Difference Between Direct Cost and Indirect Cost
Direct cost is the cost incurred by the organization while performing their core business activity and can be attributed directly in the production cost like raw material cost, wages paid to factory staff etc, whereas, Indirect cost is the cost that cannot be directly attributed to the production as these costs are incurred in general and can be fixed or variable in nature like the office expenses, salary paid to administration, etc.
If we look at the cost sheet, we will see that two types of costs stand out. The first is the direct cost, and the next is an indirect cost. Both are important for running a business.
Direct costs are costs that can be identified easily as per the expenditure on cost objects. For example, if we pick how much expenditure a business has had on purchasing the raw materials inventoryRaw Materials InventoryRaw materials inventory is the cost of products in the inventory of the company which has not been used for finished products and work in progress inventory. Raw material inventory is part of inventory cost which is reported under current assets on the balance sheet.read more, we will be able to directly point out.
In the case of indirect costsIndirect CostsIndirect cost is the cost that cannot be directly attributed to the production. These are the necessary expenditures and can be fixed or variable in nature like the office expenses, administration, sales promotion expense, etc.read more, the challenge is that we can’t identify the costs as per the cost objectThe Cost ObjectA cost object is a method that measures product, segment, and customer cost separately to determine the exact cost and selling price. read more. For example, if we try to understand how much rent is given for sitting of the machinery in a place, we won’t be able to do it because the rent is paid for the entire space, not for a particular place.
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Direct Cost vs. Indirect Cost Infographics
Let’s see the top differences between a direct cost vs. indirect cost.
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Key Differences
The key differences between these costs are as follows –
- The direct cost can be identified easily as per the cost object. Indirect costs can’t be identified easily.
- Direct cost is incurred on specific projects, units, departments, and objectives. Indirect cost, on the other hand, is incurred to provide multiple benefits to the business at large.
- Direct cost is also labeled as the variable cost since it changes as per the unit consumed/produced. Indirect cost, on the other hand, is labeled as the fixed costThe Fixed CostFixed Cost refers to the cost or expense that is not affected by any decrease or increase in the number of units produced or sold over a short-term horizon. It is the type of cost which is not dependent on the business activity.read more since it doesn’t change with the unit consumed/produced.
- As you have seen, the aggregate of direct costs is called the prime costs in the cost sheet. The sum of indirect costs, on the other hand, is called the overheads in the cost sheet.
- As an example, we can say that direct costs are the expenses incurred for the raw materials used in the production process. Since one can directly attribute how much cost is expended per unit of raw material, we call it direct cost. On the other hand, advertisement expense is an indirect cost since it benefits the organization as a whole.
Direct Cost vs. Indirect Cost Comparative Table
| Basis for Comparison | Direct Cost | Indirect Cost | ||
| Meaning | These are the costs that can be easily identified as per the cost objects. | These are the costs that aren’t easy to identify as per the cost objects. | ||
| Expended on | Particular cost objects. | Multiple cost objects. | ||
| Can be identified as | It can also be called as variable costs. | It can also be called as fixed costs. | ||
| Place in the cost sheet | It is computed at the beginning of the cost sheet. | It is ascertained after computing the direct costsDirect CostsDirect costs are costs incurred by an organization while performing its core business activity and can be attributed directly in the production cost, such as raw material costs, wages paid to factory staff, power & fuel expenses in a factory, and so on, but do not include indirect costs such as advertisement costs, administrative costs, etc.read more. | ||
| Aggregate in the cost sheet | An aggregate of direct costs in the cost sheet is called prime cost. | The aggregate of indirect costs in the cost sheet is called overhead costOverhead CostOverhead cost are those cost that is not related directly on the production activity and are therefore considered as indirect costs that have to be paid even if there is no production. Examples include rent payable, utilities payable, insurance payable, salaries payable to office staff, office supplies, etc.read more. | ||
| Can it be attributable? | Yes. | No. | ||
| Example | An example of this cost is the cost attributable to direct material, direct labor, and direct wages. | Example of this cost is rent, advertisement, etc. |
Conclusion
Understanding direct and indirect costs is essential. Because if, as a business, you don’t know how to allocate your costsAllocate Your CostsCost Allocation is the procedure of recognizing & assigning costs to different cost objects like a product, department, program, customer, etc., as per the cost driver serving as the base for this process. read more and how to attribute them correctly, you won’t be able to find out the profit per unit after selling your products/services.
As you already know, direct costs are identifiable. The challenge the business faces is with indirect costs.
For unidentifiable costs, the business can see how much they can expand on a long term basis, and then they can measure the benefit.
It is similar to understanding fixed and variable costs. If you understand how they work, it would be easier for you as a business to use them for your advantage.
Direct vs. Indirect Cost Video
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This article has been a guide to Direct Cost vs. Indirect Costs. Here we discuss the top differences between them along with infographics and comparison table. You may also have a look at the following articles for gaining further knowledge in Accounting –
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