Material cost definition
/What is Material Cost?
Material cost is the cost of materials used to manufacture a product or provide a service. Excluded from the material cost is all indirect materials, such as cleaning supplies used in the production process. Material cost usually comprises the bulk of the costs incurred to manufacture a product.
How to Calculate Material Cost
Follow these steps to determine the amount of material cost to assign to a unit of production (such as a completed finished goods item):
Ascertain the standard quantity of the material used to manufacture one unit.
Add the standard amount of scrap associated with manufacturing one unit.
Determine the standard amount of scrap associated with setting up the production run, and apportion it to the individual unit.
If any scrap is then sold, apportion the revenue back to the individual unit.
For many materials, the cost of scrap and the revenue from the resale of scrap are so small that it is not worthwhile to apportion it to the material cost.
Material Cost Variances
If the material cost has been established as a standard, then you can subsequently calculate the material yield variance to see if actual materials usage was as expected, or you can calculate the purchase price variance to see if the purchase price of the material was as expected. These variances are useful for investigating problems in the production and purchasing areas of a business.
Material Yield Variance
The material yield variance is the difference between the actual amount of material used and the standard amount expected to be used, multiplied by the standard cost of the materials. The standard unit usage is developed by the engineering staff, and is based on expected scrap rates in a production process, the quality of raw materials, losses during equipment setup, and related factors. The formula is as follows:
(Actual unit usage - Standard unit usage) x Standard cost per unit = Material yield variance
Purchase Price Variance
The purchase price variance is used to discover changes in the prices of goods and services. It can be used to spot instances in which the purchases being made differ in price from your planning levels. By using the variance, you can identify cases in which it can make sense to look for a different supplier, or to start pricing negotiations with an existing one. The formula is:
(Actual price - Standard price) x Actual quantity = Purchase price variance
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Terms Similar to Material Cost
Material cost is also known as direct material cost and raw material cost.