Material costing
Material costing is the process of determining the costs at which inventory items are recorded into stock, and their subsequent appraisal in the accounting records. We deal with these ideas individually.
Material Costs for Initial Inventory Acquisition
A corporation must determine whether to record bought products at the purchase price or to include other charges such as freight in, sales taxes, and customs fees. The inclusion of these extra charges is permissible, but may need some additional labor. It is simpler to charge these extra costs to expenses as they occur, so they show promptly in the cost of products sold.
Overhead is not given to raw materials since they have not undergone any industrial activity. Overhead is solely allocated for work-in-process and completed items inventories.
Material Costs for Future Valuation
When inventory is received into stock, it is subject to the lower of cost or market (LCM) rule. In essence, this rule specifies that the recorded cost of inventory should be the lower of the recorded cost and the market rate. From a practical standpoint, this rule is often only applied to inventory goods with the highest extended costs. Its use to low-value goods would result in no significant modifications, hence it is avoided from an efficiency standpoint.
The cost layering concept must also be applied to inventory. Cost layering is the process of charging inventory items to the cost of products sold when units are sold to consumers. There are many cost stacking ideas that may be used:
A specific way of identification.Assign costs to individual pieces of inventory and charge them to expenses when they are sold. This usually only applies to pricey and unique inventory goods.
The first in, first out technique.Assign expenses based on the presumption that the first products obtained are the first to sell. Profits tend to increase when prices rise.
Last in, first out technique.Assign expenses under the premise that the last products obtained are the first to be sold. Price increases tend to result in decreased earnings. This strategy is not permitted under international financial reporting rules.
Weighted average approach.When calculating the cost of products sold, an average of the costs of all units in stock is used.
The following are required for determining an appropriate material cost:
(I) Compute the total cost of the stuff bought.
(II) A systematic material issue method.
(III) Appropriate techniques for pricing material difficulties.
(I) Calculate the Total Cost of Material Purchased:
The supplier’s invoice contains the majority of the information required to calculate the overall cost of items bought.
The basic purchase price must be modified to account for shipping and forwarding fees, sales tax, excise duty, and other costs. Similarly, transportation and container costs must be considered. Discounts receivable must be removed correctly.
- a) Discounts:
There are three kinds of discounts to consider:
(i) Trade Discount: The supplier provides a discount to reimburse the buyer for the expenses of breaking bulk, selling in small amounts to clients, and repacking. By buying in bulk, the customer relieves the supplier of all of these expenditures. Wholesalers generally provide this discount.
(ii) Quantity or Bulk Discount: The supplier offers this discount to reflect cost savings from producing longer runs and distributing greater volumes. A portion of the supplier’s savings from a big order is passed on to the customer in the form of a quantity discount.
(iii) Cash Discount: The supplier offers a cash discount to the customer as an alternative. The discount is contingent upon payment of the invoice amount before a given due date or within a defined number of days. If the purchaser’s financial situation allows for it, he may exercise the option and get the discount. In general, this discount is regarded as a ‘financial policy’ and is not considered when calculating material costs.
(b) Transport and Storage charges: If transportation and transit storage charges are not included in the supplier’s invoiced price, they might be added as direct purchase costs to the material cost. If such expenses cannot be identified with individual items since they are paid for in bulk, they may be classified as indirect expenditure and included in overhead.
(c) Container Cost: The provider may or may not charge for individual containers. If no costs are incurred, no accounting treatment is necessary.
(II) Material Issue Procedure: Stored materials are provided to manufacturing divisions as needed. The storekeeper is only authorized to provide supplies when a material request is delivered to him.
(a) goods Requisition: Production divisions use this approved document to request goods from shops. To prevent material misappropriation, it must be started by a fully allowed person.
The request authorizes the storekeeper to supply supplies. The storekeeper writes the serial number on the demand and fills up the issue column on the bin card. Following this, the requisitions are forwarded to the cost office, where the value of the material issued is recorded and credit is provided to the item issued in the stores ledger, while the job receiving the material in the job ledger is debited.
(c) Bill of Material:
It is a document that lists all of the supplies and quantities necessary for a certain task, order, or procedure. The bill of material acts as a material requisition. The bill of material is generated for a non-standardised work so that the production department may estimate the total number of materials necessary for the job before it begins. This is useful for estimating the material cost of the task before submitting bids or quotes.
Treatment of Surplus Materials:
(a) Return of Surplus Material: Excess materials may be provided to manufacturing divisions. When these items are returned to retailers, the department responsible for the surplus supplies must produce a Material Return Note. Typically, three copies are created. One copy is kept by the department that is returning the materials. Two copies are sent to the storekeeper. The storekeeper saves one copy for making entries in the Bin card, while the second copy is forwarded to the cost office for making entries in the store ledger and crediting jobs with extra material.
(a) Avoid transferring surplus materials between jobs. This is because a record of the transfer may not be created, and the real material cost of projects may be incorrect. However, in rare cases, the item may be moved to prevent delays and handling expenses. The transfer is permitted only with the production of a material transfer note, so that the cost of the material moved is debited to the work receiving the material and credited to the job sending the material.
III) Pricing Methods Material Issues:
Material purchase costs vary due to product price fluctuations, purchasing from multiple suppliers, and quantity discounts. Because of price variations, the stock may include many lots of the same commodity acquired at varying prices. When these materials are provided to manufacturing, it is essential to determine the appropriate price at which they are charged.