Raw materials are the resources that are utilized by the company to produce its goods and services for purposes of resale. Raw materials can broadly be categorized into two categories, which are direct materials and indirect materials. As far as direct materials are concerned, they are used within the final product.
Without direct materials, the final product which the company produces cannot be produced or subsequently sold.
On the other hand, it can be seen that indirect materials are mainly utilized across the production process, but they are not directly involved with the production process. In other words, they do not constitute a major ingredient of the final product.
Examples of direct raw materials constitute cloth, which is required to manufacture a certain suit. Indirect raw materials, in this case, can be the lubricant that is required to ensure the smooth functioning of the sewing machine.
In this article, we will discuss about the accounting of raw material, specifically on recognition, recording, as we as on how it is present in the entity’s financial statements.
Journal Entry and Accounting Treatment
Raw materials are recorded on the balance sheet as a current asset under inventories lime items. When raw materials are being recorded, a debit entry is processed in the raw material inventory account (to record increasing assets).
Subsequently, to record the purchase of this inventory, a credit is made to the accounts payable account, to account for increasing credit balances that the company has to be made over the course of time.
When raw materials are used within the production process, the accounting treatment varies according to the nature of the raw materials that are utilized. In the case of direct materials, the work in process inventory account is debited to record that the inventory is currently being utilized for production processes.
Subsequently, the raw materials inventory account is credited, to reflect that the inventory is no longer in stock. However, this treatment is mostly carried out when the production process is long and spreads across a certain time frame.
Subsequently, the production process is completed, the work in process account is credited, and finished goods inventory is debited.
On the other hand, it can be seen that if the production process is short and brief, then the work in process step is eliminated. Once the goods are sold, the cost of raw materials are then recorded in the cost of goods sold account.
In the case of indirect raw materials, the overhead account is debited, and raw materials inventory asset is credited. After the end of the accounting period, the balance of overhead account is then allocated to cost of goods sold and ending inventory.
To conclude, it can be seen that raw materials are mainly inputs and materials that are required for the production process. As a matter of fact, it can be seen that these inputs are required for the core activity of the business, where goods and services are mainly produced for the purpose of resale.
Depending on their classification as direct or indirect raw materials, they are subsequently treated to reflect their utilization in the books.
However, the purchase of raw materials is different from the purchase of other goods and services, predominantly because of the reason that they are purchased with the objective of being processed and manufactured for resale (in case of direct raw materials).