Yolanda has taught college Psychology and Ethics, and has a doctorate of philosophy in counselor education and supervision.
Did you know that raw materials are a type of direct expense? In this lesson, we will define direct and indirect expenses and discuss examples of both kinds of expenses.
Direct and Indirect Expenses Defined
Direct expenses are the expenses that a business incurs that are directly associated with a cost object. A cost object is any item for which costs are measured, including products, services, employees, and even entire departments. Indirect expenses are the expenses that a business incurs that are associated with operating the business as a whole and cannot be traced back to a specific cost object. Let's take a closer look at direct and indirect expenses using an example business that we'll call Troy's.
Troy Wilker is the owner of a chain of auto repair shops across the Midwest called Troy's. Each Saturday, Troy looks at his company's income statement to calculate his total weekly expenses. Troy notes the following expenses: rent, utilities, employee wages, auto parts, office supplies, transporting auto parts, legal fees, and insurance. So, which of these expenses are direct and which are indirect?
Troy's has several direct expenses. Employee wages, auto parts, and transporting auto parts are all direct expenses because they benefit a specific cost object and can easily be traced to that cost object. For example, the repair department received the auto parts, therefore the auto parts are a direct expense to the repair department.
Some of Troy's direct expenses are fixed. For example, Troy's spends the same amount for employee wages each week. Other expenses can change. Troy's repaired twice as many cars this week than it did last week; as a result, this week's auto parts expense was higher than last's.
Other examples of direct expenses include:
Raw material (e.g. steel or wood) used to create a product that will be sold
Freight costs for taking goods to a warehouse
Research supplies related to a specific project
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Troy's also has several indirect expenses. Rent, utilities, office supplies, legal fees, and insurance are all indirect expenses because they benefit the entire company. For example, utilities provide electricity to all of the departments in Troy's. Likewise, all of the departments and locations use office supplies. Because indirect expenses are almost impossible to trace back to a specific cost object, it is much harder to divide and allocate indirect expenses.
Indirect expenses are similar to direct expenses in that some are fixed (e.g., insurance) while others vary (e.g., utilities). Like most other companies, Troy's has more indirect than direct expenses.
Other examples of indirect expenses include:
Worker's comp insurance
Printing and stationary
Administrative staff salaries
We have learned all about direct and indirect expenses thanks to Troy's. Direct expenses are those that are linked to a specific cost object, while indirect expenses are associated with the entire business and not specific cost objects. Indirect and direct expenses can be either fixed or variable. Most of a company's expenses are indirect. Indirect expenses are harder to allocate and divide than direct expenses.
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