In financial accounting, inventory value is the sum of direct materials, direct labor and manufacturing overhead costs incurred to create the product. Total direct materials cost can be calculated at the end of the year to analyze inventory costs. It's also a component in work-in-progress inventory.
What's in Direct Materials
Direct materials are the raw supplies and materials used to create a product. For example, the direct materials for a company that makes packaged cookies would be items like eggs, flour, sugar, oil and plastic wrap. Direct materials do not include materials and supplies used for machinery and other equipment used to create the product. For example, replacement whisks for the mixers used to create the cookie dough would not be part of direct materials cost.
Calculating Direct Materials
Direct materials cost is the sum of all direct materials costs incurred during the accounting period. For purposes of inventory calculation, the direct materials account includes the cost of materials used rather than materials purchased. To calculate direct materials, add beginning direct materials to direct materials purchases and subtract ending direct materials. For example, say that a company had $3,000 worth of flour stock at the beginning of the year, bought $10,000 worth of flour during the year, and has $2,000 worth of flour remaining at year end. Direct materials for the period is $3,000 plus $10,000 less $2,000, or $9,000.
Direct Materials Work-in-Progress
There's usually some incomplete inventory at the end of an accounting period. For example, for a company that makes cookies, there may be some cookie dough that's in the fridge that hasn't yet been baked and packaged. Rather than counting the dough as finished inventory, it's considered to be work-in-progress inventory.
To calculate work-in-progress inventory, add the cost of direct materials to direct labor and manufacturing overhead for the incomplete inventory. Accountants typically use standard costing to estimate the value of direct materials, direct labor and manufacturing overhead in work-in-progress inventory.
For example, say that the average cookie package includes $1 of direct materials cost, $2 of direct labor cost, $3 of manufacturing overhead cost and a tub of dough makes 20 cookies. If one pound of dough is left at the end of the accounting period, the work-in progress value is $6 (the sum of direct materials, direct labor and overhead costs) multiplied by 20 cookies, or $120.