Raw Materials: Definition, Accounting, and Direct vs. Indirect
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Summary:
Raw materials are essential components used in manufacturing goods, traded globally on commodities exchanges. This article explores the definition of raw materials, their accounting in business, and the distinction between direct and indirect raw materials.
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Understanding raw materials
Raw materials are the backbone of manufacturing, serving as the foundational components for countless products. Companies rely on these materials to create everything from vehicles to electronics. Let’s delve deeper into the world of raw materials.
What are raw materials?
Raw materials encompass a wide array of substances vital for manufacturing. These materials are the building blocks of products, and they come in diverse forms. For example, the steel used in automobile manufacturing is a prime raw material. The availability of raw materials can be influenced by natural resources, making businesses dependent on nature’s bounty.
Examples of raw materials
Raw materials span a broad spectrum, including steel, oil, corn, grain, gasoline, lumber, forest resources, plastic, natural gas, coal, and minerals. The scope of raw materials reflects the vastness of the manufacturing industry.
Accounting for raw materials
Manufacturing companies employ specialized methods to account for raw materials. This involves distinct inventory classifications on their balance sheets. Let’s explore how these materials are accounted for and valued.
Valuation of raw materials
Raw materials, including their shipping, storage, and preparation costs, must be accurately valued. Accounting for raw materials begins with journal entries, typically crediting cash and debiting inventory. As raw materials move through production, they transition from raw materials inventory to work-in-process inventory, finally reaching finished goods inventory.
Direct vs. indirect raw materials
Raw materials can be categorized as either direct or indirect, impacting their reporting and expensing. Understanding this distinction is crucial for accurate financial representation.
Direct raw materials
Direct raw materials are integral to the finished product’s manufacturing. For instance, wood used in making a chair is a direct raw material. These materials are listed in current assets and are expensed within the cost of goods sold.
Indirect raw materials
Indirect raw materials are not part of the final product but are essential in the production process. They are recorded as long-term assets and can fall under categories like selling, general, and administrative (SG&A) or property, plant, and equipment (PP&E). Depreciation schedules for indirect raw materials are usually shorter than those for other long-term assets.
Types of raw materials
Raw materials can be classified based on their extraction process. Three common types include mined raw materials, plant-based raw materials, and animal-based raw materials. Each type involves distinct procurement methods and considerations.
Examples of raw material types
– Mined raw materials include ores, stones, metals, minerals, lime, sand, soil, oil, and coal.
– Plant-based raw materials encompass fruits, nuts, flowers, vegetables, resins, wood, cotton, and latex.
– Animal-based raw materials are derived from sources like milk, meat, furs, leather, and wool.
– Plant-based raw materials encompass fruits, nuts, flowers, vegetables, resins, wood, cotton, and latex.
– Animal-based raw materials are derived from sources like milk, meat, furs, leather, and wool.
Example of raw materials
Let’s consider a company that manufactures tables and chairs as an example:
– Direct raw materials: Timber, wood, cushions, padding, cloth fabric
– Indirect raw materials: Fittings, nails, wood glue, worker equipment
– Indirect raw materials: Fittings, nails, wood glue, worker equipment
This distinction helps in cost allocation and efficient production.
Frequently asked questions
What are raw materials in food?
Raw materials in food can be standalone items like meats, milk, fruits, and vegetables. They can also refer to ingredients used in food production, such as milk in cheese making.
Is water a raw material?
Yes, water is a raw material used in various products and processes, from beverages to agriculture to industrial applications.
What is the difference between inventory and raw materials?
Raw materials are a type of inventory, representing goods on a balance sheet not yet converted to finished products. As companies use raw materials in production, they become part of finished goods inventory.
How do companies obtain raw materials?
Companies can obtain raw materials through strategic partnerships with third-party suppliers or by investing in facilities for direct collection. The choice depends on financial considerations and business strategies.
Frequently asked questions about raw materials
What are raw materials in food?
Raw materials in food can be standalone items like meats, milk, fruits, and vegetables. They can also refer to ingredients used in food production, such as milk in cheese making.
Is water a raw material?
Yes, water is a raw material used in various products and processes, from beverages to agriculture to industrial applications.
What is the difference between inventory and raw materials?
Raw materials are a type of inventory, representing goods on a balance sheet not yet converted to finished products. As companies use raw materials in production, they become part of finished goods inventory.
How do companies obtain raw materials?
Companies can obtain raw materials through strategic partnerships with third-party suppliers or by investing in facilities for direct collection. The choice depends on financial considerations and business strategies.
Key takeaways
- Raw materials are essential inputs for manufacturing.
- They can be direct or indirect, influencing accounting and expense reporting.
- Different types of raw materials require distinct procurement methods.
- Water is a valuable raw material in various industries.
- Companies strategically secure raw materials to optimize production.
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