Direct expense

Direct expense is directly involved in the production process in the case of the production or sale process in the case of commercial activities. This expense can be assigned to a specific product, service, customer, department, segment or project based on relevant documents. Such a document may be evidence of material collection, indicating the amount of material collected for the production of a given product, or a labor card, containing the number of hours worked on the production of a particular product and the hourly rate. These expenses are related to the purchase of goods for the company. They are often used to determine the price of your products or services. They become part of the total cost of goods or services sold.

Examples of direct expenses

Examples of direct expenses include:

• direct materials - raw materials and basic materials from which a given product and auxiliary materials and packaging are made, if they can be included in specific products. These can be identified in the product and can be measured and directly charged to the product. Examples of direct materials are cloth in dress making, car parts in mechanics.
• direct labour - wages of workers employed directly in the production of specific products together with surcharges on these wages, the commission and payroll taxes related to the sale of goods or services (social insurance premium and labor fund),
• Other Direct Expenses or Charges - carriage and freight on materials bought for particular jobs, if such carriage has not been included in the cost of the materials, consumption of special tools used only for the production of specific products, hire of special machinery or plant for a particular job.

Variance of direct expenses

Direct expenses are entirely dependent on the production volume. It means they are variable costs. These costs will change if you produce more or less products at any given time. The costs are divided into :

• proportional costs - costs change in direct proportion to changes in production volume (costs of direct materials),
• progressive costs - the increase in costs is faster than the increase in the level of production. The unit cost is the size that grows with the increase in the scale of production (wage costs, when production growth is achieved by employing overtime employees, on Saturdays or Sundays and holidays. Wage rates for overtime or worked on non-working days are in fact higher than the rates paid on normal working days).
• degressive costs - the increase in costs is slower than the increase in the level of production. The unit cost for this type of costs is a small decreasing amount due to the increase in production (wage costs of employees employed for piecework during the implementation of a new product).
• regressive costs - production growth causes a drop in costs. The unit cost decreases at a fast pace in relation to the production volume (the cost of heating the room).

Advantages of Direct expense

Direct expense provides a company with several advantages. These include:

• Accurate Cost Tracking: Direct expense allows a company to precisely track their cost for a specific product or service. This information can be used to accurately measure profitability and adjust pricing accordingly.
• Improved Budgeting: Direct expense makes it easier for a company to plan and budget for their future. This helps to ensure that resources are allocated to the areas of the business that need them most.
• Improved Efficiency: Direct expense allows a company to identify areas of waste and inefficiency in the production process, which can be adjusted to make the production process more efficient.
• Enhanced Quality Control: Direct expense allows a company to monitor the quality of their products and services more closely, ensuring they are of the highest possible standard.

Limitations of Direct expense

Direct expense is a useful tool to track costs associated with producing or selling a product or service, but it also comes with a few limitations. These limitations include:

• Direct expense only captures costs associated with a specific product, service, customer, department, segment, or project. It does not capture any indirect costs, such as overhead expenses, which must be allocated to multiple products or services.
• Direct expense does not capture cost savings associated with economies of scale or cost improvements due to improved efficiency.
• Direct expense does not capture the cost of capital and other intangible costs, such as goodwill or brand loyalty.
• Direct expense does not capture the cost of changes in demand for a product or service.
• Direct expense does not account for changes in the cost of raw materials or other inputs.

Other approaches related to Direct expense

• Direct expenses are also used to measure the productivity of a business. For example, tracking the costs of raw materials and labor used in the production of a product can help identify where production costs can be reduced.
• Direct expenses can also be used to measure the profitability of a business. By tracking the costs of producing a product or service, a business can determine the amount of profit or loss it makes from the sale of that product or service.
• Direct expenses can also be used to assess the performance of a business. By tracking the costs associated with producing a product or service, a business can determine how efficient its production processes are.
• Direct expenses can also be used to compare the costs of similar products or services from different businesses.

In summary, direct expenses are used to measure the productivity, profitability, performance, and cost-competitiveness of a business. By tracking and analyzing direct expenses, a business can identify areas for improvement and make adjustments to increase its efficiency and profitability.

Footnotes

Direct expense — recommended articles

Conversion cost — Direct labor cost — Mixed cost — Segment margin — Variable overhead efficiency variance — Applied overhead — Manufacturing cost — Cost per unit — Cost variance

References

• Taschner A., Charifzadeh M. (2016) "Management and Cost Accounting" Wiley-VCH Verlag&Co Weinheim, Germany,
• Rajasekaran V., Lalitha R. (2011) "Cost Accounting" Pearson India, p. 6,7, 171-173,
• Hansen D. R., Mowen M. M., Guan L. (2009) "Cost Management Accounting&Control" Cengage South-Western; Sixth edition, South-Western, p. 25, 30.
• Marcia M. (2008) Cost-of-Illness Studies in the United States: A Systematic Review of Methodologies Used for Direct Cost Gerd Clabaugh MPA, Volume 11, Number 1.
• Stancik, P. Basl, J. (2005) Research the behavior of the assistance toward fixed costs and profit making Applied Computer Science, Vol.1, no 1.
• Niazi A., Dai J. S., Balabani S., Seneviratne L. (2005) Product Cost Estimation: Technique Classification and Methodology Review Journal of Manufacturing Science and Engineering, Volume 128.

Author: Marta Bodzioch

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