Material Cost: What It Is and Why It Is Controlled
Chapter Ten
Syllabus topic 2, "Meaning, Need for and Importance of Materials, Procedures, Documentations and Inventory Control techniques"
Pages 25 to 27 of 82
In one line
Material cost is the cost of the physical inputs, and it is controlled first because in most manufacturing it is the largest single element and the easiest to lose.
What is included
CAS-6 Material Cost is the standard on this. Its requirement, stated in our own words, is that material cost be determined at the cost of purchase, which includes the purchase price and every cost of bringing the material to its present location and condition, net of taxes and duties recoverable from the authorities.
So the cost of a material is built up like this:
| Include | Exclude |
|---|---|
| Purchase price | Recoverable taxes and duties, such as input tax credit |
| Duties and taxes not recoverable | Trade discount, rebate |
| Freight inward, carriage, insurance in transit | Abnormal wastage or loss |
| Loading, unloading, handling to the store | Demurrage, penalty, fine |
| Cost of containers not returnable | Interest and finance charges |
| Normal loss in transit and in storage |
Two lines decide most questions.
Trade discount is deducted; cash discount is not. A trade discount is a reduction in price; a cash discount is a reward for paying early, which is a financial matter.
Recoverable tax is not a cost. Where input tax credit can be claimed, the tax is recovered from the government and never falls on the product. Where it cannot, it does.
Why material is controlled first
It is usually the biggest element. In most manufacturing, material is a larger share of cost than labour or overhead, so a one per cent saving on material is worth more than a one per cent saving anywhere else.
It is physical, and therefore losable. Labour cannot be stolen, spoiled or allowed to rust. Material can, and every one of those is a real cost.
It ties up money. Stock is cash the business cannot use, and the whole of the next three chapters - order quantity, stock levels, control techniques - exists to answer one question: how little can we hold without stopping production?
Two opposite errors, and control sits between them:
| Too much stock | Too little stock |
|---|---|
| Capital locked up | Production stops |
| Storage, insurance, handling cost | Emergency purchases at a worse price |
| Obsolescence, deterioration, pilferage | Loss of customer goodwill |
| Risk of price fall | Loss of quantity discounts |
Direct and indirect material
Direct material is traceable to the cost object economically: the timber in a table, the cloth in a shirt, the steel in a girder. It enters prime cost.
Indirect material cannot be so traced, or is too small to be worth tracing: glue, cleaning materials, lubricants, small tools. It enters factory overhead.
The line is economic, not physical. The nails in a wooden crate are physically in the product; if tracing them costs more than knowing their cost is worth, they are indirect.
The rest of this chapter
Module one is free. The rest of this chapter comes with the B.Com. (Accountancy) Semester 5 notes.
You are reading a chapter from a later module. Everything in module one of every subject stays free, and so does the syllabus.
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Free either way: the syllabus, and module one of every subject.
The rest of this subject
These notes are cut from the University's printed syllabus. Open the syllabus itself, or the past papers, for the same subject.