The direct costs are those expenses that can be directly associated with a product, department or cost object.
With the new costing techniques introduced by cost accounting, now total product costs are divided into two different categories. One is called direct costs and the other is called indirect costs.
Direct costs are also termed as variable costs as they vary with the change in volume of production while remains fixed for each unit of production. For example, the cost of material and labor used for the manufacturing of a product are direct costs.
Sometimes an overhead expense may also be considered as a direct cost, for example, if a manager is directly attributed to a project or production process, his salary may also be considered as a direct cost for the specific project or department. A common example of direct costs is labor, material, and fuel.
The indirect costs are sometimes fixed and sometimes variable but these costs are not directly related to a cost object.
Common examples of indirect costs include premises rent, salaries, and wages for the production department, insurance, depreciation for the period and interest rate.
Let discuss some examples for better understandings.
Let’s consider a plastic company name ABC. The company is making two products one is plastic buckets for adults and children and the other product is disposable plates and buckets.
The cost of plastic used to manufacture buckets is considered as a direct cost because this cost is easily proportionate to one unit of the plastic bucket.
While the cost of electricity for the period will be considered as an indirect cost because the electricity is not solely used for plastic tubs.
The cost of labor engage directly in the manufacturing process is also considered as a direct cost. While the salaries and wages of other staff are considered indirect costs.
The common examples of direct costs are:
- Wood in making furniture
- Leather in the manufacturing of leather products like shoes and jackets.
- Direct labor used in manufacturing and providing services.
- Any material used in the manufacturing of the product is considered as a direct cost for that product.
- Any cost related to the operation and supervision of a specific project is considered as a direct cost for that project.
Benefits of Using Direct Costing Methods:
The benefits of using the direct costing method are that it provides reasonable information to the management for decision making about the product and pricing of the product.
Also, it is relatively easy to control direct costs by efficient management as compared to indirect costs or overhead costs. Following are the common advantages of using direct costing methods:
- It helps in making a master budget for the year as direct costing provides variable per unit cost.
- Variable costs allow you to analyze the cost-volume relationship or breakeven point for your business. Breakeven is the sale volume at which there is no profit & loss for the business.
- Once the direct and indirect costs are determined, then it becomes easy for management to decide a good price for their product.
- It provides more control to the management on organization operations as direct costing pinpoints the responsibility according to organizational lines.