Elements and allocation of material costs

 

`Material costs' are the actual costs of the raw materials, components, and various supplies needed to produce the merchandise under investigation. Material costs should include all of the costs associated with the materials used. Obviously the purchase price of the material is the starting point. Items such as transportation costs must also be included. Any duties or taxes paid on imported materials must be included, but if the duties or taxes are later rebated, the rebate can be used to offset the material costs. When there is some waste in the production process, the material costs must be adjusted upward to reflect this waste. If the waste (sometimes called scrap or by-product) is sold, the amount received from the sale can be used as a credit to offset the material costs.

 

Allocation of material costs to individual products depends completely on the type of accounting system in place at the company. For foreign companies with a standard cost accounting system, the standard costs themselves represent an acceptable allocation. As long as the company can defend the development of the standards as reasonable, the Commerce Department normally accepts the standard costs. Companies without a standard cost system need to develop some other way to allocate material costs to individual products. It is best if the allocation is completely, or at least partially, based on the existing accounting system.

 

Material costs are slightly different for cost of production and constructed value, but the basic methodology for calculating the costs is the same. For cost of production, the company must calculate the average material cost of products sold in the foreign market (either home market or third country market). For constructed value, the material costs should be those for the merchandise sold in the United States. To the extent that the merchandise in the two markets is identical, the costs will be the same.

 

Special issues

 

One of the difficult issues relating to material costs is the treatment of related or affiliated suppliers. The first task is to determine when a company is to be deemed 'related' for these purposes. The Commerce Department has in recent years applied a 5% test - if one company owns .5% or more of the other company's stock, the company is usually deemed to be related. The Commerce Department has always reserved the right, however, to find 'affiliation' based on other circumstances, such as family relationships.

 

The Commerce Department now focuses its efforts on 'major inputs', those cost items that account for a significant percentage of the total product costs. There are no fixed rules but it generally focuses on items that are more than I % of the total cost of manufacturing.

 

Once the Commerce Department decides that companies are related, the foreign company bears the burden of justifying the reasonableness of the prices charged between the two companies. Three methods have historically been used to validate the price charged between the related companies. First, the Commerce Department checks whether the related supplier sells to unrelated companies at the same price that it sells to related companies. Although this method is relatively simple to apply, it is often unavailable. Foreign subsidiaries often sell to their parent company on an exclusive basis, so there are no unrelated party transactions to use to validate the related party transactions.

 

Second, the Commerce Department checks whether the parent company buys the same materials from other, unrelated, suppliers. While this method is also relatively simple to apply, it is also usually not available, since many foreign companies use related suppliers exclusively and do not purchase from unrelated suppliers.

 

Third, if there are no unrelated party prices to use, the Commerce Department looks to the cost of production of the materials being supplied. If the price charged by the related company is sufficient to cover the cost of production of the component, the Commerce Department accepts the price as a reasonable basis for calculating cost of production. However, if the price charged by the related company is insufficient to cover the cost of production of the component, the Commerce Department will upwardly adjust the price to reflect the highest of the cost of production of the component, the transfer price of the component, or the 'market price' of the component part purchased from unaffiliated suppliers or sold by the related party to other unaffiliated purchasers. Developing cost information for individual components or materials can be enormously time consuming, however. For many consumer products, there are hundreds or thousands of individual parts that go into the finished product. Validating each of the component prices is virtually impossible.

 

Source: Business Guide to Trade Remedies in the United States: Anti-dumping, countervailing and safeguards legislation practices and procedures