Direct and Indirect Costs :: Economics

Direct and Indirect Costs Direct costs ============ An organisation can apportion the costs incurred in the production of products or services in either a direct or an indirect manner. The direct costs can be defined as being the amount materials actually cost plus any other directly linked costs, such as labour. (for Quirk, materials, electricity, labour employee and management, machine depreciation) Production materials, machine or assembly wages =============================================== 1. Labour and wages – the cost of obtaining, training and retaining labour is a significantly high cost which must be allocated to each unit of production. There are many legal obligations as well as social and welfare considerations, which add to this high costs total. In order to work out the exact labour and wages costs to be attributed to each unit of production, an organisation must take a careful study of the production process and allocate the appropriate expenses. If, for example, an individual earns  £10 per hour and processes 10 units during that hour, then  £1 of direct costs may simply be added to each unit. Unfortunately, things are not that simple. There are many other individual costs which an organisation must bear in the employment of individuals. These may include employer’s national insurance contributions, pension payments and insurance policy payments. In most organisations, labour and wage costs account for the majority of direct costs. 2. Materials – the costs of materials differ according to the sector in which an organisation operates. As organisation that operates in the primary sector has comparatively low material costs. At the other end of the scale, in the tertiary sector, the costs of finished goods to a retailer for example, will be extremely high. The principal elements that affect the costs of materials should be included in the organisation's overall budgetary controls. In addition, an organisation must also consider the cost of materials in relation to market demands, as these will inevitably cause periodic fluctuations in material costs. Only those materials that are actually used in the production of a product or service should be considered part of the cost of that product or service. Task 2 Page 2 Other consumables used by the organisation are classed as indirect costs and are considered under separate budgets. Indirect costs ================== (for Quirk, rent/rates, sales/ marketing/ insurance/ non-production depreciation management salaries) Indirect costs are costs incurred in the running of an organisation that cannot be easily apportioned to the production process.