Cost Accounting and Control #4: Accounting for Materials, Labor and Overhead

Topics:
 Accounting for Materials
 Accounting for Labor
 Accounting for Overhead

Accounting for Materials

The procurement and use of materials usually involve the following steps:
1. Establishes the bill of materials
2. The production budget provides the master plan from which details concerning materials requirements are developed.
3. The purchase requisition informs the purchasing agent of the quantity and kind of materials needed.
4. The purchase order contracts for quantities to be delivered.
5. The receiving report certifies quantities received and may report results of inspection and quality testing.
6. The materials requisition authorizes the storeroom or warehouse to deliver specified types and quantities of materials to a
given department at a specified time.
7. The materials record cards record each receipt and issuance of each kind of material and serve as perpetual inventory
records.

Purchase of Materials
 Purchasing procedures should be in writing, to fix responsibility and to provide information regarding the ultimate use of
materials ordered. The purchasing department
1. Receives purchase requisitions for materials, supplies, and equipment.
2. Keeps informed concerning sources of supply, prices, and shipping and delivery schedules.
3. Prepares and places purchase orders.
4. Arranges for reporting among the purchasing, receiving, and accounting departments.
 Invoice approval by the purchasing department has the advantage of centralizing the approval of invoices in the department.
 Invoice approval by the purchasing department lessens internal control.

Purchase of Supplies, Services, and Repairs

The steps followed in purchasing materials can apply to all departments and divisions of a business.

Purchasing Forms
 Purchase Requisition
 Purchase Order
 Electronic Data Interchange

Receiving
1. Unloads and unpacks incoming materials
2. Compares quantities received with the shipper’s packing list
3. Matches materials received with descriptions on purchase orders
4. Prepares receiving reports
5. Notifies the purchasing department of discovered discrepancies
6. Arranges for inspection when necessary
7. Notifies the traffic department and the purchasing department of any damage in transit
8. Routes accepted materials to the appropriate location

The receiving report is distributed as follows:

1. The receiving department keeps one copy and sends another to the purchasing department as notice of the materials’
arrival.
2. All other copies go to the inspection department and are distributed after inspection. One copy is sent to the accounting
department.

Invoice Approval and Data Processing

 Invoice approval is important in materials control because it verifies that the goods have been received as ordered and that
payment can be made.
 The invoice and a copy of the purchase order are filed in the accounting department.
 The invoice clerk approves it and attaches it to the purchase order and receiving report for preparation of a voucher.

Cost of Acquiring Materials

 Purchases Discounts.
 Freight-In.
 Applied Acquisition Costs.

Storage and Use of Materials

The storekeeper is responsible for safeguarding materials, placing them in bins or other spaces until needed, and seeing that all
materials taken from the storeroom are properly requisitioned.
 Cost Accounting and Control #4: Accounting for Materials, Labor and Overhead

Issuing and Costing Materials

 Materials Requisition. The materials requisition authorizes the storekeeper to issue materials.
 Electronic Data Processing for Materials Requisitions.
 Bill of Materials. The bill of materials for a product is a list of all materials necessary for a typical job or production run.

Materials Subsidiary Records

 The approved invoice goes to the materials clerk for entry in the Received and Inventory sections of materials ledger records.
 When the storekeeper issues materials, a copy of the requisition is sent to the materials clerk, who enters the date, requisition
number, lot number, quantity, and cost of the issued materials in the Issued section of the materials record.

Illustration #1: Perpetual and Period Inventory System

John’s Specialty Store uses a perpetual inventory system. The following are some inventory transactions for the month of May:
1. John’s purchased merchandise on account for P 5,000. Freight charges of P 300 were paid in cash.
2. John’s returned some of the merchandise purchased in (1). The cost of the merchandise was P 600 and John’s account was
credited by the supplier.
3. Merchandise costing P 2,800 was sold for P 5,200 in cash.

Required: Prepare entries using (1) perpetual inventory system (2) periodic inventory system

Illustration #2: First in, First out (FIFO) and Average Inventory Method
The House of Dragon Corporation had the following purchases and issues during March:

Required: Compute the cost of units issued and the cost assigned to the March 31 inventory by each of these perpetual inventory
costing methods:
a. First in, first out
b. Average, rounding unit cost to the nearest tenth of a cent

Illustration #3: First in, First out (FIFO) and Average Inventory Method
The records of the Sandman Company show the following data for Item A:

The sales price for Item A was P15 per unit throughout the year.

Required:
Compute the cost of the ending inventory under the FIFO method when a periodic inventory system is used and perpetual inventory
system is used.
 Cost Accounting and Control #4: Accounting for Materials, Labor and Overhead

Quantitative Methods
Planning Materials Requirements
Materials planning deals with two fundamental factors the quantity and the time to purchase. Determination of how much and
when to buy involves two conflicting kinds of cost—the cost of carrying inventory and the cost of inadequate carrying.

Economic Order Quantity

 The economic order quantity (EOQ) is the amount of inventory ordered at one time that minimizes annual inventory cost.
 The optimum quantity to order at a given time is determined by balancing two factors:
1. The cost of possessing (carrying) materials
2. The cost of acquiring (ordering) materials.
 The costs of carrying inventory are often expressed as percentages of the average inventory investment.
 They must be considered in determining order quantities and order points. These costs include ordering costs.
 Ordering costs include preparing a purchase requisition, purchase order, and receiving report; handling the incoming shipment;
communicating with the vendor; and accounting for the shipment and payment.

Illustration #4 (Economic Order Quantity - EOQ)

A. ABC Inc. has an annual usage of 100 units of Item M, having a purchase price of P55 per unit. The following data are applicable
to Item M:
 Ordering cost – P5 per order
 Carrying cost percentage – 15%

Required: Compute the economic order quantity

B. ABC Inc. estimates a need for 2,250 A-jets next year at a cost of P3 per unit. The estimated carrying cost is 20%, and the cost to
replace an order is P12.

Required: Compute the economic order quantity

C. XYZ Company has been buying Product A in lots of 1,200 units, which represents a four-month supply. The cost per unit is P100;
the order cost is P200 per order and annual inventory carrying cost for one unit is P25.

Required: Compute the economic order quantity

D. XYZ Company estimates that it will need 25,000 cartons next year at a cost of P8 per carton. The estimated carrying cost is 25%
of average inventory investment, and the cost to place an order is P20.

Required: Compute (1) economic order quantity (2) the frequency, in days that orders should be replaced, based on a 365-day
year.

E. ABC Corporation produces fireworks in various forms. A cardboard tube, Part No. A86-E, is manufactured rather than ordered
from an outside supplier. The company estimates that its need each year for this tube is 4,800 gross and that variable
manufacturing costs are P60 per gross. Setup costs amount to P162 per production run, and storage costs are equal to 5% of
variable manufacturing costs.

Required:
1. Determine the optimal size of a production run and the total annual setup cost and total carrying cost at that size.
2. Determine the optimal size of a production run, the total annual setup cost, and the total carrying cost, assuming that
storage space is limited to 400 units
 Cost Accounting and Control #4: Accounting for Materials, Labor and Overhead

Determining the Time to Order

The question is controlled by three factors:
1. Time needed for delivery
2. Rate of inventory usage
3. Safety stock

Illustration #5 (Safety Stock and Order Point)

Green Company has obtained the following costs and other data pertaining to one of its materials:
 Order quantity – 3,500 units
 Normal use per day – 500 units
 Maximum use per day – 600 units
 Minimum use per day – 100 units
 Lead time – 5 days

Required: Compute the following

1. Safety stock (maximum)
2. Order point
3. Normal maximum inventory
4. Absolute maximum inventory

Illustration #6 (Safety Stock)

World Inc. would like to determine the safety stock it needs to maintain for a product, to incur the lowest combination of stock-out
costs and carrying costs. Each stock-out costs P75; the carrying cost for each safety stock unit is P1; the product is ordered five times
a year. The following probabilities of running out of stock during an order period are associated with various safety stock level.

Required: Determine the combined stock-out and safety stock carrying cost associated with each level and the recommended level
of safety stock.

Additional Exercises:
1. Aztec Company expects daily usage of 500 pounds of material Inca, an anticipated lead time of seven days, and a desired safety
stock of 2,500 pounds.
a. Determine the order point.
b. Determine the number of pounds to be issued from safety stock if the new order is four days later.

2. Patriot Company predicts that it will use 360,000 gallons of material during the year. The material is expected to cost P 5 per
gallon. Patriot anticipates that it will cost P 72 to place each order. The annual carrying cost is P 4 per gallon.
a. Determine the most economical order quantity by using the EOQ formula.
b. Determine the total cost of ordering and carrying at the EOQ point.

3. Match the materials control form in the left column with the person responsible for its preparation in the right column.
(A selection may be used more than once.)
a. Purchase requisition 1. Production department supervisor
b. Purchase order 2. Storeroom keeper
c. Receiving report 3. Purchasing agent
d. Debit-credit memo 4. Receiving clerk
e. Materials requisition 5. Accountant

4. Using first-in, first-out; perpetual inventory costing; and the following information, determine the cost of materials used and the
cost of the July 31 inventory:
July
1 Balance on hand, 1,000 yard of linen @ P 4.00 each.
3 Issued 250 yard
5 Received 500 yard @ P 4.50 each.
6 Issued 150 yard
11 Issued 110 yard
11 Factory returned 10 yard, which were issued on the 10th, to the storeroom.
15 Received 500 yard @ P 5.00 each.
20 Returned 300 yard to the vendor from the July 15 purchase.
26 Issued 600 yd.

5. Using the moving average method of perpetual inventory costing and the information presented above, compute the cost of
materials used and the cost of the July 31 inventory. (Round unit prices to four decimal places and totals to the nearest whole
pesos.)
 Cost Accounting and Control #4: Accounting for Materials, Labor and Overhead

6. Mystic Manufacturing Company maintains the following accounts in the general ledger: Materials, Work in Process, Factory
Overhead, and Accounts Payable. On June 1, the materials account had a debit balance of P 5,000. Following is a summary of
materials transactions for the month of June:
1. Materials purchased, P 23,750.
2. Direct materials requisitioned to production, P 19,250.
3. Direct materials returned to storeroom, P 1,200.
4. Indirect materials requisitioned to production, P 2,975.
5. Indirect materials returned to storeroom, P 385.

Required:
a. Prepare journal entries to record the materials transactions.
b. Post the journal entries to ledger accounts (in T-account form).
c. What is the balance of the materials inventory account at the end of the month?
 Cost Accounting and Control #4: Accounting for Materials, Labor and Overhead

Accounting for Labor

Accounting for incurrence and distribution of labor

The general ledger of the ABC Manufacturing Company showed these balances at the end of July: Factory labor P480,000 which
includes P288,000 of direct labor; P66,000 of indirect labor; sales salaries of P72,000; and office salaries of P54,000.

The following rates are available for payroll distribution.

 Withholding tax 1%
 SSS Contribution 10% (40% employee and 60% employer)
 Employees’ Compensation Contributions 2% (employer only)
 Phil Health Contributions 2% (50% employee and 50% employer)
 PAG-IBIG Contributions 3% (50% employee and 50% employer)

Required:
a. Prepare journal entry to record labor incurrence
b. Prepare journal entry to record labor distribution and the related employer’s contribution

Accounting for Fringe Benefits

Tony Stark, a production worker earns P 27,600 per month and the company pay the worker a year-end bonus equivalent to one
month’s wages. Stark is also entitled to a half-month paid vacation per year. Company policy provides that the bonus and vacation
payments be treated as indirect costs and accrued during 11 ½ months the employee is at work.

Required:
a. The journal entry to record and distribute the labor cost of production for the month.

Accounting for Holiday, Vacation and Bonus Pay

Assume that a factory worker, who is classified as direct labor, earns P 700 each week. In addition, the worker will receive a P 1,000
bonus at year-end, a 2-week paid vacation, and 10 paid holidays. The following entry records the weekly payroll and the costs and
liabilities related to the bonus, vacation, and holiday pay as an expense of the 50 weeks (52 weeks – 2 weeks’ vacation) that the
employee actually worked

Required:
a. Journalize the entry of the above transaction.

Accounting for Vacation and Bonus Pay

Eight factory workers and a supervisor comprise a team in the Blending Department. The supervisor earns P200 per hour and the
combined hourly direct wages of the eight workers is P 1,280. Each employee is entitled to a two-week paid vacation and a bonus
equal to four weeks’ wages per year. Vacation pay and bonuses are treated as indirect cost and are accrued over the 50-week work
year. A provision in the collective bargaining agreement does not allow these employees to work in excess of 40 hours per week.

Required:
a. The journal entry to record the vacation and bonus pay applicable to one week’s production.

Accounting for Payroll

The general ledger accounts of the MCU Company contained these credit balances for the period October 1 through November 30.

Employee Income Tax Payable P 34,000

SSS Premium Payable P 11,760
Phil Health Premium Payable P 1,160
Pag-ibig Premium Payable P 2,432

For the December 1-15 payroll, which totaled P 112,000, employees’ deductions amounted only to P 4,920 for SSS; 1.25% for Phil
Health and 2% for Pag-ibig. For the same period, income tax withheld totaled P 9,488.

The company apportions employer SSS taxes as follows: 60% to Factory Overhead, 20% Marketing Expense and 20% to General and
Administration Expenses. The company closed for the year on December 15.

Employer taxes are 5% for SSS, 1.25% for Phil Health, 2% for Pag-ibig and 1% for ECC.

Required.
a. The journal entry to record the payroll for the period December 1-15
b. The journal entry to record the payment of payroll of December 1-15
c. The journal entry to record the employer’s payroll taxes for the period December 1-15
d. The entry to record the payment of all taxes due to governmental agencies for the period October through December 31.

Computation of Gross Earnings

From the following data, compute the regular earnings (for regular and overtime hours), overtime premium earnings, and gross
earnings of each employee at Winterfell Flooring, for the week ended May 7, 2022. All employees are paid at the regular hourly rate
for the first 40 hours worked during the week. The rate for hours worked in excess of 40 is one and half times the regular rate. The
rate for hours on Sunday is twice the regular rate.
 Cost Accounting and Control #4: Accounting for Materials, Labor and Overhead

Accounting for Payroll and Employer’s Contribution

The Dragonstone, Inc. recently adopted an incentive plan. Factory workers are paid P7.50 per unit with guaranteed minimum wage
of P 2,000 per week. Following is a report on employees’ productivity ending May 19, 2022. All employees worked the full 40-hour
week.

Required:
a. Compute each employee’s gross pay.
b. What amount should be charged to work in process?
c. What amount should be charged to factory overhead control?

Prepare a Payroll Register and the Journal Entry to Record the Payroll
The Dorne Corporation is a manufacturing concern that employs six people on an hourly basis. The following data relate to the week
ended October 31, 2018:

Required:
a. Compute net earnings of each employee for the week, assuming the following deductions:
 Income tax 15%
 SSS 6.2%
 Phil Health 1.5%
 Pag-ibig 1.5%
 Union dues P10 per employee
 Employees are paid one and one-half times the regular rate for hours worked over 40.
b. Prepare journal entry to record the payroll.
 Cost Accounting and Control #4: Accounting for Materials, Labor and Overhead

Accounting for Overhead

 Factory Overhead is generally defined as indirect material, indirect labor and other that cannot be conveniently identified with
or charged directly to specific jobs, products, or other final cost objects.

The Characteristics of Factory overhead:

 Related to the product
o Unlike direct materials and direct labor, overhead is an invisible part of the finished product. Yet overhead is as much a
part of a product’s manufacturing cost as direct materials and direct labor.
 Related to the volume of production
o Overhead can be fixed, variable, or semi-variable. As volume changes, the different overhead cost behavior patterns
cause per-unit manufacturing cost to fluctuate considerably. As a result, some method is needed to determine an
amount of overhead charged to the units produced

Use of a Predetermined Overhead Rate

 Because of the impossibility of tracing overhead to specific jobs or specific products, overhead cost is allocated across jobs and
units.
 A predetermined overhead rate permits a consistent and logical allocation to each unit of output.
 It serves management’s needs for product cost information, to identify inefficiencies, and to smooth out the illogical month-to-
month fluctuations that would otherwise appear in reported unit costs.

Factor considered in Selecting Overhead Rates

1. Base to Be Used
 Physical Output
 Direct Material Cost
 Direct Labor Cost
 Direct Labor Hours
 Machine Hours
 Transactions or activities
2. Activity Level Selection
 Theoretical capacity
 Practical capacity
 Expected actual capacity
 Normal capacity
 Effect of capacity on overhead rates
 Idle capacity versus excess capacity
3. Including or Excluding Fixed Overhead
 Absorption Costing
 Direct Costing
4. Use of a Single Rate or Several Rates
 Plant-wide or blanket rate
 Department rates
 Sub-departmental and activity rates
5. Use of Separate Rates for Service Activities
 Cost Accounting and Control #4: Accounting for Materials, Labor and Overhead

Illustration #7 (Predetermined Overhead)

Timex Corporation estimates that its production for the coming year will be 10,000 units, which is 80% of normal capacity with the
following unit costs:

Materials P 40
Direct Labor P 60

Direct labor is paid at the rate of P 24 per hour. The machine should be run for 20 minutes to produce one unit. Total estimated
overhead is expected to consist of P 400,000 of variable overhead and P 400,000 for fixed overhead.

Required:
1. What is the predetermined overhead rate based on units of production using the expected actual capacity activity level.
2. What is the predetermined overhead rate based on material cost?
3. What is the predetermined overhead rate based on direct labor cost?
4. What is the predetermined overhead rate based on direct labor hours?
5. What is the predetermined overhead rate based on machine hours?
6. What is the predetermined overhead rate based on units of production using the normal capacity activity level?
7. What is the predetermined overhead rate based on material cost using the normal capacity level?
8. What is the predetermined overhead rate based on machine hours using the normal capacity activity level?

Illustration #8 (Overhead Calculation)

Data for the past two years for MAC Corporation are:

2023 2024
Units produced 10,000 11,500
Overhead applied per unit P 15.00 P 18.00
Actual overhead
Fixed P 50,000 P 55,000
Variable P 95,000 P 150,000
Estimated overhead
Fixed P 50,000 P 56,000
Variable P 130,000 P 142,000

The company determines the overhead rates based on estimated units to be produced.

Required:
1. What is the estimated units of production used to obtain the overhead allocation rates in 2023 and 2024?
2. What is the over-applied (under-applied) overhead in 2023?
3. What is the over-applied (under-applied) overhead in 2024?

Illustration #9 (Overhead Calculation)

The normal annual capacity for Mary Joy Corporation is 48,000 units with production rates being level throughout the year. The
March budget shows fixed manufacturing overhead of P 1,440 and an estimated variable manufacturing overhead rate of P 2.10 per
unit. During March actual output was 4,100 units, with a total manufacturing overhead of P 9,000.

Required:
1. What is the applied manufacturing overhead?
2. What is over and under-applied manufacturing overhead for March?
 Cost Accounting and Control #4: Accounting for Materials, Labor and Overhead

Illustration #10 (Service Allocation Method of Overhead)

TUV Company has two service departments and two producing departments. The following are the overhead costs of each
department:

Service Department
Factory Administration P 129,000
Building and Grounds P 105,000
Producing Department
Machinery P 416,000
Assembly P 380,000

Additional information:

Department Total Estimated Square Footage

Labor Hours
Factory Administration 2,900 1,200
Building and Grounds 1,100 1,500
Machinery 2,000 1,900
Assembly 1,600 3,200

The cost of factory administration are allocated based on estimated labor hours; building and grounds costs are allocated based on
square footage. The producing department uses machine hours, with 30,000 for machinery and 22,800 for assembly.

Allocate the cost of the service departments to the producing departments using the following methods:
1. Direct method
2. Step method (allocate the costs of factory administration first).
3. Reciprocal method (simultaneous method/equation)
 Cost Accounting and Control #4: Accounting for Materials, Labor and Overhead

Illustration #11 (Service Allocation Method of Overhead)

SMC Incorporated has two service departments and three producing departments. Data for 2024 are as follows:

Total Costs
Service departments
Maintenance P 250,000
Storeroom P 180,000
Producing departments
Machinery P 600,000
Assembly P 829,000
Packaging P 436,000

Additional information:

Service Provided by Number of

Maintenance Requisitions
Maintenance 0% 400
Storeroom 14% 0
Machinery 32% 3,500
Assembly 26% 6,000
Packaging 28% 4,100
Total 100% 14,000

The costs of the Maintenance Department are allocated on the basis of percent of service rendered while the costs of the Storeroom
Department are allocated on the basis of number of requisitions.

Required: Distribute the service departments’ cost to the producing departments and compute overhead rates based on direct labor
hours: 20,000 for Machinery; 36,000 for Assembly; and 18,000 for Packaging using the following methods:
1. Direct method
2. Stem method (Maintenance Department costs are allocated first)
3. Reciprocal Method (Algebraic Method)

Illustration #12 (Disposal of Over and Under Applied Overhead)

The following information is available concerning the inventory and cost of goods sold accounts of DGA Company at the end of the
most recent year:

Work in Process Finished Goods Cost of Goods Sold

Direct Materials P 5,000 P 8,000 P 11,000
Direct Labor P 6,000 P 15,000 P 15,000
Applied Overhead P 4,000 P 12,000 P 24,000
Year-end Balance P 15,000 P 35,000 P 50,000

Applied overhead has already been closed to Factory Overhead Control.

Required:
Give the journal entry required to close the Factory Overhead Control, assuming:
1. Over-applied overhead of P 10,000 is to be allocated to inventories and cost of goods sold in proportion to the balances of
those accounts.
2. Under-applied overhead of P 10,000 is to be allocated to inventories and cost of goods sold in proportion to the amounts of
applied overhead contained in those accounts.
 Cost Accounting and Control #4: Accounting for Materials, Labor and Overhead

Illustration #13 (OH Variance Analysis)

ABC Incorporated uses a standard costing system and develop its overhead rates from the current annual budget. The budget is
based on an expected annual output of 120,000 units requiring 480,000 direct labor hours (Practical Capacity is 500,000). Annual
budgeted overhead costs total P 787,200, of which P 556,800 is fixed overhead. A total of 119,400 units using 478,000 direct labor
hours were produced during the year. Actual variable overhead costs for the year were P 230,600, and actual fixed overhead costs
were P 556,250.

Budget
Annual output 120,000 units
Direct labor hours 480,000 direct labor hours
Budgeted fixed OH P 556,800
Budgeted variable OH P 230,400

Actual
Annual output 119,400 units
Direct labor hours 478,000 direct labor hours
Actual fixed OH P 556,250
Actual variable OH P 230,600

Illustration #14 (OH Variance Analysis)

Queen Corporation uses a standard cost system. The manufacturing overhead rate is based on a normal yearly volume of 180,000
units, requiring 24,000 direct labor hours, and on normal budgeted costs at that volume of:

Fixed costs P 540,000

Variable costs P 720,000
Total costs P 1,260,000

During the month of May, the company produced 15,180 units of its product, requiring 2,030 direct labor hours. Actual overhead
costs for the month included fixed costs of P 46,000 and variable costs of P 60,852.

Required:
Compute for the total variance and divide the variance using two-variance method.