There are two subcategories of raw materials, which are:
- Direct materials. These are materials incorporated into the final product. For example, this is the wood used to manufacture a cabinet.
- Indirect materials. These are materials not incorporated into the final product, but which are consumed during the production process. For example, this is the lubricant, oils, rags, light bulbs, and so forth consumed in a typical manufacturing facility.
The cost of raw materials on hand as of the balance sheet date appears in the balance sheet as a current asset. Raw materials may be aggregated into a single inventory line item in the balance sheet that also includes the cost of work-in-process and finished goods inventory.
Raw materials of all types are initially recorded into an inventory asset account with a debit to the raw materials inventory account and a credit to the accounts payable account.
When raw materials are consumed, the accounting treatment varies, depending on their status as direct or indirect materials. The accounting is:
- Direct materials. Debit the work-in-process inventory account and credit the raw materials inventory asset account. Or, if the production process is brief, bypass the work-in-process account and debit the finished goods inventory account instead.
- Indirect materials. Debit the factory overhead account and credit the raw materials inventory asset account. At the end of the month, the ending balance in the overhead account is allocated to the cost of goods sold and ending inventory.
Raw materials may sometimes be declared obsolete, possibly because they are no longer used in company products, or because they have degraded while in storage, and so can no longer be used. If so, they are typically charged directly to the cost of goods sold, with an offsetting credit to the raw materials inventory account.