In manufacturing organizations, direct material spend accounts for up 80% of an organization’s revenue.
Direct materials form a critical part of the manufacturing process. They’re the backbone of every manufacturing activity; without them, there would be no production. But what are direct materials, and how do they differ from indirect materials?
In this post, we provide a definitive guide to direct materials and various examples of direct materials used in the manufacturing process. We’ll also touch on the differences between direct and indirect materials and explain how to calculate the direct material cost.
What are Direct Materials?
Direct materials are the resources used in the production process and are directly identified with that product. The cost of direct materials is easily quantifiable, allowing you to link these resources to the finished product. Direct material cost is reported on the debit side of your trading account as the “cost of goods sold.” It can be linked to a physical item, like the cost of building materials, or artificial form, like technology.
Examples of Direct Materials
Here are a few examples of direct materials.
Example 1: Computers are made of many parts like motherboard, keyboard, hard drive, graphic cards, etc. All these components form the direct materials required to manufacture a computer.
Example 2: In a construction company, the direct materials required to build a house include bricks, cement, roofs, etc. All these materials are essential for the completion of a house and become a part of the finished product, hence are the direct material costs.
Example 3: In the case of a bakery, flour, yeast, sugar, salt, and oil are the main ingredients used to make bread, hence constitute the direct material costs.
Accounting for Direct Materials
Accounting for direct materials is easy because costs are easy to identify, allocate, and calculate. The direct material cost will be the cost of the items you purchase to manufacture your products.
Typically, organizations track these costs through a formal inventory management system that keeps a report of all the stock purchased. For the cost of goods sold, the direct materials account the inventory used in the production rather than the merchandise purchased.
Proper documentation of direct materials allows for proper allocation of resources and calculation of projected profits and profit margins.
How to Calculate Direct Material Cost
Once you have the right data, calculating the direct materials cost is a straightforward process. Simply follow these steps to calculate the direct material cost.
- Add the value of the opening balance of the raw materials
- Add the value of the total purchases made during the year
- Deduct the value of the closing stock at the end of the year
Also, make sure to include the transportation costs incurred for getting raw materials to the factory into the direct materials cost.
What are Indirect Materials?
Indirect materials are the resources used in the manufacturing and production processes but can’t be traced back to the final product.
While consumed in the manufacturing process, these materials are usually in small amounts and bought in large quantities. Businesses use indirect procurement to facilitate purchasing and accounting for indirect materials.
Examples of Indirect Materials
Let’s use car manufacturing as an example.
Car manufacturers require various components and parts to produce and assemble cars. The assembly machine that puts the car parts during production requires regular maintenance for the smooth running of machines during production.
The machine oil that lubricates and maintains the system is an indirect material because it’s not a part of the finished product. It can’t be tracked to an individual car during production. Other examples of indirect material during the manufacture of vehicles include:
- Fittings and fasteners
- Spare parts for machinery
- Equipment rentals
- Personal protective gear (gloves, helmets, etc.)
- Office suppliers
- Cleaning suppliers
- Other disposable tools
Direct vs. Indirect Materials: What’s the Difference?
The key distinction between direct and indirect materials is in “the purpose” for which the resources are intended. While direct materials become finished goods, indirect materials do not become a part of the finished product.
For example, chefs typically use hand gloves when preparing food. These gloves help prevent cross-contamination, as gloves are considered more hygienic than bare hands. The bakery also uses various cleaning agents to keep the kitchen area clean.
Since these items (gloves and cleaning agents) don’t form a part of the finished product (food), they are perfect examples of indirect costs.
Another differential characteristic of indirect costs is that they can’t be linked to a particular product. In contrast, all direct costs can be linked to an individual product.
To wrap it up, direct materials are the resources used in the production process and are directly identified with a product. In contrast, indirect costs are also used in manufacturing but can’t be tracked back to the final product.
Want to learn more? Check out our direct vs. indirect materials guide.