Materials or supplies are the basic elements that are transformed into finished products through the use of labor and indirect manufacturing costs in the production process.
Materials costs can be direct or indirect, direct materials are those that can be identified with the production of a finished article, that can be easily associated with the product and that represent a significant cost of the finished product. Eg: steel used in automobile manufacturing.
Indirect materials are the other materials or supplies involved in the production of an item that are not classified as direct materials. Eg: the glue used in the manufacture of furniture. Indirect materials are considered as indirect manufacturing costs.
Accounting for Materials
Purchase of materials
Most manufacturers have a purchasing department whose role is to order raw materials and supplies necessary for production. The purchasing department manager is responsible for ensuring that ordered items meet the company's established quality standards that are purchased at the lowest price and shipped on time.
Purchase requisition
A purchase requisition is a written request that is usually sent to inform the purchasing department of a need for materials or supplies. Purchase requisitions are generally printed according to the specifications of each company, most of the formats include:
- Requisition number
- Name of the department or person requesting
- Quantity of requested items
- Identification of the catalog number
- Item description
- Unit
price
- Total price - Shipping, handling, insurance and related costs
- Total cost of requisition
- Order date and required delivery date
- Authorized signature.
Purchase order
A purchase order is a written request to a supplier for certain items at an agreed price. The request also specifies the terms of payment and delivery.
The purchase order is an authorization to the supplier to deliver the items and present an invoice. All items purchased by a company must be accompanied by purchase orders, which are serialized in order to provide control over their use.
The following aspects are generally included in a purchase order:
- Printed name and address of the company placing the order
- Purchase order number
- Name and address of the supplier
- Date of the order and required delivery date
- Terms of delivery and payment
- Quantity of items requested
- Catalog number
- Description
- Unit and total price
- Shipping, handling, insurance and related costs. Total cost of the order
- Authorized signature
The original is sent to the supplier and the copies usually go to the accounting department to be recorded in the account payable and another copy to the purchasing department.
Reception Report
When ordered items are shipped, the receiving department unpacks and counts them. Items are checked to ensure that they are not damaged and meet the specifications of the purchase order and packing list. Then the reception department issues a reception report. This format contains
- Supplier name
- Purchase order number
- Date the order is received,
- Quantity received
- Description of the items
- Difference with the purchase order (damaged items)
- Authorized signature
The original is kept by the reception department. Copies are sent to the purchasing department and accounts payable department, copies are also sent to the accounting department and the warehouse clerk who initiated the purchase requisition, plus a copy of the materials going to the warehouse is attached.
Output of Materials
The person in charge of the warehouse is responsible for the adequate storage, protection and release of all the materials in his custody. Departure must be authorized through a materials requisition form, prepared by the production manager or the department supervisor. Each materials requisition format indicates the order number or department requesting the items, quantity, description, unit cost, and total cost of the items shipped.
The cost that appears in the materials requisition form is the quantity that is charged to production for the materials used. Calculating the total cost of materials delivered seems relatively simple: the unit cost of an item is multiplied by the quantity purchased. Quantity is easily determined from the requisition of materials format; however, determining the unit cost of the materials shipped is not so simple in periods of inflation or deflation.
Accounting systems for materials sent to production and final inventory of materials.
Accounting using the periodic inventory system
In a periodic inventory system, the purchase of materials is recorded in an account entitled "purchase of raw materials". If there is an initial inventory of materials, it is registered in a separate account called «initial inventory of materials». For purchases plus the final inventory of materials, a physical count must be made of the materials still available at the end of the period. Some commonly used methods to determine the ending inventory value and the cost of materials used in the periodic inventory system are:
Specific identification method
It is the simplest method but also the one that takes the most time to determine the cost of the materials used and the cost of the final inventory. This method requires keeping a record of the purchase price of each specific unit and the number of specific units used. The cost of the materials used is calculated by multiplying the quantity used by the specific price of each material.
Simple average cost
Using this method, the various purchase prices are added together and this sum is divided by the total number of purchases to determine the average cost per unit.
Date Unit Cost
Starting inventory 1/1 RD $ 10
5/1 40
10/1 11
---–
61 simple average =
RD $ 61/3 = 20.33
The final inventory of materials is calculated by multiplying the number of units available at the end of the period by the simple average.
Weighted average cost
This average is obtained by first multiplying each purchase price by the number of units of each purchase. The sum of the results is then divided by the number of units available to use. The final inventory of materials is calculated by multiplying the number of units available at the end of the period, by the weighted average cost per unit.
First in, first out (PEPS)
The PEPS method of inventory costing is based on the premise that the first items purchased are those that are shipped first.
Using this method, the ending inventory would be composed of the materials received at the end, and the prices, therefore, would reflect the current costs. To calculate the cost of used materials, we work from the initial inventory of materials or from the first purchase and we advance in time. To calculate the final inventory of materials, we work from the most recent purchases and go back over time.
Last in, First out (UEPS)
The UEPS method assumes that the latest materials received are the first to be used. Therefore, the ending inventory reflects the prices of the first materials received. With the UEPS, the cost of the materials used reflects exactly the current costs, the determination of the income must be more precise because the current costs face the current income. In some cases, this method also adheres to the concept of material flows.
The cost of the materials used is calculated by taking the last purchase first and then going backwards. The final inventory of the materials is calculated from the initial inventory of the materials or from the first purchase and works forward.
The main flaw in the periodic inventory method is that the cost of used materials cannot be determined without a physical count of the final inventory of materials, which can be expensive and time consuming.
Accounting using the perpetual inventory system
In the perpetual inventory system, the purchase is recorded in an account called "materials inventory". If an initial inventory of materials exists, it must also be recorded as a debit to the materials inventory account. When materials are used, the materials inventory account is credited for the cost of the materials used with a corresponding debit to the work in process inventory account. The end result is that the cost of the materials used is charged to production at the time the materials are used, and the balance of the materials inventory account shows the cost of the materials available to use.
Perpetual identification method
The cost of materials used and the final inventory of materials is calculated by multiplying the units used or available by the specific cost of each unit or still available.
Simple average cost
In the periodic inventory method, all the costs of different purchases are added together at the end of each period. This sum is divided by the number of purchases to determine the simple average cost per unit. When using the perpetual inventory system, this calculation must be made after each purchase; This technique is usually known as "simple moving average."
Weighted average cost
The weighted average cost is calculated after each purchase by dividing the total cost of available materials by the total number of units available.
Comparison of PEPS and UEPS inventory methods
The highest gross profit is generated when calculating inventory with the PEPS method, while the lowest gross profit results when using the UEPS method. The PEPS method generates a higher ending inventory of materials; the UEPS method produces the lowest final material inventory. The difference between the gross profit obtained with the Peps method versus the Ueps would be exactly equal to the difference between the two final materials inventory and the cost of the materials used.
Lower Cost or Market (CMMB)
This rule establishes that the final inventory of materials must be assigned the historical cost or the current market value, depending on which is lower. Current market value is defined as the cost of replacing an item or how much it would cost the firm today to purchase an item from inventory.
Record of the cost of materials in the journal
The perpetual inventory system is used by most medium and large manufacturing companies; This system provides better control and more information than a periodic inventory system.
When the materials are purchased, a debit is made to the materials inventory account. When direct materials are used in production, a journal entry must be made to charge the cost of the materials to the work-in-process inventory. The cost of indirect materials is due to the control of indirect manufacturing costs.
Direct materials are debited to work-in-process inventory because they represent a significant element of the cost of a product and indirect materials generally represent insignificant quantities and / or are not directly attributable to a product and are therefore charged to the indirect cost control of manufacturing.
Workforce
It is the physical or mental effort that is used in the elaboration of a product. The cost of labor is the price paid for employing human resources. The compensation paid to employees who work with production represents the cost of manufacturing labor. This can be classified into:
Direct labor is that which is directly involved in the production of a finished article, which can easily be associated with the product and represents a significant cost of labor in the production of said article. Direct labor is considered a prime cost and at the same time a conversion cost. Indirect labor is manufacturing work that is not directly assigned to a product; Furthermore, it is not considered relevant to determine the cost of indirect labor in relation to production. Indirect labor is considered among the indirect manufacturing costs.
Costs included in labor
The main cost of labor is the wages paid to production workers. Wages are payments made on the basis of hours, days, or parts worked. Salaries are fixed payments made regularly by managerial or office services.
Accounting for labor
Accounting for labor by a manufacturer usually involves three activities: time control, calculation of total payroll, and allocation of cost to payroll.
Time control
To have an exact control of this, most companies use two documents called time cards and the work ticket.
A time card (clock card) is inserted by the employee several times each day: on arrival, when leaving for lunch, when taking a break and when he finishes work. Work tickets are prepared daily by employees for each order. Work tickets indicate the number of hours worked, a description of the work performed, and the employee's wage rate.
Calculation of total payroll
The main function of the payroll department is to calculate the total payroll, including the gross amount earned and the net amount payable to employees after deductions. The payroll department distributes the payroll and maintains records of employee income, wage rate, and job classification.
Allocation of payroll costs
With time cards and work tickets as a guide, the cost accounting department must allocate total payroll costs. The total cost of payroll for any period must be equal to the sum of the labor costs assigned to individual, departmental or production work orders.
Record of labor costs in the Journal Book
Generally, payrolls are prepared weekly, biweekly, or monthly. Gross wages for an individual are determined by multiplying the hours indicated on the time cards by the hourly rate, plus any bonuses or overtime. The journal entries to record payroll and related liabilities for the amounts withheld are drawn up in each payroll period. Usually the employer's payroll expenses and payroll cost distributions are recorded in the journal at the end of the month.
Special problems related to accounting for labor
Accounting for labor includes special problems that do not arise in accounting for materials such as employee taxes, taxes and costs for extraordinary benefits to the employer, bonus for night or Sunday hours, overtime, idle time, minimum wage guaranteed and incentive plans.
Employee tax
Employers are required by law to withhold two items:
federal, state and local income taxes and social security taxes. FICA (federal insurance contributions act) taxes are designed to offer employees some amount of income upon retirement. Employers remit to the government, on a quarterly or more frequent basis, employee income taxes and withheld FICA taxes, as well as the employer's share of payroll taxes.
Employer taxes and costs for social benefits
Employers are currently required to equalize the employee contribution for social security (FICA) and also pay federal unemployment tax act (FUTA) and state unemployment insurance, here called SUI. FUTA / SUI tax is charged only to employers up to a maximum limit on total gross earnings of taxable employees. The purpose of the FUT / SUI is to provide funds that can be used to pay unemployment benefits to employees in the event of termination of work.
In general, factory employees are entitled to vacation pay after an initial period of employment. Vacation time is based on length of employment. Vacation pay should not be charged to work in process when an employee is on vacation.
An employee contributes to production only when he is on the job.
For the payment of holidays, the amount of the accumulation will depend on the clauses of the labor contract or the company's personnel policies, the number of holidays paid generally varies from 8 to 11 during a year. Accounting for holiday pay is handled in much the same way as holiday pay.
Bonuses for night or Sunday hours
This bonus for night or Sunday hours or shift differential should be charged to manufacturing indirect cost control, rather than work-in-process, and distributed across all units produced.
Overtime Bonus (overtime)
The overtime bonus represents the overtime hours multiplied by the bonus rate. The overtime bonus rate is usually some fraction of the regular rate. Overtime is commonly known as one-and-a-half hours because most overtime hours worked are paid at the regular rate plus a bonus equal to half of it.
10. Idle time
Idle time is generated when employees have no work to do, but are paid for their time. For example, when a new job is established in production, some workers may temporarily have nothing to do. If your leisure is normal to the production process and cannot be avoided, the cost of idle time could be charged to the indirect manufacturing cost control. If the idle time was due to negligence or inefficiency, it could be charged to a loss account.
Guaranteed minimum wage and incentive plans
When payments to an employee are based only on the number of units produced, they are said to be paid at a piece rate. Many employers will pay a minimum wage, but employees can earn more by producing more.
Incentive plans vary in form and in application. Two commonly used plans are the Gnatt Plan, with a bonus rate applied only to the total number of parts produced above the standard number of units and the Taylor System, a bonus rate applied to the total number of parts produced as soon as the standard is reached.
Before adopting an incentive plan, management should examine the possible negative effects. Incentive plans require additional record keeping, generating increased office costs. For incentive plans to be considered successful, increases in total payroll costs must be offset by increases in production and sales.
Indirect manufacturing costs
These costs refer to the group of costs used to accumulate indirect manufacturing costs (selling, general and administrative expenses are excluded because they are non-manufacturing costs). The following are examples of indirect manufacturing costs:
1- Indirect labor and indirect materials
2- Heating, light and energy for the factory
3- Leasing of the factory building
4- Depreciation of the factory building and equipment
5- Maintenance of the factory building and equipment
6- Taxes on ownership over factory building
Indirect manufacturing costs are divided into three categories based on their behavior with respect to production, these are:
Variable manufacturing overhead.
The total variable manufacturing overhead costs change in direct proportion to the level of production. It is defined as the activity interval within which the total fixed costs and the variable costs per unit remain constant; that is, the larger the set of units produced, the greater the total variable manufacturing overhead.
Fixed manufacturing overhead
The total fixed manufacturing overhead remains constant within the relevant range, regardless of changes in production levels within that range. Property taxes, depreciation, and leasing of the factory building are examples of fixed manufacturing overhead.
Mixed manufacturing overhead
These costs are neither totally fixed nor totally variable in nature. These should finally be separated from fixed and variable components for planning and control purposes.
Factory truck leases and factory phone service and the wages of factory supervisors and inspectors are examples of mixed manufacturing overhead.
Real Costs versus Normal Cost of Manufacturing Indirect Costs
In a real cost system, product costs are only recorded when they are incurred. This technique is generally accepted for registration of direct materials and direct labor. Indirect manufacturing costs, because they are an indirect element of the cost of the product, cannot be easily or conveniently associated with a measure that they are incurred with an exception: indirect manufacturing costs are applied to production based on actual inputs multiplied by a predetermined rate of indirect manufacturing cost application.
The two key factors in determining the application rate of indirect manufacturing costs for a period are: estimated level of production and estimated indirect manufacturing costs.
Determination of application rates for indirect manufacturing costs
Indirect cost application rates are set in dollars per unit of activity estimated on some basis. There are no absolute rules for determining which base to use as the denominator activity.
However, there must be a direct relationship between the base and manufacturing overhead. In addition, the method used to determine the application rate of manufacturing overhead should be simpler and less costly to calculate and apply. Once the total indirect manufacturing costs have been chosen and the base chosen, the normal capacity level should be estimated in order to calculate the application rate of the indirect manufacturing costs, the formula of which is the same regardless of the chosen base.
Estimated manufacturing overhead
Once the estimated production level is determined, a company must develop some procedures to obtain a satisfactory estimate of manufacturing overhead costs. An estimate of the estimated manufacturing overhead for the next period is usually prepared.
Indirect manufacturing costs applied
After determining the application rate of manufacturing overhead, the estimated manufacturing overhead is typically applied to production, on a progressive basis as items are manufactured, based on the basis used (i.e., as a percentage of direct materials costs or direct labor cost or based on direct labor hours, machine hours, or units produced).
Actual manufacturing overhead
Typically, actual manufacturing overhead is incurred daily and recorded on a regular basis in the general, auxiliary, and general ledgers. The use of subsidiary books allows a greater degree of control over manufacturing overhead as related accounts can be grouped.
Accounting for actual manufacturing overhead
Indirect manufacturing cost charges come from many sources, including:
1- Invoices. Accounts received from service providers or organizations.
2- Proofs. Bills paid.
3- Accumulations. Adjustments for accounts as accumulated services payable.
4- Adjustment seats at the end of the year. Adjustments for accounts such as depreciation and amortization expenses.
Manufacturing companies commonly use a departmental manufacturing overhead cost sheet for analysis of manufacturing overhead.
Registration of indirect manufacturing costs in the Journal.
The journal entries to record manufacturing overhead using a work order costing system or a process costing system are basically the same. The main difference is that with a work order costing system, the indirect manufacturing costs applied are accumulated by work orders, and with the other system these are accumulated by department.
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