Raw materials definition
/What are Raw Materials?
Raw materials are the constituent parts input into a production process, where they are transformed into finished goods. Most raw materials are highly standardized, and so can serve as inputs into multiple products. Since raw materials can be damaged or become obsolete, and require working capital funding to hold, organizations try to keep only a modest amount of raw materials on hand.
Characteristics of Raw Materials
The characteristics of raw materials include the following:
Classification. Raw materials that can be directly traced to a finished product are classified as direct materials, while materials that are not directly traceable but which are used in production are classified as indirect materials.
Valuation. Raw materials are typically recorded at their purchase cost.
Inventory valuation. Raw materials may be valued subsequent to their purchase using either an averaging technique (weighted average method) or a layering technique (FIFO or LIFO).
Recognition. Raw materials are initially recognized as inventory. When used in production, they are transferred into work-in-progress inventory and eventually to finished goods inventory. Once sold, they are charged to expense through the cost of goods sold account.
Impairment. If raw materials are damaged or obsolete, they may need to be written down to their net realizable value.
Impact on cost accounting. Raw materials are part of the prime costs used in production, and play a key role in calculating standard costs and analyzing variances in budgeting.
Accounting for Raw Materials
Raw materials are tracked in a separate inventory account at their historical cost. For example, a $4,000 purchase of raw materials on credit would be recorded with the following journal entry:
If their market value declines prior to being used, their recorded cost is written down to market value (known as the lower of cost or market rule).
Presentation of Raw Materials
Raw materials are expected to be used within one year, and so should be presented on the balance sheet within the current assets section. Many businesses consolidate all forms of inventory into a single line item, so the raw materials number may be included in this aggregated figure.