Direct expenses are costs specifically and directly attributable to a particular product, project, or department. Companies incur these expenses when producing or delivering goods or services. Therefore, they relate directly to the revenue generated by those goods or services. Companies can understand their cost structure and profitability by tracking and managing direct expenses.
For most companies in the manufacturing or retail sectors, direct materials are a significant part of direct expenses. These materials come with a cost that companies can calculate through various techniques. However, it is crucial to understand what these materials include.
What are Direct Materials?
Direct materials are the raw materials or components companies use in manufacturing a product or delivering a service. These materials are “direct” because they are an integral part of the finished product and easily tracible and attributable to it. Direct materials can include anything from steel and plastic used in manufacturing to the ingredients in a recipe for a baked good.
Companies track and account for direct materials separately from other costs, such as labour or overheads. It allows them to estimate the cost of goods sold. Consequently, it helps companies determine the accurate cost of producing a product and helps them make decisions about pricing, production levels, and inventory management.
How to calculate Direct Materials Cost?
Calculating the cost of direct materials involves determining the total cost of the raw materials or components used to manufacture a finished product. This information is essential for companies to make informed decisions about pricing, production levels, and inventory management. Usually, calculating direct materials cost involves several steps, as listed below.
1. Identify the direct materials used
It involves determining the raw materials or components used in producing the finished product.
2. Determine the quantity of each direct material used
It involves measuring the amount of each type of direct material used in the production process. Companies can measure it in units of weight, volume, or other relevant measures.
3. Determine the cost per unit of each direct material used
It involves determining the cost of each unit of each type of direct material used in the production process. It includes the cost of the raw materials and any additional costs, such as shipping, handling, or processing fees.
4. Calculate the total cost of direct materials
It involves multiplying the quantity of each type of direct material used by its corresponding cost per unit and then summing the costs of all types of direct materials. It will provide the total cost of direct materials used in production.
Example
Red Co. manufactures bicycles, and the direct materials used in production include steel frames, aluminium rims, rubber tires, and plastic pedals. During the last period, the company required 500 steel frames, 1,000 aluminium rims, 1,500 rubber tires, and 2,000 plastic pedals. The cost per unit for steel frames is $30, aluminium rims are $20, rubber tires are $10, and plastic pedals are $5.
Based on the above information, the direct materials cost for Red Co. will be as below.
- Steel frames: 500 units x $30 = $15,000
- Aluminum rims: 1,000 units x $20 = $20,000
- Rubber tires: 1,500 units x $10 = $15,000
- Plastic pedals: 2,000 units x $5 = $10,000
The total direct materials cost for the company will be $60,000 after adding all the above-listed costs.
Conclusion
Direct materials are items used in production directly attributable and tracible to a specific product or unit. Tracking and accounting for the cost of these products is crucial for companies. Consequently, companies can calculate direct materials cost in several steps. This process can help companies improve efficiency and profitability in the production process.
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