A peculiar thing for businesses is the purchase of goods or services that aid the day-to-day running of the enterprise. The cost incurred in the process is referred to as “expenses,” which may be related to production or regular business operations. As a business owner, it is essential to keep a record of all expenses, but it is more important to have the direct and indirect expenses tracked separately, noting that this will make it easy to follow the budget more closely and price the products or services more accurately.
What Are Direct Expenses?
Direct Expenses are expenses incurred by a business in the course of manufacturing products or providing services. These are expenses assigned to the core business operations of a company with total focus on the purchase of goods or services. They are basically the prime cost of goods or services rendered by a company and may differ based on the type of company or the service. They are also different from direct material costs and direct labor costs, which are spent on the production of products or provision of services. A direct expense can be variable or fixed; variables are the ones that change based on the number of goods produced or the service rendered, while fixed expenses remain the same every month.
Examples of direct expenses include:
- Factory lease
- Earnings (direct labor)
- Royalty payment
- The price of raw materials
- Rental fees
- Repairs and routine maintenance
- Industrial supplies
- Commission on sales
- Product cost
- Experimentation costs
What Are Indirect Expenses?
Indirect Expenses are expenses incurred by a business in its day-to-day operations and apply to more than one business activity; that is, they do not focus on a particular product or service. These types of expenses are not directly related to the cost of the core revenue-generating products or services and may differ by an organization based on costs among different departments within the firm. Indirect expenses are used to determine the net profit of a business and evaluate the income statement of that business.
Examples of Indirect Expenses are:
- Utility bills
- Stationery & Printing
- Legal & Consultancy Services
- Professional fees
- Audit costs
- Municipal taxes
- Welfare costs (medical, food coupons, etc).
8 Notable Differences Between Direct And Indirect Expenses
- Direct expenses serve the purpose of evaluating the gross profit of an organization, while indirect expenses evaluate the net profit of an organization.
- Direct expenses can be allocated to a particular product, segment, or department in a company. On the other hand, indirect expenses are distributed among different products, segments, and departments in the company.
- Direct expenses are related to the cost of goods sold, whereas indirect expenses are unrelated to the specific cost incurred in the sale of a product.
- Direct expenses can easily be traced since they are confined to a particular department and are different from direct materials or direct wages, which can be traced to a specific territory, customer, product, or process. However, indirect expenses cannot be traced because they are not confined to a department; neither can they be allocated to a particular cost object, job, or cost unit.
- Direct expenses are costs incurred while manufacturing a particular product or service. Conversely, indirect expenses are costs incurred in the running of the business on a daily basis.
- Direct expenses make up part of the prime cost, but indirect expenses are regarded as overhead costs.
- Direct expenses are recorded on the debit side of the trading account, while indirect expenses are recorded on the debit side of the income (profit and loss) statement.
- Direct expenses are necessary to know the actual cost of products; inversely, indirect expenses are necessary to know the income statement of the company.
Conclusively, direct and indirect expenses are two different terms of accounting that represent expenditure in business. These two types of expenses are carried out for the purpose of maintaining accuracy in the financial statement report of a business.