Loading the player...

What is a 'Direct Cost'

A direct cost is a price that can be completely attributed to the production of specific goods or services. Some costs, such as depreciation or administrative expenses, are more difficult to assign to a specific product and therefore, are considered to be indirect costs. A direct cost can be considered a variable cost if it is inconsistent and often fluctuates in amount.

BREAKING DOWN 'Direct Cost'

Direct costs are one of two general branches of product costs in accounting for manufactured goods. The other branch, which contains all non-traceable expenses, are indirect costs. Examples of direct costs include manufacturing supplies and commissions. Rent expense may only be a direct cost if only one cost object relates to the facility being rented.

Because direct costs can be specifically traced to a product, direct costs do not need to be allocated to a product, department or other cost object. Direct costs may be related to labor, materials, fuel or power consumption. Direct costs usually benefit only one cost object. Items that are not direct costs are pooled and allocated based on cost drivers.

Fixed vs. Variable

Direct costs do not need to be fixed in nature, as their unit cost may change over time or depending on the quantity being utilized. An example is the salary of a supervisor that worked on a single project. This cost may be directly attributed to the project and relates to a fixed dollar amount. Materials that were used to build the product, such as wood or gasoline, may be directly traced but do not contain a fixed dollar amount. This is because the quantity of the supervisor's salary is known, while the unit production levels are variable based upon sales.

Inventory Valuation Measurement

Using direct costs requires strict management of inventory valuation when inventory is purchased at different dollar amounts. For example, the cost of an essential component of an item being manufactured may change over time. As the item is being manufactured, the component piece's price must be directly traced to the item. For example, in the construction of a building, a company may have purchased a window for $500 and another window for $600. If only one window is to be installed on the building and the other is to remain in inventory, consistent application of accounting valuation must occur. Companies typically trace these costs using two methods: first in, first out (FIFO) or last in, first out (LIFO).

RELATED TERMS
  1. Carrying Cost Of Inventory

    Carrying cost of inventory, or carry cost, often refers to a ...
  2. Applied Cost

    Applied cost is a term used in cost accounting to denote the ...
  3. Avoidable Cost

    An avoidable cost refers to variable costs that can be avoided, ...
  4. Flow Of Costs

    Flow of costs refers to the manner or path in which costs move ...
  5. Direct Purchase Program

    A direct purchase program is a method by which individuals can ...
  6. Capitalized Cost

    A capitalized cost is an expense that is added to the cost basis ...
Related Articles
  1. Investing

    Key Financial Ratios for Manufacturing Companies

    An investor can utilize these financial ratios to determine whether a manufacturing company is efficient, profitable and a good long-term investment option.
  2. Investing

    How to Analyze a Company's Inventory

    Discover how to analyze a company's inventory by understanding different types of inventory and doing a quantitative and qualitative assessment of inventory.
  3. Investing

    How to Predict Where the Market Will Open

    Find out how some indicators help investors predict the likely opening direction of stocks. Also, determine how international markets influence the open.
  4. Managing Wealth

    Cost Basis 101: How To Correctly Understand It

    Understanding how to calculate cost basis is critical for tracking the gains or losses of an investment, and what the tax consequences on it are.
  5. Investing

    Key Financial Ratios for Restaurant Companies

    These 7 financial ratios provide insight into the profitability of a restaurant, prospective longevity of the business and quality of decisions being made.
  6. Personal Finance

    Can You Afford Not to Hire a Financial Advisor?

    People often worry about how much a financial advisor costs instead of what it costs not to have one.
  7. Financial Advisor

    The Cost Of Hiring A New Employee

    Hiring a new employee means more than just a salary ... a lot more.
  8. Investing

    Why Last In First Out Is Banned Under IFRS (XOM)

    We explain why Last-In-First-Out is banned under IFRS
  9. Small Business

    Retail vs. Tech: How These Companies Use Working Capital

    Learn about the difference between retail and tech businesses' use of working capital and why working capital varies so widely in the technology sector.
RELATED FAQS
  1. How are direct costs and variable costs different?

    Direct costs are expenses that can be directly traced to a product, while variable costs vary with the level of production ... Read Answer >>
  2. What are the types of costs in cost accounting?

    Cost accounting aids in decision-making by helping a company's management evaluate its costs. There are various types of ... Read Answer >>
  3. How is direct cost margin calculated?

    Find out how to calculate the direct cost margin, including how it is used in corporate finance as an indicator of operational ... Read Answer >>
  4. How are fixed costs treated in cost accounting?

    Learn how fixed costs and variable costs are used in cost accounting to help a company's management in budgeting and controlling ... Read Answer >>
  5. How do fixed costs and variable costs affect gross profit?

    Learn about the differences between fixed and variable costs and find out how they affect the calculation of gross profit ... Read Answer >>
  6. How are cost of goods sold and cost of sales different?

    Cost of goods sold and cost of sales both represent the direct costs involved in production. However, some companies use ... Read Answer >>
Trading Center