The Impact of Material Consumption Valuation Methods on Costs

Cost accounting is a totality of various accounting systems which, as individual parts, address only a portion of a company's operations. Cost accounting includes the accounting of fixed assets, materials, wages, production, services, and sales of business outputs. The method of valuing material consumption is chosen by the company itself and is recorded in the accounting policy manual.

Problem

Cost accounting is a totality of various accounting systems which, as individual parts, address only a portion of a company's operations. Cost accounting includes the accounting of fixed assets, materials, wages, production, services, and sales of business outputs. The number of different accounting systems depends, amongst other things, on the company's line of business.

An integral part of cost accounting is cost bookkeeping, which examines the elements of the business process, their consumption, and the creation of new business outputs. Costs are the price-expressed consumption of elements of the business process that arise in the production of new products. Inventories are assets in tangible form that will be consumed in creating new business outputs and are recognised as costs of consumed materials or raw materials when used. Inventories are also recognised as quantities of materials in the warehouse.

Solution and Method

The method of valuing material consumption is chosen by the company itself and is recorded in the accounting policy manual. The following methods of valuing material consumption are legally permitted: – the FIFO method, – the weighted average price method, – the moving average price method, – the standard (estimated) price method. The FIFO method assumes that materials that are acquired first are also consumed first. This means that the consumption of material inventories is calculated according to the first actual acquisition prices, whilst the closing inventory of materials is valued at the most recent acquisition prices.

Under the weighted average price method, only material purchases are taken into account, not material consumption. This means that with each material purchase, a new weighted average price is calculated. The value of each material consumption is determined on the basis of the weighted average price. Material consumption according to moving average prices takes into account all purchases and all consumption. After each purchase, a new moving average price for material consumption is calculated.

Material remaining in inventory is valued at the moving average price. Under the standard (estimated) price method, the company must calculate variances from prices when consuming materials. This method is characterised by the company determining standard acquisition prices for inventory valuation at the beginning of the accounting period.

The difference between the standard price and the acquisition price of materials is shown as a variance from the standard price. Company XY d. o. o. uses the moving average price method. This company attempts, through continuous price monitoring and searching for new suppliers in the market, to ensure the lowest prices and the highest quality materials.

The company has ensured optimal inventory levels for some materials, thereby attempting to mitigate price fluctuations in urgent purchases. The disadvantage for the company is that all these materials in inventory increase the company's material inventories. The practical example shows that the use of the FIFO method would not represent the best solution for the company, as the lowest costs are shown on the cost carrier when using the FIFO method, which would unjustifiably increase the business result.

Under the weighted average price method and the moving average price method, costs are somewhat higher and depend on price fluctuations. In calculations of material consumption according to different methods, it will not be possible to state with certainty which method is best, because the sample of recalculated materials is too small. The company currently uses approximately 2500 different materials, whilst only six were used in the practical example of the thesis.

These materials are used in the assembly of machines and in consumption for spare parts, as the company also sells spare parts for manufactured machines. When purchasing materials, it is necessary to seek a solution that ensures the best quality and the lowest prices of materials. Low price must not be the main guide, because the most important factor is the quality of materials and the associated satisfaction of customers of machines and spare parts.