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.
Well, this article is written for you and this will bring an end to the confusion about these classifications of costs. Total costs mean all and every kind of expenses which a company may incur.
Further, Fixed costs may be classified as DirectFixedcost or Indirect Fixed cost. Even if you didn’t understand the concepts till now, don’t worry, let’s start and explore all these types of costs one by one.
Indirect material Indirect labor and supervision Sales commission Additional packaging cost Utilities variable charges of administration Income tax In short, any cost related to manufacturing / producing a product is a direct cost.
Cost of wood and steel used in manufacturing a chair (furniture industry) Cost of labor which produced hand-made jackets (manufacturing sector) Cost of utility bills (electricity, water) of the production plant (Cost of food served in an airplane to the passengers (airline sector) Salaries of bus driver and crew for a tour operator (tourism sector) Commission of real estate agent for each unit of an apartment sold (real estate sector) All the above-mentioned costs are directly related to the manufacturing of goods or providing services.
There is no chance of these goods manufactured or services offered without incurring these costs. Fuel cost is directly related to the provision of service (pick and drop, city tour, transportation etc.
However, it is important to differentiate that same fuel cost will not be a direct cost for some other sectors like an I. T company, a furniture manufacturer or a towel manufacturer as this fuel is not used directly on the production of goods or delivery of services. A time record sheet can be kept to track how many hours of each developer are spent on a particular software/project.
Then, the salary of that developer will be directly allocated for those number of hours to that particular software/project. The more time a developer will spend coding a particular program, the higher will be salary recharge to that project.
Thus, electricity consumption charge of the manufacturing facility is a direct variable cost as it is being incurred directly on the production process, and it varies as per the activity level. A directfixedcost is a cost which is directly related to the production process or service delivery but does not vary as per activity level.
It is essential to understand that directfixedcost is incurred on the core product or the service which is being provided to the customer, and this cost should not increase if the activity level is increased or decreased. Similarly, rent will not decrease if that textile unit produces 800 shirts.
The full-time lecturers who are employed at a monthly salary provide this core service to the customers (i.e., students). Please note that if a lecturer is on visiting faculty and charges university at an hourly rate, then, the remuneration of that visiting lecturer would be considered as a direct variable cost.
The salary is a direct cost because doctors are directly involved in providing the service (i.e., treatment) to the customer (i.e., patient). Since the salary is fixed (regardless of the number of patients treated), it would be considered as a directfixedcost.
Example 4 If a company registers a patent of a particular formula or a product, the cost of that registration of copyright would be considered as a directfixedcost. The registration cost of this patent is directly related to the manufacturing of this medicine.
But the cost of the patent would remain fixed and will not vary based on the number of units produced. Example 5 Depreciation expense of the plant, machinery and the manufacturing equipment is a fixeddirectcost.
Variable indirect expenses are costs incurred in an organization which are not directly related to the manufacturing of a product or providing of service but which vary with the activity level of the company. Alternatively, take an example of a retail store which is in the trading business, i.e., it would buy products and then sale ahead without any modification.
The direct cost for the retail industry is the cost of the purchase of those products. However, once any product is sold, it is usually handed over to the customer in a polythene bag.
Now, the commission of the ticketing partner on the sale of the tickets is not a direct cost for the football stadium because the direct costs are related to the providing of sports facility to the player. Example 3 Let’s say that you are the owner of a restaurant and provide meals to the customers.
As part of your business strategy, you also offer free home delivery at the same rate as of dine-in. This means that fixed indirect expenses will not increase if more customers buy your product or service.
Example 1 If you are an online retailer and your I. T team is in house who handles all IT related issues. The salaries of this IT team would not increase due to the higher number of orders in a month than another.
Example 3 All routine office expenses like printing and stationery, courier, postage, electricity, water, pantry expenses and routine repair and maintenance incurred in the support function departments like HR, IT, Finance, Procurement, Administration, Security etc. These expenses are not directly related to production or service delivery.
Final Remarks Correct classification of expenses may seem easy in simple situations. With significant growth in industrialization, it might be challenging to find out what is the correct classification of a particular cost.
Although direct and variable costs are tied to the production of goods and services, they can have some distinct differences. Variable costs vary with the level of production output and can include raw materials and supplies for the machinery.
Cost objects can include goods, services, departments, or projects. Also, salaries of mangers or supervisors might also be included in direct costs, particularly if they're tied to a specific project.
Typically, direct fixed costs don't vary, meaning they don't fluctuate with the number of units produced. Conversely, variable costs fall as the production output level decreases.
Supplies for the factory or machinery might be variable, including oil for the machines or parts tied to production. Commissions for the sales staff are often tied to production or the number of units sold.
As they sell more goods, sales commissions increase as a variable cost. Merchant credit card fees, if a company accepts credit cards for payment, are typically charged to businesses as a percentage of their sales.
However, variable costs do not need to be directly related to the product. This is from my accounting notesAbsorption Costing vs Variable Costing Remember: An asset is a resource of the company that gives a future economic benefit.
Inventories are assets because they give future benefits to the company in the terms of sales revenue. Rules about unit sales and production under the two costing methods.
The value of inventory will be greater under the absorption method because of the deferred costs, however the total unit count will be the same for each accounting method.e. It allows you to improve money management and monitor the growth of your business, plays a crucial role in calculating profitability, and can help you attract investors.
Fixed costs often include rent, advertising, buildings, machinery, insurance, etc. Costs that are direct to a department could be variable or fixed.
Don’t lose track of them and make sure they are aligned in calculation approaches. Use Lean Case to perform the business model calculations.
Another metric that plays an important role in making business decisions and in setting prices is the cost of goods sold COGS) also referred to as the cost of sales. To help you understand COGS meaning, here is a simple COGS definition: Cost of goods sold is the accumulated total of all costs used to produce products or services, which have been sold.
You should keep in mind that COGS include direct costs only of those products which were purchased by customers during a certain period. But these two metrics represent different ways of spending resources in the process of running a company.
As you see, direct cost and COGS are among the crucial metrics in business planning and decision criteria for investors. The best way to keep track of all the important criteria and ensure that your presentation is convincing and not missing crucial elements is to use Lean Case.