F2-05 Accounting For Materials
F2-05 Accounting For Materials
F2-05 Accounting For Materials
FOCUS
This session covers the following content from the ACCA Study Guide.
Session 5 Guidance
Be aware of the procedures and documentation used in inventory systems (s.1, s.2).
Work through Illustration 5 and Example 1 for the mechanics of the valuation methods.
Note the specific accounts used to record inventory movements.
Note the reasons for holding inventory and the associated costs (s.3).
PROCEDURES AND
DOCUMENTS
• Requisitioning
• Ordering
• Receiving
• Purchase Invoicing
• Issuing Materials
ACCOUNTING FOR
INVENTORY MOVEMENTS
• Stores Records
• Bin Cards
• Valuation Methods
• Account Entries
INVENTORY CONTROL
• Why Hold Inventory
• Associated Costs
• Buffer Inventory
• Inventory Problems
Session 5 Guidance
Understand and apply the economic order quantity model by working through Illustration 7 and
working through Example 3.
Learn how to apply the economic order quantity when holding cost does not vary with average
inventory (Example 5) and when discounts apply (Example 6).
1.1 Requisitioning
Storekeeper requests purchasing department to obtain reorder
quantity from appropriate supplier.
Documentation is a purchase requisition, which is
authorised to raise a purchase order.
Production department requests transfer of raw materials from
stores to the factory.
Documentation is a materials requisition (s.2), where
items are despatched to production and inventory records
updated.
1.2 Ordering
Purchasing officer (or buyer) requests supply of materials
listed. A copy is sent to goods inwards/warehouse.
Documentation is a purchase order (PO), which specifies
quantity, price, delivery date and terms.
1.3 Receiving
Goods are inspected and checked to the supplier's delivery
note and copy purchase order before being recorded.
Documentation is a goods received note (GRN), which
creates a common format.
PURCHASE ORDER
To: Lyreco.com/OLO
5 star office lever arch file 10 boxes 8792M $13.58 per box
70mm A4 Cloudy Grey
BA Dowling
Purchasing Officer
For Cost
Office use
2.3.2 FIFO
For raw materials, the units purchased first are deemed to be
the first issued to be used in production.*
*Similar to raw
The unit cost for the first batch received (i.e. "first in") is the materials, for finished
issue price until the whole batch has been issued—then the goods, the units
unit cost of the next batch in becomes the issue price. manufactured first are
deemed to be the first
2.3.3 LIFO sold (e.g. cars finished
on a production line).
For raw materials, the units purchased most recently (i.e. last)
are deemed to be the first issued to be used in production.*
If a new batch is received before the previous batch is fully
issued, the new cost becomes the "last in" price until:
the new batch is fully issued (when the previous last in
price will apply); or *It is possible for the
a new delivery received (when the cost of the new batch
last units purchased
to be first used when
will apply). a "bin" system is used
and the items first
2.3.4 Weighted Average
removed from the top
A weighted average price is calculated by weighting according were the last to be
to the number of units purchased at each price.* put in.
The average price at any time is the total inventory value
divided by the number of units on hand.
$ $
Inventory at 30 November 100 8.50 850
05 December: Purchase 100 8.70 870
17 December: Purchase 200 8.90 1780
27 December: Purchase 100 9.00 900
Goods for sale in December 500 4400
Less: Inventory at 31 December (400) 8.80 (3520)
Cost of goods sold 100 8.80 880
Required:
Calculate the value of closing raw materials inventory using the following methods to
price issues:
(a) FIFO (b) LIFO (c) Weighted average
Solution
(a) FIFO
16 Jan
17 Jan
20 Jan
23 Jan
30 Jan
(b) LIFO
16 Jan
17 Jan
20 Jan
23 Jan
30 Jan
16 Jan
17 Jan
20 Jan
23 Jan
30 Jan
Advantages Disadvantages
Manufacturing overheads x
$ $
4 Reorder Quantity
average = x/2
Time
If holding a unit in inventory for one year costs $Ch then the
annual inventory holding cost (TCh) is Ch x .
2
4.1.2 Annual Order Cost
There is an incremental cost to placing each order to buy more
inventory.
For example, each order may have a fixed cost of placing it
due to the cost of sending a fax.
As order quantity , number of orders . Therefore total
annual ordering costs (TCo) .
If Co is the fixed cost of an order and D the demand per
CοD
annum in units, then the annual order cost (TCo) is .
x
Annual Cost $
Total Costs
Holding Costs
Reorder Cost
(a) Q = 200
Total cost =
(b) Q = 400
Total cost =
(c) Q = 600
Total cost =
Summary
(i) Order (ii) Holding (iii) Total
(a)
(b)
(c)
Annual demand for a particular inventory item (D) is steady at 120 units. The incremental cost of
ordering the inventory (Co) is $20 and the cost of holding a unit of inventory for a year (Ch) is $3.
Solution
Order Average Annual Numbers Annual Total
quantity inventory holding of orders reorder cost annual cost
Q Q/2 cost QCh/2 p.a. D/Q CoD/Q QCh/2 + CoD/Q
120 60 180 1 20 200
60 30 90 2 40 130
40 20 60 3 60 120
30 15 45 4 80 125
20 10 30 6 120 150
10 5 15 12 240 255
Example 3 EOQ
(a) EOQ =
2 × 90 × 9, 000
Using the EOQ formula the optimal batch size = = 900 units
2
9, 000
ABC will therefore have = 10 production runs a year.
900
2CoD
EBQ =
D Just as ACCA’s EOQ
Ch 1 −
R exam formula applies
to orders and batches
where there is instant
Where: replenishment this
EBQ exam formula
D = annual demand (or usage) applies to orders
R = annual replenishment rate and batches where
there is gradual
Co = order cost (or set up costs per batch) replenishment.
Ch = holding cost per unit per year
Example 4 EBQ
Same data as for Example 3, except that having placed an order, inventory is replaced
gradually. The supplier can deliver at a rate equivalent to 120,000 units per year.
Required:
Calculate:
(a) the economic batch quantity
(b) the number of orders to be placed each year
(c) the frequency of orders (assume 300 working days).
Solution
(a) EBQ =
Warehousing cost =
EOQ =
Step 2 If EOQ falls within a discount band, recalculate with adjusted value of Ch:
Step 3 Calculate total annual costs at EOQ and beginning of subsequent discount bands:
At EOQ
At 25,000
Conclusion:
5 Reorder Level
Having found how much to order each time (EOQ), the next
problem to be addressed is when to place an order—that is, to
what level (reorder level or ROL) can inventory fall before an
order is placed?
Stock Level
ROL
L Time
Example 7 ROL
Given daily demand for projector pens at 30, the supplier always delivers exactly four days
after the order is placed.
Required:
Calculate the ROL.
Solution
ROL =
*The time interval which minimises the annual cost of acquiring and
holding inventory is called the "economic review period".
In a JIT purchasing
6.3 Just in Time ("JIT") system, material
JIT is a production planning technique that emphasises acquiring purchases are
materials and producing goods and services (both internally and contracted so that
externally) at the moment they are required. receipt and usage
coincide to the
This "pull" system is driven by demand for finished products. maximum possible
Each component on a production line is produced only when extent.
needed for the next processing stage.
Low inventory levels and short production runs. Therefore need low set-up costs.
Session 5 Quiz
Estimated time: 10 minutes
2. True or false? An item of material may appear on more than one bin card but not on more
than one stores record card. (2.2)
3. State the precautionary motive for holding inventory. (3.1)
6. State the costs that are traded off when determining the EOQ. (4.1.1, 4.1.2)
7. State precisely the cost that is represented by Ch in the EOQ formula. (4.2)
(a) FIFO
Date Receipts Issues Balance
Quantity Value
5 Jan 100 × $5.00 = 500 100 $500
(b) LIFO
2 × $2 × 40, 000
$1
40, 000
Alternatively, usage rate = = 133.33 per day
300
Items are ordered in batches of 400
400
Therefore = 3 days' worth of inventory
133.33
Solution 4—EBQ
(a) EBQ =
2CoD
D
Ch(1 − )
R
2 × $2 × 40, 000
40, 000
$1 × 1 −
120 , 000
(b) Number of orders to be placed = 40,000 items are required per annum.
40, 000
= 82
490
Warehousing cost = each unit's worth of space which is used has a cost
of $4.25 × 2 = $8.50.
However, rental costs depend on the maximum
inventory level, not on the average inventory level.
The EOQ formula assumes that holding costs depend
on average inventory levels and therefore $8.50
must be doubled to $17 to be used in the formula.
Step 2 If EOQ falls within a discount band, recalculate with adjusted value of Ch:
Step 3 Calculate total annual costs at EOQ and beginning of subsequent discount bands:
Conclusion:
Optimal order quantity = 25,000 units
Solution 7—ROL
ROL = 4 × 30 = 120 units