Direct and indirect expenses of the company

A company is a legal entity with the specific objective of providing goods and services to its

customers. Creating goods and services includes production and supply of products. It includes many

stages, and each stage needs financial support, called costs.

Direct expenses : These are costs incurred for the manufacturing of products and services, and

they can be traced in terms of money.

Examples : direct labour, commission, wages, rent, and raw materials.

Indirect Expenses: Costs incurred to keep the business running other than direct expenses are

indirect expenses.

Examples : insurance, supervision, salary depreciation, and packaging charges.

The significance of direct and indirect expenses in terms of return on assets and allocating

overhead costs

ROA calculated by dividing a company's net income by the average total assets

Return on Asset is a statistical report on the return on asset investments. Direct and indirect

costs are key factors in the net income produced from assets. Operational (direct cost) and non operational
(indirect cost) are subtracted from revenue from the assets, and high costs reduce the total return from

assets. Allocating overhead costs should be controlled for the best performance of the asset.
 Introduction

According to Kenton (2020), Direct costs are costs that can be directly identified with making

a product or providing a service. In other words, these costs are easily or directly traced to an object or

product. In pizza production, for example, all the ingredients added to the pizza serve as direct costs

because they can easily be traced to the pizza. The person making the pizza is providing labor so that’s

direct labor cost. Indirect costs According to Mukhopadhyay (n,d), are costs that cannot be directly traced

to making a product or providing a service. These costs are essential to producing a product, however

they don’t directly go into the product or service being provided. These costs are related to the factory,

machinery, and vehicles, rent and rates, depreciation, repairs, and maintenance. In the Pizza example

again, the indirect costs in this scenario are indirect labor costs for individuals not directly involved in the

pizza production such as the supervisor who is only there to make sure quality standards are met or the

cleaner who keeps the kitchen clean to make sure the pizzas meets the hygiene standards required. Other

indirect costs in this scenario include; electricity costs etc.

Difference between direct and indirect cost

Direct Costs

a) Costs can be traced to production of goods or service

b) Common examples

1. Raw Materials

2. Manufacturing supplies

3. Wages for the production staff

4. Fuel or power consumption

5. Direct labor

Direct costs are also known as variable costs because it varies with the unit consumed or

produced.
 Indirect costs

a) Indirect costs are costs incurred to keep the business running. These costs cannot be traced to

production of a good or service

b) Common examples

1. Admin/office costs

2. Advertising costs

3. Rent costs

4. Indirect labor

Indirect costs are incurred in order to benefit the business as a whole, such as; advertising

costs.

Indirect costs are referred to as fixed cost since it remains constant regardless of the quantity

consumed or produced.

Importance of Direct and Indirect Costs in determining the return on assets

and allocating overhead cost.

Return on assets (ROA) measures a company's profitability in relation to its total assets. ROA

informs a manager, investor, or analyst about how effective a company's management is in generating

earnings from its assets. The return on assets is shown as a percentage and it is calculated by

dividing a company's net income by the average total assets and multiplying it by 100.

Overhead is a term used to describe indirect costs. Overhead costs refer to all of the costs of

running a business that isn't directly attributed to the production of a product or the provision of a service.

Indirect costs have an impact on the entire organization, not just a particular product. Advertising,

depreciation, office supplies, accounting services, and utilities are just a few examples of indirect costs.

Allocating overhead costs should be controlled for the best performance of the asset. To determine the

company's overhead price per product, an accountant would usually sum all of these overhead costs, then
allocate them on a per-unit basis. This ensures that a profit is still made on each unit, even after all

overhead costs are taken into account. Before you put on your targeted profit margin, this forms the basis

for your product's pricing. It becomes critical to identify direct and indirect costs accurately to determine

the company's profitability, efficiency, and possible cost-cutting measures. Because overhead may be

deducted from a company's tax return, it makes sense to keep track of and appropriately identify these

costs. Overhead costs are also included in a variety of financial statement accounts, including the cost of

goods sold, selling, general and administration expenses, and inventories, among others. Getting these

figures accurate also gives vital knowledge and helps in the improvement of the business's operations

Conclusion

Knowing the difference between direct and indirect costs is essential for business owners since

failing to allocate and assign costs correctly could prevent them from being able to determine their profit

per unit after selling their goods or services.

 References

Kenton, W (2020). What is a Direct Cost? Retrieved from

https://www.investopedia.com/terms/d/directcost.asp

Mukhopadhyay (n.d). Direct Cost vs Indirect Cost. Retrieved from

https://www.wallstreetmojo.com/direct-cost-vs-indirect-cost/