Is depreciation a direct or indirect expense?
2. Depreciation as direct or indirect expense
Costs are direct when we can directly trace them to cost objects (e.g., products, departments, divisions). Costs are indirect when we can associate them with cost objects, but it’s not one-to-one relationship.
Fixed assets owned by a company can comprise land, manufacturing premises, systems of transportation pipes, containers, transport conveyers, trucks, warehouses, etc. as well as administration buildings, vehicles and office furniture. Depreciation expense can be direct or indirect depending on how the related asset is used and the cost object under question. For example, most manufacturing equipment will represent a direct cost in relation to the manufacturing department (cost object in this case is the manufacturing department), but it will most likely represent an indirect cost if the cost object under question is a single unit of production.
It is important to remember that in external financial reporting there is great emphasis on correctly determining the cost of inventory and related cost of sales (i.e., the cost of sales amount is used in calculating gross margins). In this context, depreciation as direct or indirect cost should be reviewed in light of inventory as the cost object. In most cases related to costing inventory, depreciation will be an indirect expense because equipment, tools, etc. are used to produce multiple types and volumes of products (i.e., cost objects). Such depreciation becomes part of manufacturing (factory) overhead. An exception would be situations when such fixed assets are used exclusively in producing a single inventory item (e.g., vessels in shipyard manufacturing). It is also beneficial to understand that depreciation of certain fixed assets not related to the manufacturing process, would not represent an inventory cost. For instance, depreciation related to trucks used in delivering products to customers is not an inventory cost, but a selling expense.
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