Direct costs are expenses that can be traced back to a cost object like a product, production process, department, or customer. In other words, these are costs that can be directly attributed to a specific area of production, product, or customer.
A manufacturer’s managerial accountants and production managers try to categorize total expenses into direct and indirect costs, so they can see how much it is actually costing the company to produce certain products or run processes. Since direct costs can be directly attributed to something, it would only make sense that indirect costs cannot be attributed to anything.
Indirect costs are expenses like rent, administrative salaries, and utilities that can’t really be traced back to any specific job. Even though some jobs may require more electricity, a specific amount of the electric bill can’t really be attributed to a job.
Direct costs, on the other hand, can identify with one cost object. Thus, management can focus on that one cost object and track the amount of expenses it requires.
Assume Nancy’s Metal Plating, Inc. is a chrome plating business that plates rims for one of the Ford factories. On Tuesday, Nancy pays the bills for the company. She first writes a check to pay for new plating tank and chemicals for a new contract that is coming up in the next month. Second, she writes a check to pay for the utilities and rent. Third, she makes the payroll checks for the plating workers and the office staff.
The equipment and chemical purchases as well as the plating workers’ salaries are all considered direct costs because they can all be attributed to this new job or a plating process.
The utilities, rent, and office salaries can’t be traced back to a job or product, so they are considered indirect costs.
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