Generally raw materials form a very big proportion of the total cost of production. Materials costing involves the determination of the cost of materials acquired, the cost of materials issued and the cost of the inventory. Cost of materials acquired (also called the ‘acquisition cost’) includes the net price paid to the vendor plus freight-in plus the costs of maintaining the purchasing department, the stores department, the accounting department and the costs of inspection, testing and insurance. A great proportion of the requisition costs consists of fixed expenses.
On account of this fixed factor and also on account of various complications, generally the materials are priced at the net amount paid to the seller. It does not mean that the cost referred to above is in any case not relevant to the concept of acquisition cost. This extra cost is generally charged to production as manufacturing overhead.
Generally the perpetual inventory system is used because it ensures a continuous book record of various materials in stock. The main advantages of a perpetual inventory system are: (i) control over inventory is easy and effective because the latest inventory position is always available and (ii) the book inventory can always be compared with the results of physical counting.
The net amount paid to the seller is entered by the stores clerks on the stores ledger cards. He enters both the unit cost and the total cost. Then the problem which arises relates to pricing the materials issued. The following methods of costing materials issued are generally used:
(i) First-in, First-out (FIFO).
(ii) Last-in, First-out (LIFO).
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