Direct Vs Indirect Costs Explained

We are continuing our Cost Accounting Series today by discussing direct vs indirect costs. (#directVsIndirectCosts) Direct Costs are easy to explain. They are the costs directly linked to producing a product or service. Where indirect costs (#indirectCosts) cannot be directly linked to the product or service.

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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Cost Object

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.

Direct 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.

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.

Another example is the salary of staff in corporate headquarters.  The staff does not produce a product or provide a service.  They support those individuals within the company that does create a product or provides a service.  Therefore, the staff in the corporate headquarters would be considered an indirect cost. 

In Summary

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.

Another example would be the rent for a manufacturing plant that produces multiple car models at this location. I hope that you enjoyed this video.  Please remember to subscribe to the channel, and until next week, please be safe.

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