Direct Cost

What is a Direct Cost?

Direct cost is an accounting term that describes any type of expenditure that can be directly attributable to a cost object. Cost objects can take many different forms, which we will analyze below. Direct costs are correlated and causative of an object.

Direct cost is a relatively simplistic term and can better be understood by doing a comparative analysis with indirect costs so that we may better understand the difference between the two. By also knowing what constitutes an indirect cost, an elimination process can be performed to determine the direct costs.

Indirect costs cannot be attributable to a specific cost object. They may instead be attributable to multiple projects or are incurred to support overall operations. When building financial models or understanding managerial accounting, direct costs are a component that helps managers and entrepreneurs alike make sound business decisions.

Direct Costs in the Real World: Tangible Examples

Direct costs take many shapes and forms in accounting and managerial discussions. Some examples of direct costs can include the parts and labor needed to build a smartphone or the equipment needed for an assembly line.

In such an instance, the costs must be directly attributed to the manufacture and assembly of the electronic device.

Direct costs are easily traceable to the project or product that they are attributed to. Thus, they are often charged to the product on an item-by-item basis. It makes direct costs easy to categorize and examine for accountants and business professionals alike.

Direct vs. Indirect Costs: A Useful Comparison

To better understand direct costs, one must thoroughly understand the difference between what constitutes a direct or an indirect cost. The table below can help us to better understand the difference, and how they are, in fact, in many ways similar.

Tax Implications

For different countries, understanding which costs constitute direct costs is important for taxation. For example, capital spent on equipment or maintenance, the building of a new warehouse, or even the purchase of a set of trucks is tax-deductible for a company depending on the country and region in which they operate. As such, knowing exactly which expenses being incurred are direct costs can help to create new tax benefits and accurate tax filing information for corporate taxes.

If a company receives government funding, it may be the case that the government provides guidelines with the funding. The guidelines may include instructions on cost reporting and which expenses constitute a direct or indirect cost as a requirement for obtaining the loan. In such a scenario, understanding which costs constitute direct and indirect costs can make it critical to maintain or gain additional funding.

More Resources

CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

• Cost Structure
• Capital Expenditures
• Fixed and Variable Costs
• Overheads
• See all accounting resources