Article shared by :
Cost is divided into direct and indirect cost in terms of degree of traceability to cost object i.e. product or job.
The above mentioned costs are explained as below:
1. Direct Cost:
An important problem in cost accounting is to determine the costs that are clearly identifiable and traceable to a costing object, such as units of product, company segments or some other specific activity. Costs which are easily traceable or identifiable with a product are called direct costs. If output units are the objects of costing, then direct costs represent costs and resources that can be traced to or identified with the finished product. Direct materials, direct labour and direct expenses are examples of direct costs.
2. Indirect Cost:
Indirect costs are those costs which cannot be identified with, or traced to a single product because they are common to several products. The example of indirect costs are: indirect materials (lubricants and scrap material), salary of factory supervisors (indirect labour), rent, rates and depreciation (indirect expenses). Indirect costs are often referred to as overheads. Overhead costs are indirect costs with respect to a specific product since they are incurred for all products manufactured in a company.
Costs also may be direct or indirect with respect to particular company segments or divisions. That is, some costs which are indirect for a product, may be traced to a segment or department and thus, will be direct costs for that department. A segment may mean any one of a number of things, viz., department, division, specific activity, sales territory and the like. For example, the salary of the plant manager of Plant A is a direct cost of plant A. But if multiple products are produced in plant A, the manager’s salary is indirect to the specific products. Thus, what is a direct cost for one purpose, may be an indirect cost for another purpose.
Indirect costs (overhead costs) by nature create problems in cost determination and analysis. Direct cost related with a product can be measured with a high degree of accuracy. In the absence of appropriate direct measurement techniques, indirect costs have to be apportioned to different products. For example, suppose in a manufacturing concern there are three separate production departments and a Head Office of the company. Each of these four segments will have costs which can be directly traced to their own departments.
The direct or traceable costs of departments can be identified with the help of source documents and accounting records. What portion of the company Head Office expenses should be charged to different departments? Since the Managing Director’s salary and other Head Office expenses benefits all three operating departments, these costs should be charged to all three departments. These indirect costs can be traced to different production departments only by apportionment involving some formula or base which may not be 100% accurate and reliable.