Material cost is the cost of materials used to manufacture a product or provide a service. Excluded from the material cost is all indirect materials, such as cleaning supplies used in the production process. Follow these steps to determine the amount of material cost to assign to a unit of production (such as a completed finished goods item):-
- Ascertain the standard quantity of the material used to manufacture one unit.
- Add the standard amount of scrap associated with manufacturing one unit.
- Determine the standard amount of scrap associated with setting up the production run, and apportion it to the individual unit.
- If any scrap is then sold, apportion the revenue back to the individual unit.
For many materials, the cost of scrap and the revenue from the resale of scrap are so small that it is not worthwhile to apportion it to the material cost.
If the material cost has been established as a standard, then you can subsequently calculate the material yield variance to see if actual materials usage was as expected, or you can calculate the purchase price variance to see if the purchase price of the material was as expected. These variances are useful for investigating problems in the production and purchasing areas of a business.