Accounting. PRACTICE OF MANAGEMENT ACCOUNTING

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Statements on Management Accounting
PRACTICE OF MANAGEMENT ACCOUNTING

TITLE

Definition and Measurement of Direct Material Cost
TABLE OF CONTENTS
Definitions . . . . . . . . . . . . . . . . . . . . . . . . . Materiality . . . . . . . . . . . . . . . . . . . . . . . . . Material Quantities . . . . . . . . . . . . . . . . . . . Material Lost in the Production Process . . . . Samples, Prototypes, and Initial Production Runs . . . . . . . . . . . . . . . . . . 1 2 2 2 3 Unit Price of Direct Material . . . . . . . . . . . . . Use of Estimates . . . . . . . . . . . . . . . . . . . . Material-Related Costs . . . . . . . . . . . . . . . . Cost Systems . . . . . . . . . . . . . . . . . . . . . . . 3 3 4 4

CREDITS
The Institute of Management Accountants appreciates the contribution of Michael J. Sandretto, Price Waterhouse & Co., Columbus, Ohio, for his research and writing associated with this project.

Published by National Association of Accountants 10 Paragon Drive Montvale, NJ 07645 www.imanet.org

Copyright © 1986 in the United States of America by National Association of Accountants. All rights reserved ISBN 0-86641-146-1

PRACTICE OF MANAGEMENT ACCOUNTING

The term “direct material cost” as used in practice, in literature, and in litigation has a wide variety of meanings. Unless the intended meaning in a given context is clear, confusion and misunderstanding are likely to result. The purpose of this Statement is to provide a conceptual definition of “direct material cost” that, in the absence of a specified alternative, should be taken as the meaning of this term. This Statement makes the conceptual definition more concrete by describing how direct material costs should be measured. Measurement has two aspects: a. The quantity of material that is to be included as direct material; that is, the inputs that are to be counted. b. The unit price by which each of these quantities is multiplied to arrive at a monetary cost. Many of the examples used in this Statement refer to the direct material cost of goods produced in manufacturing companies. The examples apply equally well to the same or similar transactions for projects, services, and other cost objects. The allocation of joint product or by-product costs is not addressed in this Statement. In a manufacturing company, direct material cost is an element of inventory cost and of cost of sales. Differences in how companies define this term result in variations in the amount recorded as direct material cost and the amount recorded as overhead or expense. Differences in the way material costs are accounted for in cost-type contracts, in projects, and for other cost objects also lead to differences in the amounts recorded as direct material cost and the amounts recorded as overhead or expense. If users do not understand what items are included in direct

material cost in such situations, their interpretation of the information may be erroneous, and they may make unsound decisions. Definitions Direct Material Cost—Quantities of material that can be specifically identified with a cost object in an economically feasible manner, priced at the unit price of direct material. Cost Object—A product, contract, project, organizational subdivision, function, or other unit for which costs are measured or estimated. Direct Cost—A cost that can be specifically identified with a cost object in an economically feasible manner. Material Quantity—A physical amount of material, such as a pound of copper, a 50-gallon drum of a chemical, or a batch of 100 semiconductors. Scrap—Material residue from manufacturing operations that has some value. Examples of scrap include border material from stamping operations, shavings, filings, borings, and turnings. Scrap may have relatively minor recovery value, as in the case of steel, or it may be of significant value, as in the case of gold. Waste—Material that is lost, evaporates, or shrinks in a manufacturing process or is a residue that...
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