CAF8 cost and management accounting studytext ICAP

ICAP

P

Cost and management accounting


Second edition published by
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Certificate in Accounting and Finance
Cost and management accounting

C
Contents
Page

Syllabus objective and learning outcomes

v

Chapter
1

Inventory valuation

2

Inventory management

21

3

Accounting for overheads

45

4

Marginal costing and absorption costing

77

5

Cost flow in production

95

6

Job, batch and service costing

133

7

Process costing

153

8

Budgeting

201

9

Standard costing

241

10

Variance analysis

253

11

Target costing

319

12

Relevant costs

331

13

Cost-Volume-Profit (CVP) analysis

343

14

Decision making techniques

367

15

Introduction to financial instruments

391

16

Time value of money

419

17

Sustainability reporting

469

Appendix

487

Index

491

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Cost and management accounting

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Certificate in Accounting and Finance
Cost and management accounting

S

Syllabus objectives

and learning outcomes
CERTIFICATE IN ACCOUNTING AND FINANCE
COST AND MANAGEMENT ACCOUNTING
Objective
To equip candidates with techniques of cost accounting to provide a knowledge base for
decision making skills.
Learning Outcome
On the successful completion of this paper candidates will be able to:
1

establish the costs associated with the production of products and provision of
services

2

demonstrate an understanding of different costing systems

3

prepare various types of forecasts and budgets

4

apply the concepts of costing in the decision making process

5

demonstrate a functional knowledge of financial instruments

6

apply concept of time value of money

7

understand the concepts of sustainability reporting.

Grid

Weighting

Costs associated with the production

15-20

Costing system

20-30

Budget and budgetary controls

10-15

Decision making

20-25

Financial instruments

5-10

Time value of money

5-10

Sustainability reporting

5-10
Total

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Cost and management accounting

Syllabus
Ref

Contents

A

Costs associated with production

Level

1

Basis of valuation - FIFO,
weighted average, lower of cost
and net realizable value

2

2

Economic Order Quantity

2

3

Safety stock

2

4

Re-order level

2

5

Manufacturing expenses - actual
and applied

2

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vi

Learning Outcome

LO1.1.1: Apply inventory valuation
methods (namely, FIFO, weighted
average, lower of cost and net
realizable value) in simple scenarios
LO1.1.2: Comment on the suitability
of inventory valuation under FIFO,
weighted average, lower of cost and
net realizable value
LO1.1.3: Compare inventory
valuation under FIFO, weighted
average, lower of cost and net
realizable value
LO1.1.4: Calculate NRVs of
inventories in a given scenario.
LO1.2.1: Describe the economic
order quantity (EOQ) and apply the
concept in given scenarios
LO1.2.2: Calculate the EOQ from
data provided.

LO1.3.1: Describe safety stocks for
inventories
LO1.3.2: Explain the reasons for
maintaining safety stock
LO1.3.3: Calculate the safety stock
from data provided.
LO1.4.1: Explain the re-order levels
and the objectives of setting reorder levels
LO1.4.2: Calculate re-order levels
by using the data provided.
LO1.5.1: Describe manufacturing
overheads using examples
LO1.5.2: Compare manufacturing,
administrative and selling costs
LO1.5.3: Identify manufacturing
overheads from data provided
LO1.5.4: Describe and distinguish
between actual overhead and
applied overhead
LO1.5.5: Calculate applied
overheads using data provided.

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Syllabus objectives and learning outcomes

Syllabus
Ref

Contents

Level

Learning Outcome

Costs associated with production
(continued)

6

Over or under absorbed overhead

2

LO1.6.1: Compare actual and
absorbed overheads from data
provided
LO1.6.2: Analyze over or under
absorption in terms of expenditure
and volume variances
LO1.6.3: Account for over or underabsorbed overheads.

7

Production and service
departments

2

LO1.7.1: Identify production and
service departments in a
manufacturing facility and analyze
their related cost
LO1.7.2: Explain the basis of
allocation of cost of service
department to production
department

8

Apportionment, allocation and
absorption of service departments'
overheads to production

2

LO1.8.1: Allocate costs to
production and service departments
using information provided
LO1.8.2: Allocate costs of service
departments to production
department using data and
information provided.

B

Costing systems
1

Marginal costing

2

LO2.1.1: Explain the concept of
marginal costing and apply on given
data
LO2.1.2: Explain how marginal
costing helps managerial decisions
using examples.

2

Absorption costing

2

LO2.2.1: Describe and apply
absorption costing approach in
given scenarios
LO2.2.2: Compare marginal costing
and absorption costing.

3

Manufacturing cost accounting
cycle

2

LO2.3.1: Explain the flow of cost in
production process using examples.
LO2.3.2: Prepare accounting entries
for flow of cost.

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Cost and management accounting

Syllabus
Ref

Contents

Level

Learning Outcome

Costing systems (continued)

4

Job order costing

2

5

Process costing

2

6

Treatment of Joint and ByProducts

2

7

Cost of services rendered

2

8

Standard costing

2

9

Variance analysis-material, labour
and overhead

2

10

Target costing

2

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LO2.4.1: Describe job order costing
LO2.4.2: Calculate the cost of a job
and inventories by application of job
order costing
LO2.4.3: Prepare accounting entries
under the job order costing system.
LO2.5.1: Describe the process
costing including the treatment of
normal / abnormal loss / gain
LO2.5.2: Calculate cost of product
and inventories by application of
process costing
LO2.5.3: Prepare accounting entries
under the process costing system.
LO2.6.1: Describe joint and by
products using examples
LO2.6.2: Allocate joint production
costs using sales value, physical

units, average units and weighted
average methods
LO2.6.3: Account for by-products
using recognition of gross revenue,
recognition of net revenue and
replacement cost approaches.
LO2.7.1: Explain how
departmentalization in a service
organization helps in cost planning
and control
LO2.7.2: Calculate cost of services
rendered by a service organization.
LO2.8.1: Explain standard costing
using examples
LO2.8.2: Perform standard setting
for material, labour and factory
overhead.
LO2.9.1: Calculate, analyze and
interpret various variances relating
to material, labour and factory
overhead.
LO2.10.1: Describe target costing
and how target cost is determined
LO2.10.2: Apply the target costing
tools to given scenarios.

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Syllabus objectives and learning outcomes

Syllabus
Ref

Contents

C

Budget and budgetary controls
1

Level

Planning, forecasting and
budgeting of sales, cost and profit

2

Learning Outcome

LO3.1.1: Explain how budgeting
process works and how it fits into
overall planning and control
LO3.1.2: Prepare forecasts on given
data and assumptions
LO3.1.3: Identify and describe
different purposes of budgeting
LO3.1.4: Identify and describe the
various stages in the budget
process

LO3.1.5: Prepare following types of
budgets:















fixed and flexible budgets;
performance budgeting;
sales budget;
production budget;
direct materials budget;
direct labour budget;
manufacturing overhead
budget;
inventory budget;
cost of goods sold budget;
selling and administrative
expenses budget with
inflation aspects;

Master/cash budget;
zero based budgets, and
capital expenditure budgets;

LO3.1.6: Describe the human &
motivational aspects of budgets
LO3.1.7: Describe the budgeting
and planning in a non-profit
organisation
LO3.1.8: Prepare forecast and
budgets for a non-profit
organisation.

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Cost and management accounting

Syllabus
Ref

Contents

D

Decision making

Level

Learning Outcome

1

Opportunity cost

2

LO4.1.1: Describe opportunity cost
using examples.

2

Relevant cost

2

LO4.2.1: Describe relevant costs
using examples
LO4.2.2: Identify the costs that are
relevant to a particular decision in
given data.

3

Breakeven analysis

2

LO4.3.1: Explain the break-even
point using examples and margin of
safety
LO4.3.2: Calculate the breakeven
point in quantity and amount from
information provided
LO4.3.3: Apply cost volume profit
(CVP) analysis and explain its
usefulness for management.

4

Make or buy decisions

2

LO4.4.1: Apply marginal and
relevant costing concepts to analyze
make or buy options
LO4.4.2: Analyze make or buy
options in case of capacity
constraints
LO4.4.3: Discuss using examples
the importance of qualitative
consideration in make or buy
decisions.

5

Pricing for special orders

2

LO4.5.1: Perform incremental cost
benefit analysis for a special order

6

Further processing decisions

2

LO4.6.1: Perform incremental cost
benefit analysis for further
processing costs.

7

Utilization of spare capacity

2

LO4.7.1: Analyze the impact of
spare capacity on management
decisions regarding make or buy,
special order and further
processing.

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Syllabus objectives and learning outcomes

Syllabus
Ref
E

Contents

Level

Learning Outcome

Financial instruments (basic
functions)
1

Shares, debentures, bonds,
futures, options, cap, floor, collar,
swaps, forward

1

LO5.1.1: Describe direct and

indirect investment using examples.
LO5.1.2: Describe using examples
shares, debentures, bonds, futures,
options
LO5.1.3: Describe using simple
examples the following
characteristics of indirect
investments and compare them with
direct investments:




Divisibility
Liquidity
Holding period

LO5.1.4: Differentiate between
investment and speculation using
simple examples
LO5.1.5: Describe using simple
examples cap, floor, collar, swaps,
forwards.
F

Time value of money
1

Computation of net present value
and internal rate of return

1

LO6.1.1: Explain the time value of
money
LO6.1.2: Calculate net present
value and internal rate of return of
given cash flows.

G

Sustainability reporting
1

LO7.1.1: Apply the concept of
sustainability reporting

An introduction to sustainability
reporting

LO7.1.2: Describe the concept of
integrated reporting
LO7.1.3: Identify and explain the
users of sustainability reports
LO7.1.4: Explain benefits of
sustainability reporting and apply
this in given scenarios
LO7.1.5: Explain the IFAC
Framework of sustainability
reporting.

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Cost and management accounting

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CHAPTER

Certificate in Accounting and Finance
Cost and management accounting

1

Inventory valuation
Contents
1 Materials: procedures and documentation
2 Accounting for inventory
3 Valuation of inventory
4 Comparison of methods

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Cost and management accounting

INTRODUCTION
Learning outcomes
The overall objective of the syllabus is to equip candidates with techniques of cost
accounting to provide a knowledge base for decision making skills.
Costs associated with the production of products and services
LO 1

On the successful completion of this paper, candidates will be able to
establish the costs associated with the production of products and
provision of services

LO 1.1.1

Apply inventory valuation methods (namely, FIFO, weighted average, lower of
cost and net realizable value) in simple scenarios

LO 1.1.2

Comment on the suitability of inventory valuation under FIFO, weighted
average, lower of cost and net realizable value

LO 1.1.3

Compare inventory valuation under FIFO, weighted average, lower of cost
and net realizable value

LO 1.1.4

Calculate NRVs of inventories in a given scenario.

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Chapter 1: Inventory valuation

1

MATERIALS: PROCEDURES AND DOCUMENTATION
Section overview


Ordering and purchasing



The procedures and documents



Monitoring physical inventory: comparison with the inventory records

1.1 Ordering and purchasing
When an entity purchases materials from a supplier, the purchasing process
should be properly documented. There are several reasons for this.
Any purchase of materials from a supplier should be properly authorised and
approved at the appropriate management level. Documentation of the purchasing
process provides evidence that approval has been obtained.
The receipt of materials from a supplier should also be documented, to make
sure that the goods that were ordered have actually been delivered.
There should be an invoice from the supplier for the goods that have been
delivered. (In rare cases when goods are bought for cash, there should be a
receipt from the supplier.) The amount payable for the materials provides
documentary evidence about their cost.
When materials are received from a supplier, they might be held in a store or
warehouse until needed. When they are issued from the store, there should be a
documentary record of who has taken the materials and how many were taken.
This is needed to provide a record of the cost of materials used by different
departments or cost centres.
Documentation of purchases is therefore needed:


to ensure that the procedures for ordering, receiving and paying for
materials has been conducted properly, and there is no error or fraud



to provide a record of materials purchases for the financial accounts



to provide a record of materials costs for the cost and management
accounts.

1.2 The procedures and documents
The detailed procedures for purchasing materials and the documents used might
differ according to the size and nature of the business. However the basic
requirements should be the same for all types of business where material
purchases are made.
Purchasing procedures and documents
In a large company with a purchasing department (a buying department) and a
stores department, the procedures for purchasing materials might be as follows.


The stores department identifies the need to re-order an item of raw
materials for inventory. It produces a request to the purchasing department
to buy a quantity of the materials. This request is called a purchase
requisition. It should be properly authorised by a manager with the
authority to approve any such requisition.

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Cost and management accounting



A buyer in the purchasing department selects a supplier and provides the
supplier with a purchase order, stating the identity of the item to be
purchased, the quantity required and possibly also the price that the
supplier has agreed.



When the supplier delivers the goods, the goods are accompanied by a
delivery note from the supplier. The delivery note is a statement of the
identity and quantity of the items delivered, and it provides confirmation that
the items have been delivered. One copy is kept with the stores
department, and another copy is retained by the supplier (the driver of the
delivery vehicle), as evidence of the delivery.



The stores department prepares a goods received note, recording the
details of the materials received. This should include the inventory identity
code for the item, as well as the quantity received.



Copies of the delivery note and goods received note are sent to the
accounts department, where they are matched with a copy of the purchase
order.



A purchase invoice is received from the supplier, asking for payment. The
accounts department checks the invoice details with the details on the
purchase order and goods received note, to confirm that the correct items
have been delivered in the correct quantities.



The purchase invoice is used to record the purchase in the accounting
records.



In the cost accounting system, there should be inventory records to
record the quantities and costs of materials received. Data for recording
costs of purchases for each item of inventory is obtained from the goods
received note (quantity and inventory code) and purchase invoice (cost).

The purchase process
Illustration: The purchase process

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Chapter 1: Inventory valuation

Inventory records
An entity should keep an up-to-date record of the materials that it is holding in
inventory.


In the stores department, the materials should be kept secure, and there
should be systems, processes and controls to prevent loss, theft or
damage. The stores department should keep a record of the quantity of
each item of material currently held in inventory. For each item of material,
there might therefore be an inventory record card, or ‘bin card’. This card is
used to keep an up-to-date record of the number of units of the material
currently in the stores department, with records of each receipt and issue of
the inventory item. This process of continuous record-keeping is known as
perpetual inventory. The inventory record should be updated every time
materials are delivered into store from a supplier, and every time that
materials are issued to an operating department. Instead of having a
‘physical’ card for each stores item, there may be a computerised record
containing similar information.



In the cost accounting department, another separate record of inventory
might be kept, with an inventory ledger record for each item of material.
The inventory ledger record is a record of the quantity of the materials
currently held in inventory, the quantities received into store from suppliers
and the quantities issued to operational departments. In addition the
inventory ledger record also records the cost of the materials currently held
in inventory, the cost of new materials purchased and the cost of the
materials issued to each operating department (cost centre).



In a computerised inventory control system, the stores department and
the cost accounting department should use the same computerised records
for inventory.

Issues and returns of materials
A cost accounting system also needs to record the quantities and cost of items of
materials that are issued to the user departments and the quantities and cost of
any items that are subsequently returned to store unused.
The documentation for the issue and returns of materials are:


A materials requisition note: this is a formal request from a user
department to the stores department for a quantity of an items of materials



A materials return note: when items are returned to store unused, the
stores department should record the return on a materials return note.

A materials requisition note is used to record:


the details of the quantity of materials issued



the department (cost centre) that receives them, and



(in a cost accounting system) their cost.

The inventory records are updated from the requisitions notes and returns notes
to record all issues and returns of materials.

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Cost and management accounting

Illustration: Inventory documentation
Additions
to inventory

Withdrawals
from inventory

A simplified version of an inventory record for a perpetual inventory system is
shown below, to demonstrate that inventory records can be used to record
receipts and issues (and returns) of materials, and their cost or value. The record
needs to identify the cost centres that have issued or returned materials, and will
probably also record the number of the materials requisition note or materials
returns note (although this data is not shown in the example below).

Illustration: Inventory card (perpetual inventory system
Inventory item: Code number 1234
Purchases
Date

Quantity
Units

Cost
Rs.

300

630

Returns to
supplier
Quantity
Cost
Units
Rs.

Issues from
store
Quantity
Cost
Units
Rs.

Running balance

Quantity
Units

Cost
Rs.

March
1
3
7
9

250
30

505

63

12

100

210

200

400

300

630

500

1,030

(250)

(505)

250

525

(30)

(63)

220

462

(100)

(210)

120

252

1.3 Monitoring physical inventory: comparison with the inventory records
For various reasons, the inventory records in the cost accounts might not agree
with the physical quantities of materials actually held in store. There are several
reasons for this.


Errors in recording receipts, issues and returns. Mistakes might be
made in recording transactions for materials received from the supplier,
materials issued from store and returns to store. For example, an issue of
material item 1234 from inventory might be recorded as an issue of item
1243. This would result in inaccurate inventory records for both items 1234
and item 1243.



Omissions. Similarly, some purchases, issues and returns to store might
not be recorded, due to mistakes.

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Chapter 1: Inventory valuation



Theft or physical loss. Some inventory might be stolen or might get lost,
and the theft or loss might not be noticed or recorded.



Damage to stores items or deterioration of items. Stores items might
deteriorate in quality when they are stored, particularly if they are stored in
poor conditions. Damaged items might be thrown away, but the write-off
might not be recorded.

Management should try to minimise these discrepancies between inventory
records (in a perpetual inventory system) and physical inventory in the store.


It is the responsibility of the stores manager to minimise losses due to theft,
loss or deterioration and damage.



Documentation and record keeping should be accurate and mistakes
should be minimised. All movements of materials should be properly
recorded in a document, and the data from the document should be
transferred accurately into the inventory records.

Even so, good record keeping and goods stores management will not prevent
some discrepancies between inventory records and physical inventory in store.
This discrepancy should be checked from time to time. The stores department
staff can do this by carrying out a physical count of the quantity of each material
item currently held, and comparing this ‘physical count’ with the figures in the
stores records. The records should then be adjusted to the correct quantities.

(Quantities that are ‘missing’ will be recorded as a write-off of materials in the
accounts.)
Minimising discrepancies and losses
When physical inventory is checked against the inventory records, there will often
be some differences. When the differences are big, there could be a serious
problem with either:


Poor control over inventory. Some losses through theft, deterioration and
breakages should be expected, but the losses should not be large.



Poor inventory records. If the inventory records are inaccurate, the
information prepared for management from inventory records will be
unreliable.

Whichever failing is the reason for big discrepancies between physical inventory
and inventory records, management should take measures to deal with the
problem.


Theft can be reduced by keeping inventory locked in a safe place. TV
cameras can be used to monitor activity in the warehouse.



Deterioration of inventory can be reduced by keeping the inventory in better
storage condition.



Poor procedures for recording inventory movements in and out of the store
can be improved through better procedures and suitable controls, such as
better supervision of the recording process and better staff training.

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Cost and management accounting

2

ACCOUNTING FOR INVENTORY
Section overview


Introduction



Periodic inventory method (period-end method): accounting procedures



Perpetual inventory method: accounting procedures



Summary of journal entries under each system

2.1 Introduction
There are two main methods of recording inventory.


Periodic inventory method (period end system)



Perpetual inventory system

Each method uses a ledger account for inventory but these have different roles.
A company might use both systems for different types of goods. For example, a
company might record raw materials and components using a perpetual
inventory system and use the periodic system to record finished goods but note
that either system could be used for either purpose.
Both systems should be familiar to you from your previous studies.

2.2 Periodic inventory method (period-end method): accounting procedures
This system is based on the use of two ledger accounts:


Purchases account which is used to record all purchases during the year;
and



Inventory account which is used to record the value of inventory at the
beginning/end of the financial year.

It operates as follows:
Year 1
A business starts on 1 January Year 1. This business has no opening inventory.
All inventory purchased in the year to 31 December Year 1 is recorded in the
purchases account.
Illustration: Purchases through the year
Debit
Purchases
Cash or liabilities

Credit

X
X

At the end of the year a trial balance is extracted. One of the balances in the trial
balance is the purchases figure for the year.

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Chapter 1: Inventory valuation

This is transferred to cost of sales clearing the purchases account to zero.
Illustration: Year-end transfer to cost of sales
Debit
Cost of sales
Purchases

Credit

X
X

At the end of the year cost of sales must be calculated. Purchases are not the
same as cost of sales because the company still holds some of the items that it
purchased.
The number of items of inventory still held is established through an inventory
count. This involves the staff of the business counting every item of inventory and
making a record of this. The inventory is then valued (usually at cost). This figure
is the closing inventory.
It is recognised as an asset on the statement of financial position and as a credit
entry on the statement of comprehensive income (where it reduces the cost of
sales expense).
Illustration: Closing inventory double entry
Debit
Inventory (statement of financial position)
Cost of sales (Statement of comprehensive
income)

Credit

X
X

The exact location of the credit entry might be to one of several accounts but
ultimately it always achieves the same purpose, that is, to set reduce cost of
sales. Thus it might be a credit to a statement of comprehensive income
inventory account (which is later transferred to a cost of sales account or it might
be a credit to the cost of sales account.
At the end of year 1 the purchases and the credit entry for closing inventory form
part of the profit for the period. The debit entry for closing inventory is carried
down into year 2 as an asset.
Year 2
The closing inventory in year 1 becomes the opening inventory in year 2
All inventory purchased in the year to 31 December Year 2 is recorded in the
purchases account.
At the end of the year a trial balance is extracted. One of the balances in the trial
balance is the purchases figure for the year. Another of the balances is the
opening inventory which has been there since the start of the year.
The purchases together with the opening inventory are what the business could
have sold in the period. These are both transferred to the cost of sales.

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Cost and management accounting

Illustration: Year-end transfer to cost of sales
Debit
Cost of sales
Purchases

X

Cost of sales

X

Credit
X

Inventory (statement of financial position)

X

Note that this is the transfer of the opening inventory to cost of sales)
At the end of the financial year, the closing inventory is physically counted and
valued. The closing inventory double entry is then processed.
Illustration: Closing inventory double entry
Debit
Inventory (statement of financial position)
Cost of sales (Statement of comprehensive
income)

Credit

X

X

In summary
Opening inventory in the trial balance (a debit balance) and purchases (a debit
balance) are both transferred to cost of sales.
This clears both accounts.
Closing inventory is recognised in the inventory account as an asset (a debit
balance) and the other side of the entry is a credit to cost of sales.
Cost of sales comprises purchase in the period adjusted for movements in
inventory level from the start to the end of the period.
Illustration: Cost of sales

Opening inventory (a debit)
Purchases (a debit)
Closing inventory (a credit)
Cost of sales

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10

Year 1
Rs.


Year 2

X

X

X
(X)

X
(X)

X

X

Rs.
X

The Institute of Chartered Accountants of Pakistan


Chapter 1: Inventory valuation

Example:
Faisalabad Trading had opening inventory of Rs. 10,000.
Purchases during the year were Rs. 30,000.
Closing inventory at the end of Year 2 was Rs. 12,000.
At the year end the following entries are necessary
Purchases account
Balance b/d

Rs.
30,000 (1) Cost of sales

Rs.
30,000

Inventory account
Balance b/d
(3) Cost of sales
Recognition of closing
inventory
Opening balance b/d

Rs.
10,000 (2) Cost of sales
Removal of opening
inventory
12,000
Closing balance c/d
22,000
12,000

Rs.
10,000

12,000
22,000

Cost of sales
(1) Purchases
(2) Opening inventory

Cost of sales b/f

Rs.
30,000
10,000

Rs.
(3) Closing inventory

12,000

Cost of sales c/f

28,000
40,000

40,000
28,000

The cost of sales total is then transferred to the statement of comprehensive
income.
The cost of sales is part of the statement of comprehensive income and can be
presented as follows:
Rs.
Sales
Opening inventory
Purchases

X
10,000
30,000

40,000
(12,000)

Closing inventory
Cost of sales
Gross profit

© Emile Woolf International

Rs.

(28,000)
X

11

The Institute of Chartered Accountants of Pakistan


Cost and management accounting

2.3 Perpetual inventory method: accounting procedures
In a system of cost accounting, a separate record is kept for each inventory item.
This record – an inventory account – is used to maintain a record of all
movements in the materials, in terms of both quantities and cost.
Each inventory account is used to record purchases in the period and other costs
associated with the inventory. The account is also used to record all issues out of
inventory. These might be transfers into work in progress if the inventory account
is for raw materials or into cost of sales if the inventory account is for finished
goods.

Each issue (transfer out) of inventory is given a cost, and the cost of the items
issued is either the actual cost of the inventory (if it is practicable to establish the
actual cost) or a cost obtained using a valuation method.
Each receipt and issue of inventory is recorded in the inventory account. This
means that a purchases account becomes unnecessary, because all purchases
are recorded in the inventory account.
All transactions involving the receipt or issue of inventory must be recorded, and
at any time, the balance on the inventory account should be the value of
inventory currently held.
Example:
Faisalabad Trading had opening inventory of 500 units which cost Rs. 20 each
(opening inventory of Rs. 10,000).
Purchases during the year were 1,500 units at Rs. 20 each (Rs. 30,000).
During the year 1,400 units were issued to work in progress.
The following entries are necessary during the period.
Raw materials
Units
Balance b/d
Transfers in
during the year

Balance b/d

500
1,500
2,000
600

Rs.

Units

Rs.

10,000
Issues(transfers
30,000 out)
Balance c/d
40,000
12,000

1,400

28,000

600

12,000

2,000

40,000

Periodically a company employing the perpetual inventory system would check
actual inventory against the balance on the account and investigate any
discrepancies. These might be due, for example, to breakage or incorrect
recording of a transfer.

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The Institute of Chartered Accountants of Pakistan


Chapter 1: Inventory valuation

All transactions involving any kind of adjustment to the cost of inventory must be
recorded in the inventory account.
Example:
Gujrat Manufacturing (GM) had opening inventory of raw materials in the amount
of Rs. 100,000.
Purchases during the year were Rs. 500,000. Inventory with a cost of Rs. 18,000
was returned to a supplier. One of the purchases in the above amount was subject
to an express delivery fee which cost the company an extra Rs. 15,000 in addition
to the above amount.
GM transferred goods into work in progress during the year which had cost Rs.
520,000. Goods which had cost Rs. 20,000 were returned to stores from the
production line.
Just before the year end goods which had cost Rs. 5,000 were found to have been
damaged whilst being handled by GM’s staff.
The following entries are necessary during the period.
Inventory account
Balance b/d
Purchases
Special freight charge
Returns from production

Opening balance b/d

Rs.
100,000
500,000 Returns to supplier
15,000
20,000 Transfers out
Normal loss
Closing balance c/d
635,000
92,000

Rs.
18,000
520,000
5,000
92,000
635,000

The inventory records are combined into a total record for all inventory, which is
used for reporting purposes such as the preparation of a costing statement or an
income statement of the profit or loss made in a period. The system for recording
inventory and materials costs might also be a part of a bigger cost accounting
system.
A cost accounting system is a system for recording all costs and in large
organisations it is maintained in the form of a double entry accounting system of
cost records in a ‘cost ledger’. This is explained in chapter 8.

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13

The Institute of Chartered Accountants of Pakistan