Direct material is all of the physical items built into a product. The direct material concept is used in cost accounting, where this cost is separately classified in several types of financial analysis. Direct materials are rolled into the total cost of goods produced, which is then subdivided into the cost of goods sold (which appears in the income statement) and ending inventory (which appears in the balance sheet).
The direct material classification typically includes all materials physically present in a finished product, which is raw materials and sub-assemblies. However, that is not the full extent of direct materials. In addition, direct material includes that amount of scrap and spoilage normally encountered during the production of goods.
If excessive amounts of scrap and spoilage are encountered, these are not considered part of the materials directly associated with a product, but rather as a general cost of production.
Consumables are not considered to be direct material. Consumables are those supplies consumed in the general production process, such as machine oil. These items do vary with production volume, but cannot be traced back to specific units of production.
The amount of direct material used is incorporated into the material yield variance, which is one of the most useful of the classic cost accounting variances. Also, the difference between the actual cost of direct materials and its expected cost is measured with the purchase price variance.
The cost of direct materials is also used in the formulation of contribution margin, since it is nearly the only subtraction from sales when arriving at the contribution margin.
There is no direct materials concept in a services organization, where labor is the primary cost of an organization.