Provide an example of a direct cost and indirect cost from your workplace or an organization with which you are familiar. What is the difference? Explain your answer. List references if you use a source other than the text.
Direct costs are those which may be traced directly to the product, department or operation, for example, the material used in a product. While, indirect costs are those which are cannot be traced to a particular product, department or operation, the example of it is the rent of the factory. In furniture industry the wood, nails, glues are direct cost and the rent of the premises where the work is one is indirect cost.
As the direct cost is traceable and can be said with certainty, where it should fall or for which product it has been incurred therefore it is easy to track, while the indirect cost like rent which is common for all product therefore it cannot be said with certainty that where it should fall or for which product it has been incurred. The indirect cost is allocated on some basis for example; the rent for the year can be allocated on the basis of unit produced during the year. It cannot be ignored as it has also to be included in the product costing to recover this cost by charging selling price. If these types of costs are ignored, the cost of a product will not be accurate and the selling price charged can also be wrong, which may result in loss for the company.
Understanding the difference between fixed and variable costs, what area of a health care facility or physician practice do you think would have a greater amount of variable costs than fixed? What would you suggest to lower the fixed costs for the same area?
Fixed cost which remains constant in total and it is not affected by volume of activity, up to relevant range. The per unit fixed cost varies according to volume of activity. For example, rent of factory is $50000 and the maximum capacity can be produced is 200000 units. The fixed cost will remain same whatever the production is but the per unit fixed cost will be affected volume, if company produce 100000 or 200000 units the per unit fixed cost will be 50 cents or 25 cents respectively. Other example of fixed cost are supervisor salary, labor hired on monthly or weekly salary, depreciation expense for all methods except units of output method.
Variable cost does not remain constant but it varies with the volume of activity. If production is more the total variable cost will be more but per unit cost will remain the same. For example, direct material cost is $2 per unit, if production is 100000 units or 200000 units, the total direct material cost will be $200000 or $400000 respectively. Other examples are, labor cost paid on hourly basis or units of production basis, electricity cost of machines, depreciation under units of output method, depletion cost of coal mines, etc.
The healthcare will have the more variable cost as they would be providing medicines to the patient while the Physician will have fewer variable costs as it just provides the services of consultancy. The basic fixed cost would be the rent, utilities, and administrative expenses. The fixed cost which is normally uncontrollable can be controlled only by reducing its usage or getting it on cheaper rate. For example, the use of utilities should be done when it is needed and the salary of admin staff can be controlled by reducing the number of staff or lower salary package.
Reference: www.investopedia.com