Indirect cost definition and meaning

Instead, you should list indirect costs under business expenses. Indirect Costsmeans costs for a common or joint purpose benefitting more than one cost objective that are allocated to each benefiting objective using an agency approved indirect rate or an allocation methodology.

If the company produces thousands of products within the factory, it would be impossible to identify each unit and attribute a portion of rent expenses. Moreover, no matter how much the factory produces, the rent doesn’t change. For the plants, it would be the indirect cost because it’s impossible to tell how much time and effort the supervisor would invest in each plant. This can add $50 per hour of indirect cost to the musician, or the musician spent thousands of dollars building their own space in the past. Note that if electricity is not used as primary source for production then electricity cost will be treated as utility and is always indirect. For example, if electricity is required to run the boiler which in turn generates steam, then electricity needs to be allocated directly. The same cost can be labeled as indirect in one industry and direct in another.

Examples of indirect cost

Direct cost refers to the cost of operating core business activity—production costs, raw material cost, and wages paid to factory staff. JPMorgan Chase Chief Executive James Dimon spoke of the indirect costs of trade tensions to business confidence and investment. The ambassadors’ cherry-picking method—to focus solely on deaths of service members and line-item budget costs—is to ignore the considerable indirect costs of war, costs that can’t be wished away. Most cost estimates are broken down into direct costs and indirect costs.

Is salary a direct or indirect cost?

Indirect costs apply to more the just one business activity. By that, it means that it cannot be assigned to a specific product, service, or business activity. Common examples include rent, the cost of utilities, salaries and wages of employees not directly involved in the manufacturing of a product, etc.

For example, the supplies needed for a research project are easy to identify, as are the salaries of the individuals who will work on the project and travel expenses for those individuals. Indirect costs were not included because there were no data available on the association between bevacizumab usage and indirect cost avoidance. The Company’s Cost IncurredIncurred Cost refers to an expense that a Company needs to pay in exchange for the usage of a service, product, or asset. This might include direct, indirect, production, operating, & distribution charges incurred for business operations.


Direct expenses become part of the cost of the goods manufactured or purchased. Examples of expenses include routine expenses such as purchases, salaries, commissions, and utility bills. This classification allows businesses to decide the price for any product or project using the broken down and classified information.

Such costs can be difficult to manage because they are not tied to revenue-generating activities, nor are they typically tied to products or services offered by a company. As general expenses, they can be lumped together into one category, thus increasing the possibility that non-essential items are purchased or expenses are charged to the company that are not legitimate costs. While managing indirect costs is challenging, it is essential to expense control. An indirect cost rate represents the ratio between the total indirect costs and benefiting direct costs, after excluding and or reclassifying unallowable costs, and extraordinary or distorting expenditures. The indirect costs in the numerator of the equation should bear a reasonable relationship to the direct costs from the denominator.

  • Fixed costs are expenses that are the same regardless of how many goods or services you produce.
  • Examples of direct expenses include manufacturing materials, direct materials, and direct labor.
  • The deterioration of infrastructure has direct and indirect costs, sometimes measured in human lives.
  • Further, the indirect cost of informal care is barely mentioned in the friction cost method.

A fixed cost is a cost that does not change with an increase or decrease in the amount of goods or services produced or sold. Opportunity costis the benefits of an alternative given up when one decision is made over another.

Words nearby indirect cost

Indirect costs are the cost of conducting business that are incurred for common or joint objectives and therefore cannot be identified readily and specifically with specific projects or with a specific activities . On the other hand, indirect costs are difficult to assign to a single department or business project. Therefore, it is divided using indirect cost ratio between all the departments and business projects.

Examples of direct costs include raw materials, packing materials, factory workers wages etc. Indirect costs need to be allocated through a more complex cost allocation process. The costs need to be accumulated and then allocated across cost centers on the basis of a reasonable predetermined cost driver. Indirect costs are those costs that cannot be directly attributed to the core production activity of the entity but are incurred for general functioning of various activities of the entity. This article looks at meaning of and key differences between these two types of costs – direct cost and indirect cost. Misclassifying your direct and indirect expenses when claiming deductions could cause you to come under IRS scrutiny. Not to mention, failing to break down your costs could cause you to miss out on a tax deduction.

Indirect cost definition and meaning

The rent for the facility where the potter creates is an overhead cost because the potter pays rent whether she’s creating products or not. Awardees must have a detailed understanding of their terms and conditions related to the ICR or award specific rates to correctly calculate indirect cost recovery charges and any potential post-award adjustments.

List of Indirect Expenses

Identify all the activities carried on by the Department or unit and their attendant costs. All activities must be included regardless of the source of funds used to pay for them. Communication costs such as long distance telephone calls or telegrams identifiable with a specific award or activity. Other employee fringe Indirect cost definition and meaning benefits allocable on direct labor employees. Cost ObjectA cost object is a method that measures product, segment, and customer cost separately to determine the exact cost and selling price. Direct expenses are any expenses incurred to manufacture or purchase goods and to bring them into saleable condition.

For the stationary store, the purchase of bottled water is not tied to any specific sales or products offered at the store. Because of this, the water – used by your employees when they need a drink – is an indirect store supply.

Difference Between Direct Cost and Indirect Cost

It’s important to know the difference between the types of costs because it gives you a greater understanding of your product or service, thus leading to more competitive pricing. In addition, when tracking direct and indirect costs, you will have a better grasp on your accounting and be better equipped to plan for the future. The materials and supplies needed for a company’s day-to-day operations – such as computers, electricity and rent – are examples of indirect costs. While these items contribute to the company as a whole, they are not assigned to the creation of any one service. It’s crucial to understand the difference between direct and indirect costs when pricing your products or services. One are the fixed indirect costs which contains activities or costs that are fixed for a particular project or company like transportation of labor to the working site, building temporary roads, etc. The other are recurring indirect costs which contains activities that repeat for a particular company like maintenance of records or payment of salaries.

Indirect cost definition and meaning

Individuals found performing unauthorized activities are subject to disciplinary action including criminal prosecution. A .gov website belongs to an official government organization in the United States. ICR proposal preparation policies and procedures, which describe how the organization prepares its annual ICR proposal.


They are more general in nature and related to the overall functioning of the business. To manage and minimize the indirect costs, it is important to identify which indirect costs are necessary for the business and which indirect costs can be avoided. Usually, management has very little control over indirect costs as compared to direct costs which can be minimized by efficient management. According to the IRS, you must separate your business expenses from the expenses you use to determine your cost of goods sold (e.g., direct labor costs). You can use the indirect rate calculation to price your products. You want your offerings to generate enough money to cover your expenses. By considering your indirect and direct expenses, you can determine a reasonable cost for your products or services so you don’t underprice.

Indirect cost definition and meaning

Indirect variable cost is not directly related or traceable to each unit of the product but it varies as per the output, for e.g. electricity bill in the manufacturing industry. You can allocate indirect costs to determine how much you are spending on expenses compared to your sales. In cases of government grants or other forms of external funding, identifying direct and indirect costs becomes extra important. Grant rules are often strict about what constitutes a direct or an indirect cost and may allocate a specific amount of funding to each classification.

Indirect cost:

Indirect costs are infeasible to allocate to each unit of product or service since these costs are used in multiple manufacturing activities and can’t be assigned to a single unit. When it comes to claiming tax deductions, you need to know the difference between direct vs. indirect costs. Fixed costs are expenses that are the same regardless of how many goods or services you produce. The tire manufacturer can’t trace the electric bill back to a specific cost object or product because the electricity is used to make all the products produced by the manufacturer. Indirect costs extend beyond the expenses you incur when creating a product; they include the costs involved with maintaining and running a company. These overhead costs are the ones left over after direct costs have been computed.

Ethan Spielman is a freelance writer and editor who lives in Brooklyn. He’s open to most experiences, including nearly all experiences involving words. Imagine that you are a manager for a small business that provides bottled water to local companies.

  • For example, fuel cost in a telecom is usually allocated as an indirect cost, while for an airliner it is a direct cost.
  • An indirect cost rate represents the ratio between the total indirect costs and benefiting direct costs, after excluding and or reclassifying unallowable costs, and extraordinary or distorting expenditures.
  • DGA and DACS negotiate the award agreement with the awardee organizations.
  • Labor and direct materials constitute the majority of direct costs.
  • The indirect cost ratio is the ratio between indirect cost pool and direct cost base.
  • Salaries are wages (including vacations, holidays, sick leave, and other excused absences of employees working specifically on objectives of a grant or contract – i.e, direct labor costs).

All costs are bifurcated into direct costs and indirect costs to facilitate attribution to each product/cost center. You can choose the time period to calculate indirect costs according to the nature of business and revenue generated by your business. While preparing a budget for a business adventure or a new project, it is important to have the knowledge of different types of business expenses/costs that might occur. There can be two types of costs, such as direct costs and indirect cost. Smartphone hardware, for example, is a direct, variable cost because its production depends on the number of units ordered. A notable exception is direct labor costs, which usually remain constant throughout the year. Typically, an employee’s wages do not increase or decrease in direct relation to the number of products produced.

This cost is, therefore, most relevant for two mutually exclusive events. In investing, it’s the difference in return between a chosen investment and one that is passed up. For companies, opportunity costs do not show up in the financial statements but are useful in planning by management. Direct costs are variable in nature as they vary directly with a change in production level. To create the toys, the employee needs wood, which is considered a direct material. And, the employee must use wood glue, which is a manufacturing supply. Fixed costs are the costs that don’t change with the number of units produced.

They are usually split into direct and indirect labor costs, based on the worker’s contribution to the production process. While direct labor comprises work done on certain products or services, indirect labor is employee work that can’t be traced back or billed to services or goods produced. Means any cost which is identified specifically with a particular final cost objective. Direct costs are not limited to items which are incorporated in the end product as material or labor.

Funding & Awards

Cost allocation is the process of distributing your indirect costs among specific departments or projects. Indirect costs are usually allocated to cost objects based on a pro rata basis. For instance, factory overhead can be allocated to each product produced by the total number of products or based on the total number of hours it took to manufacture each product. This way the indirect costs are apportioned to the cost objects in a meaningful way.

Costs identified specifically with a contract are direct costs of that contract. All costs identified specifically with other final cost objectives of the educational institution are direct costs of those cost objectives. Both direct cost and indirect cost can either be fixed or variable. You can allocate indirect costs by taking your total indirect expenses and dividing them by some sort of allocation measure, like direct labor expenses, direct machine costs, or direct material costs. Unlike indirect costs, you do not divide direct costs among different departments or projects.


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