Indirect Materials can be regarded as a category of indirect costs. They are materials that are used within a production process, but cannot be individually traced to a certain product.
In other words, it can be seen that these are the costs that are mainly incurred holistically within the production or manufacturing process, but they are not exclusive to a certain product.
Therefore, it then gets challenging for accountants to decide how to categorize, and then make such costs traceable to the product.
The reason behind these costs being treated as indirect costs can be two-fold. Firstly, it can be seen that they are either insignificant to be associated with a certain product.
Secondly, by their very nature, they are clubbed for the production process as a whole, because of which they cannot be individually traced to a single product.
To illustrate indirect materials, two examples are given below:
- Cost of taping required to package a carton: Taping and gluing is a process to reinforce the strength of cartons whilst packaging. However, this is an item that is sourced in bulk, and it is not very costly. The insignificance of this particular item dollar value makes it redundant to be categorized or traced as an individual product cost. It would be extremely time-consuming to decide upon the grams of glue, or inches of tape required to seal a carton. Therefore, it is treated as an indirect material cost.
- Spices in a Sauce Mix: For the production of a Sauce Mix, it can be seen that numerous difference spices are used. However, given the overall ambiguity regarding the exact amount that goes into a certain recipe, it is mostly treated as an indirect material cost.
Indirect Materials can be treated in two ways. Firstly, they can be treated by including them in manufacturing overhead.
Subsequent to this, they are then allocated to the cost of goods sold and ending inventory at the end of each reporting period based on a reasonable method of allocation.
Secondly, they are simply charged to expenses as they are incurred. Depending on the category of account they belong to, they can be treated as stationery (if it is taping or glue) or any other category where they deem fit.
As far as theoretical accuracy is concerned, it can be seen that including them as manufacturing overhead is the correct approach.
However, if the amount of indirect material is insignificant, it can then be directly expensed too. If they are treated as manufacturing overhead, they are then associated with a particular product using a predetermined overhead rate.
Journal entry of Accounting for Indirect Material:
Assuming the indirect material is considered as overhead cost under the company’s policy, then the entry is as follow:
Dr Overhead ( memo in the nature of indirect material)
Cr AP/Accrual or Cash/Bank
Therefore, the key learning for indirect materials is the fact that these are expenses that are mainly incurred in the production process, but they cannot be directly traceable to a certain product. Additionally, they are not always part of the final product too.
They are just used to aid the production process. Therefore, it is difficult to trace them individually because of which they are either treated as manufacturing overhead, or they are simply expensed at the end of the year.