Is Depreciation a Direct Cost or Indirect Cost
Depreciation is typically classified as an indirect cost. Direct costs are those that can be directly attributed to a specific product, service, or project. They typically include direct labor (i.e., wages for employees who physically manufacture a product) and direct materials.
Depreciation, on the other hand, is the allocation of the cost of a tangible or physical asset over its useful life. It often involves assets that are used in the general operations of the business—not tied to the production of one specific good or service. For example, the depreciation of a manufacturing plant or equipment can’t usually be directly tied to a single product, but rather, it supports the production of all products. Therefore, it’s classified as an indirect cost.
However, in some cases, if an asset is used exclusively in the production of a specific product, its depreciation could be considered a direct cost of that product. This is less common and depends on the specifics of the business and its operations.
As always, the exact classification may depend on the accounting rules applicable in a particular jurisdiction or the accounting policies of the specific company. It’s always a good idea to consult with a qualified accountant or financial advisor for advice based on the specific situation.
Example of: Is Depreciation a Direct Cost or Indirect Cost
Here’s an example to illustrate how depreciation is typically considered an indirect cost.
Let’s consider a company named ABC Manufacturing that produces two types of products: Product X and Product Y. To produce these products, the company uses various machinery in its manufacturing plant. One particular machine, Machine A, is used to produce both Product X and Product Y.
ABC Manufacturing bought Machine A for $100,000, and it has a useful life of 10 years with no expected salvage value. This means the machine depreciates by $10,000 per year ($100,000 divided by 10 years).
Because Machine A is used to produce both Product X and Product Y, it’s challenging to attribute its depreciation cost directly to either product. Thus, the $10,000 annual depreciation expense for Machine A is generally considered an indirect cost.
Now, suppose ABC Manufacturing had another machine, Machine B, which is used exclusively to produce Product Y. In this case, its depreciation could potentially be considered a direct cost of Product Y. However, such situations are less common and can depend on specific business circumstances and accounting policies.