Whenever a business is manufacturing a product, the process will require direct and indirect materials. While the two are important in contributing to production costs and profitability, they’re different in many ways. Knowing the differences between direct and indirect materials will allow you to better understand their effects on product costing and overall profitability.
What Are Direct Materials?
Direct materials are the resources used to make a product in the supply chain. With direct materials, you can clearly link these resources to the finished product. The cost of direct materials is also easily quantifiable, allowing you to easily and accurately allocate them to individual products and their production costs.
To better understand direct materials, it can help to look at examples, which include:
- Wood to used to make tables
- Glass used to make windows
- Fabric used to make furniture
- Steel, rubber, and plastic used to make vehicles
Putting one of these examples into perspective, a piece of furniture can be constructed from measurable amounts of fabric, thus, making the fabric a direct material.
What Are Indirect Materials?
Indirect materials differ from direct materials because they can’t be traced back to the products they produce, even though they’re part of the overall manufacturing process. Indirect materials are usually small, bought in mass quantities from a supplier, and inexpensive. Therefore, they don’t really add much overall value to the product being produced.
Businesses use an indirect procurement process to optimize purchasing for goods, supplies, services, and materials that aren’t directly related to manufacturing your business's product output.
Let’s look at an example of an indirect material. Screws and bolts in an assembly line for the manufacture of a vehicle would constitute indirect materials.
When added to the vehicle during production, these bolts don’t really bring value to the finished product. Plus, the bolts are extremely inexpensive compared to the price of the vehicle. Each automobile needs a large quantity of bolts in the finished product.
This means the company producing these automobiles must buy the bolts in large quantities. Because so many of these materials are used in the manufacture of vehicles, it would be impossible for the company to allocate the cost of each bolt to the vehicle being produced.
That’s just one example of an indirect material. Here are a few more:
- Personal protective equipment (i.e. gloves, earplugs, hard hats, full body suits, respirators, etc.)
- Cleaning supplies
- Office supplies (i.e. tape, glues, adhesives, etc.)
- Fitting and fasteners
- Disposable tools
- Equipment rentals
- Spare parts of machinery
- Air and oil filters used in machines, furnaces and ventilation systems.
Direct vs. Indirect Materials
Direct and indirect materials are both critical to the production of a product. But they’re different in many ways.
Below are key points of difference between direct and indirect materials.
- Meaning: Direct materials are core to the production process, while indirect materials are ancillary to the production process. In other words, direct materials are essential to creating a product, while indirect materials provide the necessary support to the primary materials that go into an item’s production.
- Traceability to specific product: Direct materials have a 1:1 relationship with the product being manufactured. However, indirect materials can’t be directly identified with the production of a specific product.
- Proportion of product cost: Typically, direct materials make up a significant amount of the total cost of the product, compared to the low proportion of indirect materials cost to product cost.
- Accounting practices for materials: Accounting for direct materials is usually easier than accounting for indirect materials. This is because you can trace direct materials to a specific product.
Accounting for Indirect Materials
How do you account for indirect materials? You can do so in two ways. The first method involves including the indirect materials as part of the manufacturing overhead and allocating to the cost of the goods sold using an appropriate method of allocation. The second way is to charge indirect materials as an incurred business expense.
The first method is the most common. However, if the number of indirect materials your company uses in the manufacturing process, it makes sense to charge them as an expense.
Usually, indirect materials aren’t tracked through a formal inventory record keeping system. Instead, a company might use an informal system to determine when to order additional indirect materials.
To keep track of indirect materials and their cost, it can help to follow a formula. For example, you can divide the total number of indirect materials by the number of units manufactured.
Indirect Materials: Key Points to Remember
Indirect materials are essential to production operations, but unlike direct materials, they can’t be easily or conveniently linked to a product. As a result, indirect materials are often added to the manufacturing overhead.
But no matter how challenging it can be to account for indirect materials, they involve one of the most important accounting principles involved with the production process, raw materials inventory, and product cost.