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Raw Materials: Definition, Accounting, and Direct vs Indirect

Firms with holistic procurement processes can often further increase visibility into their agile supply chain by using big data, AI, data visualization, and process-mining tools. These solutions are often quite inward focused, with the main users being internal employees, central procurement teams, and admin staff. The materials being purchased are integral parts of the company’s products, and are therefore usually much more consistent over time. Most companies are simply not big enough to have large central procurement teams filled with specialists in each of these areas. The proceeds from the sale of raw materials are deducted from the purchase price in the same manner as returns inward. From this, deduct the value of unused raw materials at the end of the year (i.e., closing stock).

  1. It would be impossible for them to allocate the costs of each bolt to each truck being produced.
  2. The raw materials inventory department maintains a copy to document the change in inventory levels, and the accounting department maintains a copy to properly assign the costs to the particular job.
  3. For example, the operations of a farm are substantially different from an oil drilling rig; companies that require both raw materials must be mindful of how to most efficiently source the materials.
  4. Further, a company needs raw materials on hand for future jobs as well as for the current job.

It seldom has the same centralized procurement processes as direct materials management because indirect materials tend to be procured whenever there’s demand. In addition, different teams with independent budgets and procurement plans often like to put in their own orders from suppliers and brands of their choice. The problem of poor indirect material management stems partly from the inability of legacy and manual data management systems to quantify and measure indirect materials. These systems focus on the movement of trackable, direct materials but often ignore the indirect materials that are not utilized in the finished product. Indirect materials are goods that are part of the entire manufacturing process but are not integrated into the final product.

What are the examples of indirect materials?

Seemingly insignificant indirect materials such as glue and fuel can quickly pile up the costs when consumed in high amounts. Some analysts estimate that about 40% of a typical company’s annual expenditure is spent on indirect materials. It is sometimes difficult to determine whether to class some things as indirect or direct materials. However, either their cost is insignificant or they are not conveniently traceable. Properly allocating overhead to the individual jobs depends on finding a cost driver that provides a fair basis for the allocation.


Thus, they are consumed as part of the production process, but are not integrated in substantial amounts into a product or job. Examples of indirect materials are cleaning supplies, disposable safety equipment, disposable tools, fittings and fasteners, glue, oil, and tape. When Dinosaur Vinyl requests materials to complete Job MAC001, the materials are moved from raw materials inventory to work in process inventory.

Difference between Direct and Indirect Material

Companies do not normally track indirect materials through a formal inventory record keeping system. For many business managers, the long-time focus on direct materials has made indirect expenditure somewhat of an afterthought. Generally speaking, the split between direct vs. indirect materials depends on whether the material is part of the Bill of Materials (BOM) for a product a company sells. Let’s look at the similarities, differences, and challenges between direct and indirect material procurement, and what that means for procurement professionals.

When the product is sold, the costs move from the finished goods inventory into the cost of goods sold. Verusen’s innovative supply chain software can give you unparalleled insight into your materials data, inventory, and procurement. With our purpose-built technology, you can better understand your disparate and incomplete data and connect it to your business outcomes. Though these processes may take some time and effort to implement at the beginning, once established they can help you minimize indirect expenditure and strengthen relationships with your suppliers. For this reason, procurement teams, both indirect and direct, are turning to new technology-based solutions to help them stay ahead and scale their effectiveness. Direct material procurement, on the other hand, is often much more specialized in nature, and often requires a more technical and deeper focus on the actual materials being purchased and the suppliers involved.

Examples of raw materials include steel, oil, corn, grain, gasoline, lumber, forest resources, plastic, natural gas, coal, and minerals. GEP NEXXE is a unified and comprehensive supply chain platform that provides end-to-end planning, visibility, execution and collaboration capabilities for today’s complex, global supply chains. Built on a foundation of data, artificial intelligence and cognitive technologies, GEP NEXXE helps enterprises digitally transform their supply chains and turn them into a competitive advantage. We can also easily measure and trace them directly to the production of something.

In the same light, manufacturing companies may not want to directly invest in extracting the raw materials. For example, consider how a company that relies on oil or plastics often does not own the drilling rig that extracts the raw materials from the group. In accounting, it is important to be able to differentiate between indirect and direct materials. Therefore, it is difficult to trace them individually because of which they are either treated as manufacturing overhead, or they are simply expensed at the end of the year. In other words, it can be seen that these are the costs that are mainly incurred holistically within the production or manufacturing process, but they are not exclusive to a certain product. When both administrative and production activities occur in a common building, the production and period costs would be allocated in some predetermined manner.

A better strategy may be to take a more collaborative approach with all suppliers. Deepening your strategic supplier relationships can help you negotiate shorter lead times, better payment terms, and fairer prices. One area in which fillable form 941 increased data visibility can have a big impact is demand planning. Self-learning AI-enabled technologies can identify gaps in inventory levels and highlight material use trends that can help managers make more accurate forecasts.

Having natural resources that can serve as raw materials can boost exports and help a country grow its GDP. Businesses and investors can engage in raw trading markets through commodities markets. Unlike indirect materials, direct materials are components that are integrated into a manufactured product. For example, chips in a mobile phone are direct materials in mobile phone production. When cost savings take priority, it’s important to control spending and compliance by using a unified source-to-pay (S2P) platform for indirect materials.

In my own experience, I have noticed that most of the early tech-based solutions coming on the market are primarily focused on indirect material procurement. Streamlining things like purchasing supplies, one-off IT equipment, and other ‘overhead’ items needed to keep the internal team of a company moving. For balance sheet purpose, the direct materials is classified as current asset and is reported at its cost. The cost of direct materials purchased consists of price paid to supplier (including sales taxes) plus duties and shipment cost. The quantity of materials left unused in the stock at the end of an accounting period is presented in balance sheet as a line item named “Raw Materials Inventory”.

In the months leading up to that contract renewal, there may be a lot of activity between the procurement team and that vendor discussing renewal terms and reviewing past performance. Our writing and editorial staff are a team of experts holding advanced financial designations and have written for most major financial media publications. Our work has been directly cited by organizations including Entrepreneur, Business Insider, Investopedia, Forbes, CNBC, and many others. Let’s suppose ABC company manufactures cotton Bundles and the cost per Bundle is $200. Companies don’t often treat indirect supplier relationships with the same level of care as direct supplier relationships. Purpose-built with these unique requirements in mind, we’re bringing to life the exact tool that we wish we had ourselves when running complex global supply chains.

For example, if the cost of the legal fee is $5,000, the amount charged remains constant whether 100 or 1,000 products are sold. Then, subtract the value of raw materials at the end of the year on 31st December 2021 (i.e., closing stock) from the total raw materials available. Yes, water can be thought of as a raw material that is used in a wide range of products and production processes, from beverages to agriculture to industrial uses.