Direct Costs vs. Indirect Costs
The terms direct costs and indirect costs could be referring to a product, a department, a machine, geographic market, etc. (which are referred to as cost objects).
If the cost object is a company’s product that is being manufactured, the cost of the product’s raw materials and the cost of the employees on the assembly line are direct costs since they are directly traceable to the product. However, the cost of the other employees in the manufacturing facility (maintenance, clean-up, material handlers, etc.) and the other costs of the manufacturing facility (depreciation, property tax, maintenance, heat, and insurance) are indirect product costs since these costs must be allocated to the product. These indirect product costs are also known as manufacturing overhead costs, factory overhead costs, and burden.
If the cost object is the company’s production department, the depreciation of the production equipment and the salary of the manager of the production department are direct costs of the production department. However, the depreciation, heat, and maintenance, etc. of the building containing the production department (which also includes the warehouse for materials, the warehouse for finished goods, the shipping department, and quality control department) are indirect costs of the production department, since they must be allocated to the production department.
Fixed Costs vs. Variable Costs
If the cost object is a product being manufactured, it is likely that direct materials are a variable cost. (If one pound of material is used for each unit, then this direct cost is variable.) However, the product’s indirect manufacturing costs are likely a combination of fixed costs and variable costs. For instance, if the managers within the manufacturing facility but not on the assembly line are paid salaries which total $20,000 per month, this cost is a fixed indirect product cost. The equipment maintenance expense and the temporary shipping clerks could be a variable indirect product cost, since this cost will vary with production volume.
If the cost object is the production department, the direct and indirect department costs are likely to be partly fixed and partly variable. For example, the production department has it own electric meter to measure the electricity used to operate its equipment. Therefore, the electricity cost is a direct production department cost that is variable since it changes with the volume of products manufactured. On the other hand the salaries of the production department supervisors are a direct production department cost that is fixed.
