DISTINCTION BETWEEN DIRECT AND
Direct costs can be specifically associated with a particular unit or department or patient. The critical distinction for
the manager is that the cost is directly attributable. Whatever the manager is responsible for—that is, the unit, the department, or the patient—is known as a cost object.
The somewhat vague definition of a cost object is any
unit for which a separate cost measurement is desired. It
might help the manager to think of a cost object as a cost objective instead.1 The important thing is that direct costs can be traced. Indirect costs, on the other hand, cannot
be specifically associated with a particular cost object.
The controller’s office is an example of indirect cost.
The controller’s office is essential to the overall organization itself, but its cost is not specifically or directly associated with providing healthcare services. The critical distinction for the manager is that indirect costs usually
cannot be traced, but instead must be allocated or apportioned in some manner.2 Figure 6-1 illustrates the direct–indirect cost distinction.
To summarize, it is helpful to recognize that direct
costs are incurred for the sole benefit of a particular operating unit—a department, for example. As a rule of thumb, if the answer to the following question is “yes,” then the cost is a direct cost: “If the operating unit (such as a department) did not exist, would this cost not be in
Indirect costs, in contrast, are incurred for the overall
operation and not for any one unit. Because they are
shared, indirect costs are sometimes called joint costs or
After completing this chapter,
you should be able to
1. Distinguish between direct and
2. Understand why the difference
is important to management.
3. Understand the composition
and purpose of responsibility
4. Distinguish between product
and period costs.
CHAPTER 6 Cost Classifications
common costs. As a rule of thumb, if the answer to the following question is “yes,” then the cost is an indirect cost: “Must this cost be
allocated in order to be assigned to the unit
(such as a department)?”
EXAMPLES OF DIRECT COST AND
It is important for managers to recognize direct and indirect costs and how they are treated on reports. Two sets of examples illustrate the reporting of direct and indirect Cost Object
costs. The first example concerns a radiology department; the second concerns a dialysis center. Figure 6–1 Assigning Costs to the Cost Object.
Table 6-1 represents a report of two line
items—direct costs and indirect costs—for a
radiology department. The report concerns
procedure numbers 557, 558, 559, 560, and
561 and a total. In this report, the manager
can observe the proportionate differences between direct and indirect costs and can also see the differences among the five types of procedures.
Greater detail is provided to the manager in Table 6-2, which presents the method of allocating indirect costs and the result of such allocation. Managers should notice that the “totals” line carries forward and becomes the “indirect cost” line in Table 6-1. The purpose of the report in Table 6-2 is to reveal details that support the main report in Table 6-1. Thus,
Table 6–1 Example of Radiology Departments Direct and Indirect Cost Totals Dept: Radiology—Diagnostic
Cost Summary—Year to Date November ______
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