counting of inventories in store and
comparing the physical stock balance with that of the stores ledger balance.
Types of stock taking
1. Periodic stock taking. It involves the physical counting of materials in store
at a set or a specific date and it’s usually the end of the accounting year. The
physical stock balance is only known at the end of the year when stock take
is done. The store is often closed down for stock take to take place.
2. Continuous stock taking. It involves the physical counting of stock on a daily
basis whiles the store is still in operation. Errors are early and easily detected
for corrections.
Advantages of continuous stock taking
a. It eliminates the need for annual stock taking and its associated store’s
closure.
b. It assists in the early detection of fraud and irregularities.
c. Sales and production hold ups are eliminated.
d. Control over inventory levels are improved.
e. More time is made available for stock taking and this leads to a reduction in
errors in stock taking.
Perpetual inventory
It refers to the recording of inventories whereby the bin card and the store ledger
account are updated daily to reflect receipts and issues of materials as they occur.
Inventory cost.
Inventory cost is made up of purchasing cost, ordering cost, holding cost and the
cost of running out of inventories.
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Reasons for holding stock
a. To meet production requirements.
b. To take advantage of bulk purchase discounts.
c. To take advantage of seasonal fluctuations and any variations in usage and
demand.
d. To allow the production process to flow smoothly.
e. As an investment policy to mitigate the impact of inflation.
Effects of keeping excess stock
a. High holding cost. Examples warehouse rent, lighting, heating etc.
b. Interest charges.
c. Insurance
d. Obsolescence and deterioration
e. Theft
Effects of stock out (Running out of stock)
a. Loss of contribution from loss of sales.
b. Loss of future sales due to disgruntled customers.
c. Loss of customer goodwill.
d. Cost of production stoppages.

Inventory control level (stock levels)

Re-order level
This is the level at which an order will have to be placed in order to replenish stock.
It is set between minimum stock level and maximum stock level.
Re-order level = Maximum consumption x Maximum lead time
Minimum stock level
This is the stock level below which stock should not normally be allowed to fall. It
is the warning stock level to management in order to avoid stock out.
Minimum stock level = Re-order level-(Average consumption x average lead time)

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Maximum stock level
This refers to the level of stock above which stock should not normally be allowed
to rise.
Maximum stock level= Re-order level + Re-order quantity-(Min con x min lead
time)
Re-order quantity (Economic order quantity)/EOQ
It refers to the quantity of materials or stock that must be ordered in order to
minimize inventory cost (Ordering costs and Holding costs).
That is, the two types of costs which determine the Economic order quantity is
ordering cost and holding cost.
Total cost = Holding cost + Cost of ordering.
NOTE:
The formula for the computation of holding cost, ordering cost and the economic
order quantity would be discussed in class.

Question 2

Pam runs a mail-order business for gym equipment. Annual demand for the
TricoFlexers is 16,000. The annual holding cost per unit is ₵2.50 and the cost to
place an order is ₵50. What is the economic order quantity?

To be solved in class.

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Question 3

Abronoma Company Limited, a profit making concern has the following

information in respect of material ABC;

Re-order period……………………………………1 – 2 weeks.

Maximum consumption……………………………900 units per week

Normal consumption……………………………….600 units per week

Annual consumption………………………………..31,200 units

Purchase price……………………………………….₵40 per unit

Cost of storage per unit………………………………10% of purchase price

Cost of order …………………………………………₵6 per order

Calculate the following:

a. Re-order level
b. Minimum stock level
c. Maximum stock level
d. Re-order quantity (EOQ)

To be solved in class.

Question 4

The annual demand for material 5050 is 100,000 units. One unit of the material
5050 cost ₵4 per annum to hold. Ordering cost of the material is ₵20 per order.
What would be the Economic Order Quantity (EOQ) to minimize stock
administration cost? Determine the various costs where orders in quantities of
10,000 units, 5,000 units, 2,000 units, 1,000 units and 500 units are made.

To be solved in class.

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Economic batch quantity (EBQ)

The economic batch quantity is a modified form of EOQ. The EBQ is used when
resupply is done gradual basis instead of instantaneous.

EBQ =

Question 5

Agona Company Limited manufactures its own inventories at the rate of 4,000
units a week. Demand for the components is at the rate of 2,000 units a week. Set
up costs for each production run are ₵50. The cost of holding one unit of inventory
is ₵0.001 a week.

Calculate the economic production run.

To be solved in class.

Bulk Discounts

The economic order quantity formula is modified when bulk purchases leading to
quantity discounts are involved.

In order to decide whether to take a discount and ordering large quantities, it is

necessary to minimize the total of the following costs:

1. Total material costs

2. Ordering costs
3. Holding costs

You will do a computation without the discount and with the discount and the one
that gives the least total cost is selected.

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Question 6

The annual demand for an item of inventory is 45 units. The item costs ₵200 a unit
to purchase. The holding cost for one unit for one year is 15% of the unit cost and
the ordering costs are ₵300 an order.

The supplier offers 3% discount for orders of 60 units or more, and a discount of
5% for orders of 90 units or more.

Calculate the cost minimizing order size.

Inventory valuation

There are many methods of inventory valuation. For the purposes of paper 2.2, we
shall look at three key methods. They are:

1. First in first out (FIFO)

2. Last in first out (LIFO)
3. Cumulative weighted average pricing (AVCO)

These methods of stock pricing/ valuation would be explained in class.

Note:

Students are required to read on the advantages and the disadvantages of each of
the methods mentioned above.

Question 7

Z Company Limited had the following transactions in one of its raw materials
during April:

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 April Deatails Quantity(Units) Price ₵
1 Opening Stock 40 10
4 Purchased 140 12
10 Sold 90 15
12 Bought 60 14
13 Sold 100 16
16 Bought 200 16
21 Sold 70 18
23 Sold 80 20
26 Bought 50 18
29 Sold 60 20

Total overhead expenditure for this raw material is ₵500.

You are required to:

a. Write up the stores ledger account using (i) FIFO, (ii) LIFO and (iii) AVCO.
b. State the total cost (Cost of sales) of materials used under each method.
c. Prepare a profit statement for each method.
d. State which of the methods is preferred by the Ghana Revenue Authority
and explain why.