Direct costs are the expenses a business incurs directly to make a product or service, or buy a wholesale product for resale. (All other costs are considered to be indirect costs.)
Direct costs vary as production and purchasing increase or decrease, and also in response to external factors like changes in supplier pricing or currency exchange rates (for businesses with foreign suppliers). Hence, they are typically described as variable in nature.
In a manufacturing company, direct costs are called the cost of goods sold (COGS).
In a retail or wholesale business that buys products from suppliers, direct costs are called the cost of sales (COS).
More about direct costs
Here’s an example of how direct costs appear on a manufacturing company’s income statement. In this case, ABC Company manufactures a single product. The labour, raw materials and depreciation expenses for each unit of that product are $2, $1 and $0.5, respectively.
That means the direct cost to make a single product is $3.50.
If ABC Company sold 10,000 units of its product for $10 each, in the three months, its direct costs would be as follows: