Direct Cost
Definition
Direct cost is the forgone economic resources which are expressly used in the production of the unit of a product in question.
Direct cost is cost element that is directly associated with the production of that product. The tangible evidence is that the cost driver or component can physically be seen as part of the product. Example of these type of cost is direct raw materials, direct labor and direct expenses. These costs are also referred to as prime costs and they are directly charged to the product itself. They are also characterized by being able to vary with output.
Characteristics Of Direct Cost
The following are the features which distinguish direct cost from the other types of costs in production. These characteristics are;
Traceable in the physical product. It is possible to physically touch or see the items or components of costs used to make the product in the product itself.
Most of the direct costs are variable. That is, they vary with variance in volumes produced of goods or services.
Direct cost forms the prime cost.
Direct cost is controllable. Since the three main components of direct cost are variable, it is possible for the producer to decide how much to use of a particular type of cost.
Examples Of Direct Cost
- Direct raw materials
- Direct labor
- Direct expenses
- Manufacturing stores
Direct Cost Formula
From the aforementioned list of direct costs, the following formula is fitting in determination of direct cost.
Direct Cost = Direct Material purchased and actually consumed+ Direct Labor + Manufacturing Stores + Fuel Consumed + Other Direct Costs.
Direct Material Consumed = Opening Stock of Raw Materials + Purchases - Closing Stock of Raw Materials
Advantages Of Direct Cost
- Easy to trace and allocate to the correct object being produced.
- Simple to understand. This cost element is straight forward to users.
- Simple to compute
- Easy to control
- Useful when determining the break-even point of a firm production plan
- Helpful in decision making especially in resource allocation for optimality of resource usage.
- Helps in budgeting exercise especially in master budget where by with variable cost, it is more predictable of the expected outcome.
Disadvantages Of Direct Cost
- Lack of clear-cutting line between fixed costs and variable costs because in some circumstances, there are cases of semi-variable and semi-fixed costs
- Lack of common or universally accepted method of categorizing cost elements such as semi-fixed cost.
- Not applicable in small and medium enterprises for they are either strange or new to the owners of such businesses.
