Direct vs. Indirect Costs: Classification Practice
Here's an opportunity for you to make sure you understand direct versus indirect costs.
Classify each of the following costs with respect to a purchasing department cost object. That is, you want to determine the cost of running the purchasing department.
- The purchasing department has its own building. Is depreciation on the building direct or indirect?
Direct +
Correct! Because purchasing has the entire building, all of the depreciation is directly traceable to purchasing.
Indirect +
Incorrect. Because purchasing has the entire building, all of the depreciation is directly traceable to purchasing.
- Purchasing has several purchasing agents. Is the salary of a purchasing agent direct or indirect?
Direct +
Correct! Because the purchasing agent works full-time in the purchasing department, the agent's salary is directly traceable to purchasing.
Indirect +
Incorrect. Because the purchasing agent works full-time in the purchasing department, the agent's salary is directly traceable to purchasing.
- What about office building utilities, where purchasing uses approximately 10% of the building space?
Direct +
Incorrect. In this case, the utilities benefit the entire building, which includes other departments. While it is probable that one would allocate to purchasing 10% of the utility bill based on the square footage used by purchasing, it would be inaccurate to say that because purchasing is 10% of the space, they surely use 10% of the utilities. You don't know how much purchasing really uses. Maybe the people in the other 90% of the building like it cooler and turn their air conditioning down more. Or maybe the purchasing people work later than everyone else, and therefore have their lights on more and use more than 10% of the electricity. Although allocating based on square footage may be the most accurate way to allocate utilities, never forget that it is still an allocation of an indirect cost.
Indirect +
Correct! In this case, the utilities benefit the entire building, which includes other departments. While it is probable that one would allocate to purchasing 10% of the utility bill based on the square footage used by purchasing, it would be inaccurate to say that because purchasing is 10% of the space, they surely use 10% of the utilities. You don't know how much purchasing really uses. Maybe the people in the other 90% of the building like it cooler and turn their air conditioning down more. Or maybe the purchasing people work later than everyone else, and therefore have their lights on more and use more than 10% of the electricity. Although allocating based on square footage may be the most accurate way to allocate utilities, never forget that it is still an allocation of an indirect cost.
