Week 4-6 (Feb 22 to March 12, 2021)

Pricing and Costing Cristy T. Dioneda-Docdocos,MAMPA

2nd Semester SY 2020-2021 Instructor

Introduction

The entrepreneur must be able to study and estimate the costs that his business will incur. Every
business incurs costs even if there are no activities going on in production, service or trade. To understand
this, it is essential to know that there are direct and indirect costs.

Learning Objectives

After studying this topic, the students should be able to:

1. Describe direct and indirect cost
2. Distinguish the various types of cost
3. know how to compute overall total costs

Pre-test

1. what is cost?
2. What are the different types of cost?
3. What is the importance of cost management?

Key Concepts

DIRECT COSTS

Direct costs are expenses that a company can easily connect to a specific "cost object," which may be a
product, department or project. This can include software, equipment and raw materials. It can also
include labor, assuming the labor is specific to the product, department or project.
Direct or Variable Costs: Vary directly with the number of items made or sold. This includes all money
spent for supplies and materials to make the product or to provide the service. For example, the cost of
raw materials, packaging and labor.

For example, if an employee is hired to work on a project, either exclusively or for an assigned number
of hours, their labor on that project is a direct cost. If your company develops software and needs specific
assets, such as purchased frameworks or development applications, those are direct costs.

Labor and direct materials constitute the majority of direct costs. For example, to create its product, an
appliance maker requires steel, electronic components and other raw materials. Two popular ways of
tracking these costs, depending on when your company uses materials in production, include last-in,
first-out (LIFO) or first-in, first-out (FIFO). This can be helpful if the costs of your materials fluctuate in
the course of production.

Usually, most direct costs are variable. Smartphone hardware, for example, is a direct, variable cost
because its production depends on the number of units ordered. A notable exception is direct labor costs,
which usually remain constant throughout the year. Typically, an employee's wages do not increase or
decrease in direct relation to the number of products produced.

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 Direct Cost are those costs that depend directly on the number of products, services or goods produced.
Direct costs are composed of two sub-groups:
1. Direct Material costs
Expenditures for all items that become part of a product or are used to produce a service or are
bought for resale enter into the category of direct material costs. Costs linked to the acquisition
of raw materials such as transport from the supplier to the enterprise are included as direct
costs.
2. Direct labor costs
All wages for workers and helpers that are directly involved in the production or the delivery of
services. This also includes benefits like social security.
Staff wages for the retailer and wholesaler are NOT considered as direct costs.

INDIRECT COSTS
Indirect costs extend beyond the expenses you incur creating a product to include the costs involved
with maintaining and running a company. These overhead costs are the ones left over after direct costs
have been computed.

The materials and supplies needed for a company's day-to-day operations are examples of indirect costs.
While these items contribute to the company as a whole, they are not assigned to the creation of any
one service.

Indirect costs include supplies, utilities, office equipment rental, desktop computers and cell phones.
Much like direct costs, indirect costs can be both fixed and variable. Fixed indirect costs include things
like rent. Variable costs include the fluctuating costs of electricity and gas.

Indirect or Fixed Costs: Are the business expenses or overheads that must be paid whether or not its
products are sold. Indirect costs include items such as rent, electricity, telephone, salaries, insurance and
depreciation.

To calculate the manufacturing costs of one single product or one single service, the entrepreneur has
to calculate the indirect costs proportionally.

If the business produces a single product/service, or if the products are quite similar, for example chairs,
beds, and tables, the indirect costs are divided to the direct costs to calculate the total cost per unit of
an item.

Total Indirect cost

= Total Cost per unit
Total Direct Cost

In a service business, the indirect costs are generally calculated on the basis of working hours and added
to the time spent in delivering the service.

Total wage per hour + total time spent= total indirect cost

DISTINCTION BETWEEN DIRECT AND INDIRECT COST

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To make the distinction between direct and indirect costs is not always easy, for example the glue used in
furniture making. The quantity used for one chair is so small that it represents only a very small portion
of the price of the glue. The cost of a can of glue is therefore considered as an indirect cost. Also if a helper
serves several workers, his salary cannot be attributed to one single product. The salary of the helper will
therefore be counted as an indirect cost.

To get the total cost of a product/service, one adds all the direct material costs, the direct labor costs, and
the proportion of indirect costs calculated for making the product or delivering the service.
The formula is:

Sum of direct material costs + sum of direct labor costs + proportion of indirect costs= Total cost per
product/service.

Task

Check out on our Gclassroom for a short quiz.

References

A. Online References

• Direct Costs vs. Indirect Costs: What Are They, and How Are They Different? By Ethan Spielman
on Business News Daily Contributing Writer Updated Jun 12, 2020.
https://www.businessnewsdaily.com/5498-direct-costs-indirect-costs.html
• Direct vs. Indirect Costs. Rachel Blakely-Gray | Mar 22, 2018.
https://www.patriotsoftware.com/blog/accounting/direct-vs-indirect-costs-difference/

B. Book References
• Kuratko, Donald F. (2017). Entrepreneurship. Cengage Learning.
• Barringger, Bruce R. & R. Duane Ireland (2013). Entrepreneurship Successfully Launching New
Ventures, Fourth Edition, Pearson Education Limited, Edinburg Gate, Harlow, Essex, England,
• Medina, Roberto G. (2015), Entrepreneurship and Small Business Management, Rex
Bookstore, Manila, Philippines
• Scarborough, Norman M.(2013). Essentials of Entrepreneurship and Small Business
Management, Sixth Edition, Pearson Education Limited, Edinburg Gate, Harlow, Essex,
England.
• Principles of Marketing by Young & Pagoso
• Small Enterprises Research and Development Foundation.(2013). Windows to
Entrepreneurship; A Teaching Guide. SERDEF, UP Diliman,Quezon City, Philippines

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