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What is the difference between direct and indirect costs?

Costs can be of a direct or indirect nature. Direct costs can easily be assigned to certain goods or services and with indirect costs you have to use an allocation key and journal entries. However, the distinction is by no means always clear, for example when a DGA produces goods itself, but is also active in the general policy of the company. Below we explain a few things.

Meaning of Direct Cost, what is it?

Direct costs are expenses that can be allocated “directly”, for example to a specific customer, product, purchase or department. With direct costs it is therefore easy to judge what the result of the cost is, why the cost is necessary, and so on. Examples of direct costs and how they can be allocated:

  • Cost of purchasing inventory: can be directly allocated to products, sales, and revenue
  • Personnel costs of the sales department: can be directly allocated to a specific department and possibly also to products, services and to revenue
  • Machine for mass production of one product: the depreciation costs can be directly allocated to the produced good and thus also to the turnover of that product

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Meaning of Indirect Cost, what it is?

With indirect costs, it is not possible to allocate expenses “directly” to a specific customer, product, purchase or department. In other words, here the costs are not easy to allocate and an allocation key must be used for the allocation. Examples of indirect costs and why they cannot be allocated:

  • Energy costs: The energy costs cannot be directly allocated because all departments require energy and energy is required for the production of all goods
  • DGA salary: the DGA works for all departments of the company and does not produce specific goods himself. As a result, the DGA salary is also indirect.

Read about source to pay.

These indirect costs must be allocated to the turnover of various products or services on the basis of an allocation key. For example, if the customization machine produces 80 times the product X and 20 times the product Y, the depreciation costs can also be allocated for 80% to the turnover of the product X and 20% to the turnover of the product Y Sometimes, however, it is less simple.