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.
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. Whether you should classify your company’s labor and material costs as fixed or variable depends on if they are direct or indirect expenses.
Direct costs are expenses that can be easily traced or connected to the items your business produces or the services it provides. Your company’s direct material expenses are the costs of the consumable things that you need to produce the items your business sells.
Your direct labor cost will equal the amount of money you pay to the employees and contractors who are immediately responsible for the physical production of the items your business sells. Examples of fixed expenses include loan payments, insurance premiums and management salaries.
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.
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.
A directvariablecost is that type of direct cost, which is proportional to the activity level, i.e., this cost will increase if more units are products and this cost will decrease if fewer units are produced. Example 2 Another example is the cost of direct labor, i.e., the worker or staff who worked directly on manufacturing that product or delivering that service will be considered as a directvariablecost.
The more trips a bus will make, the higher will be the fuel cost. 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.
The more time a developer will spend coding a particular program, the higher will be salary recharge to that project. If more medical products are manufactured, the higher will be the electricity consumption charge.
Thus, electricity consumption charge of the manufacturing facility is a directvariablecost as it is being incurred directly on the production process, and it varies as per the activity level. (Please note that we are not referring to fixed-line rent of the electricity meter here, as it would remain fixed regardless of activity level).
It is essential to understand that direct fixed cost 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.
Thus, rent expense of the production facility is considered as a direct fixed cost. The full-time lecturers who are employed at a monthly salary provide this core service to the customers (i.e., students).
Example 3 In the healthcare segment, where doctors are employed at a fixed monthly salary, the salaries of such doctors will be considered as a direct fixed 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).
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 fixed direct cost. Similarly, depreciation of the building where manufacturing is carried out will be considered as a direct fixed cost.
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. For example, let’s take the case of a factory outlet which sales shoes.
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 cost of polythene would increase with each level of activity, i.e., sales; thus, it would be considered as an indirect variable cost.
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. 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. For example, some theorists would classify the electricity cost of the production department as an indirect variable cost.
December 16, 2020, December 16, 2020 / Steven Bragg Direct material cost is the cost of the raw materials and components used to create a product. The materials must be easily identifiable with the resulting product (otherwise they are considered to be joint costs).
The direct material cost is one of the few variable costs involved in the production process; as such, it is used in the derivation of throughput from production processes. Throughput is sales minus all totally variable expenses.
To determine the amount of directmaterialscost in a product, work with the engineering staff to create a bill of materials, which specifies the quantity of each raw material item and component included in a product. Then assign a standard cost to each item, based on recent prices paid for them (including freight and sales taxes), and add a reasonable allowance for scrap and spoilage.