Direct Costs vs. Indirect Costs: What Are They, and How Are They Different? | Cost Classification

Cost classification. Direct costs and indirect costs. Cost classification is an essential process in budgeting, accounting, and project management. Categorization of expenses help project teams to understand what kind of costs will be spent during the project lifecycle. Cost classification is the process of distinguishing costs into subcategories. Many different types of cost classifications can be made such as Direct and indirect costs. Fixed and variable costs. Customer costs. Departmental costs. Manufacturing costs. Typically, direct costs are attributable to a product, goods, or service itself. They are directly related to production. On the other hand, indirect costs are those which is required to produce the product but not directly related to the product itself. Let's analyze each concept. Direct cost. A direct cost is a price that can be utterly attributed to the production of products or services. Some costs, such as direct materials, direct labor, equipment are examples of common direct costs. Direct costs are often variable costs. If the manufactured units increase, direct costs increase. Because creating more units requires more materials and resources. Example. Assume that you will produce 1,000 metrekup concrete in the batch plant. You need 300 tons of cement to produce 1,000 metrekup concrete and 1 ton cement costs $100. So you need $30,000 to purchase cement. This is your direct cost. As the quantity increases, direct cost increase. Indirect cost. Indirect costs are not spent just on only one product. Overhead costs, ongoing costs, project management costs, operational costs are indirect costs. The quantity of manufactured units doesn't affect your rental price. Another example of a variable cost is your heating and cooling expenses that can change on a monthly basis. Example. Assume that this month you will produce 1,000 metrekup concrete. If you increase the production and produce 1,500 metrekup concrete, this does not change your head office costs or marketing costs. What are the differences between direct and indirect costs? It is easy to determine direct costs considering the product or service. On the other hand, it is not easy to identify indirect costs. Detailed analysis is required to identify indirect costs. Direct costs are attributable to a specific product, department, goods, or service. On the other hand, indirect costs are attributable to multiple products or services. Direct costs are variable costs that change based on the quantity of a product or service. However, indirect costs are fixed costs.