Direct costs refer to expenses related directly to production a product and they can be traced in the final product. They include things like materials, fuel or even labor .This cost usually vary in amount according to rate of output but remain uniform in each unit of production therefore termed as inconsistent.
During analysis of direct material (raw material) as a direct cost, variations may occur due material price variation or usage or efficiency variation. Price variation is the difference between the standard cost and the actual cost for the quantity of material used. Direct material usage variance comes when there is a difference between the standard amount of materials that could have been utilized for a set number of units and the actual amount of materials used that is valued at standard cost for a unit of material.
1 kg of wheat flour at € 10 per kg/unit
Assuming further that during given period, 50 cakes were manufactured, using 80 kg of flour which cost € 960.
Under those assumptions direct material usage variance can be calculated as:
Direct material utilization variance can be reconciled to direct material total deviation by way of direct price of material variation.
All the other direct costs including labor and fuel face the same challenges, but among the biggest challenges facing analysis of direct cost is ensuring that they aren’t captured in any other part of total cost.
The analysis of direct costs and its remedy lie on analysis of two parameters, price analysis and cost analysis Price analysis entails comparison of the price with known indicators by close examination of how fair is the asking price of a service or product without considering profit calculations and specific costs the vendor used in deriving the price, its generally used on material and other general procurements which can be compared with others. When adequate price competition does not exist, some other form of analysis may be required. It’s a critical tool in direct cost analysis since it helps us to analyze the price of raw material before purchase in order to avoid deviations from the budgeted values.
Cost analysis methods are the techniques used to thoroughly examine direct costs leading to final price. The cost elements assessed include direct material costs, labor costs, overhead and equipment. These costs can be related to actual costs previously incurred for a similar work, the pricing or cost data proposed by other suppliers and breakdown from independent cost estimates. Cost analysis involves item-by-item examination of the actual or estimated cost of a contract in order to determine the probable cost with the ultimate goal of forming an opinion on if the proposed costs are in agreement with what is incurred. This analytical tool is used where price analysis has failed to give a reasonable and a fair price. It helps the analyst to estimate the total cost of the total cost of production thus bargaining effectively in order to avoid deficits.
Conclusion.
Direct costs part of the recipe in production, but if not planned well there can be variations which can cause deficits which can be reflected as loses in the business therefore to avoid this deviations price and cost analysis techniques are used as pointers on how best the costs can be adjusted depending on the effectiveness of production and prevailing economical conditions.
Reference.
Jae K. Shim, J. G. (2009). Modern Cost Management and Analysis. New york: Barron's Educational Series.
