Hi, my name is Nancy and today I am going to continue our cost accounting series by explain the difference between direct and indirect costs.
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Before we get into the difference between direct and indirect costs, we need to start with what is a cost object. A Cost Object refers to a product or service which costs needs to be tallied. Another way to think of a cost object is something that costs are assigned. For a construction business this would be an individual project. For example, building a custom home. Another example, a bank would say that their cost object would be their accounts. For a car manufacturer it would be the model of car produced at its factory. For a bank it would be its accounts. I think you get the idea. Now, we can start move on to direct and indirect costs.
There are two types of costs associated with the cost object. First is a direct cost. Direct Costs are any costs linked to a service product, project, organizational unit, or activity. An example would be the cost of lumber for a construction project. Another example would be the cost of wheels and tires for a car manufacturer. Next, I will discuss the indirect costs.
Now the second cost is indirect costs. Indirect costs are costs that cannot be directly traced to a product, service, project, organizational unit, or activity. Indirect costs are allocated rather than being traced to individual products or services, as there is not a cost-effective way to trace them directly. An example would be the rent for a plant used to manufacture cars of multiple varieties. This cost cannot be directly traced to only one car model. Now, if only one model of the car were produced, then it would be a direct cost.
To summarize what we learned today, a cost object is a product or service where costs are assigned, whereas a direct cost is a cost that can be assigned to a cost object. A direct cost can be directly traced back to the product or service. Now, an indirect cost cannot be directly traced back to the cost object, otherwise known as the product or service. An example of indirect costs would be headquarters employees who support those employees who provide the service or produce the product.
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