The following points highlight the six main components in direct material cost. The components are: 1. Indirect Taxes 2. Transport, Storage and Delivery Charges 3. Quantity Discounts 4. Trade Discount 5. Cash Discount 6. Packing and Container Charges.
Component # 1. Indirect Taxes:
The indirect taxes like sales tax, central sales tax, excise duty, customs duty payable by the buyer and included in invoice cost is treated as forming part of direct material cost.
Component # 2. Transport, Storage and Delivery Charges:
If these charges are included in the invoice price, it will form part of direct material cost. If these expenses are incurred and accumulated separately as production overhead and absorbed into production cost. Where these charges are invoiced per unit or by weight or can be easily prorated, then these costs should be taken as part of direct material cost.
Component # 3. Quantity Discounts:
Quantity discounts are offered by the sellers to encourage bulk orders from the buyers. For example, if an order is received for 1,000 units then the purchaser will be given another 100 units free.
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The quantity discounts will reduce the overall cost per unit of the order placed and it benefits the purchaser in reducing cost of direct materials and hence the direct material cost should be shown after taking credit of quantity discounts. It is important to remember that by placing a bulk order, the ordering cost will be lesser but the cost of carrying the inventory would be more.
Component # 4. Trade Discount:
It is normally offered by a supplier to purchaser for pushing up or increase sales in the market by giving incentives like compensation for carrying additional inventory, concessional loans for capital expenditure, repacking into consumer packs etc. This should be taken into consideration in reducing the material cost.
Component # 5. Cash Discount:
It is offered by the supplier to buyer for early payment of debt. This discount is offered to encourage prompt payment and it is a debtors collection policy of the management giving an option to the purchaser for availing this discount. The cash discount is purely of financial item and is neither considered as reduction of material cost nor included in Cost Accounts.
Component # 6. Packing and Container Charges:
All costs incurred on packing and containers for materials received should be taken as part of purchase price i.e., (a) charges of packing and non-returnable containers, (b) the difference between the charge for returnable containers and the amount refunded when the container is returned.