Difference Between Direct and Indirect Cost
The key difference between direct and indirect cost is that 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 there are two types of costs that 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 inventory, we will be able to directly to point out.
In the case of indirect costs, the challenge is that we can’t identify the costs as per the cost object. 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.
In this article, we will try to understand the comparative analysis between direct and indirect cost
Let’s get started.
Direct Cost vs Indirect Cost Infographics
Key Differences Between Direct and Indirect Cost
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 cost 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 aggregate 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.
|Basis for Comparison||Direct Cost||Indirect Cost|
|1. 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.|
|2. Expended on||Particular cost objects.||Multiple cost objects.|
|3. Can be identified as||It can also be called as variable costs.||It can also be called as fixed costs.|
|4. Place in the cost sheet||It is computed at the beginning of the cost sheet.||It are ascertained after computing the direct costs.|
|5. Aggregate in the cost sheet||Aggregate of direct costs in the cost sheet is called prime cost.||The aggregate of indirect costs in the cost sheet is called overhead cost.|
|6. Can it be attributable?||Yes.||No.|
|7. 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.|
Understanding direct and indirect costs is important. Because if as a business, you don’t know how to allocate your costs and how to attribute them properly, 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 costs and variable costs. If you understand how they work, it would be easier for you as a business to use them for your own advantage.
Direct vs Indirect Cost Video
This has been a guide to Direct vs Indirect Costs. Here we discuss the top differences between direct costs and indirect costs along with infographics and comparison table. You may also have a look at the following articles for gaining further knowledge in Accounting –