Is purchasing raw materials an expense?

What is Raw Materials Inventory?

Raw materials inventory is the total cost of all component parts currently in stock that have not yet been used in work-in-process or finished goods production. There are two subcategories of raw materials, which are:

• Direct materials. These are materials incorporated into the final product. For example, this is the wood used to manufacture a cabinet.

• Indirect materials. These are materials not incorporated into the final product, but which are consumed during the production process. For example, this is the lubricant, oils, rags, light bulbs, and so forth consumed in a typical manufacturing facility.

Presentation of Raw Materials Inventory

The cost of raw materials on hand as of the balance sheet date appears in the balance sheet as a current asset. Raw materials may be aggregated into a single inventory line item in the balance sheet that also includes the cost of work-in-process and finished goods inventory.

Accounting for Raw Materials Inventory

Raw materials of all types are initially recorded into an inventory asset account with a debit to the raw materials inventory account and a credit to the accounts payable account. When raw materials are consumed, the accounting treatment varies, depending on their status as direct or indirect materials. The accounting is:

• Direct materials. Debit the work-in-process inventory account and credit the raw materials inventory asset account. Or, if the production process is brief, bypass the work-in-process account and debit the finished goods inventory account instead.

• Indirect materials. Debit the factory overhead account and credit the raw materials inventory asset account. At the end of the month, the ending balance in the overhead account is allocated to the cost of goods sold and ending inventory.

Raw materials may sometimes be declared obsolete, possibly because they are no longer used in company products, or because they have degraded while in storage, and so can no longer be used. If so, they are typically charged directly to the cost of goods sold, with an offsetting credit to the raw materials inventory account.

Materials requisition, the movement of materials into the production process, is one of the early stages in the manufacturing of goods. The entire production process is recorded in the financial records of the company, and each stage of the process has its own journal entries. However, this doesn't mean that the overall inventory account balance actually changes. Learning the journal entries of the production process can help you determine the effects of production on the balances of balance of inventory or any other account.

Purchase of Raw Materials Journal Entry

When you initially purchase materials for use, you record the purchase in the accounting records at cost. This entry consists of a debit to raw materials inventory and a credit to accounts payable or cash, reports Accounting Tools. The entry increases the total inventory account. If you make the purchase on account, it also increases current assets and current liabilities. However, if you make the purchase with cash, assets do not change. Because raw materials inventory is a permanent account, the purchased materials will remain at cost until you use the materials in production.

Requisitioning Materials

Requisitioning materials, also known as putting materials into production, is the second step in the production process. Company accountants must account for direct and indirect materials separately. The journal entry for direct materials, that is, materials that can be directly traced to products, is a debit to the work in process and a credit to the raw materials inventory accounts.

Record indirect materials, materials that cannot be directly traced to products, as a debit to the manufacturing overhead account and a credit to raw materials inventory. Because the requisitioning process is a transfer between two inventory accounts, the overall inventory balance on the financial statements does not change.

Finished Goods

Once goods are completed, you transfer costs out of the work in process account and record them as finished goods. Make this entry as a credit to work in process and a debit to finished goods. Like a requisition, this entry is a transfer between two inventory sub-accounts, and the overall inventory balance does not change. The cost of goods manufactured will remain in the finished goods inventory account until the goods are sold, reports Bank of America.

Cost of Goods Sold

The last step in the inventory process is to sell goods to customers. Record this step in the process as a debit to the costs of goods sold account and a credit to finished goods inventory. In addition, the company will record a credit to the sales account and a debit to the accounts receivable or cash account. The first entry accounts for the cost of the product, and the second entry accounts for the revenue from the sale.

The difference between the two entries is the gross profit on the sale. The movement of cost from finished goods to cost of goods sold decreases assets and increases expense. However, the recognition of the sale of the goods in the second entry increases revenue and assets. If the item is sold at a profit, the increase in revenue in the second entry will be greater than the increase in expense in the first entry.

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Is purchase of raw material an asset?