What are direct materials?

Definition

Direct materials are the parts and stock you can point to in a finished unit. On the books, their cost starts in raw materials inventory and moves with the job until the goods are sold.

A metal fab shop that cuts $400 of steel into a railing can trace that steel to the job. Shop rags, welding gas, and a shared grinding disc are usually indirect, even though the job used them.

Cash-basis books may feel the steel when the supplier is paid. Accrual books hold purchased steel as a current asset until it is issued, then keep that cost inside inventory as the job moves.

This cost is the traceable material. It is not the welder's wage, and it is not the rent on the bay.

Where it shows up

Balance Sheet: Located in the inventory section until the goods are sold.

P&L: Related to the materials that later become cost of goods sold.

Cash flow: Increases in inventory, reported cash from operating activities decreases.

See also: Cost Of Goods Sold · Raw Materials Inventory · Job Costing

When you look at your Balance Sheet, this cost sits inside the inventory grouping. Unused bars wait as raw materials; cut pieces on a job sit in work in process inventory; completed railings wait as finished goods inventory.

When the materials balance is high, cash is often sitting in steel. When it is low, the shop may be buying job by job, or it may be close to a stockout on a common bar size.

The Income Statement does not list this cost as a standing line while the goods are unsold. The related expense shows up as cost of goods sold only when the finished unit sells.

On the Statement of Cash Flows, paying the steel supplier is the cash event. Cash from operating activities falls when you pay, and inventory rises until those goods sell.

How it works

The shop buys steel and records it as raw materials inventory at cost. If the vendor bill is open, accounts payable rises with it.

When a job starts, the bookkeeper issues the bars to the floor. That move takes cost out of raw materials and into work in process inventory.

The bill of materials tells the shop how many pounds or pieces the unit should take. Extra cuts and scrap still belong to the job if they came from the issued steel.

Stay with the traceable stock when you read this cost. A bottle of cutting fluid shared across every job is usually overhead, not this line.

If the finished railing sells, the job's material cost leaves inventory with the rest of the unit cost. Until that sale, the steel is still an asset.

A purchase price that is higher than the expected price does not change what the steel is. It only changes how many dollars ride with those bars.

Keep the receiving tickets and the issue slips. Anyone tying a job to the steel rack should be able to see which bars left.

Do not treat the vendor bill as the job cost if the steel is still in the rack. The bill is payable; this cost waits for the issue, then for the sale.

After the unit sells, the material dollars are gone from the Balance Sheet. They do not sit in a permanent materials expense account of their own.

Example

A metal fab shop issues $1,200 of steel to a railing job. The bars leave the rack and go to the floor.

The issue is recorded:

Debit: Work in process inventory $1,200

Credit: Raw materials inventory $1,200

Raw materials fall by $1,200, and work in process rises by the same amount. Cash has not moved, and the Income Statement has not changed yet.

The $1,200 is still inventory, now sitting on an open job. It becomes cost of goods sold only when the finished railing is sold.

If $300 of unused drops go back to the rack, that $300 should return to raw materials. The job then holds $900 of steel.

Common mix-ups

Direct materials are not the same thing as all inventory. Inventory also holds work in process and finished goods, plus supplies you cannot trace to one unit.

Direct materials are not cost of goods sold. The steel is still an asset until the finished unit sells; only then does that cost hit the P&L.

Direct materials are not direct labor. The welder's wages are a different job cost, even when they are spent on the same railing.

Related terms

• Cost Of Goods Sold: The direct cost of the products sold during the period.
• Raw Materials Inventory: Purchased materials waiting to enter production.
• Job Costing: Tracking revenue and cost for each individual job, project, or order.
• Landed Cost: The full cost of getting a purchased item to your door, including freight and duties.
• Standard Cost: A pre-set expected cost per unit used for planning and comparison.
• Purchase Price Variance: The difference between what you paid for materials and the standard price.
• Work In Process Inventory: Partially completed goods still moving through production.
• Bill Of Materials: The list of components and quantities needed to build one unit.