Product costs may be classified as either direct or indirect.

Direct costs are expenditures in a factory that can be specifically traced to a manufactured item and that becomes part of its overall cost.

Indirect costs are also incurred in a factory where production takes place, but they are more general and cannot be attributed to any specific product.

There are three broad categories of product costs associated with a manufactured item:

1. Direct materials
2. Direct labor cost
3. Manufacturing overhead

Direct materials are raw materials that will be used to create finished goods. Their cost becomes part of the product that customers ultimately purchase.

Direct labor is the cost of hourly wages of production workers who assemble manufactured goods. These employees work on products that are sold to customers when finished.

Manufacturing overhead is an indirect cost and includes ANY expense in a factory that is not specifically traced to products that customers purchase. These may be general expenses, such as utilities, insurance, property taxes, depreciation, supplies, maintenance, supervisor salaries, and expired prepaid items. Therefore, manufacturing overhead includes materials or labor that do not directly become part of the product (such as parts and supplies used to repair a machine used in the manufacturing process).

In short, any cost that is incurred as part of manufacturing that is not direct materials or direct labor is manufacturing overhead.

Here is a short review of direct and indirect costs:

You can view the transcript for “Direct vs. Indirect Costs” here (opens in new window).

Let’s review your understanding of direct and indirect costs: