Direct vs. Indirect Costs: Cost Objects—A Key

The cost object is a key. That is, you have to define the cost object before you can determine whether a cost is direct or indirect, because you have to ask yourself, "Direct or indirect with respect to what?" A cost that is direct with respect to one cost object can actually be indirect with respect to a different cost object. So, you can't just memorize the handling of a particular cost. For example, it is incorrect to make a statement like, "The depreciation of the plant is always indirect."

Let's take a product example: the salary of the plant manager. If the cost object is the plant, then the salary of the plant manager is directly traceable to the cost object. If the plant makes only one product, the salary of the plant manager would also be directly traceable to that product. If several products are made in the plant and the plant manager oversees the entire plant, the plant manager is indirect with respect to the individual products and the salary would have to be allocated among them, if you choose a product cost object.

Now, take a service example, the salary of an accountant. If the cost object is the accounting department—you are trying to keep track of the cost of running your accounting department—the salary of an accountant is directly traceable. If you are trying to determine the cost of having a human resources department (human resources does need the accountants to keep the financial records involving human resource salaries and other human resource department costs) you cannot trace the accountant's salary to the human resources department. A certain amount of the accountant's salary could be allocated to running the human resources department. Put another way, if you closed down, that is, outsourced human resources, at least in theory there would be a little less accounting to do and as you outsource departments you might be able to reduce the number of accountants you need.

Again, do not just memorize. Review the particular situation. If you have an accountant whose only job is to keep records for human resources, that accountant's salary would be directly traceable to the human resources department.

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