What type of costing is direct labor and raw materials?

Direct Material Cost is the total cost incurred by the company in purchasing the raw material along with the cost of other components, including packaging, freight and storage costs, taxes, etc., that are related directly to the manufacturing and production of various products of the company.

Table of contents

Table of contents

Components of the Direct Material Expense

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Source: Direct Material Cost (wallstreetmojo.com)

1. Raw Material Cost: It includes the cost incurred by the company to acquire the raw material required for the production of goods.
2. Indirect Tax: There are different types of indirect taxesTypes Of Indirect TaxesIndirect tax, also known as consumption tax, is the type of tax the person does not directly bear. In contrast, the incidence of such taxes is passed on to the end consumer of goods or services by adding such taxes to the value of those goods or services, like Excise duty, Service tax, VAT, etc.read more included in the invoice that is payable to the seller by the buyer of the goods. So, these costs also form part of the direct cost of the company.
3. Discounts: There are different types of discounts offered by the supplier of the raw material to the buyer, such as cash discounts, trade discountTrade DiscountThe reduction in list price allowed by a supplier to the consumer while selling the product in bulk quantities is referred to as a trade discount. It is carried out in order to boost the sale of the business.read more, and quantity discounts. These discounts reduce the overall expense of the material and thus are subtracted while calculating the direct material expense of the company.
4. Freight and Storage Charges: Costs incurred by the company for the freight and the storage charges are included in this cost if the same is included in the price as per the invoice or can be easily prorated according to its units or weight.
5. Packing and the Container Charges: The expense incurred by the company for the non-returnable material used for packing or for the containers used to get the material from the supplier is included in the direct material expense of the company.

Calculation Example of the Direct Material Costs

From the information of the transaction given below for the company A ltd. for October 2019, calculate the total direct material costs of the company for the month ending on October 31, 2019.

• The total cost of raw material purchased: $ 550,000
• Indirect taxes as mentioned in the invoice: $ 70,000
• Wages paid to the employees that are involved directly in the production activities of the company: $ 150,000
• Packing and container charges paid, as mentioned in the invoice: $ 5,000
• Freight inward paid: $7,000

Solution

The total cost incurred by the company concerning the raw material and the cost of other components incurred to purchase the material related directly to the manufacturing of the company’s different products will become part of the direct material cost of the company.

In the case of company A ltd, all the expenses mentioned will be included in the direct material costs except the cost incurredCost IncurredIncurred Cost refers to an expense that a Company needs to pay in exchange for the usage of a service, product, or asset. This might include direct, indirect, production, operating, & distribution charges incurred for business operations. read more for paying the wages to the employees. Wages paid will be considered while calculating the direct labor expense as they are related directly to manufacturing the company’s product. Still, the same will not form the part of the direct material expense.

• =550000+70000+5000+7000
• =632000

Advantages

The various advantages are as follows:

• Segregating the value of the direct material from the total material expense incurred by the company helps in knowing the entire raw material or the other cost incurred for purchasing the materials by the company that relates directly with the production of the goods in the company where the cost of material left after subtracting the direct material cost out of total material costs will be an indirect material cost incurred by the company.
• It is an essential component of the company’s product cost. The company’s product cost cannot be calculated in case the amount spent on direct materialDirect MaterialDirect materials are raw materials that are directly used in the manufacturing process of a company's goods and/or services and are an essential component of the finished goods manufactured.read more is not available.

Disadvantages

The various disadvantages are as follows:

• There prevails some of the cost of material where the person concerned cannot judge whether the cost incurred is the direct material or the indirect material expense. If any of such incidences is there, then there are chances that the direct material expense calculated is wrong.

Important Points

The different vital points are as follows:

• It is among the significant components of a company’s product cost, whereas the other product cost components cost includes direct labor cost and the manufacturing overheadManufacturing OverheadManufacturing Overhead is the total of all the indirect costs involved in manufacturing a product like Property Tax on the production premise, Remunerations of maintenance personnel, Rent of the manufacturing building, etc. read more costs.
• A direct material expense incurred by the company includes the amount paid for purchasing the raw material used for the production, indirect taxes paid on raw material, packing and container charges paid to get the supply of the raw material, freight inward charges paid, etc.
• To increase the efficiency in the production process and reduce the company’s cost, managers track the direct costDirect CostDirect cost refers to the cost of operating core business activity—production costs, raw material cost, and wages paid to factory staff. Such costs can be determined by identifying the expenditure on cost objects.read more incurred during the production as they watch how the purchased materials are getting converted into the finished products in the company, thereby streamlining the process by making the necessary changes wherever required.

Conclusion

Thus the direct material cost is among the significant product cost components of the company. In contrast, the other product cost components cost includes direct labor cost and the manufacturing overhead costs total cost incurred by the company concerning the raw material along with the cost of other components incurred to purchase the material related directly to the manufacturing of the different products of the company.

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