Keep customer-owned material separate from company stock

Why standard inventory valuation breaks on customer-supplied stock

In precision machining, automotive tier-supply and electronics contract manufacturing, OEM customers frequently buy high-value castings, forgings or proprietary integrated circuits directly and supply them as Free-Issue Material (FIM) (also called customer-owned or bailment stock). The contract manufacturer provides machine time, tooling and inspection, billing only a conversion fee per finished piece.

When a plant lacks a dedicated customer-ownership partition, storekeepers often receive those parts using a standard Goods Receipt Note at either a dummy price of ₹1 or the customer's declared challan price. Both workarounds create operational and financial errors:

• Valuated receipt at customer challan price: Overstates company-owned raw material assets, creates a phantom payable to the customer and distorts gross-margin percentages when the finished part ships at a conversion-only price.
• Dummy ₹1 receipt in shared bins: Hides the ₹34,00,000 bailment custody exposure sitting on the shop floor, fails to prevent cross-allocation to another customer's order when part numbers match, and leaves finance without a ledger when machining scrap exceeds the contractual allowance.

Keep customer-owned material separate from company stock — reporting workflow

Follow the workflow below, or open its complete text version.

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1. Receive customer challan into zero-asset store → Hard-peg bailment lots to owning customer order
2. Hard-peg bailment lots to owning customer order → Separate raw-blank defects from process scrap
3. Separate raw-blank defects from process scrap → Compare process scrap against contract cap
4. Compare process scrap against contract cap → Reconcile challan balance and net conversion bill

Four pillars of customer-owned inventory governance

1. Zero-asset balance-sheet isolation with memorandum valuation

Every customer-supplied receipt carries ownership = CUSTOMER_BAILMENT and company_asset_value = ₹0.00. Simultaneously, the receipt stores the customer's declared unit value (memo_unit_value = ₹8,500) in an off-balance-sheet memorandum register used for plant insurance declarations and contractual scrap-exposure reporting.

2. Hard customer-order pegging

Even when two OEM customers supply physically identical bearings, connectors or alloy blanks, the ERP reservation rule hard-pegs each inward lot to its owning customer_id and inward challan number. Material planning never nets one customer's bailment stock against another customer's demand or internal make-to-stock jobs.

3. Three-way reject classification at inspection

When a customer-supplied forging fails during machining, quality inspection classifies the reject into one of three disposition buckets before closing the operation:

• Raw material / inclusion defect (MRB-CUST-FAULT): Internal porosity, crack or dimensional short-fill present in the customer's raw blank uncovered during initial roughing. Returned to the customer without scrap penalty (and billed for agreed rough-machining proof-cut recovery where specified by contract).
• Contractual allowance scrap (SCRAP-FIM-ALLOW): Normal setup and tool-wear rejects within the contractually agreed allowance cap (for example, up to 2.00% of inward batch quantity).
• Excess process scrap (SCRAP-FIM-EXCESS): Operator or fixture errors above the contractual allowance cap, which trigger a material debit at the contractually agreed replacement value.

4. Piece-by-piece challan conservation

Customer audit rules and commercial job-work controls require 100% quantity conservation against every inward challan: Dispatched Good Units + Certified Open WIP + Raw Defect Returns + Scrap Units Returned = Total Challan Units Received.

Worked example: 400 free-issue titanium valve bodies (JW-2026-118)

Illustrative OEM customer CUST-AERO-07 ships 400 raw forged Ti-6Al-4V valve bodies (FIM-TI-6AL4V) on inward challan CH-IN-8821 for 5-axis CNC machining under contract JW-2026-118:

• Customer declared memorandum value: ₹8,500/unit (₹34,00,000 total custody exposure; ₹0 on the manufacturer's balance-sheet asset ledger).
• Contractual conversion fee: ₹1,400/unit for completed machined valves, plus ₹350/unit Operation-10 proof-cut recovery when a raw forging is rejected for subsurface casting porosity.
• Contractual process scrap allowance: 2.00% of inward quantity (8 units across the 400-unit challan); any process scrap above 8 units is debited at the agreed ₹8,500/unit forging value.

At month-end settlement, the reconciliation report accounts for all 400 physical units and their billing impact:

Why this reconciliation protects margin and customer audits

1. Clean financial statements: Throughout the month, the contract manufacturer's inventory asset ledger remains ₹0, while the custody report tracks the remaining ₹1,87,000 (22 units) of open customer property on the shop floor.
2. Protected defect attribution: Because the 7 porous forgings (MRB-CUST-09) were isolated at Operation 10 with inspection evidence and excluded from the process-scrap counter, the plant avoided an erroneous ₹59,500 material penalty and recovered ₹2,450 for the initial proof cuts.
3. Exact net billing: Out of 11 total machining rejects (8 + 3), the report applies the 8-unit contractual allowance and deducts only the 3 excess fixture-error units (-₹25,500), yielding a reconciled net invoice of ₹4,80,950 (₹5,04,000 + ₹2,450 - ₹25,500).

Implementation checklist for customer-owned stock control

• Dedicated non-valuated store code: Route all customer-supplied receipts into WH-FIM-CUST where general-ledger inventory asset posting is disabled.
• Configurable challan aging alerts: Set automated review alerts (for example at 60, 90 and 120 days according to contract and finance policy) so planners reconcile open challans on time.
• Mandatory inspection evidence on raw defects: Require inspection records on every MRB-CUST-FAULT disposition before excluding the unit from the process-scrap calculation.