Direct vs. Indirect Costs: Understanding the Difference - Essay Sample

Introduction

In understanding costs incurred during operations, it is essential to establish the difference between direct and indirect costs.

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Direct Costs

Direct costs are identified from the precise establishment association with a specific business activity that resulted in that particular cost (Morris et al., 2012). In business, they are known as cost objects. Labor costs are one example of these direct costs. It is the cost incurred in the acquisition of human resources. It is allocating consideration to the total sum of wages and compensation benefits recorded as payments to a firm’s employees during the entire production process of a good or service. It is important to understand that some labor costs are identified as indirect costs. Differentiating is important in identifying which forms of labor costs are direct or indirect. Indirect labor costs are those that supplement the primary labor force at a firm. There is an example of the labor costs to the acquisition of maintenance services. The other example of direct labor costs are those experienced with the acquisition of materials necessary for the actualization of all production processes. An example of the costs of acquiring raw materials during manufacturing. The cost of purchasing equipment also another form of direct cost. There existing precision in the exact source of such costs. At any business, these costs are well quantifiable with available methods and tools for calculations on the same. The existing advanced tools like activity-based costing that increase on the specificity of deduced figures related to cost.

Indirect Costs

Indirect costs, on the other hand, offer some sense of complexity in identifying the specific source to the experienced costs. There existing several business activities observed to be related to a given cost. As such, no pinpoint identification of a particular activity as the source cost object to that cost. As identified in the course, they involve the correlation of overhead costs with the costs of selling and administration. Overhead costs are establishing to be the most prevalent during operations showcasing significant levels of difficulty to their clear deduction. Theses costs play an essential role in assuring the continued existence of a business in the current competitive business environment. The income statement a significant tool that aids in the identification of these costs (Rosslyn-Smith et al., 2020). They are all costs except those defined in the pool of direct costs. Examples of these costs include utilities that are used by all general operational sections at a firm. Every existing department involved in the consumption of these resources, but no specific establishments of the portion possible utilized in each section. Insurance is the other example of such costs. Insurance packages purposed to cover all property and personnel involved with a business there existing different operational departments and functions. As such, the costs incurred from buying insurance cannot be allocated to a specific cost object.

Rent also the other precise example of these indirect costs. These costs are covering all property and people owned by a company. No particular section an identifiable source to these costs. In the case of selling and administration, these are costs in initiating selected business strategies that affect the general performance of a business. For example, to increase their reach and brand recognition, firms spend significantly on their marketing. The costs from this cannot be allocated to a specific cost object within the organization’s operational portfolio.

References

Morris, P. W., Pinto, J. K., & Söderlund, J. (Eds.). (2012). The Oxford handbook of project management. OUP Oxford.

Rosslyn-Smith, W., De Abreu, N. V. A., & Pretorius, M. (2020). Exploring the indirect costs of a firm in business rescue. South African Journal of Accounting Research, 34(1), 24-44. https://doi.org/10.1080/10291954.2019.1667647