The relationship of direct & indirect costs with fixed & variable costs is a very crucial concept to understand for doing a real interpretation of costs in any manufacturing business. At the very outset, it should be clear that all costs can be classified into direct / indirect as well as fixed / variable. In brief, we can say that any cost be categorized under one of these categories viz. direct and variable, direct and fixed, indirect and variable, indirect and fixed.
Before moving towards understanding the above dual cost classification concepts, let us recapitulate the basic definitions of direct, indirect, variable and fixed costs
Direct costs are those costs which are related to the product and amount of expense is easily assignable / traceable to the product. These costs are assigned to the product based on cause and effect relationship.
Indirect costs are those costs which are related to the product but the amount of expense is not traceable in an economically feasible manner. These costs are allocated to the product based on the some reasonable basis.
Total variable cost is that cost which changes in proportion to the change in output like direct material costs. Per unit variable cost remains fixed.
Total fixed cost is that cost which does not change in proportion to the change in output like monthly salary cost of a supervisor. Per unit fixed cost is variable.
Now let us look at those dual cost classifications:
Direct and Variable Costs
These are those costs which are related to the product, traceable and whose total cost change in proportion to the change in total output. This is very simple to understand and the best and simple example can be the direct material costs like tones of sand in preparation of tiles.
Direct and Fixed Costs
These are those costs which are related to the product, traceable but whose total cost does not change in proportion to the change in output. It is little difficult to visualize. Example for such a cost can be the salary of supervisor of tile x in the factory where tile x and y are manufactured. Here we know that the cost is incurred because we are manufacturing tile x but this cost will not increase or decrease in tandem with the change in manufacturing output of tiles as its nature is fixed for a period.
Indirect and Variable Costs
These are those costs which are not directly related to the product and therefore not traceable but whose total cost changes in proportion to the change in total output. For example, power cost at tiles factory where tile x and tile y is manufactured. Here, we know that the increase in output of any of the tiles – x or y will increase the power cost which makes it variable cost but at the same time the power cost cannot be easily allocated to tile x or tile y. It is very difficult to say how much power cost is incurred for tile x or tile y and hence it is an indirect cost.
Indirect and Fixed Costs
These are those costs which are not directly related, traceable to product but whose total cost does not change in proportion to the change in the output. It is again a simple to visualize cost. Example can be salary of the supervisor who looks after the production of both tile x and tile y. Here, we can see that the salary cost is a fixed cost which would not change with the change in output of the tiles. But at the same time, it is difficult to say how much cost of his salary is because of tile x or tile y. Therefore the cost is an indirect cost.