material mgmt project

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MATERIAL MGMT PROJECT

Welcome to Accounting For Management

Home Controlling and costing materials

Controlling and Costing Materials:

Effective materials management is essential in order to (1) provide the best service

to customers, (2) produce at maximum efficiency, and (3) manage inventories atpredetermined levels to stabilize investments in inventories.

Successful materials management requires the development of a highly integrated andcoordinated system involving sales forecasting, purchasing, receiving, storage, production,

shipping, and actual sales. Both the theory of costing materials and inventories and thepractical mechanics of cost calculations and record keeping must be considered.

Costing materials present some important, often complex, and sometime highly

controversial questions concerning the costing of materials used in production and the costof inventoryremaining to be consumed in a future period. In financial accounting , thesubject is usually presented as a problem of inventory valuation; in cost accounting, the

primary problem is the determination of the cost of various materials consumed in productionand a proper charge to cost ofgoods sold.

The discussion ofmaterials management in this chapter deals with:

1. Procedures for materials procurement and use .2. Materials costing methods .3. Cost of materials in inventory at the end of a period .4. Costing procedures for scrap, spoiled goods, and defective work 5. Summary of materials management


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Procedures for Materials Procurement and Use:

Although production processes and materials requirements vary, the cycle ofprocurementanduse ofmaterials usually involves the following steps:

1. Engineering and planning determine the design of the product, the materials

specifications, and the requirements at each stage of operations. Engineeringandplanning not only determine the maximum and minimum quantities to run andthe bill of materials for given products and quantities but also cooperate in developingstandards where applicable.

2. The production budgetprovides the master plan from which detailsconcerningmaterials requirements are eventually developed.

3. The purchase requisition informs the purchasing agent concerning the quantity andtype of materials needed.

4. The purchase ordercontracts for appropriate quantities to be delivered at specified

dates to assure uninterrupted operations. 5. The receiving report certifies quantities received and ma y report results of

inspection and testing for quality. 6. The materials requisition notifies the storeroom or warehouse to deliver specified

time or is the authorization for the storeroom to issue material to departments. 7. The materials ledgercards record the receipt and the issuance of each class of

materials and provide a perpetual inventory record.

Accounting procedures for materials procurement anduse involve forms and recordsnecessary forgeneral ledgerfinancial accounting as well as those necessary for costing ajob, process or department, and for maintaining perpetual inventories and other statistical

summaries. The purchase requisition, purcha se order, receiving report, materialsrequisition, bill ofmaterials , scrap report, returned materials report, materials ledgercards ,and summary of materials used are some of the forms used for materials control under acost system. The purchases journal, the cash payments journal, the general journal, and the

general ledger control accounts are also used.

The discussion here is not based on any particular type or size of industry. It is, rather ageneral description of the accounting andcontrolling procedure involved intheprocurement anduse ofmaterials . To understand the detailed procedure ofpurchasing, receiving stocking, and using materials ( materials procurement anduse ) click

on the following links:

y Purchases of p roductive material.y Purchases of supplies, services, and repairs .

y Materials purchasing forms.y Receiving materials.y Invoice approval and data processing .y Correcting invoices.y

Electronic data processing (EDP) for materials received and issued .

y Cost of acquiring materials .y Storage and use of materials .y Issuing and costing materials into production .

y Materials ledger card --perpetual inventory.


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Materials Costing Methods:

The ultimate objective in cost accounting is to produce accurate and meaningful figures.These figures can be used for purpo ses of control and analysis and eventually matchedagainst revenue produced in order to determine net operating income .

After the unit cost and total cost of incoming materials are entered in the received section ofamaterials ledgercards , the next step is to cost these materials as they move either fromstoreroom to factory as direct materials orindirect materials or from storeroom tomarketing and administrative expense accounts as supplies. The more common methodsofcosting materials issued and inventories are:

1. First-in-First-Out (FIFO) Costing Method

2. Average Costing Method 3. Last-in-First-Out (LIFO) Costing Method4. Other Methods-Month end average cost, last purchase price or market price at date

of issue, and standard cost .

These methods relate to assumptions as to flow of costs. The physical flow of units may

coincide with the method of cost flow, though such a condition is not a necessaryrequirement. Although this decision deals with materials inventory, the same costing

methods are also applicable to work in process (WIP) and finished goods inventories .

Cost of Materials in Inventory at the End of a Period:

When the cost basis is used in costing inventories for financial statements and income taxreturns, the sum total of the materials ledgercards must agree with the general ledgermaterials control account which, in turn, is the materials inventory figure on the balancesheet. Unless a shift from the cost basis is made in valuing the year end inventory, themethod used for costing materials issued is the method used for assigning dollars

to inventory.

y Inventory valuation at cost or market whichever is lowery American Institute of Certified Public Accountant (AICPA) cost or market rules y Adjustments for departures from the costing method used y Inventory pricing and interim financial reporting y Transfer of materials cost to finished production y Physical inventory

y Adjusting Materials Ledger Cards and Accounts to Conform to Inventory Accounts

Costing procedures for scrap, spoiled goods, and defective work:

Generally, manufacturing operations cannot escape the occurrence of certain losses oroutput reduction due to scrap, spoilage, or defective work management and the entirepersonnel of an organization should cooperate to reduce such losses to a minimum. As long

as they occur, however, they must be reported and controlled.

y Scrap and waste y Spoiled goods

y Defective work


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Summary of Materials Management:

Materials managers are constantly confronted with these problems and requirements:

1. Inventories account for a large portion of the working capital requirements of mostbusinesses. This fact makes materials or inventory management a major problem

requiring constant attention by all three management levels (top, middle and low). 2. At present, the problem of materials management has become even more acute

due to market condit ions and inflation. 3. Effective materials management and materials control is found in an organization

in which individuals have been vested with responsibility for, and authority over, thevarious details of procuring, maintaining, and disposing off inventory. Such a personor persons must have the ability to obtain, coordinate, and evaluate the necessaryfacts and to take actions when and where needed.

Materials Management: Material ValuationBelow is a snippet from one of hundreds of articles available t o ERPtips subscribers.

If you would like a complimentary copy of the full article, please [email protected](include the title of the article in your email)To subscribe to ERPtips, go towww.ERPtips.com/Subscribe.asp.ERPtips Journal is published by Klee Associates, Inc.ERPtips University provides both public and onsite training for SAP clients.For more about ERPtips University, including the current schedule, click here:www.ERPtips.com/WorkshopSchedule.aspMaterials Management: Material ValuationIf your company's stockholders weren't happy with the Balance Sheet at the lastStockholder'smeeting, you may find the CFO asking how the SAP Material Valuation works. Perhapshe/shewill want to make the assets look greater, to show a stronger asset positionor perhapshe/she will want Click here to read this SnippetCopyright 2008 by Klee Associates, Inc. Page 1www.SAPtips.comMaterials Management:Material Valuation

By Jocelyn Hayes, SAPtips Director of Consulting and Traini ngEditors Note: If your company's stockholders weren't happy with the Balance Sheet at thelastStockholder's meeting, you may find the CFO asking how the SAP Material Valuationworks.Perhaps he/she will want to make the assets look greater, to show a stronger asset

positionorperhaps he/she will want a smaller value reflected, to minimize tax debt. Jocelyn Hayesprovidesa brief, but thorough primer of the three types of Material Valuation, their benefits, andconfiguration. Any way you look at it, this article is a valuable contribution to your SAP "howto"library.Overview


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The main functions of Valuation and Account Determination in the SAP system are todeterminehow a material is valuated, which then feeds the Financial Ledgers and Reports, and then todesignate how various movements for the material post to General Ledger (G/L) accounts.Setting up different methods of Balance Sheet Valuation for materials is the first key activityinthis process. Methods include LIFO, FIFO, and Lowest Value Determination valuation. Theotherimportant activity is to understand employing the Account Determination Wizard inconfiguration.Balance Sheet Valuation

Three methods to perform Balance Sheet Valuat ion exist in SAP: LIFO Valuation FIFO Valuation Lowest Value DeterminationGenerally, the LIFO method of Valuation decreases the value of stock on your books; whiletheFIFO method increases the value. Therefore, using FIFO indicates greater capit al assets onyour

books, and results in greater taxes paid to the government by your company.In standard SAP configuration, both LIFO and FIFO valuation are set as active viatransactionOMWE, as shown in Figure 1.IMG Path: Materials Management Valuation and Account Assignment Balance SheetValuation Procedures Configure LIFO/FIFO Methods General Information Activate/Deactivate LIFO/FIFO Valuation.Copyright 2008 by Klee Associates, Inc. Page 2www.SAPtips.com


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There are five basic approaches to valuing inventory that are allowed by SIMMS

Inventory Software

1. Standard : Under the Standard costing method approach, both inventory and the costof goods sold are based on the standard fixed cost assigned to the items within the

item manager at the time of reporting.2. First-in, First-out (FIFO) : Under FIFO, the cost of goods s old is based upon the cost

of material bought earliest in the period, while the cost of inventory is based upon thecost of material bought later in the year. This results in inventory being valued closeto current replacement cost. During periods of infla tion, the use of FIFO will result inthe lowest estimate of cost of goods sold among the three approaches, and thehighest net income.

3. Last-in, First-out (LIFO) : Under LIFO, the cost of goods sold is based upon the costof material bought towards the end of the period, resulting in costs that closelyapproximate current costs. The inventory, however, is valued on the basis of the costof materials bought earlier in the year. During periods of inflation, the use of LIFO willresult in the highest estimate o f cost of goods sold among the three approaches, andthe lowest net income.

4. Weighted Average : Under the weighted average approach, both inventory and thecost of goods sold are based upon the average cost of all units currently in stock atthe time of reporting. When inventory turns over rapidly this approach will moreclosely resemble FIFO than LIFO.

5. Average : Under the average approach, both inventory and the cost of goods soldare based upon the average cost of all units received in stock.

Firms often adopt the LIFO approach for the tax benefits during periods of high inflation, andstudies indicate that firms with the following characteristics are more likely to adopt LIFO -rising prices for raw materials and labor, more variable inventory growth, an a bsence ofother tax loss carry forwards, and large size. When firms switch from FIFO to LIFO in valuinginventory, there is likely to be a drop in net income and a concurrent increase in cash flows(because of the tax savings). The reverse will apply when firms switch from LIFO to FIFO.


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Easily select the Inventory Valuation/Sale Price Method you wish to utilize, the optionsavailable are Standard, FIFO, LIFO, Average and Weighted Average Costing

From the inventory Item Manager in SIMMS Inventory Software you can quickly view aselected items, Cost and Price Average, FIFO and LIFO thus far as well as the last Costand Price

Utilize the powerful Inventory Valuation Report Generator in SIMMS Inventory Softwareand select for yourself the valuation options you wish to take advantage of within the

report, some of the available options are;

y Print the Current Stock Valuationy Print the Historical Stock Valuation by the end of a selectable month and yeary Print the RMAStock Valuation (based on item repair costs)y Print based on the Standard Valuation Methody Print based on the FIFO Valuation Methody Print based on the Average Valuation Methody Print based on the Weighted Average Valuation Methody Group by location code or ca tegoryy Sort by location code or category


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IF tracking your true inventory Valuation is important to you then SIMMS is the correctsolution. So what are you waiting for? Contact us (604-504-4215) by phone or by e-mail ([email protected]) so we can help you take the first steps towards the solution youhave been seeking.

There are three methods with which you can revaluate your stock for Balance Sheet

purposes.Irrespective of the method you select, you will be able to valuate your stock either

at the Company Code level or at the Valuation Area level:

1. LIFO (Last-In-First-Out): This method is based on the assumption that the materials

received last were the ones issued/consumed first. The valuation is based on the initial

receipt.

2. FIFO (First-In-First-Out): Here the assumption is that the materials received first are the

ones consumed/issued first. So, the valuation is based on the most recent receip t. The FIFO

method can also be used in conjunction with the lowest value method. By this you can

determine whether the system should make a comparison between the FIFO determined

price and the lowest value price. You can also determine whether the FIFO pri ce should beupdated in the material master record.

3. Lowest Value Method: Here, the stocks are valued at their original price or the current

market price whichever is lower. This method is suitable when the inventory needs to be

valued to take into account material obsolescence, physical deterioration, or changes in

price levels.

STORES ACCOUNTING

Any inventory item has both physical and financial characteristics. Whereas the

physicalcharacteristics (flow of goods) are factual and measurable, financialcharacteristics (flow of

costs) aremainly subjective in nature. The financialcharacteristics associated with the flow of costs are

usuallyemphasized in stores accounting and valuation.

WHY STORES ACCOUNTING?Stores accounting plays a very important role for the estimation of the cost o

f a

product for pricingdecisions. Material costing is very important in terms of the valuation of the cost of

materialsconsumed by say, the production department during a given period of time as well as in

terms of theestimation of the value of materials held in stock. In this context, two important aspects,

viz., costingof the materials receipt and of materials issue, are considered in stores accounting.1 Costing of the Receipt of Materials

The factors that are to be included in building up the cost of the materials received are material price,freight charges, insurance, and taxes. Price usually refers to the price quoted and accepted in

thepurchase orders. Prices may often be stated in various ways, such as net prices, prices with

discountterms, free on board (FOB) and cost insurance and freight (CIF). For costing purposes the

actual costincurred needs to be calculated by taking price quoted by supplier as the basis, subtracting

thediscounts and adding any other expenses not covered.2 Costing of the Issues of Materials to Production


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There are several methods that are in use for costing the issues of materials to the production andother

departments of an organization. First in first out (FIFO), last in first out (LIFO), average cost,standard

cost, base stock method, market price at the time of issue, latest purchase price, andreplacement or

current cost methods are a few of the methods used for this purpose.Material Costing : Is important for:

1) Valuation of the cost of materials consumed, and

2) Estimating the value of materials held in stock. - at various stagesFLOW OF COSTS (or) Pricing material issues

1) Actual cost method.

2) FIFO First-In-First-Out

3) LIFO Last-In-First-Out

4) HIFO Highest-In-First-Out

5) Simple Average Cost Method

6) Weighted average Cost Method

7) Periodic Average Cost Method

8) Standard Cost Method

9) Replacement Cost Method (market price method)10) NIFO Next-In-First-Out method

11) Base Stock Method


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S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

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FIFO Method Assumption: Oldest stock is depleted first.

At the time of issue the rate pertaining to that will be applied. Since actual prices are used

there cannot be any profit or loss in the pricing arrangement. The value of stock on hand is the money that has been paid for that amount of stock at latest


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price levels and hence can be straight away used in the balance sheet, truly reflecting value.

Example 1 The periodic inventory record shown in Table 13.1 is available on an item. A physical count of

the items on 1 April reveals an ending inventory of 300 units. What is the value of the endinginventory?

Whatis

the

costofgoods

soldfor

the

period?

Advantages: Easy to understand and simple to price the issues.

A good store keeping practice in which the material leaves the store in a chronological order

based on its age.

Involves less clerical costsMethod of valuation is accepted under standard accounting practice

Inventory valuation is nearest to recent market prices.

Limitations

Process becomes unwieldy when too many changes in price occur.

Problem in accounting for returns to stores.

2 LIFO Method

In the LIFO method, it is assumed that the most current cost of goods should be charged to the costof

goods sold, and hence, in LIFO, the cost of units remaining in inventory represents the oldest

costsavailable, while the units issued are valued at the latest costs available. The underlying purpose

ofLIFO is to match current revenues against current costs, so the method charges current

revenueswith amounts approximating replacement costs.

Assumption: Most recent receipts are issued first.

Advantages:

a. In a period of rising prices, latest (higher) prices are charged to issues, thereby leading to

lower reported profits and hence savings in tax.

b. When there are wide fluctuations in price levels, LIFO tends to minimise unrealised gains or

losses in inventory.

- Limitations same as that of FIFO


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3 Average Cost Method

In an attempt to provide a better estimate of the ending inventory and cost of goods sold, the

averagecost method is proposed. This method does not attempt to indicate which unit goes out first or

last.Instead, it determines the average cost for each itemduring a time period. The following three

types ofaverage method are in use:

i)Simple average,

ii)Weighted average, and

iii) Moving average.While all three types are suitable for with a periodic inventory system, the movin


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g average is best

suited to the perpetual inventory system. The simple average is determined by dividing the sum of production or purchase unit costs by

the number of production runs or orders. The simple average does not consider the size of the lotor the

number of units and assigns equal weight to the unit production or purchase cost of eachlot. The

weighted average corrects the distortion of the simple average by considering quantity aswell as unit

cost. The weighted average divides the cost of goods available during the period.

The moving average computes an average unit cost after each purchase or addition to stock,

making it better suited for computerized inventory operations. Since the simple average and

theweighted average cannot be calculated until the period is over, they are not well suited toperpetual

inventory systems. All of the averages are suitable for periodic inventory systems,since costs are not

allocated till the end of the period. With the average cost method, the costs of all like items available during the period are

averaged to obtain the ending inventory value. The unit cost cannot be equated to any tangible

figure, and it does not reveal price changes as clearly as may be desired.Example 5

The periodic inventory recordshown in Table 5 is available foran item. A physical count of theitem onApril reveals an endinginventory of 300 units. Calculatethe values of the ending inventoryand the cost

of goods sold usingthe (a) simple average,(b) weighted average, and

(c) moving average methods


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Specific Cost Method


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Of all the inventory flow assumptions, the specific cost method provides the most realistic valuation

ofending inventory and cost of goods sold. The procedure consists of tagging or numbering each

itemas it is placed into inventory so its exact cost is readily discernable. Since an item is both valued

andexpensed at its specific cost, the cost flow and the physical flow are identical with this method.

Thecost of maintaining records under this method can mount very quickly, so it is most appropriate

forgoods of significant value, which is few in number. The specific cost method has the added

flexibilityof being suitable for either perpetual or periodic inventory items used in custom-mad

e

products. If thenumber of custom orders being processed is large, its implementation can be

extremely expensiveand difficult. Thus, its use is more commonly confined to small operations.A number of methods are included in this category. They are as follows:

i)Market Value,ii)Standard Cost,

iii) Closing Stock

A brief description of each of this method is given below.i) Market Value: This method is also known as replacement rate costing. Herethe materials that are

issued are costed at the market rate prevailing at the time of issue. Hence, when prices increase,thestock on hand is continuously underestimated, because receipts are costed at actual rates and

issuedat higher rates. Conversely, when the prices are falling, the stock on hand is grossly

overestimated.This may in turn lead to writing off huge amounts to make it realistic. Besides, this

system requirescontinuous monitoring of market rates for all materials and hence, is very unwieldy

and unreliable.

ii) Standard Cost: Here, a standard rate is determined based on detailed analysis of market prices

and trends. This standard rate is kept fixed for a definite period of six months or so. During this

periodcosting is done on the basis of this standard rate, irrespective of the actual rates. At the end of

theperiod, a review is done and fresh standards are set for a further period of six months.

Efficient use of materials is truly reflected by adopting this method, as the accounting

isdivorced from fluctuations in rates. Moreover, it is not necessary to obtain fresh rates at every point

oftime. This means greater clerical efficiency and quicker estimation of costs. However, in this

methodalso, at the time of rising prices the stock on hand is underestimated, and at the time of falling

prices,the stock on hand is overestimated.iii) Closing Stock Costing: Generally the guideline used here is that either the market price or stock

at cost is to be used, whichever is less. The main factors, which determine the cost of closing stock,are price levels, obsolescence, and deterioration.

Reasons for discrepancies in stock

Discrepancy = difference between physical stock and stock shown in records.

Items placed in wrong location.

Pilferage and theft by insiders/outsiders.

Stock returns not recorded properly.

Arithmetical errors in calculating the balances in bin card.

Clerical errors in stores ledger.

Shortage due to spoilage, evaporation, wastage in material handling and storing,Increase/decrease in weight.

Issue and receipt of stock without proper recording.


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Actual quantity supplied differs from the quantity mentioned in the Delivery Challan.

Steps to avoid discrepancies

Restrict entry to stores to authorized personnel only.

Materail requisition to be signed by authorized persons only, and issue material only then.

Proper maintenance of store records Bin Card, Stock Card, Stores Ledger etc.

Regular checks by independent staff to detect and correct mistakes.

Record all movements of stock.

Physical verification and counting at the time of receipts and issues.

Use of FIFO method for stock issue to avoid deterioration and obsolescence.STOCK VERIFICATIONIt is the process of physically counting, measuring or weighing the entire

range of

items in the storesand recording the results in a systematic manner. Stock Verification is usually

carried out by thematerials audit department, reporting to either the materials manager or the internal

audit. Oneperson is usually given the exclusive responsibility with adequate facilities and authority.

The mainobjectives of stock verification are as follows:a. To reconcile the stock records and documents for their accuracy and usefulness,Systems

b. To identify areas which require more disciplined document control,

c. To back up the balance sheet stock figures, andd. To minimize pilferage and fraudulent practices.The physical verification of stock may be carried out either as a periodic or continuous

basis. These two methods are briefly discussed below.

Periodic Verificationand Continuous Verification


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Materials, obsolescence, etc. A regular verification process ensures


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material mgmt project

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