A direct cost is a cost that can be clearly associated with specific activities or products. These costs are commonly used in incremental decision making, where the sales manager needs to know the direct cost of a product in order to ensure that a one-time sale transaction can be made at a price that exceeds the total of all direct costs.
There are very few direct costs, since there is usually not a clear association between a cost and an activity or product. Here are examples of several direct costs:
- Direct materials
- Manufacturing supplies
Costs that cannot be directly associated with specific activities or products are called indirect costs. Several examples of these costs are:
- Rent expense
- Machinery maintenance
Direct costs are not sufficient for constructing an ending inventory valuation. The various accounting frameworks mandate that factory overhead costs also be allocated to ending inventory in order to derive the total ending inventory valuation. Otherwise, the logic is that all overhead costs will be charged to expense in the period incurred, rather than when the goods with which they are associated are sold.