Cost Type: Direct & Indirect
Accountants classify cost as either direct or indirect.
Differences between direct and indirect costs
It is important to know the difference as this helps when it comes to:
- Pricing of goods and services
- Business Planning
- Controlling costs
- Understanding profitability of customers, products and services
- Improving efficiency
This refers to cost related to the production of products.
Below are some examples:
- For a manufacturing company direct costs would consist of raw materials (direct materials), wage and salary costs of those individuals making the product (direct labour) and (say) royalty and patent costs (direct expenses).
- For an airline company, direct materials would include the fuel used in the aircraft; direct labour would be the wage costs of the pilot and crew.
- For a restaurant, the direct materials would include the cost of the food and drink purchases, direct labour would include the wage costs of the chefs/cooks.
- For a theatre company, direct materials would include the costs of state set and scenery, direct labour would include the fees for the performers, and direct expenses would include copyright and royalty fees.
Indirect costs (overheads) refers to cost which are incurred to support an organisations main activities.
- For a manufacturing company indirect costs would consist of glues, screws, consumables, supervisory wages, depreciation and factory rent.
For an airline company, indirect costs would include the wage costs of the ground crew, IT and HR costs.
- For a restaurant, indirect costs would include the costs of condiments, sauces, the wage costs of the waiting and front of house staff.
- For a theatre company, indirect costs wound include the depreciation of office computers, the wages of the admin staff and the rent payable on the building.
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