Allocating Purchased and Manufactured Parts

Apr 16, 2015

I recently came across a situation where a manufacturing client was making a number of parts, as well as purchasing parts that went into the finished product and then of course into their finished goods inventory. The products they were buying were unique or required specialized manufacturing processes which the business did not have the capability to produce. As a result, the purchase of parts was the most expedient method to acquire the required parts for finished goods inventory.

The question surrounding this unique scenario was what cost should be assigned to these purchased parts? It is clear the cost of the part and the delivery charges should all be included with the inventorial cost of this product. However, some of the parts were sent out for additional processing such as painting, plating or, e-coating. Others were simply purchased and kept in the inventory until they were needed and used in the state which they were purchased.

As we discussed this situation further, I concluded that any secondary processes done to the purchased parts were clearly part of the product cost and should be allocated to that purchase part. For instance, a purchase part that cost $1.00 to buy and have delivered to the inventory, but then was sent out for painting for another $.20, should be carried in inventory for $1.20 to reflect the complete cost it takes to have the part available for inclusion in the final finished good product. Naturally, the next question that arose was associated with what amount of overhead cost should be assigned to these purchase parts?

Some members of the costing team thought any overhead costs, like the inventory management and purchasing process, were all overheads. Therefore, period cost, and should not be assigned to any purchase parts on some allocation basis. However, as I began to think about this question, it was clear to me purchase parts are no different than parts that we manufacture in our normal process of producing finished goods, and therefore, should include any appropriate overheads that would be assigned to a manufactured part.

I believe in this case any purchase parts should include some portion of a warehousing cost and a purchasing function that are relevant to the total cost of acquiring and making available those products as part of our manufacturing process. I don’t believe that the period cost concept, meaning an overhead cost is not assignable because it is strictly related to an operating period and should be expensed when incurred is valid in this case. There are numerous overheads that are also fixed costs which good manufacturing cost systems routinely assign to manufactured parts. I believe the concept should be the same when dealing with purchase parts although the cost bands to be allocated and assigned might be slightly different. The basic concept of full absorption costing would apply and purchase parts should include all cost associated with acquiring and using that purchased part. A large mix of purchased and manufactured parts is often a unique situation, but it does not make it exempt from needing to have accurate costs with correctly allocated fixed and variable costs.

Categories: Cost Accounting