What is Raw Material Inventory?
The raw material inventory can be defined as the initial input materials for the production of work in process inventory and finished goods. They can be purchased from the wholesale market, and the marketplace where the traders facilitate the buy and sell of the raw materials are termed as the factor market.
The inventories in the business can be bifurcated to three broad types, namely raw materials, work in process, and finished goods. The raw materials can be termed as the initial input that is employed by the manufacturing business to initiate production for work-in-process and finished goods inventory. Therefore, the manufacturing business performs the budgeting of line items in detail, which further requires the adoption of a special framework that gets incorporated on the accounting front in the balance sheet and the income statement.
The raw materials can be termed as those items that are in stock but have not been utilized for work-in-process and finished goods production. The raw materials can be bifurcated into direct materials and indirect materials. The direct materials can be termed as those components that form the part of the final product.
The indirect materials are those raw materials that do not form the part of the actual and final finished goods, but rather it acts as a raw material for the work-in-process inventory, and they tend to get consumed in the process of production. Indirect materials generally comprise of lubricant, oils, rags, and light bulbs.
How to Calculate Raw Material Inventory?
The computation of raw materials varies on the basis of their nature and type, such as direct materials and indirect materials. The raw materials are generally recorded with a debit treatment to the asset account for the inventory, and credit treatment in the liabilities account for the account payable. The direct materials are regarded as the debit in the work in process inventory and similarly as a credit to the asset account of raw materials.
The indirect materials are recorded as a debit to the factory overhead account and as a credit to the account of raw materials. Therefore, in order to compute the final balance of the raw materials, take up the beginning balance of the raw materials. Next, deduct the raw materials that are utilized for either work in process or in the finished items inventory. Finally, add any purchase of raw material for the accounting period to arrive at the ending balance.
The following would be the formula for the raw materials inventory: –
Ending Balance of Raw Materials = Beginning Balance of Raw Materials – Raw Materials Utilized + Raw Materials Purchased.
Example of Raw Material Inventory
Let us take the example of a manufacturing business ABC Corp. The business had raw materials amounting to $32,000. The Business utilized raw materials amounting to $23,000 in the finished goods. Additionally, the business made purchases of raw materials amounting to $20,000. Help the management determine the ending balance of the raw material.
Compute the ending balance of the raw material as displayed below: –
Ending Balance of Raw Materials = Beginning Balance of Raw Materials – Raw Materials Utilized + Raw Materials Purchased
- Ending Balance of Raw Materials = $32,000 – $23,000 +$20,000
- Ending Balance of Raw Materials = $29,000
Therefore, the ending balance of the raw materials is at $29,000.
Importance of Raw Material Inventory
The raw materials form a critical part of any manufacturing business as it is the starting input for initiating production. A business cannot produce finished goods or marketable goods if it does not have an inventory of raw materials to start it. They have to be utilized quickly as well as such items are perishable in nature. The raw materials can also be used as collateral as well. The cost management of the raw materials forms the key component to successful inventory management and production process.
Raw Material Inventory vs Finished Goods
The raw materials can be regarded as input for the finished goods. The finished goods are the final version of the business’s products or produce using the desired or correct levels of the raw materials. The raw materials can not be marketed directly as they are not complete or not in the desired state to be marketed to the consumers, whereas finished goods can be marketed and sold directly. Therefore, the cost of raw materials is recognized when purchasing such items, whereas the effective value of finished goods is arrived at as per the accounting basis fair market value.
Some of the benefits are given below:
- The raw materials offer benefits in terms of reusability between transitional production process.
- The raw materials are the building blocks of the manufacturing and production business.
- Some type of raw materials can be marketed to manufacturers that generally utilize similar raw materials to get the desired level of finished goods.
- The best example can be that of oil. The oil as the raw material can be processed to form petrol, whereas it could also be utilized to produce Vaseline or lubricants as finished goods by some other manufacturer.
Some of the disadvantages are given below:
- The raw materials are in perishable form and have to be utilized immediately on procurement.
- The raw materials can get damaged in the process of transit itself.
- If the management fails to deduce the optimum amount and quantity of raw materials, then it could hamper the production process.
- If not utilized in a timely fashion, the raw materials can also become obsolete as an input for the production process, and this can further add to the effective carrying cost of the manufacturing business.
The raw materials are one of the variants of the inventories. It is utilized by the manufacturing business to initiate production, which in turn results in finished goods. The raw materials can further be bifurcated into direct and indirect materials.
This is a guide to Raw Material Inventory. Here we also discuss the definition and how to calculate raw material inventory? Along with benefits and disadvantages. You may also have a look at the following articles to learn more –