Question

Why are the terms direct cost and indirect cost independent of the terms fixed cost and variable cost? Give examples of each to illustrate.

Answer 1

Direct Vs Indirect costs: A direct cost is a cost that can be traced to a cost object in a cost-effective manner. It is a cost that can be identified easily as the cost of a specific cost object; the cost of such identification is quite limited. In other words, the benefit of the identification of this type of cost to a specific cost object outweighs the cost of this type of identification. On the other hand, an indirect cost is a cost that cannot be traced to a cost object in a cost-effective manner. It is a cost that cannot be identified easily as the cost of a specific cost object. If we try to identify an indirect cost to a cost object, it may be possible to design the process of identification, but the cost of such identification is very high. In other words, the cost of the identification of this type of indirect cost to a specific cost object outweighs the benefit of such identification. Direct cost and indirect cost are independent of fixed cost and variable cost. This can be explained with the help of an example. A company has five different branches, and each branch sells ten different products. Every branch has a manager who is paid a monthly salary, and the salary paid to a branch manager is fixed in nature. This means that it remains the same every month irrespective of the volume of work done by him or her or the magnitude of results obtained by him or her. So, a branch manager's salary is a fixed cost. Now, this cost is to be used in the process of cost accumulation. Let us have two different cases. The first case is the case of cost accumulation where the primary cost object is the branch. In this case, the branch manager's salary can be easily traced to a specific branch, thus it becomes a direct cost. The second case is the case of cost accumulation where the primary cost object is the product. In this case, the branch manager's salary cannot be easily traced to a specific product, thus it becomes an indirect cost.