8.4 Direct and indirect production costs

Production costs can be further classified as direct costs or indirect costs. Direct costs include:

• Direct material costs, which are the costs of materials that can be directly traced to the production of a product or delivery of a service.

• Direct labour costs, which are the costs of the workforce directly involved in the production or delivery of a product or service. These costs are calculated by measuring the time spent in direct production/performance work.

• Other direct expenses, which are expenses incurred as a direct result of making a product, providing a service, or running a department. The difference between direct expenses and overheads is that direct expenses are directly related to the production or delivery of a product or service, whereas overheads are not. Direct expenses vary in direct proportion to the output or activity level, whereas overheads are usually fixed or semi-variable. Direct expenses can be controlled easily, whereas overheads are difficult to control.

On the other hand, indirect costs are expenses that cannot be directly tied to a specific product or service. These costs are indirect because they are necessary for the overall operation of a business and support the production of multiple products or services. Examples of indirect costs include supervisors’ wages, rent of the factory, legal and accounting fees, cleaning materials and building insurance.

Total cost is therefore all direct costs (material, labour and other direct expenses) plus all indirect costs (also known as overheads).