Direct Costs

What is Direct 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, power & fuel expenses in a factory, etc. but doesn’t include indirect costs like advertisement expenses, administrative expenses, etc.

These costs can be identified easily as per the expenditure on cost objectsCost ObjectsA 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 pick how much expenditure a business has had on purchasing the raw materials inventory, we will be able to directly point out.

Direct Cost Colgate 1

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What is Cost object in Direct Costs?

  • A cost object is a particular unit for which cost can be identified. The most common form of a cost object is the company’s products/services. It is the output of the company. Other than that, we can also identify process, production line, department as costs objects since they can be identified as cost units.
  • Cost objects can be outside the company as well. For example, a cost unit can be accumulated costs for suppliers or customers.

Direct Cost Examples

Example 1

Example: ABC Factory has the following information, and from the below-furnished information, you need to calculate per unit cost of salesCost Of SalesThe costs directly attributable to the production of the goods that are sold in the firm or organization are referred to as the cost of sales.read more.

Find out the cost of sales per unit.

In this direct cost example, every input is given. We just need to put the figures in the right place.

Statement of Cost of ABC Factory

ParticularsAmount (In US $)
Raw Materials – Opening Stock100,000
Add: Purchases during the period225,000
Less: Raw Materials – Closing Stock(70,000)
Cost of material consumed255,000
Add: Direct Labour120,000
Prime Cost375,000
Add: Works overheads35,000
Works Cost410,000
Add: Administration overheads26,000
Cost of Production436,000
Add: Selling & Distribution overheads38,000
Total Cost of Sales474,000
Finished Units200,000 units
Cost of Sales per unit$2.37 per unit

Example 2

Let’s say that Company Q has two departments. The first department A consumed 1000 units of electricity for August, and the second department B consumed 1200 units. Electricity Board charges typically $1 per unit. How many departments A and B would cost?

For two departments, Company Q would pay –

  • Department A = (1000 * $1) = $1000.
  • Department B = (1200 * $1) = $1200.

That means here we can see that the cost of each department (cost object) can be identified, and at the same time, the cost is variable because the cost would increase/decrease as per the units consumed (variable cost).

Direct Cost vs. Variable Cost

Direct costs are often called variable costs. But how true is it?

If we look at a business, we will see that the business has two types of costs for producing goods or services, and they do not concern cost objects. These two kinds of costs are called – fixed costs and variable costs.

We know that there’s an element of attribution in the direct costs, which we can see in the variable costs too since the variable cost will only increase or decrease as per the units consumed/produced.

So, we can label direct costs as variable costs.

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This article has been a guide to Direct Cost definition and its meaning. Here we take its examples along with the concept of cost objects as direct costs and indirect costs.  You may learn more about accounting from the following recommended articles –

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