The cost of operating a business is known as a direct cost and includes things like production cost, raw material cost, and wages paid to factory staff. Direct costs can also include overheads like direct labor, direct material, manufacturing supplies, freight, and fuel or utilities such as power. Direct cost is different from indirect cost. Indirect costs cannot be linked to an object and are often associated with overhead and operating costs.
What is a Direct Cost?
Any expense that is directly associated with a company’s production or a specific cost object is considered a direct cost. Direct costs are typically tied to one project and are not divided among many different projects or allocated. Direct costs can either be fixed or variable costs. A salary of an employee who does direct labor on a project is an example of a fixed direct cost.
What are the Examples of Direct Cost?
There are different types of direct costs and below are some examples of each type:
- Direct labor: This includes wages paid to employees that are directly involved in the production process.
- Direct material: This includes the raw material that is used in the production process.
- Manufacturing supplies: This includes items that are consumables such as registers, pens, and paper, etc.
- Transportation: This includes the movement of goods, such as freight paid for by the company.
- Utilities: This includes various types of fuel and power used to operate machinery and equipment.
Where is Direct Cost Usually Reported?
Direct costs are usually capitalized on the balance sheet as inventory and eventually expensed to the Cost of Goods Sold on the income statement. Cost of Goods Sold (COGS) measures the direct cost incurred in the production of any goods or services. It includes material cost, direct labor cost, and direct factory overheads, and is directly proportional to revenue.
How Does Direct Cost Influence Product Pricing?
In order for a business to remain competitive with other businesses, it is important to know the production costs and to set product prices high enough to cover those costs and still turn a profit. In order to do this, it’s necessary to track the production costs, which include direct costs, such as raw materials, and any indirect costs, known as overhead, associated with producing the product.
A cost object is how direct costs are traced. It includes wholesale-purchased products, raw materials used in manufacturing, and the labor associated with the work to make the product. Direct costs can be variable, and because they are tied directly with providing the product or service, direct costs typically increase as the business manufactures and sells more products. It is important for a business to factor in this when calculating product pricing.
Why are Supplies for Production a Direct Cost?
Direct costs are typically associated with measurable, tangible cost objects and are tied to production. These include things such as labor, raw materials, or consumable supplies. The reason why supplies for production are a direct cost is that they can be explicitly attached to a particular item or service.
What is the Difference Between Direct and Indirect Costs?
The main difference between direct and indirect costs is that with the direct cost you can directly apply the expense to produce a specific cost object, like a good or service. It is difficult to tie indirect costs to producing a specific cost object because indirect costs are typically tied to more than one business activity.
What is Direct Manufacturing Cost?
Direct manufacturing cost is the costs that a business incurs from production during a reporting period. Direct manufacturing costs include manufacturing fees, raw materials, direct labor, freight and duty, and factory overhead costs that can be directly attributed to the manufacturing of a product.
What is the Importance of Maintaining Direct Cost?
It is essential to understand the difference between direct and indirect costs in order to keep accurate records. The difference between direct and indirect costs can impact financial statements and tax returns. Correctly recording these categories of costs can help in making important business decisions about products, pricing, hiring, and overhead.
Is Rent Considered as Direct Cost?
If rent can be tied directly to the production of a product or service, the rent can be considered a direct cost. Typically, rent is considered overhead and is an indirect cost because it is often tied to other business activities. Unlike direct costs, you cannot assign indirect expenses to specific cost objects.
Is the Majority of Direct Costs Variable?
Just because a direct cost can be tied to providing a product or service does not make it a variable cost. There are a few differences between direct costs and variable costs. Variable costs also include things like electricity for the production plant and since it isn’t tied to one specific product it wouldn’t be considered a direct cost. As mentioned before, direct costs are directly traced to a product. Variable costs can vary with production. So, not all direct costs are variable costs.
Is Direct Cost Used to Calculate the Company’s Gross Profit?
Yes, a company can use the Cost of Goods Sold and direct cost to calculate the company’s gross profit. To arrive at a company’s gross profit, you deduct sales returns and allowances from total sales revenue. The expense incurred directly from creating a product is the Cost of Goods Sold and can include any raw materials and labor costs incurred.
