Reviewed by Aug 27, 2020| Updated on
What are Raw Materials?
Raw materials are substances primarily used in the production or manufacturing of goods. Raw materials are commodities or items that are bought and sold on the commodities exchanges globally. Ideally, the raw material is a basic substance in its natural, semi-processed state, or modified used as an input in a production process for consequent modification or transformation into a finished good.
Examples of raw materials are steel, oil, corn, grain, gasoline, lumber, forest resources, plastic, natural gas, coal, and minerals, to mention a few.
Understanding Raw Materials
Raw materials are used in several manufactured products. They can be in different forms. The inventory of a company can consist of different kinds of raw materials depending upon the type of manufacturing they do. The inventory of raw materials needs detailed budgeting and a particular structure for accounting on the statement of profit and loss as well as the balance sheet.
The manufacturing companies take appropriate steps to account for raw materials inventory. It includes three different inventory classifications on their balance sheet compared to just a single account for the non-manufacturers. The portion of current assets in the balance sheet for manufacturing companies will include:
- Inventory of raw materials
- Finished goods
All inventory, including raw materials, should be prized at its comprehensive cost. The value includes shipping, storage, and preparation.
The regular journal entries in an accrual accounting system for the initial purchases of raw materials inventory is to credit the cash account and debit the inventory. By debiting, the inventory increases the current assets and crediting cash will decrease the cash account by the inventory amount.
When a company uses raw materials in production, it shifts them from the raw materials inventory to the account of work-in-process inventory. When a company finishes working on the work-in-process items, it adds the item to the finished goods inventory, getting them ready for sale.
Types of Raw Materials
There are two classifications to raw materials:
- Direct raw materials:
These raw materials are those that companies directly use within the finished product, like the wood used for a chair. Direct raw materials are classified under the current assets on a balance sheet.
Direct raw materials are incurred on the statement of profit or loss, included as the 'cost of goods sold'. Manufacturing companies must also take extra steps over non-manufacturing companies to generate more detailed expense reporting on costs of goods sold.
- Indirect raw materials:
This type of raw materials do not form part of the final product but are alternately used for support in the production process. Indirect raw materials are recorded as long-term assets. Within long-term assets, they can take several forms, such as selling, general, and administrative or property, plant, and equipment.
Raw material supply plays an essential role in the progress of an economy. A country may be dependent upon another for a particular raw material or can also be self-sufficient. Accordingly, the extent of generation or production of the raw materials affects the entire supply chain.