Traceability

When we assign costs to products, we typically treat labor and material as direct costs. Direct labor is the touch labor directly associated with the actual production process, as opposed to those who support the production process. Following this reasoning, the wages of a worker who sets up a machine are an indirect cost, but the wages of the worker who actually runs the machine to make the product are a direct cost. Similarly, raw material (also called direct material) is treated as a direct cost, although there are some exceptions. Some materials, such as small hardware, are too inexpensive to justify spending a lot of time tracking them. Consequently, such items are often classified as indirect costs. Other indirect materials include lubricants, small tools, sandpaper, rags, adhesives, and some finishing materials.

Indirect costs (or overhead or burden) are classified as fixed or variable. (For further discussion of fixed and variable costs, refer to the section on cost behavior if you have not already read that material.) The following table summarizes the types of costs that are typically included in variable and fixed overhead.

Type of Cost	Examples
Variable overhead	Setup labor, miscellaneous supplies and small hardware, small tools, lubricants, power
Fixed overhead	Factory supervision, depreciation on factory and machinery, insurance premiums, property taxes, rent on the production facility; power may have a fixed and a variable component (fixed charge per month plus so much per kilowatt hour)

Copyright © 2004 Gerald M. Myers. All rights reserved. This site has been developed as aid to instructors and students in managerial accounting. The scenarios contained herein are not intended to reflect effective or ineffective handling of managerial situations. Any resemblance to existing organizations is purely coincidental.

Last modified: August 03, 2005