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1. COSMAN 1
Topic 3: Accounting for
Materials pt. 2
September 11, 2023

2. Objectives:
● Control procedures for Materials
● Materials Inventory Management

3. 1. Control
Procedures

4. Control Procedures
● Total cost of a finished product = amount spent for
materials, direct labor, and a share in the factory overhead.
● It is necessary to adopt a cost control system for each element.
● Efficient purchasing, management, and investment in materials
depend on an accurate forecast of sales and production
schedules.
● Forecasts help determine when to order materials.
Controlling inventory can be accomplished by scheduling
production.

5. Control Procedures
The following are commonly used control procedures:
1. Order Cycling
2. Min-max method
3. Two-bin method
4. Automatic order system
5. ABC Plan

6. Order Cycling
● Is a method where materials on hand are reviewed on a regular or
periodic cycle.
● The cycle length depends on the type of material being reviewed.
● Essential materials = shorter review cycle
● Less Essential materials = longer review cycle
● A common technique for small items is the 90-60-30 day method.
○ When inventory drops to a 60-day supply, an order will be
placed for a 30-day supply.

7. Min-max method
● Is a method used in the assumption that materials have a minimum
and maximum level.
● When an inventory reaches the minimum level, an order is placed
to increase the inventory to a maximum level.
● Determination of the minimum and maximum level requires
quantitative techniques.

8. Two-bin method
● Is a method used for materials that are inexpensive.
● Materials are divided into two bins.
○ Bin #1 – the quantity of materials = the time an order is
received and the time when the next order will be placed.
○ Bin #2 – the quantity of materials = the time it takes for
ordering and delivery to be completed + safety stock.
Jan. 1 Mar. 30 30 days ordering
& delivery
May 1 Jul. 30
BIN 1
BIN 2
Apr 1 - 30
BIN 1

9. Automatic Order System
● Used by companies that have a computerized system.
● An order is automatically placed when the level of inventory
reaches a predetermined order point quantity.
● With the use of a computer, it is possible to periodically recompute
the optimum investment in inventory and thus revise the quantity to
be purchased.

10. ABC Plan
● Is a method used by companies with a large number of materials,
each with a different value.
● It is a systematic way of grouping materials according to their value
and determining the degree of control that each group requires.
○ Group A = High value items = more sophisticated method
such as automatic system
○ Group B = Medium value items = combination of A and C
○ Group C = Low value items = simplest method such as the
min-max method or two bin method

11. Physical Control of Materials
● Just like cash, inventories should be protected from unauthorized
use or theft as it represents a significant portion of a Company’s
current assets. The following are the physical control of materials:

12. Physical Control of Materials
1. Limited Access – only authorized personnel should have access
to the warehouse. Issuance of materials for production should be
properly documented and approved.
2. Segregation of Duties – the following should be separate: C-A-R-
E
3. Accuracy in Recording –
a) Inventory records should be able to determine inventory
quantities on hand upon request.
b) Cost records should provide the data for the valuation of
inventory for the preparation of the FS.

13. 2. Materials
Inventory
Management

14. Material Inventory
Management:
● The central issue in inventory management is to maintain an
optimum investment in inventories that considers a risk reward
relationship.
● In inventory management, we need to consider the following
tradeoff:
○ Overinvesting in inventory avoids shortages but incurs
costs.
○ Underinvesting in inventory saves on costs but increases
the risk of shortages.

15. Material Inventory
Management:
We can basically summarize this in two questions:
1. How many units should be ordered:
a) ORDERING COSTS
b) CARRYING COSTS
2. When to make the order?
EOQ =
D -> Annual Demand or usage in units
O -> Costs of placing one Order
C -> Cost of Carrying one unit of one year
EOQ- basically refers to the order size that
minimizes the sum of ordering costs and carrying
costs

16. EOQ PROBLEM:
Keme Company requires 40,000 units for its signature product Devil Judge. The units
will be used evenly throughout the year. The cost to place one order is P100 while
the cost to carry the inventory for one year is P2 per unit.
Required:
a. Determine the optimal order quantity (EOQ)
b. How many and how often orders should be placed within a year?
c. Determine the average inventory in units
d. Determine the annual inventory carrying costs
e. Determine the annual inventory ordering costs

17. Step 1: Determine DOC
D = 40,000 ; O = P100 ; C = P2
Step 2: Solve for EOQ
Step 3: Solve for the rest
B) No. of orders: 40,000 units / 2,000 units = 20 orders = D / EOQ
Frequency: 360/20 orders = Every 18 days = 360 / No. of Orders
C) Average Inventory: EOQ / 2 = 2,000 units / 2 = 1,000 units
Why do we use EOQ/2 for Average Inventory?
This is the simple average formula:
(Beg Inv + End Inv)/2
We should assume that at the end of the period,
all inventory will be sold, hence the simple
average formula will be converted to:
(EOQ + 0) / 2

18. D. Carrying Costs = ( EOQ / 2 ) x C = 1,000 (2) = P2,000
D. Ordering Costs = ( D / EOQ ) x O = 20 (100) = P2,000
TOTAL COST AT 2,000 EOQ = P4,000
GUIDES:
What can we infer?
a) EOQ is the optimal order quantity. Or the quantity of orders that will
result to the lowest cost possible.
b) At EOQ, will Carrying Cost = Ordering cost?

19. Material Inventory
Management:
We can basically summarize this in two questions:
1. How many units should be ordered:
a) ORDERING COSTS
b) CARRYING COSTS
2. When to make the order?
a) STOCKOUT COSTS
b) CARRYING COSTS
REORDER POINT = refers to the
number of units at which goods
should be re-ordered to minimize
on the sum of carrying costs and
stock-out costs.

20. REORDER POINT
Ideally, companies would implement JIT (Just in Time) method. This
is when goods would arrive just in time when your inventory runs out.
But this has cons (you are highly reliant on your supplier).
To achieve JIT, we compute for the reorder point. Reorder point uses
the concept of lead time. Lead time can either be:
● Normal/Average lead time- refers to the usual delay in the receipt
of ordered goods.
● Maximum lead time- this adds to normal lead time a reasonable
allowance for further delay.

21. REORDER POINT
PROBLEM
EWAN purchases 7,200 units of product butterfly every year. EWAN works 360 days
per year. The normal purchase lead time is 10 working days while maximum lead
time is 15 days.
Required: (a) Safety (buffer) stock (b) Reorder point

22. Step 1: Compute for Average Daily Demand:
7,200 units / 360 days = 20 units
Step 2: Compute for Safety Stock:
(15 days – 10 days ) * 20 units = 100 units
(Maximum lead – Normal lead) x Average Daily Demand
Why important? Increasing safety stock increases carrying cost
This will have an implication on the average inventory formula:
(EOQ / 2 ) + Safety Stock
Step 3: Compute for reorder point:
What will we use? 15 days or 10 days?
15 days x 20 units = 300 units

23. How does Reorder Point answer the
question of when to order?
When your inventory reaches 300 units, you still
have 15 days (max number of days before you
receive the next inventory order). Therefore,
you should already order when your inventory
level reaches 300 only.
This all refers to TIMING. There will be no
overlapping of old inventory, hence you will
have no carrying costs. As you will also receive
inventory JIT, you will also not incur any stock
out costs.

24. Alternative Solution: Use the Normal lead
time
Alternative Formula :
Reorder point = Delivery Time Stock + Safety
Stock
Delivery Time Stock = Normal lead time x
Average Usage per unit of time
Delivery Time Stock = 10 days x 20 = 200
units
Reorder Point = 200 + 100 safety stock = 300
units

25. Summary of Formulas
Main formula:
Reorder point = Maximum Lead time x Average usage per unit of time
Alternative Formula :
Reorder point = Delivery Time Stock + Safety Stock
Delivery Time Stock = Normal lead time x Average Usage per unit of time
Safety Stock = (Maximum Lead time – Normal lead time ) x Average Usage per unit of time

26. Next week:
● Stock out costs
● Accounting for Labor
TIMELINE:
● September 18 – Accounting for Labor
● September 20 & 25 – Accounting for Overhead
● September 29 – Long Exam
● October 2-7 – Midterm Exams