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Cost of Purchase

It consists of the purchase price including duties and taxes, (other than those subsequently recoverably by the enterprise from the taxing authorities) freight inwards and other expenditure directly attributable to acquisition, less trade discounts, rebates, duty drawbacks and subsidies in the year in which they are accounted, whether immediate or deferred, in respect of such purchase.

Cost of Conversion

It consists of:

(i)Costs of which are specifically attributable to units of production i.e. direct labour, direct expenses and sub contracted work.

(ii)Production overheads, ascertained in accordance with absorption costing method. Production overheads exclude expenses which relate to general administration, finance, selling and distribution.

Now, let us know the meaning of fixed overheads, variable overheads and Absorption Costing Method.

Fixed production overheads are those indirect costs of production that remain relatively constant regardless of the volume of production, such as depreciation and maintenance of factory buildings and the cost of factory management and administration. Variable production overheads are those indirect costs of production that vary directly, or nearly directly with the volume of production, such as indirect materials and indirect labour.

The allocation of fixed production overheads for the purpose of their inclusion in the costs of conversion is based on the normal capacity of the production facilities. Normal capacity is the production expected to be achieved on an average over a number of periods or seasons under normal circumstances, taking into account the loss of capacity resulting from planned maintenance. Variable overheads are assigned to each unit of production on the basis of actual use of the production facilities.

Other Costs

Costs other than production overheads are sometimes incurred in bringing inventories to their present location and condition, for example, expenditure incurred in designing products for specific customers. On the other hand, selling and distribution expenses, general administration overheads, research and development costs and interest are usually considered not to relate to putting the inventories in their present location and condition. They are, therefore, excluded from determining the valuation of inventories.

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