Direct Cost vs Indirect Cost

Direct cost is the cost incurred by the organization while performing its core business activity. It can be attributed directly to the production cost like raw material cost, wages paid to factory staff, etc., whereas, Indirect cost is the cost that cannot be directly attributed to the production as these costs are incurred in general and can be fixed or variable in nature like the office expenses, salary paid to administration, etc.

If we look at the cost sheet, we will see that two types of costs stand out. The first is the direct cost, and the next is the indirect cost. Both are important for running a business.

Direct costs can be easily identified as per the expenditure on cost objects. So, for example, if we pick how much expenditure a business has had on purchasing the raw materials inventory, we will be able to directly point out.

In the case of indirect costs, the challenge is that we can't identify the costs as per the cost object. So, for example, if we try to understand how much rent is given for sitting the machinery in a place, we won’t be able to do it because the rent is paid for the entire space, not for a particular place.

Let's see the top differences between a direct cost vs. indirect cost.

The key differences between these costs are as follows –

• The direct cost can be identified easily as per the cost object. Indirect costs can’t be identified easily.
• Direct cost is incurred on specific projects, units, departments, and objectives. Indirect cost, on the other hand, is incurred to provide multiple benefits to the business at large.
• Direct cost is also labeled as the variable cost since it changes as per the unit consumed/produced. Indirect cost, on the other hand, is labeled as the fixed cost since it doesn't change with the unit consumed/produced.

• As you have seen, the aggregate of direct costs is called the prime costs in the cost sheet. The sum of indirect costs, on the other hand, is called the overheads in the cost sheet.
• As an example, we can say that direct costs are the expenses incurred for the raw materials used in the production process. Since one can directly attribute how much cost is expended per unit of raw material, we call it direct cost. On the other hand, advertisement expense is an indirect cost since it benefits the organization as a whole.

Understanding direct and indirect costs is essential. Because if, as a business, you don't know how to allocate your costs and how to attribute them correctly, you won't be able to find out the profit per unit after selling your products/services.

As you already know, direct costs are identifiable. The challenge the business faces is with indirect costs.

For unidentifiable costs, the business can see how much it can expand on a long-term basis and then measure the benefit.

It is similar to understanding fixed and variable costs. If you understand how they work, it would be easier for you as a business to use them to your advantage.

This article is a guide to Direct Costs vs. Indirect Costs. Here we discuss their top differences, infographics, and comparison tables. You may also have a look at the following articles for gaining further knowledge in Accounting –

• Direct Material Cost Example
• Depreciated Cost
• Expense vs Expenditure
• IFRS vs Indian GAAP