Direct costs and variable costs are expenses associated with production. Direct costs are expenses that can be directly traced to a product, while variable costs vary with the level of production output. Although these costs appear to be similar, direct costs are associated with a cost object, while variable costs are not.
Direct costs are expenses that can be accurately and easily traced to cost objects. Cost objects may be goods or services, departments or projects. Direct costs can include fixed and variable costs. Direct fixed costs can be easily traced to cost objects and do not vary with the level of production. Direct variable costs vary with production levels.
For example, suppose the engineering department of a company is producing a new technology device. Employees’ salaries are the same every year, no matter how many devices the employees produce. The engineering department must also purchase new software and materials to produce the technology device. Both of these are considered to be direct costs because they can easily be traced back to the department. The salaries are considered direct fixed costs because they do not vary with production.
Variable costs are corporate expenses that vary as the production of goods and services varies. Unlike direct costs, variable costs depend on the company’s production volume. When a company’s production output level increases, variable costs increase. Variable costs fall as the production output level decreases.
Unlike a direct cost, a variable cost does not have to be easily traceable to a cost object. A variable cost can also be an indirect cost. An indirect variable cost is an expense directly related to a cost object, or a product. The total cost associated with the cost object changes as the production level changes. For example, suppose the company uses multiple production machines to produce the new technology device. The production machines require electricity to operate. This is an indirect cost because it is very difficult to trace the electricity expense back to the department and the production machines. However, the cost of the electricity is considered a variable cost, because as more products are produced, the total electricity consumption is increased, thereby increasing costs.