Direct material cost is the cost of the raw materials and components used to create a product. The materials must be easily identifiable with the resulting product (otherwise they are considered to be joint costs). The direct material cost is one of the few variable costs involved in the production process; as such, it is used in the derivation of throughput from production processes. Throughput is sales minus all totally variable expenses.
Examples of direct materials are:
- The timber used to construct a house
- The steel included in an automobile
- The circuit board included in a radio
- The fabric used to assemble clothing
Some costs are for materials that are not considered direct materials, and so are instead classified as indirect material costs. These materials are so immaterial as not to be worth tracing to a specific product, or cannot be clearly associated with a specific product. Examples of indirect materials are:
- Rags and solvents used during the construction of a house
- The grease used on machines that manufacture products
- The thread used in clothing
A company may buy direct materials from suppliers, create them on-site, or buy them from its own subsidiaries.
To determine the amount of direct materials cost in a product, work with the engineering staff to create a bill of materials, which specifies the quantity of each raw material item and component included in a product. Then assign a standard cost to each item, based on recent prices paid for them (including freight and sales taxes), and add a reasonable allowance for scrap and spoilage. The total is the direct material cost of the product.