Cost of Acquiring Materials | Materials Acquisition Cost

Cost of Acquiring Materials | Materials Acquisition Cost:

A guiding principle in accounting for the cost of materials is that all costs incurred in entering a unit of materials into factory production should be included.

Acquisition costs, such as the vendor’s invoice price and transportation charges, are visible costs of the purchased goods. Less obvious costs of materials entering factory operations are costs of purchasing, receiving, unpacking, inspecting, insuring, storing, and general and cost accounting.

Controversial concepts and certain practical limitations result in variations in implementing the principles of costing materials even with respect to easily identified acquisition costs. Calculating a number of cost additions and adjustments to each invoice involves clerical expenses which may be greater than benefits derived from the increased accuracy. Therefore, materials are commonly carried at the invoice price and paid the vendor, although all acquisition costs and price adjustments affect the materials cost. As a result, acquisition costs are generally charged to factory overhead when it is not practical to follow a more accurate costing procedure.

Purchase Discount: The handling of discounts on purchases is one major problem in accounting for materials costs. Trade discounts and quantity discounts normally are not on the accounting records but are treated as price reductions. Cash discounts should be treated as price adjustments but often are accounted for as other income, although income is not produced by buying. A low purchase cost may well widen the margin between sales price and cost, but it takes the sale to produce income. When the vendor quotes term such as 2/10, n/30 on a $100 invoice, is the sale price $100 or $98? The purchaser has two dates to make payments: on the tenth day, which allows time to receive, unpack, inspect, verify, voucher, and pay for the goods; or twenty days later. For the additional twenty days an additional charge or penalty of two percent is assessed. If regarded as interest, the extra charge is 36 percent per year[(360 days / 20 days) × 2%]. On these terms the seller is pricing on essentially a cash basis, and the purchaser has no reasonable choice except to buy on cash basis.

Although the nature of a purchase discount is readily understood, for practical reasons the gross materials unit cost of the invoice is commonly recorded in the materials account; the cash discount is recorded as a credit account item. Otherwise it would be necessary to compute the discount on each item, with unit costs having four or more decimal places.

Freight in: Freight or other transportation charges on incoming shipments are obviously costs of materials, but differences occur in the allocation of these charges. A vendor’s invoice for $600 may show 25 items weighing 1,700 ponds shipped in five crates, with the attached freight bill showing a payment of $48. The delivered cost is $648. But how much of the freight belongs to each of the invoice items, and what unit price should go on the materials ledger card? When the purchased units are not numerous and are large in size and unit cost, computation of actual amounts of freight may be feasible; otherwise, some logical, systematic, and expedient procedure is necessary.

If freight charges are debited to materials, the total amount should be added proportionately to each materials card affected. This might be done by assuming that each dollar of materials cost carries an equal portion of the freight. For example, freight of $48 on materials costing $600 would add $0.08 ($48/$600) to each dollar on the invoice. The relative weight of each item on the invoice might be determined and used as a basis for calculating the applicable freight. If an invoice item is estimated to weigh 300 ponds, then $8.47 [(300 / 1,700) × $48] would be added for freight. This procedure is also likely to result in unit costs having four or more decimal places on the materials ledger cards. To simplify procedures, all freight costs on incoming materials and supplies may be charged to freight in. As materials are issued for production, an applied rate for freight in might be added to the unit price on the ledger cards. The same amount is included in the debit to work in process (WIP) or factory overhead (indirect materials), and freight in is credited. Any balance in  freight in at the end of a period is closed to cost of goods sold or prorated to cost of goods sold and inventories.

Another often advocated method of accounting for incoming freight costs on materials is to estimate the total for an accounting period and include this amount in computing the factory overhead rate. Freight in then would become one of the accounts controlled by factory overhead. For materials or supplies used in marketing and administrative departments, freight, transportation, or delivery costs should be charged to the appropriate non-manufacturing account.

Applied acquisition costs: If it is decided that the materials cost should include incoming freight charges and other acquisition costs, and applied rate might be added to each invoice and to each item instead of charging these costs directly to factory overhead. A single rate for these costs can be used but amore accurate method is to use separate rates for each class of costs, as shown below:

  • Rate per purchase or rate per dollar purchased = [Estimated purchasing department cost for budget period / Estimated number of purchases or estimated amount of purchases]
  • Rate per item = [Estimated receiving department cost for budget period / Estimated number of items to be received during period]
  • Rate per item, cubic foot, dollar stored, etc. = [Estimated materials department cost for budget period / Estimated number of items, feet of space, dollar value, etc.]
  • Rate per transaction = Estimated accounting department cost for budget period / Estimated number of transaction

This procedure results in the following accounting treatment:

Materials

xxx   

Applied purchasing department expense
Applied receiving department expenses
Applied materials department expenses
Applied accounting department expenses

xxx
xxx
xxx
xxx


Actual expenses incurred by each of the departments for which applied rates are used will be debited to the applied accounts. Differences between the expenses incurred by the departments during the period and the expenses applied to the materials cost would represent over or under applied expenses and would be closed to cost of goods sold or prorated to cost of goods sold and inventories.

Imputed interest: A company making an inventory purchase with a non interest bearing not or a note with an interest rate that varies from prevailing interest rates should classify the effective interest imputed to the note as interest expenses, rather than as a cost of the materials. For example, assume that a $100,000, six months, non interest bearing note is used to purchase materials. If the company can borrow at a short term credit rate of 80%, the inventory should be costed at $96,154 ($100,000 × 0.96154, the present value of one dollar at 8% for six months). The differences of $3,846 should be debited to interest expense.

You may also be interested in other useful articles from “controlling and costing materials” chapter:

  1. Purchases of productive material
  2. Purchases of supplies, services, and repairs
  3. Materials purchasing forms
  4. Receiving materials
  5. Invoice approval and data processing
  6. Correcting invoices
  7. Electronic data processing (EDP)  for materials received and issued
  8. Cost of acquiring materials
  9. Storage and use of materials
  10. Issuing and costing materials into production
  11. Materials ledger card – perpetual inventory
  12. First-in-First-Out (FIFO) Costing Method
  13. Average Costing Method
  14. Last-in-First-Out (LIFO) Costing Method
  15. Other Methods-Month end average cost, last purchase price or market price at date of issue, and standard cost
  16. Inventory valuation at cost or market whichever is lower
  17. American Institute of Certified Public Accountant (AICPA) cost or market rules
  18. Adjustments for departures from the costing method used
  19. Inventory pricing and interim financial reporting
  20. Transfer of materials cost to finished production
  21. Physical inventory
  22. Adjusting Materials Ledger Cards and Accounts to Conform to Inventory Accounts
  23. Scrap and waste
  24. Spoiled goods
  25. Defective work
  26. Discussion Questions and Answers about Controlling and Costing Materials


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