Many business owners get stuck in figuring out the differences between direct vs indirect costs. But, figuring out this difference is much needed if someone wants to operate a business successfully. You have to keep your accounting books updated, receive tax deductions, and make business decisions accordingly in the process.
So, this year we will teach you the fundamental differences between direct and indirect costs. But, before that, let’s take a look at the definitions of these indicators so that we can understand them even better.
What Is Direct Cost?
Before we explain the difference between direct vs indirect costs, let’s find out what direct cost is. When you can quickly identify the cost of a product, that is a direct cost. If you want me to elaborate, when you use some products directly for the production or manufacturing process, they are your direct costs.
For example, direct labors, direct manufacturing supplies, direct materials, direct equipment-all are direct costs. You have to add all the cost objects of direct material and direct labor to find out the total direct cost. When you categorize something under direct cost, you can always trace the cost to the thing, so it is easier to track down.
What Is Indirect Cost?
Now, the confusion of direct vs indirect costs won’t end if we don’t explain to you what indirect cost is. Indirect cost is more difficult to figure out because they are not directly attributed to the cost object.
Instead, these costs are expended on multiple cost objects. Therefore, you must ascertain the indirect costs after you have already calculated your direct costs.
For example, rent, utilities, office supplies, employee training, facility maintenance, equipment purchasing, insurance, and legal fees are indirect costs. Like the direct costs, indirect costs can also be variable or fixed once you calculate all the direct costs and subtract them from the total business cost to derive the indirect costs.
Direct Vs Indirect Costs – What Are The Differences?
The direct vs indirect costs debate won’t end if you don’t understand the critical differences between the two phenomena. So, let’s take a look at them;
|Direct costs are easily attributable to the cost objects. So, it is much easier to calculate direct costs.
|On the contrary, indirect costs are not easily attributable to the cost objects. So, it is more difficult to calculate the indirect costs.
|Direct costs are incurred on specific units, business departments, projects, and also to particular objectives.
|However, indirect costs are incurred in multiple aspects. They also provide a wide array of benefits to the company apart from generating revenue.
|Nature Of Cost
|Most of the time, direct cost is variable. That’s because these costs are involved in the production process and depend on the production output.
|But, indirect costs are primarily fixed in nature. That’s because these costs are involved in the day-to-day operations of a business, and people spend them mostly once a year.
|Name On Income Statement
|Since the direct costs are directly related to the production process, it is known as prime cost.
|However, indirect cost is termed as overhead cost in the income statement.
|The money you spend on raw materials in the production process is a direct cost. Without the production process, there won’t be anything to sell, so direct cost is the leading indicator for generating revenue.
|On the other hand, advertising is an excellent example of indirect cost. Only when the direct cost is spent, the need to spend indirect cost arises.
Frequently Asked Questions [FAQs]
We have outlined here all the possible differences between direct vs indirect costs. But, we have often found people asking us some more questions regarding this topic. So, we have hand picked a few other questions regarding direct vs indirect costs here. Let’s check them out;
1: How Do Managers Decide Whether A Cost Is A Direct Or An Indirect Cost?
Ans: Direct costs are related to the specific price of an object and can also be traced to it. However, indirect costs are also associated with the cost of an object but cannot be traced to it. That is how managers decide which price is direct and which cost is indirect.
2: What Are The Fundamental Differences Between Direct And Indirect Material?
Ans: Direct materials are consumed during the production process, but most people consider them damaged goods or excess items. However, indirect materials are also consumed during the production process, but they don’t have any economic significance. These are the fundamental differences between direct and indirect materials.
3: Is Training A Direct Or Indirect Cost?
Ans: Training is always an indirect cost because it does not directly relate to the production process. When employees are trained, they become more skilled and play a part in generating revenue. But those skills are not now required to enhance the production process, so it is not a direct cost.
4: Is Rent A Direct Expense?
Ans: No, rent is not a direct expense because rent also does not directly relate to company production. Rent benefits the entire company and not only the production process. Similarly, the utilities, office supplies, and tax charges are also indirect expenses.
Putting It All Together
We hope you have now understood the differences between direct vs indirect costs. You must go through this article more than once to grasp the concepts well. Both the prices are essential in a business operation, but they have very different implications.
So, if you understand the differences between direct vs indirect costs, you won’t have any difficulty running a business in the future. After going through this article, if you think there are some questions still unanswered in your mind, please post them down in the comment section.