Pricing based just on direct costs makes the most sense in situations where there is an opportunity to sell a few extra units on a one-time sale with excess production capacity. Using Direct Costs and Indirect Costs in PricingĪt a minimum, direct costs should always be included in the derivation of a product’s price, since the established price must always equal or exceed its direct cost otherwise, every sale will generate a loss. It can be too difficult to derive a cost-effective methodology for the assignment of indirect costs the result is that many of these costs are considered part of corporate overhead or production overhead, which will exist even if a specific product is not created or an activity does not occur.ĭirect costs tend to be variable costs, while indirect costs are more likely to be either fixed costs or period costs. The concept is critical when determining the cost of a specific product or activity, since direct costs are always used to compile the cost of something, while indirect costs may not be assigned to such a cost analysis. These costs are usually only classified as direct or indirect costs if they are for production activities, not for administrative activities (which are considered period costs). A cost object is something for which a cost is compiled, such as a product, service, customer, project, or activity. The essential difference between direct costs and indirect costs is that only direct costs can be traced to specific cost objects.
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