Direct costs and variable costs are similar in nature and are both types of costs involved in production. Direct costs are expenses that can be directly traced to a product, while variable costs vary with the level of production output.
Direct costs are costs directly tied to a product or service that a company produces. Direct costs can be easily traced to their cost objects. Cost objects can include goods, services, departments, or projects.
Direct costs include:
- Direct labor
- Direct materials
- Manufacturing supplies
- Wages tied to production
Direct fixed costs do not vary and can be traced back the cost object. However, direct variable costs vary with production levels.
Variable costs are costs that vary as production of a product or service increases or decreases. Unlike direct costs, variable costs depend on the company’s production volume. When a company’s production output level increases, variable costs increase. Conversely, variable costs fall as the production output level decreases.
Direct costs can be variable costs or fluctuate with volume. For example, the packaging costs associated with a product would be a direct cost, but also a variable cost since the packaging costs would increase as sales increased. The raw materials used to make the product would also be variable costs since the cost of materials would rise and fall depending on sales volume of the product. The raw materials would also be a direct cost.
However, variable costs do not need to be directly related to the product. In other words, a variable cost can be an indirect cost.
For example, a company produces mobile phones and has several production machines to produce their devices. The production machinery needs electricity to function. The cost of electricity is an indirect cost since it can't be tied back to the product or the specific machine. However, the cost of electricity is a variable cost since electricity usage increases as the number of products manufactured increases. With variable costs, the total cost associated with the cost object changes as the production level changes.