Raw Materials

Loading the player...

What are 'Raw Materials'

Raw materials are materials or substances used in the primary production or manufacturing of goods. Raw materials are often referred to as commodities, which are bought and sold on commodities exchanges around the world. Raw materials are sold in what is called the factor market, because raw materials are factors of production along with labor and capital.

BREAKING DOWN 'Raw Materials'

Raw materials are accounted for in an intermediate inventory account used by manufacturing companies. As raw materials are used, raw materials inventory is decreased, while work-in-progress accounts are increased. When the work-in-process items are completed, they are transferred to finished goods, and are accounted for as cost of goods sold upon sale.

Direct vs. Indirect Raw Materials

Raw materials may be divided into two major classifications: direct and indirect. Direct raw materials are materials that can be directly traced to the finished product. For example, lumber may be directly traced to a completed chair, so in this situation, lumber is a direct expense.

Indirect raw materials are items that cannot be specifically traced. An example is the wood finish placed on the manufactured chair. Although the entire drum of wood finish is evident, the specific wood finish within the drum cannot be traced to the exact location on each produced chair. Raw materials may also be classified as indirect if the total dollar amount is immaterial.

Fixed vs. Variable Costs

Another major classification that can be used to describe raw materials is "fixed or variable costs." Fixed costs relate to charges that do not vary based on inputs or production levels. Variable costs relate to charges that fluctuate based on the quantity being produced. For this reason, raw materials are typically variable manufacturing costs because they are only purchased during the production of a good. If no good is being produced, the cost is not incurred, and because it can be avoided by reducing production, raw materials are a variable cost.

Direct Raw Materials Budget

A manufacturing entity calculates the amount of direct raw materials needed for specific periods, to ensure shortages do not occur. Also, with the specific amount of direct raw materials, an entity has the ability to reduce inventory stock and security, lower ordering costs, and reduce the risk of material obsolescence. The direct raw materials budget is calculated by adding the raw materials required for production to the anticipated or desired ending balance of direct raw materials. This summation is reduced by the amount of direct raw materials on hand at the beginning of the period. The final figure is the total direct raw materials that need to be purchased.

RELATED TERMS
  1. Goods In Process

    An inventory account that is usually identified on the balance ...
  2. Bill Of Materials - BOM

    A comprehensive list of raw materials, components and assemblies ...
  3. Work In Progress - WIP

    Material that has entered the production process but is not yet ...
  4. Value Chain

    A high-level model of how businesses receive raw materials as ...
  5. Prime Cost

    A business's expenses for the materials and labor it uses in ...
  6. Commodity Paper

    A loan or advance for which raw materials owned by the borrower ...
Related Articles
  1. Markets

    How Does a Company Use Raw Materials?

    Raw materials are the basic components of a finished product.
  2. Markets

    Explaining the Value Chain

    A model of how businesses receive raw materials as input, add value to the raw materials, and sell finished products to customers.
  3. ETFs & Mutual Funds

    The Top 5 Materials Equity Mutual Funds for 2016

    Read about five mutual funds covering the basic materials sector that could be excellent buys after a catastrophic 2015 for the category.
  4. Markets

    What Does Short Run Mean?

    Short run is the concept that for a business, at least one factor of production is fixed while others are variable.
  5. Investing

    Understanding Explicit Costs

    Common examples of explicit costs include wages, utilities, rent, raw materials, and other direct expenses companies pay to conduct business.
  6. Markets

    Calculating Production Costs

    Production cost is any expense associated with manufacturing a good or providing a service.
  7. Markets

    Understanding Marginal Cost of Production

    Marginal cost of production is an economics term that refers to the change in production costs resulting from producing one more unit.
  8. Markets

    Manufacturing Is Suffering, Consumers Don't Care

    The recent divergence between consumer sentiment and the manufacturing sector's health has continued, with a flurry of data releases Thursday highlighting this rift in the American economy.
  9. Investing

    How to Analyze a Company's Inventory

    Discover how to analyze a company's inventory by understanding different types of inventory and doing a quantitative and qualitative assessment of inventory.
  10. Investing

    What is Absorption Costing?

    Absorption costing is an accounting method primarily used in manufacturing. In absorption costing, the cost of a manufactured product includes the direct costs plus an apportioned share of the ...
RELATED FAQS
  1. What is the difference between work in progress (WIP) and raw materials in accounting?

    Learn about the difference in inventory financial accounting between works in progress and raw materials, as reported in ... Read Answer >>
  2. What are some examples of prime cost items?

    Learn about prime cost, including the definition of raw materials and direct labor, and how the types of expenses included ... Read Answer >>
  3. What commodities are the main inputs for the electronics sector?

    Explore the use of commodities in the electronics sector. Discover potential risks and opportunities presented by raw materials ... Read Answer >>
  4. Does a company logo change require a material disclosable event?

    A company logo change usually constitutes a material disclosable event. Securities law requires that companies disclose all ... Read Answer >>
  5. How is work in progress (WIP) typically measured in accounting?

    Understand what work in progress is and why a company would have this on its financials. Learn how work in progress is typically ... Read Answer >>
  6. What is the difference between prime cost and conversion cost?

    Understand the difference between prime costs and conversion costs, and learn how each type is used in analyzing business ... Read Answer >>
Hot Definitions
  1. Put Option

    An option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security ...
  2. Frexit

    Frexit – short for "French exit" – is a French spinoff of the term Brexit, which emerged when the United Kingdom voted to ...
  3. AAA

    The highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has ...
  4. GBP

    The abbreviation for the British pound sterling, the official currency of the United Kingdom, the British Overseas Territories ...
  5. Diversification

    A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique ...
  6. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
Trading Center