Differences between direct costs and indirect costs

Understanding the differences between direct costs and indirect costs is an important starting point for grasping the basics of cost accounting.

As a quick reminder, cost accounting is the branch of accounting that is concerned with analyzing how costs are computed and working to find the optimal action to minimize the costs. Costs accounting is important because it gives the managers a basis for operational conduct and it allows them to plan for the future. Now on to direct and indirect costs...




Direct Costs 

Direct costs are costs that are easily recognized and distinguished. They are costs that can be clearly attributed to a particular product or process. Locating a direct cost is a bit like locating the culprit to a car wreck. The person who caused the wreck is usually easily identified, and it doesn't take much analysis to reach a conclusion. It is the same with a direct cost. An example of a direct cost, in the book publishing industry, is the cost of paper that the book is printed on. You don't have to following winding rabbit trails, or survey the work force to find out how much the paper costs. Its direct. It is there and as obvious as the shining sun.




Indirect Costs 

In contrast, and indirect cost is a cost that is not easily identified. It is a cost that takes some effort and time to locate. It is much like the problem posed to a teacher who notices that the pencil sharpener is stuffed with celery. It apparent that there is a problem, but there is no way to quickly identify which student is responsible. She has to dig, and search for the culprit by various methods. An example of an indirect cost in the publishing industry are the costs associated with the book publishers telephone bills. In order for the publisher to efficiently conduct business, he needs a telephone which means he must have the money to pay for the phone bill. Where does he get the money? Well from his job, which is publishing books. He most take the cost of his phone bill into consideration when he is pricing his service. Every business must find ways to allocate these indirect costs. They must spread the costs out over the products they offer.


Indirect costs are trickier than direct costs because they are evasive. They are tough to find and even tougher to account for. But it is equally as important to grasp them as it is important to understand direct costs. Both serve as the foundation for costs accounting, and it is important to be familiar with them.





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