Direct costs and indirect expenses serve as components of absorption costing. Expenses that can be directly assigned to a certain item or service are referred to as direct costs. Raw materials, labor, and similar expenditures incurred during the production process are included in these prices.
Expenses that are not linked to a certain good or service are referred to as indirect costs. These overhead expenses consist of things like rental payments, utilities, or insurance. Typically, indirect costs are assigned to goods or services based on some metric of activity, like the quantity produced or the quantity of direct labor hours needed to make the item.
Absorption costing considers both types of expenses. This means that in addition to the direct expenses of creating each unit, the price of a product also includes a share of the indirect costs incurred during the production process. The cost of each unit is then calculated by dividing the total manufacturing costs by the quantity of units produced.