Packing materials are of various types. Type of packing material required for a product depend upon the nature of the product to be packed. It varies with industry to industry as items to be packed will be different as in the table below:
Food Packaging Bakery items, dairy products, confectionary, snacks, frozen items, ice creams- food packaging foils, food packaging laminates, flexible packaging foils, cookies packaging, cracker packaging, bread packaging material, chips packaging, chocolate packaging, wafer packaging, namkeen packaging, pastry packaging, toffee wrappers, lollipop wrappers, chewing gum wrappers, chocolate wrappers and many more.
Beverage Packaging Beer, drinks, water bottle, juice, soft drinks bottles / can
Personal care cosmetic Packaging Cosmetic, oral care, Toiletries, soap, shampoo, glass like clear polymer bottle / tubes / pouch etc.
Pharmaceutical Blister, Aluminium / cellophane / glassine paper foil for strip or blister packing of tablets / capsules, bottle (glass / plastic), closures, (metal / plastic / Rubber closures for vials) jars , tubes, aerosol etc.
Heavy machinery packing Wooden crates / boxes / pallets.
Fertilizers, cement, sugar, HDPE Bags
Paper/stationery Wrapper, liner, strings, gum tape, wooden , bottle (for ink / gum), tubes, box for holding pens/pencils
Textiles Yarn in hanks packed in burlap and bales; Yarn in cones packed in boxes/bags; Cloth packed in bales; fancy cloth in wooden/cardboard cases/ boxes; Other packing material used are hessian, cloth, paper board, polythene paper, lining paper, iron/plastic hooks, nails, sewing thread etc.
On the basis of source of supply, packing materials are classified as indigenous materials/ imported materials. Indigenous packing materials are manufactured within the country and imported packing materials are purchased from other countries.
However for the purpose of this standard Packing Materials are classified into primary and secondary packing materials. In simple words the packing material used for holding a product is classified as “Primary Packing Material’ and packing material used for storing, transport etc. is classified as ‘Secondary Packing material. These aspects are dealt in detail under definition.
A. Packing Material Cost
The cost of material of any nature used for the purpose of packing of a product is called packing material cost.
It can be divided into two parts namely:
(a) Primary Packing
(b) Secondary Packing
Industry Primary Packing Material Secondary Packing Material
Pharmaceutical Insertions related to product. Foils for strips of tablet and capsules. Cartons used for holding strips of tablets and card board boxes used for holding cartons.
Industrial Gases Cylinders or bottles which are used for filling the gaseous products.
Confectionary Industry Butter Paper and wrappers Jars for holding wrapped chocolates. Cartons containing packs of biscuits.
Textile Card board boxes used for holding cones on which yarn is woven.
Primary Packing Material is for holding the product, keeping the contents clean, fresh, sterile and safe for the intended shelf life and sale. Primary packing material required for a product will depend upon the type of the product to be packed.
Above example indicates various types of primary packing material. For pharmaceutical industry primary packing material will be insertion related to product, Blister strips for tablets/ capsules, bottle, tubes etc. For confectionary / food products, it may be butter paper, wrappers, box, tray, can, jar and so on.
Primary packing material may also be intended for shop display. But the function of primary packing material is essentially for holding a product. But depending upon use, the same material may be classified as secondary packing material. For example, a shrink wrap can be primary packaging when applied directly to the product, and secondary packaging when combining smaller packages.
Primary packing material cost is part of production cost of a cost object.
Secondary packing material is the term used to describe larger cases or boxes that are used to group quantities of primary packaged goods for distribution and display.
Secondary Packing material also include transit packaging such as wooden pallets, board and plastic wrapping and containers that are used to collate the groups into larger loads for transport, which facilitates loading and unloading of goods.
Some products such as sugar, fertilizers, cements and the like are sold in bags and do not need any further packing. Such packing is to be treated as secondary packing and will form part of cost of sales.
However, classification between primary and secondary packaging would entirely depend upon the specific facts and circumstances of industry/product/business and may be decided after taking into consideration practical aspects and industry practice.
B. Principles of Measurement – Valuation of receipts of packing materials
The packing materials receipt should be valued at purchase price including duties and taxes, freight inwards, insurance, and other expenditure directly attributable to procurement (net of trade discounts, rebates, taxes and duties refundable or to be credited) that can be quantified at the time of acquisition.
The valuation of receipt of packing materials is to be based on the terms and conditions stated in the purchase /supply order and source of supply i.e. indigenous or imported etc.
Purchase of indigenous Packing material
The purchase / supply order inter-alia states
(1) Specification of packing material being purchased
(2) Purchase price
(3) Quantity of supply
(4) Time of supply
(5) Place of supply
(6) Payment terms
(7) Other commercial conditions regarding inspection, rejection, trade discount etc.
In addition to basic purchase price, duties and taxes, freight inwards, insurance and other expenditure directly attributable to procurement are to be taken into account while valuing the receipt of packing material if these can be quantified with reasonable accuracy at the time of receipt. If any of these items of expenditure cannot be quantified with reasonable accuracy, these are treated as material handling cost, an item of overheads.
Trade/ cash discount, rebates, taxes and duties refundable (or to be credited by the taxing authorities) are to be set off. Examples of taxes and duties to be deducted from cost are CENVAT Credit, credit for countervailing custom duty credit, sales tax set off / VAT credits and other similar items of credit recovered / recoverable.
Imported Packing Material:
Packing Materials are imported from other countries depending upon the availability in the country / economics of import. Import license may be required in certain cases. Terms of Purchase inter alia may be FOB, CIF port/airport. FOB (Free on Board) means that goods are loaded on the ship and there is no additional charge relating to loading and the like. Purchaser has to pay transit insurance and freight from place of loading to its destination. In case of CIF (Cost, Insurance & Freight) price, price includes besides basic price, transit insurance and freight.
Following points are to be considered while valuing imported packing material:
a. Actual customs duty paid on the basis of classification by the customs authorities will be assigned, net of any credits. Higher duty paid under protest will not be included in cost if there is reasonable expectation that the entity will satisfy the conditions for the excess duty to be refunded.
b. Packing Material imported free of duty or at concessional rate of duty under export incentive scheme will be accounted for at the actual rate of duty applicable so long as there is reasonable expectation that the entity will satisfy the conditions for the duty exemption or concession. In case the packing material is used other than the intended purpose, provision for import duty / penalty leviable, if any, shall be provided. This entry may be offset when the material is available for export purposes at the imported parity rate of material.
c. Harbour dues, stevedoring charges, congestion charges, and the like on the basis of actual, if imported singly. If the packing material is imported as part of a basket, then a suitable basis such as proportionate weight, volume or value will become the basis for assigning the above charges.
d. If Intermediate storage is called by the nature of transport, actual charges by the storage provider will be included in the cost.
e. Commission Agent’s Charges will be added to cost of materials. Where other services are also provided by the commission agent besides procurement of orders, e.g. arranging for LC, the charges for such services will also be assigned to the materials covered on a suitable basis.
f. Adjustment of CENVAT /VAT as per applicable regulation.
g. Duty drawback and other similar duties subsequently recovered shall also be deducted from the cost of material
h. Bank Charges are in the nature of borrowing cost or in the nature of administrative overheads will not form part of packing material cost.
Cost incurred for acquisition, inspection, storage, movement of materials and insurance is also to be assigned to packing material cost on rational basis.
(i) Finance costs directly incurred in connection with the acquisition of packing materials should not form part of packing material cost.
Finance costs are interest and the like on borrowed funds. Finance costs are excluded from packing material cost. The letters of credit charges are for credit risk or a transaction risk (demand bill) and / or part of bank charges, which form part of administrative overheads. Such charges are not finance charges except where they are in the nature of borrowing costs.
Sometimes goods are kept in bonded warehouse and clearance of goods is delayed. This may happen due to any financial stringency delaying the payment to the bank. Such payments of storage are to be excluded from packing material cost and are dealt with in the financial accounts.
(ii) Handling costs upto works / factory gate: If handling cost is specific and handled singly, it is to be assigned to the packing material handled. If employees are used for handling the packing material, it is to be treated as procurement overheads and not included in Packing Material Cost. In other cases where handling charges are included in the carrier’s responsibility, there will be no assignable cost due to handling.
(iii) Incoming Inspection: If the packing material calls for inspection by a third party, specific cost will be assigned to the packing material inspected. If the inspection is carried out internally with own employees, it is to be treated as procurement overheads and not included in Packing Material Cost. If the inspection is part of the vendor’s responsibility, no separate inspection cost will be assigned.
Other cost incurred for packing material acquisition is insuring of packing material. If insurance premium is specific and insured singly, it is to be assigned to the specific packing material insured. In case it is part of a comprehensive policy then the assignment of the insurance premium will be on the basis of the proportionate value insured. If insurance becomes part of the carrier’s responsibility no separate cost will be assigned in this regard.
(iv) Self-manufactured packing materials should be valued including direct material cost, direct employee cost, direct expenses, job charges, Factory/Production Overheads including share of administrative overheads comprising factory management and administration and share of research and development cost incurred for development and improvement of existing process or product. In the other words, the self-manufactured packing material should be valued by taking into account all the relevant cost incurred in manufacturing the packing material e.g. material cost, duties & taxes, freight inwards, insurance and other expenditure (net of trade discounts, rebate, taxes and duties refundable or to be credited), direct employees cost, direct expenses, utilities, job charges, Factory/Production Overheads, share of administration overheads, development & improvement expenses etc.
(v) The valuation of captive consumption of packing materials shall be in accordance with of Cost Accounting Standard (CAS-4). Para 5 of the Cost Accounting Standard on Cost of Production for Captive Consumption (CAS-4) deals with the determination of cost production for captive consumption. While valuing the cost for captive consumption of packing material, the following elements of costs are to be considered:
(a) Material consumed (indigenous, imported, bought out items, self-manufactured items, process material etc.)
(b) Direct employee cost (as per CAS-7)
(c) Direct expenses (for example cost of utilities, royalty, technical know-how charges for design)
(d) Quality control Cost
(e) Research and Development
(f) Share of factory overhead (including factory administration and management expenses)
(g) Inputs received free
(h) Adjustment for misc. income, if any.
(vi) Normal loss or spoilage of packing material prior to receipt in the factory should be absorbed in the cost of balance materials net of amounts recoverable from suppliers, insurers, carriers or recoveries from disposal.
Sometimes packing materials are lost in transit or spoiled. Treatment of loss will depend upon the terms and conditions of purchase order. If the purchase order does not specify any level of loss, and supplier is responsible to supply good quantity, the loss is to be recovered from suppliers or insurers as the case may be.
The normal loss is to be absorbed by the good units. Abnormal loss of packing material is taken to reconciliation and does not form part of the packing material cost.
(vii) Abnormal cost arises due to some abnormal causes viz. heavy break-down in plant, theft, fire, material not according to required specification, etc. They are not considered in the cost of production and charged to costing profit & loss account. In case of packing material which is rejected after issue due to abnormal causes such as misprinting, material of wrong specification/size etc. is to be treated as abnormal cost. It is to be excluded from cost of packing material cost of the product. Any realization from disposal of such rejected packing material is to be credited to the abnormal cost.
(viii) If defectives/spoiled work cannot be made into a first-class/useable packing material without uneconomical expenditure, it is to be disposed off as rejects. Rejects or scrap or waste is discarded material having some value.
The rejection may occur in the following stages:
(1) In course of inspection
(2) Rejection in testing/packing at the finished stage
(3) Rejection by customers after finished products has been dispatched from the factory.
(ix) Discarded packing material is disposed of as scrap. Any value realized from disposal of discarded material if insignificant, is to be treated as other income. If discarded material can be reintroduced in the production of packing material, it shall be valued at its realizable scrap value.
(x) The FOREX component of imported packing material cost should be converted at the rate on the date of the transaction. Any subsequent change in the exchange rate till payment or otherwise will not form part of the packing material cost.
FOREX conversion has to be on the date of transaction. The cost and financial accounts will have the same basis for alignment. The date on which the transaction first qualifies for recognition in accounts is adopted as the date of transaction. The difference between the actual payment and the amount taken as packing material cost is taken to a separate financial account as exchange rate variations not being part of the packing material cost.
(xi) Any demurrage, detention charges or penalty levied by the transport agency or any authority will not form part of the cost of packing materials.
Demurrage and penalties are abnormal cost and are not part of the packing material cost. It is taken to reconciliation.
(xii) Any subsidy or grant or incentive or any such payment received or receivable with respect to packing material should be reduced for ascertainment of the cost to which such amounts are related.
Subsidy and grant received should be recognized on a systematic basis. These should be matched with the related cost for which these are intended to compensate. Subsidy received for any packing material is to be reduced from the packing material cost.
Subsidy receivable for using specific packing materials produced on account of environmental reasons shall be adjusted against the packing material cost.
C. Principles of valuation of issue of packing material
(a) Issues shall be valued using appropriate assumptions on cost flow e.g. FIFO, LIFO, Weighted Average. The method of valuation once adopted should be followed consistently from one period to another and with uniformity between different product/units.
Accounting Standard AS-2 provides for cost formulae, viz. Specific identification, FIFO (First in First out) and Weighted Average cost method. Any of the above assumptions on cost flow can be used for valuation of issue of packing material. In addition, LIFO assumption can also be used, the Cost Accounting Standard on Material Cost (CAS 6) does not preclude the use of specific identification of cost.
LIFO method can be gainfully applied while estimating or projection of cost as it reflects current price cost. Any accepted method of pricing of issue may be used. However, whatever method of pricing is adopted under CAS 6, the same should be specified and followed consistently.
(b) If packing material costs includes transportation costs, determination of costs of transportation should be governed by the principle of average (equalized) cost of transportation as per Cost Accounting Standard (CAS-5).
Inward freight will form the part of the packing materials cost. In case inward freight charges are indicated in the invoice which is for more than one material, inward freight shall be allocated to different materials indicated in the invoice on appropriate basis such as weight, volume, nos. and the like.
If the packing material is carried by special carrier, it will be assigned to the specific packing material transported.
(c) The packing material cost will not include imputed cost. However in case of Cost of Production of Excisable Goods for Captive Consumption the computation of cost shall be as per Cost Accounting Standard (CAS 4). Under CAS-4 in case packing material is supplied free of cost by the user of the captive product the landed cost of such material shall be included in the cost of production.
(d) If the packing material are accounted at standard cost the price variances related to such materials is to be treated as part of packing material cost and the portion of usage variances due to normal reasons should be treated as part of packing material cost. Usage variances due to abnormal reasons should be treated as part of abnormal cost.
When standard costing system is in vogue, there can be other variances relating to usage during the course of packing the cost object which may be due to normal or abnormal reasons.
Variances due to normal reasons shall be treated as cost while the variances due to abnormal reasons are treated outside the cost of production.
(e) The normal loss arising from the issue or consumption of packing materials should be included in the packing materials cost. Certain losses are inherent in the use of packing material and cannot be eliminated. For example losses occur in cutting wood/cardboard to make box/crate. These losses occur even under efficient operating condition and are referred to as normal loss. Thus Normal loss arising from the issue or consumption of packing materials is to be treated as a part of packing material cost.
(f) Any abnormal cost where it is material and quantifiable should be excluded from the packing material cost. For example, loss of packing material due to major fire accident is abnormal loss and should be treated as abnormal Cost and should not form part of cost of the packing material consumed and it should be dealt with in the costing profit and loss account.
In case of packing material which is rejected after issue due to abnormal causes such as misprinting, material of wrong specification, size and the like is to be treated as abnormal cost. It is to be excluded from cost of packing material cost of the product. Any realization from disposal of such rejected packing material is to be credited to the abnormal cost.
(g) The credits/recoveries in the nature of normal scrap arising from packing materials if any should be deducted from the total cost of packing materials to arrive at the net cost of packing materials.
D. Assignment of Cost
Assignment of packing material cost involves establishing a suitable procedure to identify and record the packing material consumed by the cost object. Cost object includes a product, service, cost centre, activity, sub-activity, project, contract, customer or distribution channel or any other unit in relation to which costs are ascertained. It is the logical sub-unit for collection of cost.
Material requisition is the source document indicating details of packing material issued for a product. It records the job number, type of packing material, and items listed are priced at their acquisition cost. Thus material requisition represents the source of information for assigning the cost of packing material to cost object. Based on actual issues, the cost of packing material is traced to cost object to the extent economically feasible.
Packing material cost may also be assigned on the basis of standard bill of packing material in place of actual issues. Under this method packing material is issued as Standard Bill of material. The standard cost for each item of packing material is defined at the beginning of the year. The variances from standard on account of price and consumption are adjusted to consumption at suitable interval. Any variation between the actual issues (both quantity and value) and the standard as accumulated over the period is charged off to consumption.
In many situations packing materials cannot be issued for the exact quantity required for packing the products produced. This may happen because the material is bulky e.g. wood used for making crates and they cannot be cut to the exact size in the stores. It may also happen that packing materials of small value like nails, glue etc. are issued in bulk as it is cumbersome to issue them for the exact quantity. In such cases, the quantity of packing materials issued cannot be taken as consumption.
In such cases, the material issued to the packing department is treated as departmental stock and the quantity of packing material required to pack the quantity of the product produced as per norms is relieved from the stock, on production being reported. The normative consumption so arrived at will be adjusted for excess or short consumption based on physical stock taking of packing materials in stock in the packing department at periodic intervals. Quantity of packing material consumed so arrived at can be valued either at standard rate or actual rate depending on the cost system in vogue in the Company.
For assigning the packing material cost, the following principles should be kept in view:
(a) Packing material cost should be directly traced to a cost object to the extent it is economically feasible.
(b) If the packing material costs are not directly traceable to the cost object, these may be assigned on the basis of quantity consumed or similar measures like technical estimates. For example, Nails, adhesive, tapes, gums etc. are consumed while packing the cost object. Such packing materials are used in small quantities and/or of not significant value. In such cases it may not be economical to issue individual requisition to charge to cost object each time. It is desirable to take the total consumption of such packing material per month and divide the cost between costs objects packed based on a technical estimate or on a sample survey of usage during a selected period. Such studies may be reviewed periodically to correct for changes taking place affecting the consumption.
(c) The packaging cost of reusable packing should be assigned to the cost object taking into account the number of times or the period over which it is expected to be reused. For example, gas cylinders are returnable packing material. Filled cylinders are supplied against a security deposit and user is charged rent. Cylinders are depreciated over its useful life and any repair and depreciation will form packing material cost.
While arriving at the cost of reusable packing material, the cost of freight and other costs attributable to activities associated to make the packing material reusable like minor repair cost, storage cost of these material, manpower dedicated for this activity shall identified and forms part of the packing material cost .
(d) Cost of primary packing materials should form part of the cost of production. Certain products such as sugar, fertilizers, cement etc. are packed in HDPE/gunny bags and are transported/sold without any further packing. For such products even though there is only one type of packing material cost, it is treated as secondary packing and is taken as part of cost of sales.
(e) Cost of secondary packing materials should form part of selling and distribution overheads. Since, these packing materials are used to make the product marketable.