Accounts - What Are Direct Costs?

Question

Hi I understand that direct costs are deducted from income in order to calculate gross profit. Looking at a tax return that an accountant did for me, I'm a bit puzzled about what constitutes a direct cost, I think I understand that these direct costs are dependant and proportional to the amount of income - i.e. the more items you sell, the higher these costs will be, as opposed to fixed overheads like heating and water and rent which doesn't change, or advertising which can be whatever you choose to spend. In an internet sales business, in order to actually sell the product there is cost of stock cost of shipping to get stock from supplier cost of shipping to send stock to customer cost of packaging

These things my accountant included in direct costs - but he didn't include the fees I have to pay for accepting electronic payments - these are proportional to takings and necessary also.

Is there any particular reason why these would not have been included as a direct cost?

Thank you.

eyup · Accepted Answer

Probably because he/she didnt know the exact nature of the cost. We come across it all the time. Inform him/her that you consider it slightly inaccurate and would like it amending in future. Afterall they are your accounts and it wont effect anything other than the disclosure of the numbers.

eyup · Answer

ps reading it again it was probably looked at as similar bank charges. I would have treated it the same way and not included in cost of sales. The amount of transactions you make impacts many admin costs that we consider not to be a cost of sale. You can still ask for it to be altered in future though.

Ronald Raygun · Answer

It is not the fact that the expenses are proportional to sales which makes them "direct". Traditionally the cost of shipping stock from supplier to you is counted as cost of sales, and therefore affects gross profit, but the cost of getting goods from you to your customers (including packaging) is not. Instead it is treated as an overhead expense, and therefore affects not your gross, but your net profit. Payment fees are also an overhead expense.

Of course even "net profit" is still gross of tax, so you don't lose out on that front simply because some expenses are in a different place.

Maria · Answer

I see. Is there any reason why carriage and payment fees are not treated as direct costs? I'm just trying to get it clear in my head which things should be allocated where!

Thanks - I'm wanting to know more out of curiosity as I like to know how things work, but also in order to value the business in order to sell it.

Maria · Answer

Thanks. Please see my reply to Ronald- how is it decided which items are direct or indirect ?

Ronald Raygun · Answer

It is just a traditional accounting convention that the cost of getting goods to a trader are counted as part of the trading costs, but the costs of sending goods to the customer are an overhead. The value of goods returned from customers and to suppliers for refunds are also dealt with withing the trading account, whereas the value of discounts you receive from suppliers, or of discounts which you allow to your customers, are dealt with in the non-trading part of the P&L account, if they are settlement discounts (i.e. an incentive for early payment), but are part of the trading account if they are trading discounts (i.e. an incentive to buy).

I'm assuming that "direct costs", which I take to be a term used in Ltd Co accounts, corresponds with the trading expenses of a sole trader, BICBW.

Accounts - What Are Direct Costs?

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