indirect costs

Managerial accounting is the art of planning, decision making and controlling in business. In order to do that, we must identify what we want to track. Are we looking at a product, a store, a department within the company, or even a customer? Since managerial accounting gives us so much flexibility, we need to make sure we understand to what we want to assign costs.

cost object is anything for which a company wants to assign costs. Cost objects can take many different forms including:

  1. Individual units of a product
  2. An order for a specific customer
  3. A product line
  4. A department within the company, like the marketing or human resources department
  5. A geographic segment of the business
  6. A store
  7. A service provided by the company
  8. A customer

There is almost no limit to what you can identify as a cost object as long as you can find a way to assign costs to it. The most important aspect of determining a cost object is the ability to assign costs in order to get a complete picture to plan, make decisions and perform controlling activities. If you cannot fully assign costs to the object, you may want to consider if the object chosen is the correct one. In most cases, we can find ways to assign costs, however.

Direct and Indirect Costs

All costs related to a cost object are either direct costs or indirect costs.

direct cost is a cost that is easy to trace to a cost object. For an accounting or law firm, it is easy to trace the number of hours and cost of working on a client because all staff is required to assign their time to clients throughout the work week. Engines used in a Boeing 747 are easy to trace to each plane and therefore the cost is easy to calculate. The salaries for marketing employees are easy to trace to the marketing department of a company. Direct costs are assigned to a cost object easily.

An indirect cost is a cost that must be allocated to a cost object because it cannot be directly traced to the cost object. The cost of a receptionist in an accounting firm is hard to allocate to individual clients because his or her time is not being tracked by client. Supervisors at the Boeing plant are supervising employees working on several different projects and it is impractical to track his or her time to each individual plane. Some materials are so insignificant that the cost of tracking how much glue goes into a product outweighs the benefit of knowing the cost of glue per unit.

Sometimes it is possible for a cost to be a direct cost for one cost object and an indirect cost for another object. For example if my cost object is the marketing department, costs associated with marketing salaries are a direct cost which are easy to assign to the marketing department. However, if the cost object is one of 20 products a company manufactures, the marketing salaries are an indirect cost for that product since the cost is not easy to trace back to our cost object.

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