Hello,
I'm having trouble understanding Direct Cost, Overhead Cost and Indirect Cost. ***Also Period cost and Product cost.
please can anyone explain it and give examples for each! thanks
Direct Cost:
A price that can be completely attributed to the production of specific goods or services. Direct costs refer to materials, labor and expenses related to the production of a product. Other costs, such as depreciation or administrative expenses, are more difficult to assign to a specific product, and therefore are considered indirect costs.
For example, the cost of meat in a hamburger can be attributed directly to the cost of manufacturing that product, as could the cost of packaging materials and preservatives. These are considered variable costs that are inconsistent and change amounts often. An indirect cost, such as the hamburger manufacturer's legal fees and staffing, is anything that is not a direct cost.
Direct costs generally include:
Salaries are wages (including vacations, holidays, sick leave, and other excused absences of employees working specifically on objectives of a grant or contract – i.e, direct labor costs).
Other employee fringe benefits allocable on direct labor employees.
Consultant services contracted to accomplish specific grant/contract objectives.
Travel of (direct labor) employees.
Materials, supplies and equipment purchased directly for use on a specific grant or contract.
Communication costs such as long distance telephone calls or telegrams identifiable with a specific award or activity.
Overhead Cost:
Overhead is those costs required to run a business, but which cannot be directly attributed to any specific business activity, product, or service.
Thus, overhead costs do not directly lead to the generation of profits. Overhead is still necessary, since it provides critical support for the generation of profit-making activities. For example, a high-end clothier must pay a substantial amount for rent (a type of overhead) in order to be located in an adequate facility for the sale of clothes. The clothier must pay overhead to create the proper sale environment for its customers.
Examples of overhead are:
Accounting and legal expenses
Administrative salaries
Depreciation
Insurance
Rent
Taxes
Utilities
The other type of expense is direct costs, which are those costs required to create products and services, such as direct materials and direct labor. Overhead and direct costs, when combined, equal all of the expenses incurred by a company.
Indirect Cost:
An expense (such as for advertising, computing, maintenance, security, supervision) incurred in joint usage and, therefore, difficult to assign to or identify with a specific cost object or cost center (department, function, program). Indirect costs are usually constant for a wide range of output, and are grouped under fixed costs.
Indirect costs are those costs that are not classified as direct. Examples of indirect costs are :
Salaries of administrative and clerical staff providing normal support activities in the department, college or school
Office supplies including postage
Local telephone calls
Memberships
Product Costs
For financial accounting purposes, product costs include all the costs that are involved in acquiring or making product. In the case of manufactured goods, these costs consist of direct materials, direct labor, and manufacturing overhead. Product costs are viewed as “attaching” to units of product as the goods are purchased or manufactured, and they remain attached as the goods go into inventory awaiting sale. So initially, product costs are assigned to an inventory account on the balance sheet. When the goods are sold, the costs are released from inventory as expense (typically called Cost of Goods Sold) and matched against sales revenue. Since product costs are initially assigned to inventories, they are also known as inventoriable costs. The purpose is to emphasize that product costs are not necessarily treated as expense in the period in which they are incurred. Rather, as explained above, they are treated as expenses in the period in which the related products are sold. This means that a product cost such as direct materials or direct labor might be incurred during one period but not treated as an expense until a following period when the completed product is sold.
Period Costs
Period costs are all the costs that are not included in product costs. These costs are expensed on the income statement in the period in which they are incurred, using the usual rules of accrual accounting that we learn in financial accounting. Period costs are not included as part of the cost of either purchased or manufactured goods. Sales commissions and office rent are good examples of period costs. Both items are expensed on the income statement in the period in which they are incurred. Thus they are said to be period costs. Other examples of period costs are selling and administrative expenses.
At the end of the current year, $19,900 of fees have been earned but not billed to clients.
a. What is the adjustment to record the accrued fees? Indicate each account affected, whether the account is increased or decreased, and the amount of the increase or decrease.
b. If the cash basis rather than the accrual basis had been used, would an adjustment have been necessary? Explain.
Hello!
I'd be happy to explain the concepts of Direct Cost, Overhead Cost, Indirect Cost, Period Cost, and Product Cost. Let's break them down one by one:
1. Direct Cost: Direct costs are expenses that can be specifically traced to a particular product, project, or activity. These costs can be easily allocated and directly tied to the output. Examples of direct costs include raw materials used in manufacturing a product, direct labor costs, and any other costs that are directly incurred in the production process of a specific product.
For example, if you are a cake baker, the cost of the ingredients (e.g., flour, sugar, eggs) and the wages of the cake decorators who work on a specific wedding cake order are considered direct costs for that particular cake.
2. Overhead Cost: Overhead costs, also known as indirect costs, are expenses that cannot be directly traced to a specific product or service but are necessary for the overall functioning of a business. These costs are incurred to support the production process or the overall operations of a company. Overhead costs are typically allocated to products or services using relevant cost drivers, such as machine hours, labor hours, or square footage.
Examples of overhead costs include rent of a factory, utilities, depreciation of machinery, insurance, and salaries of administrative staff. These costs are incurred regardless of the level of production or sales.
3. Indirect Cost: Indirect costs are very similar to overhead costs and are often used interchangeably. Indirect costs refer to the expenses that are not specifically associated with a particular product or activity but are required for the general operation of a business. These costs cannot be easily traced to a specific cost object.
For instance, if you have a manufacturing company, the salary and benefits of the production manager, who oversees the entire production process, would be an example of an indirect cost.
4. Period Cost: Period costs are expenses that are not directly associated with the production process or the making of products. Instead, they are incurred during a specific accounting period and are expensed in that period. Period costs are not included in the valuation of inventory. Examples of period costs include salaries of administrative staff, advertising expenses, rent of the office space, and legal fees.
5. Product Cost: Product costs are the expenses directly incurred in the production or acquisition of goods intended for sale. These costs are assigned to the products being manufactured and are typically accounted for as inventory until the products are sold. Product costs consist of direct materials, direct labor, and manufacturing overhead costs. They are considered as part of the cost of goods sold when the items are sold.
To summarize, direct costs are easily traceable to a specific product, overhead costs refer to indirect expenses incurred to support overall business operations, and indirect costs are similar to overhead costs. Period costs are expenses unrelated to production and are incurred during a specific accounting period, while product costs are directly associated with the production or acquisition of goods.
I hope this explanation helps to clarify the differences between these terms!