What are Raw Materials?
Raw materials are basic substances or things that haven’t been changed much yet and are super important for making stuff. Companies need these raw materials to create their products. These materials are usually taken from nature and then turned into other things that companies use to make their final products. Raw materials are a crucial part of how companies manage their stuff and make the things they sell. Accountants keep track of these materials by putting them under current assets on the company’s list of things they own. But sometimes, the prices of these raw materials can go up and down a lot because of things like how much people want them, problems in making them, and rules from the government. So, managing and keeping an eye on raw materials is a big deal for firms.
Geeky Takeaways:
- Raw materials are defined as the basic substances or things that are minimally processed and essential for product manufacturing.
- Raw materials are used by firms as inputs to transform into final goods for sale.
- Raw materials are typically derived from nature and then modified for business use.
Table of Content
Sources of Raw Materials
1. Mined Raw Materials: These are resources obtained from the Earth, encompassing a variety of substances like lime, sand, soil, oil, ores, stones, metals, minerals, and coal. Mined raw materials play a crucial role in various industries, serving as the foundation for the production of diverse goods.
2. Plant-Based Raw Materials: Derived from trees or plants, this category includes a wide array of resources like resins, wood, cotton, fruits, nuts, flowers, vegetables, and latex. Plant-based raw materials are pivotal components in manufacturing processes, contributing to the creation of products across different sectors.
3. Animal-Based Raw Materials: Extracted from animals, this category comprises resources such as leather, milk, meat, furs, and wool. These materials find applications in numerous industries, from food production to the manufacturing of clothing and accessories.
4. Forestry and Agriculture-Derived Raw Materials: Plant-based raw materials sourced specifically from forestry and agriculture include timber, corn, sugar, and wheat. These materials are integral to a range of industries, playing a vital role in the production of goods and commodities.
5. Waste Materials (Secondary Raw Materials): Secondary raw materials are obtained from waste materials that have undergone recycling processes and are reintegrated into the production cycle. This sustainable approach contributes to environmental conservation and reduces the dependence on primary raw materials, offering a responsible and efficient way to manage resources.
Importance of Raw Materials
1. Diversity in Usage: Raw materials play a pivotal role in the manufacturing processes across various industries, contributing to the creation of diverse products, including but not limited to food, clothing, electronics, and automobiles. They serve as the foundational elements necessary for the production of goods, showcasing a range from natural materials like wood, cotton, and minerals to synthetic counterparts such as plastics and chemicals.
2. Backbone of Manufacturing: Considered the backbone of the manufacturing industry, raw materials are indispensable for the creation of products essential to daily life. Their significance extends beyond individual sectors, forming a critical component of primary production and supporting the global economy and international trade.
3. Versatility and Global Impact: With applications in the production of finished goods, energy, and intermediate materials, raw materials have a profound impact on the global economy. They are integral to international trade, serving as the building blocks for future products and contributing to the development and sustainability of various industries.
4. Market Dynamics and Forecast: The raw materials market operates in a dynamic environment influenced by factors such as consumer behavior, supply chain uncertainties, manufacturing disruptions, and regulatory changes. The volatility in these markets is evident, and forecasting for the future, particularly in 2023, suggests challenges arising from reduced availability, potentially leading to supply chain issues.
Accounting for Raw Materials
1. Recording Process: When companies acquire raw materials, the initial step involves recording these materials in the raw materials inventory as a current asset on the balance sheet. This is executed through a debit to the raw materials inventory account and a corresponding credit to accounts payable, establishing a comprehensive record of the acquired inventory.
2. Classification Principles: Raw materials find their place in two primary categories: direct materials and indirect materials. Direct materials are those actively integrated into the final product, contributing directly to its composition. On the other hand, indirect materials, although not part of the end product, are crucially consumed throughout the production process.
3. Accounting Treatment for Direct Materials: Direct materials follow a specific accounting treatment, involving a debit to the work-in-process inventory account and a credit to the raw materials inventory asset account. In cases where the production process is brief, the work-in-process account may be bypassed, and the finished goods inventory account is directly debited.
4. Accounting Treatment for Indirect Materials: Contrarily, indirect materials undergo a distinct accounting treatment. This process includes debiting the factory overhead account and crediting the raw materials inventory asset account, establishing a clear delineation between direct and indirect material transactions.
5. Inventory Management and Cost Calculations: Maintaining an optimal quantity of raw materials in the right location is crucial for streamlined production processes, averting potential shortages or overstocking issues. Additionally, cost calculations are an integral aspect, employing formulas such as the opening raw material plus raw material purchases minus closing raw material, equating to the raw material used.
Types of Raw Materials
1. Direct Materials: Direct materials are fundamental components, typically in their raw or unprocessed state, that companies directly use in the manufacturing of finished products. These materials are essential for the final product’s composition. When a company incorporates direct materials into the manufacturing process, the work-in-process account is debited, reflecting the usage of these materials. On the other hand, when there is no inventory of direct materials, a credit is made to the work-in-process account. This accounting process helps track the consumption and availability of direct materials in the manufacturing workflow, contributing to accurate cost calculations.
2. Indirect Materials: In contrast to direct materials, indirect materials do not form a direct part of the end product. Instead, they play a supporting role in the production process. Accounting for indirect materials involves a consideration of their nature and type, recognizing their importance in facilitating the manufacturing process. While not directly traceable to each unit produced, indirect materials contribute to overall production efficiency and are accounted for within the broader framework of manufacturing overhead. Understanding and managing indirect materials are crucial for maintaining an efficient and cost-effective production environment.
Examples of Raw Materials
1. Direct Raw Materials: Direct raw materials involved in furniture manufacturing include timber, wood, cushions, padding for chairs, and cloth fabric for covering chairs. These materials are directly associated with the production of tables and chairs. When calculating the cost on a per-unit basis, these direct raw materials can be precisely traced to each unit, contributing to the overall cost efficiency.
2. Indirect Raw Materials: Indirect raw materials encompass fittings, nails, wood glue, and equipment for workers. Unlike direct materials, these items are not easily traceable to individual units produced, primarily due to their relatively lower quantities or indirect associations. Costs associated with indirect materials, such as glue, nails, and worker equipment, are typically allocated to products through manufacturing overhead. This allocation ensures a fair distribution of these costs across the entire production output, considering their less direct impact on individual units.
Difference Between Direct Raw Materials and Indirect Raw Materials
|
Basis |
Direct Raw Materials |
Indirect Raw Materials |
|---|---|---|
|
Definition |
Direct raw materials are substances that are an integral part of the finished product and are used directly in its manufacturing process. |
Indirect raw materials, on the other hand, are not part of the final product but play a crucial role in the overall production process. |
|
Traceability |
Direct raw materials are easily identifiable and can be directly linked to each unit produced. This traceability is crucial for tracking costs and ensuring accurate allocation. |
Indirect raw materials lack direct traceability to the individual units produced. Their usage is more generalized across the production process, making it challenging to attribute costs to specific units. |
|
Cost Incurrence |
The cost of direct raw materials is directly incurred in the manufacturing process. It is included in the cost of goods sold (COGS), as these materials contribute directly to the production of the finished goods. |
The cost of indirect raw materials is not directly linked to the cost of goods sold. Instead, it is included in manufacturing overhead. This cost is then allocated to the final product as part of the overall production cost. |
|
Reporting |
Direct raw materials are reported as a current asset on the balance sheet since they are part of the inventory until they are used in production. |
Indirect raw materials are included in manufacturing overhead, and their cost is allocated to the final product. They are not separately reported on the balance sheet as a current asset. |
|
Importance |
Understanding the distinction between direct and indirect raw materials is critical for accurate inventory management and cost accounting. It allows businesses to track costs more precisely and make informed decisions about production efficiency. |
The differentiation between direct and indirect raw materials is essential for making informed decisions about material usage and managing associated costs. It helps in the accurate allocation of overhead costs and overall cost control. |
Frequently Asked Questions (FAQs)
1. What does the manufacturing of raw materials involve?
Answer:
Manufacturing refers to the process of transforming raw materials or parts into finished goods, utilizing tools, human labor, machinery, and chemical processing. This process enables businesses to sell finished products at a higher cost than the value of the raw materials used.
2. What are raw materials called?
Answer:
Raw materials, also known as primary commodities, unprocessed materials, or feedstock, are fundamental substances used in the manufacturing of goods, final products, or intermediate materials that serve as the raw materials for future finished products.
3. Is plastic considered a raw material?
Answer:
Yes, plastics are made from raw materials like natural gas, oil, or plants, which undergo a refining process into ethane and propane. These materials are then treated with heat through a process called “cracking,” transforming them into ethylene and propylene. Different polymers are created by combining these materials.
4. Are raw materials direct or indirect expenses?
Answer:
Raw materials and labor costs are considered direct expenses as they directly contribute to the manufacturing of products by a company. These parameters also impact the final cost of a product or service provided by the company.
5. What properties do raw materials possess?
Answer:
Raw materials exhibit properties such as size, shape, density, deformation in response to applied forces, moisture content, adsorption and desorption of water, hydrodynamic properties, and other characteristics describing the physical state of agricultural material.