When recording business expenses, it’s important to remember that all costs fall into three categories – direct costs, indirect costs and general & administrative costs. It is important to account for your expenses accurately because it helps you understand where you are spending your money and at what point your business begins generating a profit. This week’s article will explain the differences between these three categories.
Direct costs are all costs that are directly related to a service, product or project. These costs are typically variable costs because they vary based on the quantity of products produced. They are the primary expenses incurred. This category is typically a small category under your cost of goods sold as far as the type of accounts that fall under this heading. The most common types of accounts are direct labor, direct materials and subcontractor costs. There will be no doubt as to which job or project these costs were incurred for. All other costs that are incurred for a product or project that cannot be tied directly to just one particular project are called indirect costs.
Indirect costs are costs that are necessary to run create a service, product or project; however, they are incurred for various projects or products not just one in particular. The accounts that fall under this section are also under cost of goods sold but will include more accounts that the direct costs section. These costs are usually assigned using an allocation rate. Accounts that fall under this heading are indirect labor, insurance, telephone and small tools. The telephone and utilities that fall under this heading are typically related to the cost of running the area of the business facilities that produces the product, such as a manufacturing plant. Often times they are called the hidden costs of a product or project.
General & Administrative Costs
The third category is general & administrative costs. These costs are all other costs that do not fall into the previous two categories. They are the costs associated with running your back office. They will include accounts for advertising, office salaries and office expenses.
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