Material Costs: Everything You Need to Know
Material costs are, simply put, what the direct materials cost to manufacture a given product or provide a certain service.3 min read
Material costs are, simply put, what the direct materials cost to manufacture a given product or provide a certain service. Also known as raw material costs or direct material costs, these interchangeable terms all describe the cost of integral materials in a product or service. Material costs are distinct from labor and manufacturing overhead costs.
The supplies and materials used for machinery or other equipment used to create the product or service are not considered material costs. The direct material cost is one of the few variable parts of the production process, which allows it to be utilized to separate throughput from production processes. Throughput is just all variable costs taken away from sales.
The cost of scrap and any potential revenue from the resale of scrap are so small that it is not worthwhile to include within the material cost for most products and services.
Examples of Material Costs
- Wood used to construct a building
- The steel used to create a train
- The circuit board in a cell phone or computer
- The fabrics used to assemble clothing
Understanding the Different Costs in Production Costs
Aside from direct labor costs like wages, tips, and benefits, the biggest other production cost is typically manufacturing overhead costs, which include indirect materials, indirect labor, and other costs. Indirect materials are as the name implies, not directly discernable in the final product or service. They include things like rags used in the construction of a house, thread used to stitch clothing together, and the lubricants or oil used on the machines that create the products or services.
Indirect labor costs include the entire cost of all labor, including those not directly involved in the production processes. Utilities, leases, and insurance are all also typically covered under manufacturing overhead costs. An example of the cost plus percentage of cost method contractors often use to determine pricing can help you determine your own prices.
How to Calculate Direct Materials Costs
Although it can seem like a daunting thing to ascertain, calculating direct materials cost simply requires that you know how much your company has really spent on materials used during production for whatever period you're looking at. Armed with this vital piece of information, you can analyze inventory costs and determine your in-progress inventory. In-progress-inventory corresponds to inventory that is not completely ready at the time of your analysis.
One vital, important manner to help streamline efficiencies and to cut costs is to track direct costs through the manufacturing process. Have accountants analyze how the direct materials are purchased, assembled, and the operations it takes to integrate them into the finished product or service. They might suggest how incorporating in Delaware is a significantly successful strategy for cutting costs.
In order to determine the amount of direct materials cost in a given service or product, work with engineering to come up with a bill of options, specifying the quantity of each component included in a product or service.
Steps to Determine the Amount of Material Cost to Assign to a Unit of Production
- Figure out how much material is the standard for producing one unit.
- Determine the standard amount of scrap corresponding with producing one unit and add it to the cost of the direct material.
- If a standard amount of scrap isn't available, determine the standard amount of scrap for the full production run and break it down to the individual unit.
- If any scrap is subsequently sold, apply the revenue back to the individual unit.
Product Costs Vs. Period Costs
Product costs are what is needed to manufacture a product. Period costs, in contrast, are non-manufacturing costs that are expensed within the period that they happened. Product costs are typically production and manufacturing costs.
What are Work-In-Progress Direct Materials?
At the end of an accounting period, there is usually some incomplete inventory left over. Calculating the work-in-progress inventory efficiently is easy; add the cost of direct materials to direct labor and manufacturing overhead for the incomplete inventory costs. Accountants will normally use a standard cost to estimate the value of direct materials, direct labor and manufacturing overhead in work-in-progress inventory.
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