Direct vs Indirect Costs
Companies experience a number of expenses in their day to day business activities. Some of these expenses can be directly associated with the production of goods and services while some of the expenses cannot be directly related to any product or project in particular. These costs are known as direct and indirect costs. Understanding the difference between these two types of costs is important to calculate the total cost of production accurately. The article that follows offers a clear explanation on each type of cost and shows with examples how they are different to one another.
Direct Cost
Direct costs are costs that can be directly related to the production of goods and services. Direct costs can be found in any type of business and could be found in the stages of research and development, manufacturing, marketing and sales. The key to identifying direct costs is to see which costs apply only to a specific project and cannot be attributed to other business activities. In order for the cost to be a direct cost, the expenses should have been incurred for that particular product, service, or project. For example, for a company that produces furniture, the funds that are spent on wood, paint, varnish, and the labor cost for hiring a craftsman will be direct costs. This is because these costs can be directly associated with the production of the furniture.
Indirect Cost
Indirect costs are costs that cannot be directly associated with the production of goods and services. Indirect costs are associated with not just one particular project or product, but with the entire business operation. Taking the previous example into consideration; indirect costs for a furniture business would be the rent that is paid for the building and office space, utility bills, administrative expenses, etc. Furthermore, the expenses that are associated with the accounting, legal, and clerical operations are considered to be indirect costs as they benefit the entire business operation and is not focused on one project or product. One of the main features of indirect costs is that it is very difficult to allocate these expenses to various units within the organization.
What is the difference between Direct and Indirect Cost?
A company accounts for two different types of costs; direct costs and indirect costs. Direct costs are the costs that can be directly associated to a particular project, product, service, etc. These costs include raw material cost, labor cost, and other direct expenses. Indirect costs are costs that benefit the entire business operation as a whole and are not focused on just one product or service. Examples of indirect costs include utility bills, rent, insurance on premises, legal costs, accounting expenses, etc. The man difference between direct and indirect costs is that direct costs can be charged directly to a particular product, service or unit. Indirect costs need to be apportioned among the various departments within the organization by using some method of allocation.
Summary:
Direct vs Indirect Cost
• Direct costs are costs that can be directly related to the production of goods and services.
• Indirect costs are costs that cannot be directly associated with the production of goods and services.
• The main difference between direct and indirect costs is that direct costs can be charged directly to a particular product, service, or unit. Indirect costs need to be apportioned among the various departments within the organization by using some method of allocation.