Direct and Indirect Costs

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Direct and Indirect Costs

Direct costs

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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

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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

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(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.

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