Costs come in many flavors: Part 2, direct vs. indirect costs
By Brandon Battles
Maintenance managers have expressed frustration to me when they hear or discuss various terms involving different types of costs such as variable, fixed, direct, indirect, discretionary, period, and many others. Often the frustration occurs because costs, and all that they imply, fall outside of the manager’s area of maintenance expertise. And, as with many of us when placed in an unfamiliar situation, discomfort and frustration can quickly set in. The following offers a brief explanation about costs. The intent is not make you an expert but to make you feel more comfortable when exposed to these terms, whether in text or conversation.
Direct vs. indirect costs
However, as discussed last issue, fixed and variable are just two terms frequently associated with costs. Two other terms that maintenance managers have asked about are direct and indirect. Whereas fixed and variable deal with a cost’s behavior, direct and indirect deal with the attachability or traceability of a cost.
Direct costs are directly attributable to an activity or product. Let’s use a maintenance example to illustrate. If a technician works on an aircraft (product or activity) to replace a part, the labor cost is directly attributable to the aircraft. For that matter so is the part’s cost.
An indirect cost is not directly attributable to an activity or product. Therefore, it is more difficult to handle and must have some basis of allocation. For example, if an organization wants to assign hangar costs to each aircraft in the fleet, then some type of allocation method is required. Remember, if we want to determine as accurately as possible the cost of each aircraft, then the allocation method needs to be reasonable. The allocation method can be quite simple or complex depending upon the cost.
Let’s assume that an organization with four aircraft has a $10,000 monthly hangar rental fee. Depending upon the significance of the fee, the organization might use the following methods to assign the fee to each aircraft.
- The easiest method would be to assign an equal amount of $2,500 to each aircraft.
- If each aircraft is different in type, the organization could use size as the basis, such as wingspan, aircraft height, cabin volume, or empty weight. Determine the hangar fee unit cost based upon the basis selected, and then allocate to each aircraft.
- If the hangar fee is somewhat significant, then perhaps a more elaborate allocation basis could be used based upon number of days (hours) each aircraft is in the hangar. Determine each aircraft’s percentage of the total and apply that to the monthly fee.
An organization could certainly get carried away assigning indirect costs to an activity or product. The objective is to get as accurate a cost picture as possible, within reason, for the activity or product of interest.
As a manager in maintenance it is important to understand the basis used to allocate costs. You may not have input to the method chosen, but you will have a better understanding about how the total cost per hour is calculated. And you will have more information to answer questions on an aircraft’s cost per hour and to differentiate between the costs that you control vs. those that you don’t.
Direct and indirect costs up to this point probably seem easy enough. However, there is one more point that is worth mentioning. A direct cost in one instance may not be a direct cost in another. The same is true for indirect costs. Remember, what makes a cost direct or indirect is its traceability or assignability to an activity or product. Costs can also be assigned to the department in which the aircraft operated. In this case the hangar fees change from indirect to direct. At the department level, the hangar fees no longer have to be assigned or allocated. If the activity or product changes, the classification of costs may also change.
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