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Indirect Materials

See Also:
Indirect Labor
Audit Committee
Managed Sales And Use Tax Audit Programs
Mining the Balance Sheet for Working Capital
Inventory to Working Capital

Indirect Materials Definition

In accounting, the indirect materials definition is a category of indirect cost. Indirect materials are materials used in a production process, but they are not directly traceable to a cost object. Consider these costs as overhead costs. Then treat them accordingly.

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Indirect Materials Example

It is not always easy to distinguish between direct and indirect materials. Some materials may be used in the production process or in the services provided; however, you would still consider them indirect because they are not monetarily significant or not conveniently traceable. Let’s look at an indirect materials example…

For example, spices added to a hot sauce during the production of the sauce. The spices are necessary for the recipe, but they are not easily traceable. Instead, consider those spices indirect materials and treat them as such.

Another simple example of this could be office supplies at a service company. In order to provide the service, you may need to have office supplies, such as pens, paper, and staplers. But these costs are not substantial enough and not directly traceable to the service provided. So they are treated as indirect material costs and part of overhead.


Treat indirect materials, like other indirect costs, as overhead. Either expense them in the period in which they are incurred, or allocate them to a cost object via a predetermined overhead rate. Want to check if your unit economics are sound?  Download your free guide here.

Indirect Materials, Indirect Materials Definition, Indirect Materials Example

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Indirect Materials, Indirect Materials Definition, Indirect Materials Example

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Direct Materials

See Also:
Direct Cost vs Indirect Cost
Direct Labor
Cost Driver
Direct Labor Variance Formulas
Direct Material Variance Formulas
Absorption Cost Accounting

Direct Materials Definition

In accounting, direct materials are the resources used to make a product. You must clearly link these resources to the product you are producing. Direct material costs are one of the costs associated with producing a product. Furthermore, direct materials are in contrast to indirect materials. Indirect materials are materials used to produce a product not clearly linked or traceable to the final product.

Examples of direct materials include the following:

  • Wood used to make tables
  • Glass used to make windows
  • Fabric used to make furniture

Direct Material and Overhead Allocation

Sometimes it may be appropriate to use direct materials as a cost driver to allocate indirect costs to a production process.

Indirect costs, such as overhead costs, are not directly traceable to the final product; however, they are necessary for the production of the process. Therefore, incorporate them in the overall cost of the product and then allocate them to the final product by way of a cost driver.

In production processes in which direct material is an appropriate cost driver, on can allocate indirect costs to the cost of units of output via direct material. The measurement of the cost driver depends on the type of material. If it’s wood, then the cost driver may be based on feet of wood used, or pounds of wood used.

Using direct materials as a cost driver requires quantifying the direct material with some physical or otherwise quantifiable measure. Then allocate indirect costs to the units of output using a cost driver rate, such as $2 dollars per foot of wood, or $0.40 per square foot of fabric, depending on what direct material you use and the specifics of the production process.

direct materials


Hilton, Ronald W., Michael W. Maher, Frank H. Selto. “Cost Management Strategies for Business Decision”, Mcgraw-Hill Irwin, New York, NY, 2008.


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Construction Accounting

See Also:
Progress Billing for a General Contractor
Cash Flow Statement
How to Select Your Commercial Insurance Broker
Chief Financial Officer (CFO)
Financial Ratios

Construction Accounting Definition

Construction accounting, a type of project accounting, is the method for financially tracking the progress of a construction job. This is essential for bidding, request-for-proposals, project management, invoicing, construction retention payments, and more.

The process of construction accounting management involves monitoring both costs and revenues. Costs fall into 3 main categories: Direct (Direct Labor, Direct Materials, etc.); Indirect (Indirect Labor, Indirect Materials, etc.); and selling, general, and administrative.

To account for revenue, compare the expected project value to the approximate percentage of completion of the project. Over time, you will receive cash with completion invoices. A final payment made upon satisfactory completion of the job. The construction retainer is the final payment because it retains the contractor until that the project is completed.

Construction accounting and financial management involves monitoring draw, progress billing, work-in-progress, and a slew of construction accounting methods which range from GAAP compliant to industry-specific. Generally, the industry has accepted a series of unique methods of financial reporting that are not present anywhere else. These aid in construction accounting and taxation.

Construction Retention Definition

Construction retainage is the final amount of payment kept, by the customer, to ensure satisfactory completion of a project. In both residential and commercial construction, construction retainage is also referred to retention money. Although it is extremely common to the construction world, you can use this method of quality control in other places.

In the world of construction, retention accounting occurs in a similar method as above. Projects are paid with increasing completion until finished. Then, the customer will examine the project, with the project manager, to ensure that it meets their needs. The customer makes the final payment once this is agree upon. To contractors and other workers in construction, this is when retention release has occurred.

Laws exist to protect the investment of the customer as well as the contractor. Laws vary from state to state. An attorney that is experienced with construction retention laws should deal with any discrepancies. In the event of unacceptable or negligent construction, recovery of the retainage is a possibility. Maintain every document and record for each client and each project so that in the event of a disagreement, you will have support to your case.

Construction Accounting Example

The founder of Cabinetco, a custom cabinetry builder, is Maggie. Her projects, pieces of art in their own right, have continuously pleased customers. Maggie, over time, has become well versed in the process of accounting for her projects.

Maggie begins her projects with a Request-for-proposal, or RFP. Her records of past projects allow her to closely estimate the total cost of each new project. Upon this foundation Maggie makes a bid for the estimated cost of each project. In her experience, customers are always pleased when they pay less than the estimate. Therefore, Maggie makes sure to present customers an estimated cost which will be less than her billed price. She does this with a keen eye so as to ensure consistent profitability on each project.

Maggie knows that her bid price does not drive her business: customers do. She has made great efforts to present excellent work and has created happy customers. Word-of-mouth is her most effective marketing message. This leverage allows her to negotiate the lowest retainage payment possible. Maggie knows the importance of cash flow in the survival of her business.

How To Account on Long Projects

Once Maggie has confirmed her bid with a customer she begins building. She then orders the perfect materials and has a trusted team to subcontract her building. Her role in this process is as a project manager. Her ability to control quality drives word-of-mouth recommendations to Cabinetco.

On long projects Maggie sends regular invoices. These state the percentage of completion on the project, the payment due for that level of completion, expected date to the next invoice or benchmark, and other details.

Maggie, finally, presents the project to the customer. She knows that every time she sees a happy face she is retaining customers as well as defining her brand. She then sets a date for final completion and invoices for her project retainage.

Maggie has cracked the code to success in her business. To her, it is about accountability, over-delivering, and project management.

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construction accounting

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