What is the difference between a direct cost and an indirect cost?
Direct cost is a cost that can be attributed directly to a cost unit or cost centre. The cost of raw materials (e.g., cost of planks used in the manufacture of tables and chairs) is an example of a direct cost. This is because the cost of planks is traceable to the tables and chairs (cost unit) produced.
Indirect cost is the cost that cannot be attributed to a cost unit or cost centre. In the manufacture of tables and chairs, a supervisor may be employed to ensure that all tables and chairs produced meet a required standard before delivery to the customer. The supervisor's salary is not traceable to a particular cost unit but absorbed by all the tables and chairs produced. This is different from the salary that is paid to the carpenter who drives the nail into the wood to make it come out as a table or chair. In this illustration, while the salary of the supervisor is an indirect cost, the salary of the carpenter is a direct cost.
The difference between direct costs and indirect costs is that direct costs can easily be attributed to the cost object in question. Indirect costs cannot be assigned to the cost object. It is possible for a cost to be direct for one cost object and indirect for another.
Let us think about a factory that produces a number of different kinds of soft drinks. If the cost object is one type of soft drink, the sugar that goes into it could be a direct cost. Management will know how much of the sugar that it bought went to that kind of soda. On the other hand, the salary of the factory manager is an indirect cost of that particular kind of soda. It is not possible to say how much of the manager's salary should be assigned to one kind of soda as opposed to the other types of soda that are produced.