Product Costing for Iranian Manufacturers: From Inventory to True Gross Margin

If your factory looks profitable but never has cash, the problem is usually not sales — it is the number you call product cost. This is written for owners and accountants of small and mid-sized Iranian manufacturers who need a costing system that supports pricing decisions and survives a tax assessment.

Why book gross margin is usually wrong

In most small plants I have reviewed, cost of sales is computed as a residual: everything spent during the year, less what is left in the warehouse. That hides three errors. Administrative and selling costs leak into production cost; abnormal scrap disappears into unit cost; and the effect of idle capacity is capitalised into inventory. The result is a figure that is useless for pricing and indefensible in an audit.

The three cost elements

Direct materials are materials traceable to the product. The weak point in most plants is the absence of a material issue note for each consumption: if usage is only recorded in bulk at period end, variance analysis becomes impossible. Inbound freight, import duty and unloading belong in material cost; purchase discounts are deducted.

Direct labour covers only workers who actually work on the product. Production supervisors, storekeepers and quality control are overhead. Statutory benefits, severance accrual, the employer's social security share and overtime must be loaded onto the labour rate — ignoring them understates unit cost significantly.

Manufacturing overhead covers plant depreciation, energy, maintenance, indirect materials and indirect labour. The allocation base should follow the plant's logic:

The cost flow

Four stations, each needing its own ledger account: raw material store, work in process, finished goods, and cost of goods sold. If one of these is missing from your system, you do not have product costing — you have an estimate.

Job order or process costing?

If products are made to customer specification (tooling, machining, printing), you need job order costing with a cost card per job. If production is continuous and homogeneous (tiles, paint, food), process costing accumulates cost by stage and spreads it over equivalent units. Choosing the wrong one is the single biggest reason costing reports get ignored.

Idle capacity and scrap

Two items distort cost more than anything else. Idle capacity: fixed overhead must be absorbed at normal capacity. A plant running at 40% that spreads all fixed overhead over that reduced output inflates unit cost and swells closing inventory; the unabsorbed portion is a period expense. Scrap: normal, unavoidable scrap is part of the cost of good units, while abnormal scrap from breakdowns, operator error or long stoppages is a period cost. Mixing them both misstates profit and destroys the operational signal.

Inflation and inventory valuation

Iranian standards permit specific identification, FIFO and weighted average; LIFO is not allowed, and inventory is carried at the lower of cost and net realisable value.

Under inflation, FIFO reports low cost of sales and high profit — and much of that profit is inventory holding gain that must be spent buying the same materials again. Distributing it consumes working capital. My practical advice: alongside the statutory report, produce a management view at replacement cost, so pricing decisions rest on the next purchase price rather than the last one. This is the same distortion that makes reading financial statements in an inflationary economy a skill of its own.

What the assessor looks for

Cost of goods sold is the largest single deduction from profit, so it attracts the most attention. A defensible file has: a complete purchase chain (valid invoice, goods receipt, payment record); dated material issue notes per production order; production cards reconcilable to output; a signed physical count report with documented variances; a written and stable overhead allocation basis; and a one-page quantity reconciliation of purchases, consumption, production and sales. Under the amended Article 97 the assessment starts from your return and records — where records are absent, the administration determines income from the data it holds. Orderly documentation is your only real leverage at that point. The counting procedure itself is covered in the year-end inventory count guide.

Implementation checklist

1. Document the bill of materials for every product.
2. Define and separate production and support cost centres.
3. Choose and record an allocation base per centre.
4. Set normal capacity per line so absorption rates mean something.
5. Make store documents (receipt, issue, return) mandatory.
6. Compute material, labour and overhead variances monthly and investigate causes.
7. Reconcile absorbed overhead and work-in-process balances before year-end closing.

Key takeaways

• Production cost is materials, direct labour and manufacturing overhead only.
• Absorb fixed overhead at normal capacity and expense the unabsorbed portion.
• Separate normal from abnormal scrap and document the latter.
• Under inflation part of your gross profit is a holding gain — do not distribute it.
• Without issue notes, production cards and a documented count, product cost cannot be defended.