Direct materials is a term used in cost accounting when determining all of the costs that are directly assignable to each unit of production, cost center, or work order. These actual costs are compared to standard costs and production variances are determined. Unfavorable variances typically are investigated further to determine the causes.
A subtopic of cost accounting is standard costing. This is the method of comparing the actual costs of a product to a predetermined standard cost. Standard costs of direct material, direct labor, and manufacturing overhead are applied to the production units and the actual costs are then compared.
There are almost always production variances, and these undergo a variance analysis. Unfavorable production variances usually indicate to management that the company’s profits will also be unfavorably affected. Generally, the faster they find out about these variances the sooner they can try to correct the cause.
Direct materials are taken from a direct materials inventory, which is one of the accounting items that go into the units of production. Two variances are derived from this: direct materials price variance and direct materials usage variance. Direct material price variance is the actual price minus the standard price multiplied by the actual quantity of goods produced in a time period.
In contrast, direct material usage variance involves the actual units of production minus the standard units of production multiplied by the standard price. It is also known as direct materials quantity variance or the direct materials efficiency variance. A favorable variance would be when the actual costs per unit are less than the estimated standard costs. The reverse would hold true for an unfavorable variance.
Generally, direct materials is a cost that is connected to an inventory account. Also, they are connected to production variances that directly affect a company’s profits in a favorable or unfavorable way. Other costs that are treated in a similar manner include direct labor, variable manufacturing overhead, and fixed manufacturing overhead.