Tag Archives | overhead allocation

Direct Materials

See Also:
Direct Cost vs Indirect Cost
Direct Labor
Cost Driver
Direct Labor Variance Formulas
Direct Material Variance Formulas
Absorption Cost Accounting

Direct Materials Definition

In accounting, direct materials are the resources used to make a product. You must clearly link these resources to the product you are producing. Direct material costs are one of the costs associated with producing a product. Furthermore, direct materials are in contrast to indirect materials. Indirect materials are materials used to produce a product not clearly linked or traceable to the final product.

Examples of direct materials include the following:

  • Wood used to make tables
  • Glass used to make windows
  • Fabric used to make furniture

Direct Material and Overhead Allocation

Sometimes it may be appropriate to use direct materials as a cost driver to allocate indirect costs to a production process.

Indirect costs, such as overhead costs, are not directly traceable to the final product; however, they are necessary for the production of the process. Therefore, incorporate them in the overall cost of the product and then allocate them to the final product by way of a cost driver.

In production processes in which direct material is an appropriate cost driver, on can allocate indirect costs to the cost of units of output via direct material. The measurement of the cost driver depends on the type of material. If it’s wood, then the cost driver may be based on feet of wood used, or pounds of wood used.

Using direct materials as a cost driver requires quantifying the direct material with some physical or otherwise quantifiable measure. Then allocate indirect costs to the units of output using a cost driver rate, such as $2 dollars per foot of wood, or $0.40 per square foot of fabric, depending on what direct material you use and the specifics of the production process.

direct materials

Source:

Hilton, Ronald W., Michael W. Maher, Frank H. Selto. “Cost Management Strategies for Business Decision”, Mcgraw-Hill Irwin, New York, NY, 2008.

 

Share this:
0

Direct Labor

See Also:
Direct Cost vs Indirect Cost
Cost Driver
Direct Materials
Direct Labor Variance Formulas
Absorption Cost Accounting
Direct Material Variance Formulas

Direct Labor Definition

In accounting, direct labor (DL) costs are the costs associated with paying workers to make a product or provide a service. The workers must be clearly involved in producing the product or providing the service. Direct labor costs are one of the costs associated with producing a product or providing a service. Furthermore, direct labor costs are in contrast to indirect labor costs. Indirect labor costs are costs associated with workers who are necessary, but they are not directly involved with making the product or providing the service.

Examples of direct labor costs include the following:

  • In a manufacturing setting, wages paid to workers in an assembly line
  • In a service setting, wages paid to workers in the kitchen of a restaurant

Direct Labor and Overhead Allocation

Sometimes it may be appropriate to use direct labor as a cost driver to allocate indirect costs to a production process.

Overhead Allocation

Indirect costs, such as overhead costs, are not directly traceable to the final product; however they are necessary for the production of the process. As a result, they must be incorporated in the overall cost of the product. In addition, allocate indirect costs to the final product by way of a cost driver.

Direct Labor

In production, processes in which direct labor is an appropriate cost driver, allocate indirect costs to the cost of units of output via DL hours. Then, allocate indirect costs to the units of output using a cost driver rate. For example, it could be $2 dollars per hour of direct labor, or $0.40 per hour of direct labor, depending on the specifics of the production process.

Direct labor is a typical cost driver for allocating indirect costs to units of output from a production process. But as production processes have become more automated over time, using DL is no longer as common as it once was. As a result, other cost drivers are frequently used to allocate indirect costs in a production process or in providing services to customers.

If you want to check if your unit economics are sound, then download your free guide here.

direct labor

Strategic CFO Lab Member Extra

Access your Projections Execution Plan in SCFO Lab. The step-by-step plan to get ahead of your cash flow.

Click here to access your Execution Plan. Not a Lab Member?

Click here to learn more about SCFO Labs

direct labor

Source:

Hilton, Ronald W., Michael W. Maher, Frank H. Selto. “Cost Management Strategies for Business Decision”, Mcgraw-Hill Irwin, New York, NY, 2008.

 

Share this:
0

LEARN THE ART OF THE CFO