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Statements on Management Accounting



Definition and
Measurement of Direct
Material Cost


Definitions . . . . . . . . . . . . . . . . . . . . . . . . . 1 Unit Price of Direct Material . . . . . . . . . . . . . 3

Materiality . . . . . . . . . . . . . . . . . . . . . . . . . 2 Use of Estimates . . . . . . . . . . . . . . . . . . . . 3
Material Quantities . . . . . . . . . . . . . . . . . . . 2 Material-Related Costs . . . . . . . . . . . . . . . . 4
Material Lost in the Production Process . . . . 2 Cost Systems . . . . . . . . . . . . . . . . . . . . . . . 4
Samples, Prototypes, and Initial
Production Runs . . . . . . . . . . . . . . . . . . 3


The Institute of Management Accountants appreci- Waterhouse & Co., Columbus, Ohio, for his research
ates the contribution of Michael J. Sandretto, Price and writing associated with this project.

Copyright © 1986 in the United States

Published by of America by National Association of
National Association of Accountants Accountants.
10 Paragon Drive
All rights reserved
Montvale, NJ 07645
www.imanet.org ISBN 0-86641-146-1

The term “direct material cost” as used in prac- material cost in such situations, their interpreta-
tice, in literature, and in litigation has a wide vari- tion of the information may be erroneous, and
ety of meanings. Unless the intended meaning in they may make unsound decisions.
a given context is clear, confusion and misunder-
standing are likely to result. The purpose of this Definitions
Statement is to provide a conceptual definition Direct Material Cost—Quantities of material that
of “direct material cost” that, in the absence of can be specifically identified with a cost object in
a specified alternative, should be taken as the an economically feasible manner, priced at the
meaning of this term. unit price of direct material.

This Statement makes the conceptual definition Cost Object—A product, contract, project, organi-
more concrete by describing how direct material zational subdivision, function, or other unit for
costs should be measured. Measurement has which costs are measured or estimated.
two aspects:
Direct Cost—A cost that can be specifically iden-
a. The quantity of material that is to be included tified with a cost object in an economically feasi-
as direct material; that is, the inputs that are ble manner.
to be counted.
b. The unit price by which each of these quanti- Material Quantity—A physical amount of material,
ties is multiplied to arrive at a monetary cost. such as a pound of copper, a 50-gallon drum of a
chemical, or a batch of 100 semiconductors.
Many of the examples used in this Statement
refer to the direct material cost of goods pro- Scrap—Material residue from manufacturing
duced in manufacturing companies. The exam- operations that has some value. Examples of
ples apply equally well to the same or similar scrap include border material from stamping
transactions for projects, services, and other operations, shavings, filings, borings, and turn-
cost objects. The allocation of joint product or ings. Scrap may have relatively minor recovery
by-product costs is not addressed in this value, as in the case of steel, or it may be of sig-
Statement. nificant value, as in the case of gold.

In a manufacturing company, direct material cost Waste—Material that is lost, evaporates, or

is an element of inventory cost and of cost of shrinks in a manufacturing process or is a
sales. Differences in how companies define this residue that has no significant recovery value in
term result in variations in the amount recorded excess of its disposal costs.
as direct material cost and the amount recorded
as overhead or expense. Differences in the way Defective Units—Production that does not meet
material costs are accounted for in cost-type quality standards. Defective units may be
contracts, in projects, and for other cost objects reworked and sold, or they may be rejected and
also lead to differences in the amounts recorded disposed of for salvage value.
as direct material cost and the amounts record-
ed as overhead or expense. If users do not Material-Related Costs—Costs, other than direct
understand what items are included in direct material costs, that are incurred as a result of


the acquisition, inspection, storage, or move- many manufactured products. If a large project is
ment of direct material quantities. broken down into a series of smaller projects,
products, or subassemblies, the material cate-
Cost Item—A subdivision of cost, such as freight, gories listed in this paragraph typically are not
duty, insurance, sales tax, or outside processing included in the direct material cost of these
costs. subdivisions.

Unit Price of Direct Material—Invoice price and Costs classified as direct material costs must be
acquisition-related cost items that can be specif- excluded from costs used in calculating over-
ically identified with direct material quantities in head rates. For example, if one project is large
an economically feasible manner and that can enough to include fasteners and lubricants in
be measured with reasonable accuracy. direct material quantities, but those items are
included in overhead for other projects, the cost
Materiality of fasteners and lubricants should not be includ-
If a cost item is immaterial, it should be account- ed in the overhead rate applied to the first proj-
ed for in a manner that is economically feasible. ect. It follows that entities that define direct
material costs differently for different cost
Material Quantities objects will have two or more overhead rates.
If the cost object is the production of a manufac-
tured or processed product, its direct material Material quantity should include the cost of
cost normally should include quantities of mate- packaging material to the extent it is included in
rial that become a physical part of the cost the finished product. Examples include bottles
object and those materials that are consumed in for liquor and perfume and containers for cos-
the manufacturing process that can be specifi- metics and medical products.
cally identified with that cost object.
Material quantity should include packing sup-
If the cost object is the production of a service, plies necessary to deliver goods to customers,
its direct material cost normally should include to the extent that the goods are packed with
all quantities of material that can be specifically these supplies as part of the production
identified with producing the service. process.

If the cost object is the production of a project, Material Lost in the Production Process
its direct material cost normally should include Direct material cost should include the material
all quantities of material that can be specifically cost of scrap, waste, and normally anticipated
identified with the project. For a large project, defective units that occur in the ordinary course
direct material cost typically includes far more of the production process. The following exam-
categories of direct material quantities than in a ples depict situations in which such costs
product because it is relatively easy to identify should be classified as direct material costs:
quantities of material specifically with a large
project. Examples include fasteners, adhesives, a. A part is stamped from a roll of strip steel, or
lubricants, and other items whose unit costs are a finished unit is produced by turning a cast-
too low to be considered direct material costs for ing. The amount of material lost in these


processes through ordinary scrap usually can totypes should not be included in direct material
be predicted with reasonable accuracy. The cost.
cost of the predicted scrap should be includ-
ed in the direct material cost of the part. Unit Price of Direct Material
b. A quantity is lost in the production process The unit price of direct material should include
through evaporation, dehydration, spoilage, the invoice price and other costs paid to vendors
shrinkage, or similar causes. The amount of to deliver the material quantity to the production
material that is lost in these processes usu- facility or to a point of free delivery. The following
ally can be predicted with reasonable accura- costs are included in the unit price of direct
cy. The cost of the predicted amount of lost material:
material should be included in the direct
material cost. ● Invoice price for direct material quantity,
c. Engineering estimates are developed for the ● Invoice price for outside processing,
percentage of defective units expected from a ● Shipping costs (inward freight) paid or owed
given production process, and they are rea- to outside vendors,
sonably accurate. The cost of material in the ● Sales tax,
estimated percentage of defective units ● Duty, and
should be included in the direct material cost ● Cost of delivery containers and pallets, net of
of completed production. return refunds.
d. In most cases, the net salvage value of esti-
mated scrap, waste, and defective units Trade discounts, refunds, and rebates should be
should reduce the direct material cost. The deducted in calculating the unit price of direct
direct material cost should be increased, material.
however, if the related costs exceed the sal-
vage value, as in the case of certain chemical If cash discounts offered by the vendor exceed
or nuclear wastes. reasonable interest rates, the price of direct
material should be reduced by the excess.
Unanticipated quantities of scrap, waste, or
defective units should not be included in direct Demurrage charges should not be included in
material cost. These quantities should be includ- direct material cost.
ed in manufacturing overhead or should be
expensed. Royalty payments and licenses should be includ-
ed in direct material cost if they are functions of
Samples, Prototypes, and Initial direct material quantities used in producing the
Production Runs cost object.
Routine quality assurance samples that are test-
ed to destruction should be included in direct Use of Estimates
material cost. Nonroutine quality assurance Estimates of direct material quantities and unit
samples taken due to quality problems should prices may be used if they are sufficiently accu-
not be included in direct material cost. rate to be considered “specifically identified”
with a cost object. The following situations are
The material cost of marketing samples and pro- examples of estimates that are sufficiently accu-


rate to be considered direct material costs in production process.

most instances:
Certain cost items may be closely related to mate-
a. A manufacturing firm establishes standard rial quantities and may be allocated to cost
material quantities for its products, but its objects based on direct material quantities or
system does not trace variances to these costs. They are, however, more closely related to
products. Nevertheless, there is a reason- the production process than to the acquisition of
able expectation that variances are propor- material and are not typically considered material-
tional to the standard quantities and thus related costs. Furthermore, they may be applica-
that the actual material quantities are propor- ble to different time periods than the period in
tional to the standard quantities. which the direct material cost was incurred.
b. A manufacturing firm uses standard purchase Examples of those cost items are:
prices for its materials. Although standard
purchase prices are not necessarily the same ● Material storage costs subsequent to enter-
as actual purchase prices, the firm is able to ing the production process,
associate major deviations from standard ● Issuing costs for material subsequent to
purchase prices with specific products or entering the production process,
product lines. ● Production planning and control costs, and
c. Inward freight costs are added to direct mate- ● Internal transportation costs.
rial cost by a rate that approximates the actu-
al cost, such as a percentage of price paid to Cost Systems
the vendor or a percentage of the weight per This Statement does not discuss standard cost
unit of cost. systems in detail and does not address how
standards should be determined. In most cases,
Material-Related Costs cost analysis and control are improved if the
Certain costs are closely related to the quantity standard material quantity includes normal scrap
of material acquired or used, but they cannot be and waste as defined in this Statement but
specifically identified with a cost object in an excludes all lost or defective units. Differen-
economically feasible manner. These indirect tiating between good units and normally antici-
costs are material-related costs. Material-related pated lost units helps focus management’s
costs should be allocated to cost objects on the attention on lost units. Additionally, including in
basis of some measure of direct material quan- direct material the standard material quantity of
tity or cost rather than on direct labor hours or both good units and normally anticipated lost
cost. Costs for the following functions usually units helps focus management’s attention on
are considered material-related costs: total material cost.

● Purchasing, The cost accounting systems of some firms, par-

● Receiving, ticularly retail firms, include many material-
● Receiving inspection, related costs as direct material cost. In such
● Material storage costs prior to purchased systems, direct material is defined more broadly
material entering production, and than in this Statement. Nevertheless, if the rele-
● Issuing costs for material initially entering the vant material-related costs are allocated on the


basis of direct material, the resulting product

costs may be substantially the same under this
Statement as under a broader definition of direct
material cost. The broader definition is useful for
certain management accounting purposes, how-
ever, it should be recognized that direct material
cost as measured in such systems—and for
other purposes—may be different from direct
material cost as measured according to the con-
cepts of this Statement.

The cost accounting systems of many firms allo-

cate material-related costs on some measure of
direct labor, as contrasted with a measure of
direct material, as recommended by this
Statement. Allocation based on direct labor is, in
many cases, easier to compute. It is likely, how-
ever, that allocation on some measure of direct
material yields a more accurate measure of both
direct and total cost of a cost object.