Unit 9-Accounting for Material and Labour Costs (Fin Man 1B 2011) - Part 2

8/3/2019 Unit 9-Accounting for Material and Labour Costs (Fin Man 1B 2011) - Part 2

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Department of Finance and

Investment Management

Unit 9 part 2Accounting for materialand labour costs

Slides only


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Department of Finance and

Investment Management

MATERIAL COSTS


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Learning Outcome

Valuation of inventory according to the FIFOand weighted average methods.

3


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4

Assessment standards

After you have worked through this unit, you should be able to do thefollowing:

Define the procedure for the control of materials whichdemonstrates a thorough understanding of the manner in which thevarious source documents and reports are used during the control

process.

Value inventory according to the FIFO and weighted averagemethods.

Discuss the arguments for and against FIFO, LIFO, weightedaverage, replacement cost and standard cost methods of inventoryvaluation.


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OVERVIEW

Other direct

Direct

IndirectManufacturing

Material

Labour

PRODUCTCOSTS

(Valuation)

Direct

Manufacturing


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Definition of terms: RECAP

Raw material inventory

Items purchased by the company (not issued to the productiondepartment yet)

For use in the manufacture of a finished product

Raw materials of one company can be the finished product ofanother company

E.g. steel plates (finished product) to use in the manufacturing ofmotorcars

Work-in-progress inventory

Items currently in production

Partially finished at some intermediate stage of completion

Can be completely finished in respect of materials or labour

Finished goods inventory

Items that have been produced but not yet sold

Cost of sales

Cost of goods that have been sold


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INVENTORY VALUATIONUSING FIFO AND

WEIGHTED AVERAGE

METHOD


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Inventory Valuation

We will use the FIFO and WAM methods.

The cost accountant must decide which cost should be assigned toclosing inventory and which costs should be assigned to

inventory that has been issued to production.

Inventory valuation is the process of assigning a cost to inventory.


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FIFO First-in-first-out

The cost of the raw material issued to production will bethe cost of the oldest raw material in stock.

Price materials using the purchase price of the oldest unitin inventory first

During periods of inflation, this assumption leads to alower cost of sales calculation and higher profit

The closing inventory will be the latest and therefore thehigher prices


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FIFO Example

Three tyres bought on 1 July @ R50each

R50 R50 R50

Three tyres bought on 8 July @R55 each

R55 R55 R55


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FIFO

If2 tyres are issued to production on

10 July, the cost of the oldest 2 tyres (R50)will be assigned to those tyres.

Look at the cost of the inventory left in thestoreroom:

R50 R55 R55 R55


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FIFO

If another two tyres are issued to production on 15 July,they will be issued as follows :

1 tyre @ R50 and 1 tyre @ R55

What is now left in the storeroom?

R55 R55

What is the value of closing stock?

The value of closing stock is therefore : 2 x R55= R110


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We use a stock ledger card to record thepurchase, issue and balance of inventory

DATE RECEIPTS ISSUES BALANCE

Qty Price Amt Qty Price Amt Qty Price Amt

1 July 3 50 150 3 50 150

Etc.

NB : After every receipt or issue,

the balance must be updated


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FIFOStock ledge card continued

Date Receipts Issues Balance

Quant Price Amt Quant Price Amt Quant Price Amt

3 Jul 3 50 150 3 50 150

8 Jul 3 55 165 3

3

50

55

150

165

10 Jul 2 50 100 1

3

50

55

50

165

15 Jul 1

1

50

55

50

55 2 55 110

255C.O.S

Valueofclosing

stock


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Example 2: FIFO

Using the FIFO method and a stock ledger card,calculate the value of closing inventory after thefollowing transactions:

Jan 1 Opening balance 200 units @ R20 each

5 Sales : 50 units

8 Purchases : 75 units @ R22 each

11 Purchases : 100 units @ R22,50 each

14 Sales : 180 units15 Return to supplier : 25 units bought on 11th

21 Purchases : 80 units @ R22,80

28 Sales : 150 units


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DATE RECEIPTS ISSUES BALANCE

JAN QTY PR AMT QTY PR AMT QTY PR AMT

1 200 20 4000 200 20 4000

5 50 20 1000 150 20 3000

8 75 22 1650 15075

2022

30001650

11 100 22.50 2250 150

75100

20

2222.50

3000

16502250

14 15030

2022

3000660

45100

2222.50

9902250

15 (25) (22.50) (562.50) 4575

2222.50

9901687.50

21 80 22.80 1824 457580

2222.5022.80

9901687.50

1824

28 457530

2222.5022.80

9901687.50

684

50 22.80 1140


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WEIGHTED AVERAGE METHOD (WAM)

The WAM-method requires the calculation ofa new average unit cost each time moreinventory ispurchased

Units issued are then costed at the mostrecently calculated average unit cost

Total Cost

Average unit cost = Total no of units


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Inventory ledger card using the weighted average method

Total cost of an item of material in inventory divided by the totalquantity of inventory

The cost of sales and the closing inventory will fall somewhere

between the values as recorded for the FIFO and LIFO methods



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WAM

Tyre Example:

3 July : Purchase 3 tyres @ R50 each (R150)

8 July : Purchase 3 tyres @ R55 each (R165)

THE WEIGHTED AVERAGE COST PER UNIT IS NOW :

Total cost = 150 + 165

Total no of units 3 + 3

= R52,50 per unitUnits issued now, will be issued at R52,50 per unit



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Example 3

Business Ltd buys 50 units for resale at a particular dateat R3 per unit; a week later it buys a further 25 units atR3.10 per unit; and a week after this transaction it buysa further 30 units at R3.25 per unit. A customer buys 80

units and pay R400 in total.

REQUIRED:

Calculate the value of closing inventory using thefollowing methods:

a) FIFO method

b) WAM method


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Example 3

FIFO:

Total number of units sold is 80 units

50 units bought for R3.00 150.0025 units bought for R3.10 77.50

5 units bought for R3.25 16.25

Total cost of sales 243.75

Closing inventory=

25 units at R3.25 per unit = R81.25


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Example 3:

WAM:

Total number of units sold is 80 units

AVERAGE COST METHOD80 units bought at R3.09524 247.62

(Total items 105; Total cost R325)

Closing inventory: 25 units at R3.09524 = R77.38


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Example 4

The following transactions relating to a certain inventory item were concluded:

1 January: Inventory 50 units @ R5 per unit

3 January: Issued 20 units

4 January: Purchased 80 units @ R6 per unit

5 January: Issued 20 units

6 January: Issued 30 units7 January: Returns to supplier 10 units

(received on 4 January)

Create an inventory ledger card using the following methods:

(a) FIFO(b) Weighted average.


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FIFO

Date Received Issued Balance

Qty. Price Amount Qty. Price Amount Qty. Price Amount

1 Jan 50 5,00 250,003 Jan 20 5,00 100,00 30 5,00 150,00

4 Jan 80 6,00 480 30 5,00 150,00

80 6,00 480,00

5 Jan 20 5,00 100,00 10 5,00 50,00

80 6,00 480,006 Jan 10 5,00 50,00

20 6,00 120,00 60 6,00 360,00

7 Jan (10) 6,00 (60,00) 50 6,00 300,00


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Weighted average

Average # (R150 + R480) (30 + 80) =R5,73 per unit

Date Received Issued Balance

Qty. Price Amount Qty. PriceAmount Qty. Price Amount

1 50 5,00 250,003 20 5,00 100,00 30 5,00 150,004 80 6,00 480 110 5,73

#

630,00

5 20 5,73 114,54 90 5,73 515,466 30 5,73 171,81 60 5,73 343,657 (10 6,00 60) 50 5,67 283,65


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ADVANTAGES & DISADVANTAGES:FIFO

ADVANTAGES: Assumes that the accounting flow of materials is the same

as the physical flow of material, i.e. goods received first isissued first.

Closing inventory is valued close to market value at balancesheet date

Acceptable in terms of GAAP

DISADVANTAGES: During periods of inflation it might understate the cost of

sales (and overstate profits)


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ADVANTAGES & DISADVANTAGES:LIFO

ADVANTAGES: LIFO provides an income statement perspective in the sense that

net income measured using LIFO combines current sales pricesand current acquisition costs

DISADVANTAGES: Closing inventory is understated

Not acceptable in terms of tax requirements and GAAP, i.e. forexternal reporting purposes

Permits management to influence income by timing thepurchases of inventory items

When inventories are depleted the value of cost of goods soldmay be much lower than current replacement values, leading to

an overstatement of income.


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ADVANTAGES:Weighted average

ADVANTAGES: Acceptable in terms of GAAP

Subject to minimal manipulation by management action

Less extreme results than either FIFO or LIFO


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LIFO

Last-in-first-out

Price materials using the purchase price of the latest unitin inventory

During periods of inflation, cost of sales will be higher andtherefore profits will be lower than FIFO method

The value of the closing inventory will be the earliest andtherefore the lower prices


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PRACTISE

QUESTIONS


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Question 1

Lizzie Limited accounts for its stock on the FIFO basis. Youhave been provided with the following transactions for themonth of April and have been asked to provide theaccountant with the closing stock balance to be included inhis month end report.

Opening inventory: 200 shirts at R100 each

REQUIRED

1. Determine the closing stock balance to be included in theaccountants month end report

2. Calculate the value of cost of sales for April


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Question 1 continued

Purchase

Date Quantity Price per shirt Shirts sold

2 250 R1258 220

15 150 R135

20 200

29 50


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Question 1:Solution

Closing balance = 130 x R135= 17 550

130 = (200 + 250 + 150 - 220 200 50)

Alternative calculation:1/4 Opening balance 20 000

2/4 Purchases 31 250

8/4 Sales (22 500)

15/4 Purchases 20 250

20/4 Sales (25 000)

29/4 Sales (6 450)

Closing Balance 17 550


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Question 1:Solution

Date Purchases Purchases Sales Sales Balance BalanceQuantity Value Quantity Value Quantity R

1 Openingbalance

200(200 @ 100)

20 000

2 250 31 250(250 @ 125)

350(200 @ 100 +

250 @ 125)

51 250

8 220 20 000(200 @ 100)

230(230 @ 125)

28 750

2 500(20 @ 125)22 500

15 150 20 250(150 @ 135)

380(230 @ 125

150 @ 135)

49 000

20 200 25 000(200 @ 125)

180(30 @ 125150 @ 135)

24 000

29 50 6 450(30 @ 12520 @ 135)

130(130 @ 135)

17 550


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Question 1:Solution

Cost of sales = R53 950

Alternative: Cost of sales calculation

8/4 200 x R100 =20 x R125 =

20 0002 500

22 500

20/4 200 x R125 = 25 000

29/4 30 x R125 =

20 x R135 =

3 750

2 700

6 45053 950


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Question 2

Three students, Jane, Thabo and Frederik are equalpartners in a joint venture which involves them, on apart-time basis, in buying and selling of memory sticks.

The transactions for the three months ended 30 Junewere as stated below.

You may assume that the purchases were made at thebeginning of each month and that the sales weremade at the end of each month at the fixed price of

R150 per memory stick.


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Question 2 continued

Purchases SalesMonth Memory sticks Unit cost Memory sticks

RApril 1 000 10,00 500May 500 12,00 750June 1 000 10,00 200


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In July they held a meeting to review their financialposition and distributed the profits, but there wasdisagreement because each partner had priced the issueson a different basis.

Jane had used FIFO, Thabo had used LIFO and Frederikhad used a weighted average. His weighted average isbased on all the purchases of the above months.

Shown below is an extract from the stores ledgerrecords:


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Receipts Sales BalanceMonth Qty Price R Qty Price R Qty Price R

April 1000 10,00 10000 500 500

May 500 12,00 6 000 750 A 250 BJune 1000 10,00 10000 200 C 1 050 D


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REQUIRED:

Calculate the values for A, B, C and D according toJane

Calculate the values for A, B, C and D according toFrederik

Give reasons why Thabos valuation is not acceptable


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Janes records using the FIFO method

Receipts Sales BalanceMonth Qty Price R Qty Price R Qty Price RApril 1 000 10.00 10 000 500 10.00 5 000 500 10.00 5 000May 500 12.00 6 000 500

250 10.0012.00 50003000 250 12.00 3 000June 1 000 10.00 10 000 200 12.00 2400 50

1 00012.0010.00

60010 000


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Frederiks records using the weighted average method

Receipts Sales BalanceMonth Qty Price R Qty Price R Qty Price RApril 1 000 10.00 10 000 500 10.00 5 000 500 10.00 5 000May 500 12.00 6 000 750 11.00 8 250 250 11.00 2 750June 1 000 10.00 10 000 200 10.20 2 040 1 050 10.20 10 710


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Thabos valuation is not accepted because:

Closing inventory maybe understated

Not acceptable in terms of tax requirements and GAAP,i.e. for external reporting purposes

Permits management to influence income by timing thepurchases of inventory items

When inventories are depleted the value of cost ofgoods sold may be much lower than currentreplacement values, leading to an overstatement ofincome.

Documents

Unit 9-Accounting for Material and Labour Costs (Fin Man 1B 2011) - Part 2