COST ACCOUNTING AND BUDGETTING.

ACCOUNTING FOR PRIME COSTS

ACCOUNTING FOR MATERIAL COST(S)

Materials
The term material refers to all items that are consumed in the process of manufacture.
Materials are anything that can be stored, stocked or stockpiled. Materials can be regarded as either
direct material or indirect materials in costing
Direct Material.
These are the raw materials from which the product is made. They are these materials from whose
consumption may be identified with specific production units and which usually part of the finished
product becomes
Indirect Materials.
These are consumable stocks used in production and are those materials which can not be conveniently
identified with individual cost units eg. oil

Material or inventory control is a systematic control and regulation of purchase storage usage of
materials in such a way so as to maintain a even flow of production and at the same time avoiding
excessive investment in those inventories.

OBJECTIVES OF MATERIAL CONTROL.

The broad objectives of material control are:
(i) No under stocking
(ii) No overstocking
(iii) Economy in purchasing ie purchasing materials at the most favorable prices. A purchaser should be
able to make a valuable contribution to the reduction in cost.
(iv) Proper quality ie while purchasing materials due consideration should be given to the quality
(v) Minimum wastage ie the objective is to minimize the loss of material. Proper storage conditions must
be provided to different types of materials
(vi) Information about materials. This is concerned with the system that gives complete and up to date
accounting information about the availability of materials.

ESSETIAL REQUIREMENTS OR PRINCIPLES OF MATERIAL CONTROL

1. there should be proper coordination and cooperation between various departments dealing in
materials
2. there should be a purchasing department under the control of a competent and expert purchase
manager.
3.there should be proper classification and codification of materials.
4. material requirements should be properly planned ie. There must be an effective MRP II system.
5. the perpetual inventory system should be operated so that up to date information is available about
stock levels.
To infect the above essential requirement of material control there are various techniques that are
commonly used ie.
(i) ABC technique
(ii) economic batch quantity
(iii) economic order quantity
(iv) perpetual inventory systems etc.

SETTING STOCK LEVELS.

In order to avoid the two dangers of over stocking and under stocking. Most companies adopt a
scientific approach of fixing stock levels by adhering to these levels each item of material will
automatically be held within appropriate units of control. These levels are not permanent and must be
changed to suit the changing circumstances.

The stock levels here are

(i) maximum stock level
(ii) minimum stock level
(iii) re-order level
(iv) re-order quantity
(v) danger level

MAXIMUM LEVEL
This is that level above which stocks should not normally be allowed to rise. The maximum level may
however be exceeded by certain case( when conditions dictater eg. x-mass period
Max.level =reoderlevel +reoderquantity-(min.consumption x mini.reoder period)

MINIMUM LEVEL.
It is that level below which stocks neither should nor normally be allowed to fall. It’s essentially a safe
stock and is not normally touched.
In case of stock falling. Below this level, there is a risk of stoppage in production
Min.level=reoderlevel-(normal consumption x normal reoder period)

RE-ORDER LEVEL
This is the level at which new orders are made. It’s that level at which purchase requisition is initiated
for free materials. It’s fixed some where above the minimum level.
Reorder level=max. Consumption x max.reorder period

DANGER LEVEL
This is the level at which normal issues are stopped and materials are issued for important jobs only.
This level is generally fixed somewhere below the minimum level.
Danger level=normal consumption x max.reorder period (under emergence conditions)

AVERAGE STOCK LEVEL

This refers to the level of stock you need for use.
Average level = max.level + minimum level
2
Alternatively = minimum level + ½ reorder qty.

ILLUSTRATION
Assume two materials A&B are used as follows
Minimum usage 50 units per week@
Maximum usage 150 units per week@
Normal usage 100 units per week @
Re-order qty: Material A 600units
Material B 1000units
Delivery period: Material A 4 to 6 weeks
Material B 2 to 4 weeks
Calculate the various stock levels.
Maximum level
Max. level= RO + RQ- (min con.x min.reorder period)

A (150x6) +600-(50x4) B (150X4)+1000-(50X2)

900+600-200 600+1000-100
1300 1500
Minimum level= RO-(normal cons x normal reoder period
A= (150x6)-(100x4+6)
2 B (150x4) –(100x4+2)
900-(100x5) 2
900-500 600-(100x3)
400 600-300
300

Re-oder level= max cons x max Re-order period

A = 150 x 6 =900
B = 150 x 4 = 600
Danger level
DL = Normal cons x max re-order period
A 100x6
600
B 100x4
400
Average stock level
Av = max + min
2 min level + ½ reorder level
A = 400+ ½ x600
= 400+300
= 700
A = 1300 + 400
2
= 850 B = 300+ ½ x1000
= 300 +500
= 800
B = 1500+300
2
= 900

VALUATION OF MATERIALS
When materials are issued from stores to production departments, a difficulty arises regarding the
price at which materials issued are to be charged. This is because the same type of material may have
been purchased in different lots at different times and at different price
This means that the actual cost can take all several different values and therefore a method of pricing
material issues must be selected.
There are two categories of the methods:
Methods that are not relevant for decision making (suitable for external reporting).
They include:-
a) LIFO method.
b) FIFO method.
c) Average weighted cost method (AVCO)
b) Methods that is relevant for decision making.
These include: –
a) Net realizable Value (NRV)
b) Replacement cost method
c) Standard price method (standard cost method)

1. FIRST IN FIRST –OUT (FIFO).

This method is based on the assumption that materials which are purchased first are issued out first.
It uses the price of the first batch of materials purchased for all issues until all units from the batch
have been issued. After the first batch is fully issued the price of the next batch received becomes
the issue price.
Upon this batch, once all the materials are used still the price of the next batch is used for pricing ad
so on.
In this method, the materials are issued at the oldest cost price listed in the stores ledger account and
thus the materials in stock are valued at the price of the latest purchases.
There are 3 important effects when using FIFO method and these are;
(i) Materials are price at their actual costs
(ii) Change to production for materials costs is at the oldest prices of the materials in stock
(iii) Closing stock is valued at the latest price paid

Illustration
From the following transactions prepare a store ledger account using FIFO, FIFO, AVCO and methods
2009.
DATE MONTH PURCHASED/ISSUED QTY UNIT PRICE

1 JULY OPENING STOCK 500@ 20,000

4 JULY PURCHASED 400@ 21,000

5 JULY ISSUED 600@

8 JULY PURCHASED 800@ 24000

9 JULY ISSUED 500@

13 JULY ISSUED 300@

24 JULY PURCHASED 500@ 25000

28 JULY ISSUED 400@

STORES LEDGER A/C , FIFO METHOD.

PURCHASE ISSUES BALANCE

Date GRN QTY PRICE DATE NRN QTY PRICE QTY AMOUNT
1/July Opening stock - - - - - 20,000 500 10,000,000
4/July 001 400 21,000 - - - - 900 18,400,000
- - - - 5/July 601 600
- - - - - 500 20,000 400 8,400,000
- - - - - 100 21,000 300 6,300,000
8/July 002 800 24,000 - - - 1100 25,500,000
- - - - 9/July 102 500
- - - - 300 21,000 800 19,200,000
- - - - 200 24,000 600 14,400,000
- - - - 13/July 103 300 - 300 7,200,000
24/July 003 500 25,000 - - - 800 19,700,000
28/July 104 400
300 24,000 500 12,500,000
100 25,000 400 10,000,000

2. LAST IN FIRST OUT (LIFO)

This method operates with a reserve order of the FIFO method. It is based on the assumption that the
last batch of materials purchased is the first is the first batch of which the materials are issued. The
unit price to be quoted for the material issue is the price of the last batch purchased until all units
from this batch have been issued that the price of the previous batch is used. These important paints
should be noted regarding this method.

i) Materials issues are priced at actual cast.

ii) Charge to production for materials cast is at later prices paid.
iii) Closing stock valuation is at the oldest price paid and is completely out of line with the current
prices.\

Look at how you adjust for cases where there is ascertainable inflation.
Illustration
Using the same transactions above use LIFO to prepare stores ledger accounts

Purchases Issues Balances

Date GRN Qty Price Date NRN Qty Price Qty Amounts
1/July Opening stock 500 10,000,000
4/July 201 400 21,000 900 18,400,000
6/July 201 600
400 21,000 300 10,000,000
200 20,000 300 6,000,000
8/July 202 800 24,000 1100 25,200,000
9/July 202 500 24,000 600 13,200,000
13/July 203 300 24,000 300 6,000,000
24/July 203 500 25,000 800 18,500,000
28/July 204 400 25,000 400 8,500,000

AVERAGE WEIGHT COST METHOD (AVCO)

You consider the previous amounts divided by the total units’ e.g. 18400000 / 900=20,444

PURCHSES ISSUES BALANCES

Date GRN Qty Price Date NRN Qty Price Qty Amount
1/july Opening 500 10,000,000
stock
4/july 301 400 21,000 900 18,400,000
5/July 301 600 20444 300 6,133,600
8/July 302 800 24,000 1100 25,336,000
9/July 302 500 2303 600 13,821,000
13/July 303 300 2303 300 6,912,000
24/July 303 500 25,000 800 13,191,200
28/July 304 400 16489 400 6,595,60
0
ACCOUNTING FOR LABOUR COST
Labour recording
Remuneration
Measurement of lab our turn over, efficiency and utilization
Costing systems
Pay roll accounting

Introduction
Employees are paid either a salary or a wage
 A salary is a fixed amount normally spread over equal periodical period.
 A wage is a payment based either on the type worked in the period or o the out put of the
performance (items produced). For the purpose of labour cost analysis, we need to understand
some of the details relating to labour recording remuneration methods, skills measurement of
labour turn over, computation of idle time over time etc. and labour costing systems.

LABOUR RECORDING
In most manufacturing companies, and many of the service sector, records of attendance time for each
worker are required for operations, processes parts, times quantities, sales made, inquiries handled or
whatsoever is used as the basis for the incentive scheme
These records from the basis of wage calculations and for such casting data as direct and
indirect labour cost over head build up and labour cost control.
These records may be maintained manually or electronically.

TYPES OF LABOUR RECORDS

They are two types:
a) Those for attendance
b) Those relating to out put or performance

A) ATTENDENCE RECORDS
These involve use of clock cards. One clock card may be maintained for each worker using the time
recording clock usually based at the entrance to the premises. The clock is the basis of time recording
and whatever time additional time records are kept. They must be reconciled on the clock card by the
time recording clock.
(Look at the merits and demerits)

b) OUT PUT RELATED RECORDS

The following are typical records relating to out put and these include:
i) The daily and weekly time sheets
ii) The job cards
iii) Operation cards
iv) Idle time cards
v) Wages sheet (a mini pay roll)
 vi) Employees records

DAILY AND WEEKLY TIME SHEETS

These are records filled in by the workers and counter signed which show how he/she spent his / her
time during the day or week.
The general objective is to reconcile all the time in attendance ( recorded on the clock card) with time
booking s either at jobs or operations
Weekly rime sheets tend to be less accurate but require less clerical efforts

ii) THE JOB CARDS

Un like time sheets which related to individual employees and may maintain booking relating to numerous
job, a good card relates to single job or batch is likely to contain entries relating to numerous
employees Upon completion of the job, it will contain a full record of the times and quantities involved
in the job or the batch.

iii) OPERATIONAL CARDS (PIECE WORK TICKET)

These are used where employees are paid on the piece of work basis. They contain details of a number
of items to be produced by each employee and this is multiplied by the rate per item to give the total
wage.
iv) IDLE TIME CARD

This may be used to record the amount of waiting time or idle time. If a productive worker is un
occupied for a short period, for reasons say machine break down, un empty tank at the petrol station
etc.
Holidays for students
v) WAGES SHEET
All the employees are listed on the wage sheet alphabetically or in accordance with serial
numbers the hours worked by each employee are entered in the wages sheet from the clock card and
multiplied by the rate of pay specifically the wages sheet
Contains gross pay, over time pay, bonus, and any allowances and deductions such as advances, PAYE,
NSSF Contributions etc..
vi) EMPLOYEES RECORD CARDS
These contain basic information about the employees. The card is raised when the employee is
still engaged and it shows the history of the employee during his time in the organization. His date of
appointment, title, promotion, Transfers and dates of departure.

LABOUR RENUMERATION METHODS

People are either paid according to the length of time spent working. There are three basic types of
remuneration schemes.

1. Time rate (time based)

2. piece work rates (output based)
3. Inactive schemes (bonus schemes)

TIME BASED SYSTEMS

1. Basic pay system
2. High day rate systems
3. Common systems

BASIC PAY SYSTEMS

At the simplest level, workers would be paid for the number of hours worked at basic rate per hour up
to say 40 hrs per week.

Ratios
[edit] Profitability ratios

Profitability ratios measure the company's use of its assets and control of its
expenses to generate an acceptable rate of return

Gross margin, Gross profit margin or Gross Profit Rate[7][8]

OR

Operating margin, Operating Income Margin, Operating profit margin or

Return on sales (ROS)[9][8]

Note: Operating income is the difference between operating revenues and

operating expenses, but it is also sometimes used as a synonym for EBIT and
operating profit.[10] This is true if the firm has no non-operating income.
(Earnings before interest and taxes / Sales [11][12])
Profit margin, net margin or net profit margin[13] [14]

Return on equity (ROE) [14]

Return on investment (ROI ratio or Du Pont Ratio)[6]

Return on assets (ROA)[15]

Return on assets Du Pont (ROA Du Pont)[16]

Return on Equity Du Pont (ROE Du Pont)

 Return on net assets (RONA)

Return on capital (ROC)

Risk adjusted return on capital (RAROC)

OR

Return on capital employed (ROCE)

Note: this is somewhat similar to (ROI), which calculates Net Income per
Owner's Equity
Cash flow return on investment (CFROI)

Efficiency ratio

Net gearing

Basic Earnings Power Ratio[17]

[edit] Liquidity ratios

Liquidity ratios measure the availability of cash to pay debt.

Current ratio[18]

Acid-test ratio (Quick ratio)[18]

Operation cash flow ratio

[edit] Activity ratios (Efficiency Ratios)
Activity ratios measure the effectiveness of the firms use of resources.

Average collection period[3]

Degree of Operating Leverage (DOL)

DSO Ratio[19]

Average payment period[3]

Asset turnover[20]

Stock turnover ratio[21][22]

Receivables Turnover Ratio[23]

Inventory conversion ratio[4]

Inventory conversion period

Receivables conversion period

Payables conversion period

Cash Conversion Cycle

Inventory Conversion Period + Receivables Conversion Period - Payables
Conversion Period

[edit] Debt ratios (leveraging ratios)

Debt ratios measure the firm's ability to repay long-term debt. Debt ratios measure
financial leverage.

Debt ratio[24]

Debt to equity ratio[25]

Long-term Debt to equity (LT Debt to Equity)[25]

Times interest-earned ratio / Interest Coverage Ratio [25]

OR

Debt service coverage ratio

[edit] Market ratios

Market ratios measure investor response to owning a company's stock and also the
cost of issuing stock.

Earnings per share (EPS)[26]

Payout ratio[26][27]

OR

Dividend cover (the inverse of Payout Ratio)

P/E ratio

Dividend yield
 Cash flow ratio or Price/cash flow ratio[28]

Price to book value ratio (P/B or PBV)[28]

Price/sales ratio

PEG ratio

Other Market Ratios

EV/EBITDA

EV/Sales

Cost/Income ratio

Sector-specific ratios

EV/capacity
EV/output