Direct Cost vs Indirect Cost

Updated on April 11, 2024
Article bySayantan Mukhopadhyay
Edited bySayantan Mukhopadhyay
Reviewed byDheeraj Vaidya, CFA, FRM

Difference Between Direct Cost and Indirect Cost

Direct cost is the cost incurred by the organization while performing its core business activity. It can be attributed directly to 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 the indirect cost. Both are important for running a business.

Direct costs can be easily identified as per the expenditure on cost objects. So, 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. So, for example, if we try to understand how much rent is given for sitting 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.

Direct Cost vs Indirect Cost

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Direct Cost vs Indirect Cost (wallstreetmojo.com)

Direct Cost vs. Indirect Cost Infographics

Let’s see the top differences between a direct cost vs. indirect cost.

Direct Cost vs Indirect Cost

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Direct Cost vs Indirect Cost (wallstreetmojo.com)

Financial Modeling & Valuation Courses Bundle (25+ Hours Video Series)

–>> If you want to learn Financial Modeling & Valuation professionally , then do check this ​Financial Modeling & Valuation Course Bundle​ (25+ hours of video tutorials with step by step McDonald’s Financial Model). Unlock the art of financial modeling and valuation with a comprehensive course covering McDonald’s forecast methodologies, advanced valuation techniques, and financial statements.

Key Differences

The key differences between these costs are as follows –

  • 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 cost refers to the cost of operating core business activity—production costs, raw material cost, and wages paid to factory staff. Such costs can be determined by identifying the expenditure on cost objects.read more.
Aggregate in the cost sheet An aggregate of direct costs in the cost sheet is called prime costPrime CostPrime cost is the direct cost incurred in manufacturing a product and typically includes the direct production cost of goods, raw material and direct labour costs. It is an essential part of total manufacturing expenses. Costing and effective pricing of the goods are primarily determined on their basis.read more. 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 it can expand on a long-term basis and then 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 to your advantage.

Direct vs. Indirect Cost Video

 

Recommended Articles

This article is a guide to Direct Costs vs. Indirect Costs. Here we discuss their top differences, infographics, and comparison tables. You may also have a look at the following articles for gaining further knowledge in Accounting –