Costs are incurred in the process of producing goods and services. The costs incurred can be classified into direct and indirect costs. This essay briefly discusses direct and indirect costs in regard to the process of production.
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Direct costs are the expenses which can be attributed directly to a specific project. For instance, the cost of a material used to manufacture a product is treated as a direct cost – it is directly related to the cost of the final product. Direct costs form a bulky of the expenditure in a project undertaken; approximately, sixty to seventy percent of all the expenses incurred in a project are direct costs.
Examples of direct costs include the wages paid to the employees who specifically work on a particular project, and the cost of the materials used in a project among others. Direct costs can be classified into direct materials, labor and expenses.
The sum of cost of the materials and labor is often referred to as a prime cost. In some cases, the direct costs may be equal to the cost of a good. Calculating the direct cost will depend on the product being manufactured and thus the methods used vary.
It has been observed that in most cases, the direct costs are variable costs. Variable costs change with the volume of unit outlets; the more units produced the high the direct costs. This is because the production of more units will often require more input of the direct costs, for instance, the volume of materials has to be increased to produce more unit outlets.
In the same way, more input of labor will also be required to ensure that the output volume is sustained. In getting the cost of a project or a product, the direct costs are fully added to the costs of production.
Indirect costs are the costs incurred in carrying out a project but cannot be related directly to that particular project. The costs affect the whole organization and cannot be pinned down to one particular project or product. These costs are spread across the board.
These costs are said to form about thirty to forty percent of the total costs of production. The most common indirect costs are: “engineering overhead, materials overhead, manufacturing overhead, general and administrative expense, and selling expense” (Burt, Petcavage & Pinkerton, 2010, p. 341).
In most cases, the indirect costs are fixed and thus are independent of the volume of output. A good illustration is the salary of an administrator overseeing a project; regardless of how much the output volume will be increased chances are his/her or her salary will remain fixed.
It has been pointed out as significant to distinguish between direct and indirect as indirect costs are tax-deductible items. A given percent of the indirect costs are added to the cost of a product when calculating the cost of a product. The percent of the direct cost to be included in the cost of production has to be proportionally calculated.
In conclusion, it has been shown that direct and indirect costs are different. While in most cases, direct costs are variables, the indirect costs are fixed.
The direct costs form a huge part of the cost of a product and are added directly to the cost of a product while the indirect costs form a small percent of the cost of a product and only a percent of the indirect costs are added towards the cost of the product (Direct and Indirect Costs, 2011).
Burt, D. N., Petcavage, S. D., & Pinkerton, R. L. (2010). Supply management (8th ed.). Boston, MA: McGraw‐Hill.
Direct and Indirect Costs. (2011). Understanding Direct and Indirect Costs. Office of Sponsored Programs. Web.