Cost of Raw Materials and Supplies

Direct costs are the costs that can be traced easily within the cost object. These are direct material costs and direct labor costs.

Direct material costs are the cost of the material used in the product which can be easily traced. For example, if the company can calculate the amount of carbon fiber material used in the frame of a carbon bicycle, then the carbon fiber used is assigned as direct material cost for the product.

Indirect costs are the costs that are related to the product but cannot be traced easily and also there may be some costs that are not included product, but they are consumed for the production purposes.

The expenses for raw materials and supplies can be traced within a four-step approach (Büyükmirza, 2014: 148);

1. Documentation and recording process

2. Determination of purchase costs

3. Determination of consumption

4. Pricing the consumption

When a consumption occurs, Materials account is credited with the purchase cost. If the consumption is for the raw materials then Direct Material Expenses account is debited reciprocal with Material account. If the consumption is for the supplies, then Overhead Expenses account is debited.

When the material is purchased, it is recorded into Warehouse Receipt Document.

In this document there is information about the date of the transaction (the date when the material accepted by the warehouse), the name of the supplier company, information about the shipper, inventory code, name, quantity and amount of the material and also some expenses related to the purchase.

To monitor raw materials and supplies inventory card is used.

There are three main parts of the inventory card: Receipts column shows the purchased raw material and supply whereas Issues column shows the consumption of the materials. The Balance column shows the remaining materials inventory on hand.

This is the substantiating document that shows the inventory flow from the warehouse to the production plant. The slip carries information about the name, code and the quantity of the material, the name of the requester, sender and receiver and some other necessary information. According to this document materials are sent from the warehouse and recorded into Issues column of the inventory card.

The excess material must be returned to the warehouse in order to calculate the material costs correctly. Because the data for calculating material costs are drawn from the material request slip. So, if excess materials are not sent back to the warehouse, it is assumed as if they were consumed for production. With the Material Return Slip errors in calculating the material costs are avoided.

The purchase cost includes the purchase price and the necessary purchase expenditures for the material to be ready for the production. Purchase cost of a material includes purchase price, transportation fees, insurance fees, loading and unloading fees, commissioner fees, custom fees and other necessary expenditures needed to make the material ready for production.

Companies use periodic inventory system in which the total cost of the material issued is calculated at the end of the period. In other words, periodic inventory system the purchased material can be tracked continuously whereas the inventory on hand and the cost of the materials issued to production is determined at the end of the period.

If the characteristic of the material issued to production allows the company to calculate the cost of the material issued, then companies can easily track the material inventory continuously. Therefore, there is no need for the companies to calculate the inventory on hand and total cost of the material issued at the end of the period. Cost of the material issued to production can easily be tracked within the period. This system is called as the perpetual inventory system.

The companies use inventory flow assumptions in order to identify the cost of the material issued to production and the ending inventory.

In FIFO method, it is assumed that the material issued to the production is from the initial purchased material from the inventory. Materials purchased with different purchase prices are recorded separately from each other. When the material is issued to production the earliest purchased material is issued first. If the material from the earliest receipts doesn’t meet the requested quantity then the company moves onto the next batch of materials.

LIFO method is just the opposite of FIFO method. In LIFO method, the material issued to production is from the latest purchased material. When the material was issued to production, the latest ones in the inventory were issued first.

In this method, an average price is calculated for a period by the relation between quantities and costs. The company calculates just one average price for the whole period. The average price is calculated as;

Cost of Beginning Inventory+Cost of Receipts / BeginningInventory+Total Quantity of Receipts.

In moving average method, an average price is calculated with every new purchase. So, when the company makes a purchase, a new average price must be calculated and this price will be used for pricing the issued materials until the next purchase. Calculating the average price is similar with the weighted average price calculation.

Cost of Inventory on Hand+Cost of NewPurchase / Quantity of Inventory on Hand+Quantity of NewPurchase

When the material is issued to the production its cost will be charged to the product. On inflationary economies market prices will differ from historical costs so rapidly that companies take some precautions in order to replace the materials issued to production. As a result, companies may charge the product with the material’s market price rather than its historical cost. In other words, the company will use the replacement cost of the material. In this method, upon the next material purchase, the company will use the replacement cost of the material.