Raw Materials

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21 Aug, 2024

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Raw materials refer to unfinished substances or unrefined natural resources used to manufacture finished goods. These materials undergo processing and transformation into intermediate substances, further used to make final products for sale. Examples include cotton, crude oil, coal, raw biomass, rubber blanks, mineral ores, wood, etc.

Sometimes known as primary commodities, these unprocessed or less processed materials are critical components of primary production. There may be direct or indirect materials, depending on their use in the production of end products. These factors of production trade on commodities exchanges. They also play a crucial role in the economic growth of a nation.

Raw Material Definition

Raw materials meaning describes unprocessed substances or natural resources used to manufacture finished products for sale. They form an integral part of the inventory management and factors of production.
Primary commodities can be plant-based (corn, lumber, and sugar), animal-based (like leather, wool, and silk), and mineral-based (iron ore, natural gas, coal, and precious metals).
Multiple countries depend on their mineral reserves that act as unfinished materials for other countries. These factors of production play a crucial role in their economic growth.
Classification of unfinished materials into direct (used directly in the final product) and indirect (utilized only in the production process of the end product) will make their accounting more straightforward.

Understanding Raw Materials

Raw materials form an essential aspect of inventory management for manufacturing businesses. Hence, keeping track of these supplies becomes critical to avoid any production issues. Almost everything manufactured and sold comes from processing unfinished materials dug up from the earth. For example, steel is a raw commodity for the automobile industry.

Naturally available in different forms, these resources act as primary inputs in the mass production of several products. On the other hand, recyclable waste becomes a secondary commodity in the manufacturing of finished goods.

Many countries rely on their mineral reserves, which serve as unprocessed materials for others. Also, a country with abundant natural resources has the potential of becoming a self-sufficient economy.

Export is the ideal way for nations to generate revenue to improve their domestic production and create more jobs. However, exporting raw or unfinished materials could be detrimental to a country's economy. For example, importers opt-out of such an agreement because of export taxes and restrictions imposed by the exporter, which affects the former's revenue collection.

Sources Of Raw Materials

These materials can be classified into three categories, depending on how they are derived:

Animal-Based: Agro-industries are the most common users of these commodities. Textile, leather, dairy, and other industries, process substances like leather, wool, silk, etc., to produce finished products.
Plant-Based: These are forestry and agriculture-derived materials. Sometimes referred to as vegetable-based unrefined resources, this category of unprocessed substances includes sugar, cellulose, cooking oil, corn, lumber, cork, cotton, etc.
Mineral-Based: These materials obtained through extraction include clay, sand, marble, iron ore, gasoline, natural gas, coal, precious metals, etc. Substances from this category are utilized in industrial settings or carving beautiful jewelry items.

Practical Examples

Let us consider the following raw materials examples for an in-depth understanding of the concept:

Example #1

A study conducted by the Organization for Economic Co-operation and Development (OECD) examined how mineral commodity exports can contribute to overall economic growth. It analyzed export restrictions on metals and minerals put forth by four African nations.

Gabon, South Africa, Zambia, and Zimbabwe banned the export of copper, manganese, lead, chromite, respectively, to encourage domestic downstream industries. OECD studied their export control measures, such as export tariffs, outright export bans, and non-automatic export license requirements.

The study revealed that these restrictions did not do any good to downstream mineral processing industries. On the contrary, the results harmed the mining sector. It also indicated that the economic impact of export restrictions depends on the mineral that a particular country exports.

The phenomenon where a nation has plenty of natural resources to benefit from but still suffers from a lack of economic growth and development is termed "Dutch disease" or "resource curse." The OECD concluded that reducing mineral export obstacles can have a favorable impact on global economic prosperity.

Example #2

Recently, the European Union and Ukraine signed a Memorandum of Understanding (MoU) to boost raw material supplies after the negative impact of COVID-19 on various industries. These supplies will help support green and digital projects in defense, aerospace, automotive, renewable energy, healthcare, electronics, and other industries.

It came following the introduction of the Action Plan on Critical Raw Materials by the European Commission in September 2020. In 2020, the EU announced to increase supplies of bauxite, strontium, titanium, and lithium to reinforce mineral supply chains post-pandemic economic recovery.

Accounting For Raw Material

Budgeting and accounting of raw materials inventory on a balance sheet are critical for manufacturing units. In the balance sheet, the inventory label lists unprocessed commodities as current assets. An entry is made in the debit side of the inventory account when documenting an unrefined resource. On the other hand, the accounts payable account shows the purchase of these materials as a credit.

After the completion of the production, the finished goods inventory is debited while the work in process account is credited. Also, if the production process is short, the work in the process portion is omitted.

Categorizing raw or unfinished materials into direct and indirect will make the accounting process simple.

Direct Materials – These are primary input goods or unprocessed resources, such as wood, cotton, etc., used directly by companies to manufacture a finished product. For direct materials, the work in process account is debited with unrefined materials used for the manufacturing process. On the contrary, the same account is credited when there is no inventory.
Indirect Materials - These are unprocessed materials that do not directly form a part of the end product. Instead, they contribute to its production only. Examples of these long-term factory supplies include glue, tape, oil, etc. Additionally, accounting of indirect materials used in the manufacturing process considers their nature and type.

A separate inventory account tracks the historical cost of direct materials. When goods are sold, raw materials prices reflect in the Cost of Goods Sold (COGS) account. The overhead account is debited for indirect materials, and the raw materials inventory asset is credited. The remainder is subsequently split between the cost of goods sold and closing stocks after the accounting period.

Frequently Asked Questions (FAQs)

What is the raw materials?

Raw materials are unfinished materials or natural resources used to produce or manufacture finished products for sale. These materials can be used in their unprocessed or processed form as found suitable. Examples include cotton, crude oil, coal, rubber blanks, mineral ores, wood, etc.

What are the two types of raw materials?

Direct materials are substances used directly by companies to manufacture a finished product. These include unrefined natural resources like wood, cotton, etc.

Indirect materials do not directly form a part of the finished product but contribute to its production. Examples of these long-term assets include glue, tape, oil, etc.

What is the basic rule of accounting for raw materials?

In the balance sheet, the inventory label puts unfinished materials as a current asset. An entry is made in the debit side of the inventory account while recording the unprocessed material. The acquisition of primary commodities is shown as a credit in the accounts payable account.