Direct materials definition
/What are Direct Materials?
Direct materials are those materials and supplies that are consumed during the manufacture of a product, and which are directly identified with that product. Items designated as direct materials are usually listed in the bill of materials file for a product. The bill of materials itemizes the unit quantities and standard costs of all materials used in a product, and may also include an overhead allocation.
Which Costs are Included in Direct Materials?
The costs that are included within the direct materials classification are as follows:
Purchase cost of raw materials. This is the basic cost paid to acquire the raw materials used directly in the production of goods. It includes the price per unit multiplied by the quantity purchased and is often the largest component of direct material cost.
Freight charges. These are the costs incurred to transport raw materials from the supplier to the company’s production facility. If the company pays for delivery, these charges are added to the cost of direct materials.
Import duties and taxes. If raw materials are imported, any customs duties, tariffs, or import-related taxes are included in the direct material cost. These are necessary to bring the materials into the country and make them available for production.
Handling and storage costs. Costs for storing and handling raw materials at the warehouse or factory can be included, but only if they are directly attributable to bringing the materials to a usable condition. For example, special handling for fragile materials may be counted as a direct material cost.
Insurance on goods in transit. If the company insures materials while they are being transported, the insurance premiums for that transit are considered part of the direct material cost. This ensures the full landed cost of materials is captured accurately.
These costs are all directly traceable to the final product and are essential in determining accurate production costs and pricing.
Direct materials do not include any materials that are consumed as part of the general overhead of a business. For example, the air filters used in the ventilation system of a manufacturing facility are not direct materials; they are instead included in manufacturing overhead. Conversely, the wood used to construct furniture that is to be sold is classified as direct materials.
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Direct Materials Use in Throughput Analysis
Direct materials is an important concept in throughput analysis, where throughput is the revenue generated by a product sale, less all totally variable costs. In most situations, the only totally variable costs associated with a product are its direct materials. Direct labor is not totally variable in most situations, and so is usually not included in the throughput calculation.
Presentation of Direct Materials
The direct materials cost may be included as a separate line item in the cost of goods sold section of the income statement. It is also one of the few line items included in a contribution margin analysis.
Direct Materials Variances
Direct materials are measured using two variances, which are noted below.
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. To calculate the material yield variance, subtract the standard amount of unit usage from the actual unit usage, and then multiply the result by the standard cost per unit. 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 the difference between the actual price paid to buy an item and its standard price, multiplied by the actual number of units purchased. The purchase price variance is the difference between the actual price paid to buy an item and its standard price, multiplied by the actual number of units purchased. The formula is:
(Actual price - Standard price) x Actual quantity = Purchase price variance