Direct Costs and Indirect Costs

Direct costs are costs that can be specifically identified and traced back to specific cost object (e.g. product or cost center) easily. In other words costs that can be directly assigned or associated with certain cost object are called direct costs.

The relative ease is usually derived out of that fact that a certain direct cost is usually applied to a certain single cost object.

For example material-A is used only by Department-1.

Indirect costs are costs that are hard to trace in relation to certain cost object. Its not that its impossible to trace indirect costs, its just that its not economically beneficial i.e. cost outweighs the benefits to track indirect cost.

The fact that they are difficult to assign to cost object is a reason that a single cost is usually covering multiple cost objects and its difficult to compute how much a certain cost object has consumed. Therefore, arbitrary basis are used to apportion such common costs among cost objects.

For example factory rent is a common cost for different departments within factory. We have no easy way to measure how much rental cost a particular department is incurring.

An important point to remember about a cost being direct or indirect is that it is judged in relation to cost object. Both direct costs and indirect costs are required to calculate total product or service cost. Costs that are not related to production (or has any bearing on it) do not require direct and indirect classifications. But for understanding sake or under rare situations if we need to know, non-production costs such as administrative expenses are indirect costs.

Classification of cost as direct or indirect is necessary for product costing. Direct costs most certainly adds up to production cost as it can be computed easily. However, to assign indirect costs to cost objects a suitable cost apportionment technique is used. For costs of periodic nature (e.g. administrative and selling costs) such classification and apportionment isn’t necessary as they are charged to specific period irrespective of production activity.

Most often direct costs tends to be variable costs as well and indirect costs are usually observed to be “fixed” in nature. However, it is not always the case as direct costs can be fixed and indirect can be variable in nature.  For example a fixed annual royalty is a direct cost yet fixed in nature. Same way, maintenance costs, electricity costs are indirect costs and are variable in nature.


Following are the costs incurred by furniture manufacturer. Classify each of them as direct or indirect costs.

  1. Seasoned lumber
  2. Compensation above the basic salary for overtime worked
  3. Compensation for the overtime worked on request of customer
  4. Salary of supervisor
  5. Adhesives, stain, paint and nails
  6. Electricity and heating
  7. Manager’s salary working in assembly department only


  1. Direct cost
  2. Indirect cost
  3. Direct cost
  4. Indirect cost
  5. Indirect cost
  6. Indirect cost
  7. Direct cost