In the past, manufacturing operations were mainly labor paced, and direct costs comprised the majority of product costs. Since the early 20th century, automation has been evolving which then gradually replaced labor cost. Those allow almost every staffs/workers to multi-tasking. The emerging trends increases the use of indirect costs in manufacturing which then increased the need for costing systems to deal adequately with indirect costs.

The first thing to do in classifying cost is to test if a cost is direct—a cost that is uniquely and unequivocally attributable to a single “cost object”. If the cost fails the test of being direct it is classified as indirect.

If a single cost object consumes a consumable resource, the cost of the consumable resource is a direct cost for that cost object. The cost of wood used to make a table in a furniture factory is a direct cost that would be assigned to the table. Any cost that fails the test of being a direct cost is an indirect cost. This may sound simple, but disputes in costing about whether a cost should be treated as direct or indirect, outnumber all other costing disputes. So, how to deal with indirect cost in a manufacturing environment? Before going to the topic, you would need to be familiar with some terms used in costing which I will introduce now. Following on, let’s also have a look how cost flows in manufacturing organization and how to differentiate direct and indirect cost. Read on…