Direct Material Definition
Direct material refers to the raw materials that are directly used in the production process of goods and/or services of a company and are an essential component of the finished goods manufactured. Direct Material Costs are reported in the trading account debit side under the head “cost of goods sold”. They are also referred to as the expenditures incurred to make a particular product that can trace back to its original form.
It can be in physical form or can be in artificial form like technology. Eg: In a company like Amazon, the main cost of the company is to build a system so that it can reach the maximum number of people across the globe. Here the technology cost will be looked at as the direct materials since without setting up a proper technical infrastructure, the company will not be in a position to sell the products on the platform. In cost accountancy, it is more studied in detailed since it directly has an impact on the final product costing.
They are broadly divided into the following categories.
- Raw Materials: Raw Materials are the base materials used in the manufacturing process to make the finished goods.
- Work in Process: WIP refers to the direct materials used in the process which are under unfinished form and requires additional processing to turn them into a finished product.
- Finished Goods: These are the goods which are ready for consumption or sales.
Formula Direct Material Cost
The formula for calculating direct material costs incurred for the year to make the product.
Examples of Direct Material
Below are some of the examples for Direct materials:
- Example 1: In the case of a computer, it is made up of many parts like keyboard, hard disk, motherboard etc. In this, all these form a part of the direct materials required to manufacture a computer.
- Example 2: In the case of a textile company, yarn works out as a raw material in order to process the same into a finished product like a cloth which is then used to make clothes.
- Example 3: In the case of a brick manufacturing company, cement is the basic direct material required to make the brick used in the construction of buildings.
- Example 4: In the case of a real estate company, the direct material cost required to build the building is in the form of the purchase of cement, steel, etc which is essential in order to start the construction work. Any change in the prices of these essential commodities may inflate the selling price of the flats in the project as these costs are directly related to the project and cannot be avoided under any circumstances.
- Example 5: In the case of apple, the chip used inside the phone would be the basic material cost for the company in order to make the phone.
- Example 6: In the case of a medicine company, the bulk drug used in the product acts as a direct material which is essential in order to manufacture the medicine for the general public.
- They form an essential component of product costing and without direct raw materials, no product can be manufactured.
- Very useful in the contribution analysis of a product which is computed by revenue minus the cost of goods sold to arrive at the gross profit margin.
- They are easily traceable since they are the main component in order to manufacture a particular product.
- Plays a major part in the budget prepared for the future.
- Is the deciding factor to compute the major ratios used for the management for analysis.
The cost cannot be avoided since it forms the crust of the manufactured product and an increase in the direct materials costing eventually ends up in an increase in the price of the goods sold.
- For a company who relies heavily on the procurement of direct materials for its final product, may struggle a bit if at all there is an issue in the materials to be procured.
- Direct Costs are often exposed to huge fluctuations which have an impact on the factory overheads as well.
Direct materials form a very crucial element of the product costing of the company since even a minor change in it may result in a massive financial impact on the profit and loss of the company. The cost cannot be avoided and is often used in standard costing or process costing methodologies to arrive at the effective cost of the product so that the company can fix up the selling price and if the cost is too high, it may suggest improvements in it to curb it.
This has been a guide to what is direct material and its definition. Here we discuss the examples of direct material cost along with the formula and its types. You can earn more about financing from the following articles –