What is a Direct Cost?

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.

Examples of Direct Costs

Examples of direct costs are direct materials, manufacturing supplies, and commissions. Direct materials are the raw materials and components that are consumed in the production of goods. Manufacturing supplies are the incidental supplies used in the production process, such as grease and oil. Commissions are the amounts paid to salespeople only if they close a sale with a customer.

Indirect Costs

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, and utilities expense.

Direct Costs in Inventory Valuation

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.