Direct Cost and Indirect Cost

Direct cost is the cost tied directly to the products or services, and it is the main cost (material) which the product must-have. It is often referred to as the variable cost, which includes both direct material and direct labor. The direct cost will fluctuate due to the production quantity. While the indirect cost stays the same or insignificant change when the production increase or decreases.

Example of direct cost

The direct cost may be different from one company to another due to the nature of production as well as the product type. In the car production, the steal, tie, and the machine is the direct material which is part of direct cost. However, in cloth manufacturing, the direct cost includes worker wage, fabric and so on. In general, the direct cost includes:

  • Direct labor: the worker who works directly with the product.
  • Direct material: the material which is the main part of the final product

These are the costs that can be easily tract to the final product.

Indirect Cost

Indirect cost is the cost that incurs within the business operation but we cannot track it directly to the finished product. However, the company cannot operate their business without indirect cost. They include rental, depreciation, admin expense and so on. They are the expense that remains after we allocate the direct cost. These costs will be allocated to the finish product base on the different method such as Process Costing, Activities Base Costing, Life cycle.

Different between Direct and Indirect cost

Direct Cost Indirect Cost
Can track to the final product Can not track to the final product
Will Change due to production quantity Fix or slightly change as the production change
Example: direct labor (salary of a worker, Over timer…), Direct material and manufacturing supplies. Example: Depreciation, Salary of administrative Staff, Rental, Insurance…

Direct Vs Indirect cost in manufacturing

In manufacturing, direct cost is the raw material that can be tracked to the finished goods. They can be physically identified, and their costs are similarly allocated to each product. Moreover, it also includes the direct labor of workers who physically involved in the production process. Without them, the raw material will not convert into finished products.

For example, in PC manufacturing, the direct material includes Monitor, Hard disk, Ram and CPU, and mainboard. We know exactly how much we spend on each set of the computer by including all these material costs.

In order to assembly all these materials, we need to hire the workers who work on set up, inspection to ensure that the PC works fine. The salary for these people classified as the direct cost, they work consistent with the number of PC complete. The more we produce, the more we spend on them.

Besides direct cost, PC manufacturing requires us to have some more expenses such as factory rental, machine depreciation, utilities and staff salary (management, Administrative, Marketing…). These expenses will almost remain the same even the production change. And it practically impossible to tract these expenses to the physical product.

Why do we need to understand the direct and indirect costs?

It is very important to understand the difference between direct and indirect costs as it will help us set a competitive price in the market without hurting our profit. When we know the ultimate cost of the product, we can play around with the price to reflect with some external factors such as competitors.