A.     Determination of cost of production of domestic producers

 

Production costs include costs on account of raw materials, utilities, labor, and other production related expenses. There are a number of other expenses that are incurred by a business which is not related to a business relating a particular product, but are nevertheless an integral part of a business enterprise. If a business enterprise has to recover its expenses from sale by goods on the basis of expenses incurred by such business enterprises, it is obvious that the business enterprise would have to recover all such expenses from different products produced by the company and sold to various to various customers in the domestic and international market. To figure out the cost of production of the product, the expenses incurred by the company on production of such product would have to be ascertained and thereafter quantified in terms of cost of production incurred in the product sold by the company. Therefore, correct assessment of cost of production becomes a very crucial determination, particularly when the price is required to be fixed based on cost incurred in producing such goods.

In trade defence laws, and particularly in India, the quantum of relief (duty) is determined considering the cost of production of the article involved, as it is considered that as long as the domestic industry is earning a reasonable return on the investments made, low price imports should be welcomed and not condemned. So much has become the importance and relevance of cost of production of the article involved that the dumping investigations in India are now heavily leaned towards appropriate determination of cost of production and fair price of the product.

In production cost, there are direct costs and indirect costs. For example, direct costs for manufacturing are raw materials, utilities, labor costs incurred to produce such an article. Indirect costs include overhead costs not directly linked to each unit produced, such as rent, administrative expenses or other expense. A company that knows how much it will cost to produce goods will have a clearer picture of how to price the goods.

General Methodology for determination of cost of production of manufacturing goods

 

The methodology generally followed in India for determination of cost of production is illustrated in the table below.

SN Items Direct & Indirect allocation and apportionment
1 Raw material Generally directly to the product under consideration
2 Utilities & Packing Generally directly identifiable with the product. It is however

sometime Common then applied to fairly assess costs on this account.

3 Factory      overhead other                  than

depreciation

Generally directly identifiable with the product. It is however sometime Common then applied to fairly assess costs on this account. Such as direct cost ratio, production ratio, production value ratio, production cycle time, vessel occupancy ratio, labour

hours, machine hours, etc.

4 Depreciation Generally   directly   assets    identifiable   with    the    product, depreciation on common assets & facilities needs to be added on

some equitable and reasonable basis.

6 Admn. Overheads, Selling & Interest cost Costs are required to be apportioned to the product under consideration on some equitable and reasonable basis. Such as turnover ratio.
7 By-Product generated    in    the process     of     main

product

Credit for by-products, after deducting subsequent costs (i.e. Net Sales Value less post separation costs) is required to be given to the relevant products
8 Other Income Generally directly identifiable with the product. It is however Common then adopting apportionment method.

Some of the below items are not considered as a part of cost

As far as Indian investigating authority is concerned, it is seen that typically the following items of expenses are not treated part of expenses for determining cost of production. Such as Trading purchase & sales, Sundry debit/credit but written off, Export related expenses, Expenditure relating to trading goods, Freight outward, Product development expenses amortized, Donation, Preliminary exp & Prior period exp., Abnormal non recurring cost due to strike, lockout & major breakdown in plant etc., Profit and loss on sale of fixed assets, Discount off invoice & on invoice, Sales commission, Excess provision written off, Unrecoverable CENVAT on free sample/distribution/ transfer to branch, Free sample distribution, Export income, Interest income on fixed deposit disallowed and Sales of export license

B.     Determination of cost of production of foreign producers

 

While in general the methodology applied for determination of cost of production for the domestic producers and foreign producers should be the same, in practice, it does not appear so. In fact, the issues have remained highly contentious. Some of the areas where contentious issues have arisen are discussed below.

Raw Material & Utility: The Investigating Authority normally ascertained whether costs on this account are understated for any of the following reasons

  1. Relationship between producer and some input
  2. Both the parties negotiated the terms and prices from time to
  3. Whether raw Material purchases were made in the normal course of international trade and were at arm’s length transactions reflecting the market

Packing material – Production of the product involves different kinds of packing – (i) primary packing, (ii) secondary packing and (iii) container packing (to make the product sea worthy for export). The packing costs would normally differ for goods destined for domestic and export markets.

Determination of cost at actual production – the cost of production is required to be determined on the basis of actual production of the goods. Even if a producer is not utilizing its capacities to the full extent, the cost of production would still be determined on the basis of actual production. The only exception in this regard is adjustment of start up operations in a case where a producer has set up new production facilities and the operations were affected due to start up operations. No claims on account of idle costs are allowed. It is pointed out in this regard that the rules provide for determining “actual cost of production” and not “normated cost of production”.

Interest expense – In a multiproduct company, it is seen that charging of interest expenses have been a contentious issues. While countries such as Europe and USA consider that these expenses are not linked to a particular product and are charged to different products on some equitable basis (such as turnover), it appears that in India, exporters have successfully reported such costs by claiming segregated expenses for different products.

C.      Concerns of industry with regard to Indian practice

 

It is an experience in India that wherever actual costs are not available, the authority tends to adopt conservative approach for determination of cost of production and in allocation of expenses, thus leading to lower cost apportionment to the product under consideration and higher apportionment to other products.

About Author:
Vikas Arora, Senior Advisor- Costs TPM Consultants