How Costs are Categorized

There are two basic types of accounting: managerial (or cost) accounting, and financial accounting.

In financial accounting we show costs as expenses on the Income Statement. Direct costs are sometimes shown as an expense line right below revenues. We call this expense line Cost of Goods Sold or COGS.

In cost accounting our focus is on what is costs to produce something. Our goal is to manage costs and optimize them. The less something costs to make, the more profit.

We bundle expenses to parse cost information so we can gain managerial insights. Our goal is to better analyze product or manufacturing costs.

We separate our costs into two general categories: direct and indirect costs. There are three basic elements of costs: direct materials, direct labor, and overhead. Materials and labor are the major components that make up direct costs. Overhead is an indirect cost. We group these all together as manufacturing costs.

In financial accounting we show costs as expenses on the Income Statement. Direct costs are sometimes shown as an expense line right below revenues. We call this expense line Cost of Goods Sold or COGS.

What gets measured gets managed, so measure what matters.

In cost accounting our focus is on what is costs to produce something. Our goal is to manage costs and optimize them. The less something costs to make, the more profit.

We bundle expenses to parse cost information so we can gain managerial insights. Our goal is to better analyze product or manufacturing costs.

We separate our costs into two general categories: direct and indirect costs. There are three basic elements of costs: direct materials, direct labor, and overhead. Materials and labor are the major components that make up direct costs. Overhead is an indirect cost. We group these all together as manufacturing costs.

Creating value is the process of transforming inputs into a product or service. The cost of raw materials and labor are what make up direct costs.

Direct materials include purchased parts. They are directly associated with making the product. There are materials that support the process but don’t end up in the finished good. Things like oil for machines or masking tape for painting. These are indirect materials. We account for indirect materials as part manufacturing overhead.

Direct labor is the cost of the workers who make the product. Indirect labor includes workers who do not use the direct materials to build the product. Supervisors, managers, and maintenance workers are indirect labor. Indirect labor is part of manufacturing overhead.

Manufacturing overhead costs include indirect materials, indirect labor, and all other manufacturing costs. Depreciation on factory equipment is part of overhead. Costs related to the factory like rent, insurance, taxes, and utilities are also part of manufacturing overhead.

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