Direct and Indirect Costs

Costs that are assigned to cost objects can be divided into two broad categories Direct and Indirect costs. Both categories can be further divided into direct and indirect material costs, and direct and indirect labour costs Each of these categories is discussed in the following sections.

Direct Materials

Direct materials represent those material costs that can be specifically and exclusively identified with a particular cost object. Where the production of products or the provision of services represent the cost object, the cost of direct materials can be directly charged to the products or services because physical observation can be used to measure
the quantity consumed by each individual product or service. in other words, direct materials become part of a physical product or are used in providing a service. For example, wood used in the manufacture of different types of furniture can be directly identified with each specific type of furniture such as chairs, tables and bookcases.

Direct Labour

As with direct materials. direct labour costs represent those labour costs that can be specifically and exclusively identified with a particular cost object Physical observation can be used to measure the quantity of labour used to produce a specific product or provide a service. The direct labour cost in producing a product includes the cost of
converting the raw materials into a product, such as the workers on an assembly line at Nissan Cars or machine operatives engaged in the production process in the manufacture of televisions. The direct labour cost used to provide a service includes the labour costs in providing a service that can be specifically identified with an individual client in a firm of accountants or the labour costs that can be identified with a specific repair in a firm that repairs computers.

Indirect costs

Indirect costs cannot be identified specifically and exclusively with a given cost object. They consist of indirect labour, materials and expenses. Where products are the cost object the wages of all employees whose time cannot be identified with a specific product represent Examples include the labour cost of staff employed in
the maintenance and repair of production equipment and staff employed in the stores department. The cost of materials used to repair machinery cannot be identified with a specific product and can therefore be classified as Examples of indirect expenses, where products or the provision of a service are the cost objects, include lighting and heating expenses and property taxes. These costs cannot be specifically identified with a particular product or service

Overheads

The term overheads is widely used instead of indirect costs. In a manufacturing organization overhead costs are categorized as either manufacturing administration and marketing (or selling) overheads include all the costs oi
manufacturing apart from direct labour and material costs. Administrative overheads consist of all costs associated with the general administration of the organization that cannot be assigned to either manufacturing, marketing or distribution overheads.

Examples of overheads

  • Top-executive salaries costs
  • General accounting costs
  • Secretarial costs
  • Research and development costs

Those costs that are necessary to market and distribute a product or service are categorized as marketing (selling) costs. These costs are also known as order-getting and order-filling costs. Examples of marketing costs include advertising sales personnel salaries/commissions, warehousing and delivery transportation costs.

non-manufacturing and Manufacturing costs
non-manufacturing and Manufacturing costs

This image illustrates the various classifications of manufacturing and non-manufacturing costs. You will see from this figure that two further classifications of manufacturing costs are sometimes used. consists of all direct manufacturing costs (i.e. it is the sum of direct material and direct labour costs) is the sum of direct labour and manufacturing overhead costs. It represents the cost of converting raw materials into finished products.

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Cost Terms and Concepts

Accounting information systems measure costs that are used for different purposes i.e profit measurement and inventory valuation, decision-making, performance measurement and control. Therefore different types of costs are used in different situations. Because the term ‘cost’ has multiple meanings, a preceding term must be added to clarify the assumptions that underlie a cost measurement. A large terminology has emerged to indicate which cost meaning is being conveyed. Examples include variable cost, fixed cost, opportunity cost and sunk cost. First step to understanding of the basic cost terms and concepts that are used in the management accounting literature.

COST OBJECTS

A cost objects is any activity for which a separate measurement of costs is desired. in other words, if the users of accounting information want to know the cost of something, this something is called a cost object.

Examples of cost objects

  • cost of a product
  • cost of rendering a service to a bank customer
  • cost of rendering a service to a hospital patient
  • cost of operating a particular department or sales territory

Anything for which one wants to measure the cost of resources used.

Cost accounts will be classified them into type of expense (e g. direct labor, direct materials and indirect costs) or by cost behavior (such as fixed and variable costs) and then assigns these costs to cost objects.

Please Read More: Direct Costs, Indirect Costs