Indirect Cost Overview

While these items contribute to the company as a whole, they are not assigned to the creation of any one service. Today’s cost estimation software solutions help streamline the process of calculating indirect costs, integrating market trends, historical data, and predictive algorithms. Once the project is underway, accounting modules within these tools help track actual expenses against the budgeted figures, and highlight any deviations. In the dynamic world of construction, a static approach to costs can lead to financial missteps. Specifically, when dealing with indirect costs, periodic assessments are essential to monitoring financial performance.

Tracking each type of cost separately can help small businesses understand their cash flow, price their items properly and attain the maximum allowable tax deductions. If you need assistance with breaking down your business’s expenses, contact a professional accountant or choose accounting software that can support your business. The tools used in construction projects — especially those that are reusable across different projects —are considered indirect costs. While a specific excavator might be a direct cost to a particular project, smaller tools used across multiple projects, like hammers or drills, are considered indirect costs.

How to Use Indirect Costs

The role of a financial analyst is to make sure costs are correctly attributed to the designated cost objects and that appropriate cost allocation bases are chosen. For that reason, a company may decide to classify certain costs as operating expenses instead of COGS. For example, a business may incur some direct labor costs even if it does not sell a single product/service.

As the owner of a startup or small business, you should understand the distinction between direct and indirect costs when pricing your products or services. When you know the true costs involved with producing and providing your goods or services to customers, you can price both competitively and accurately. Additionally, certain costs are tax-deductible, so properly tracking both direct and indirect costs can help you maximize deductions. Finally, if you ever apply for and receive a grant, there indirect costs are also referred to as are several rules around the types of indirect costs and the maximum amount you can claim. Indirect costs – costs incurred for a common or joint purpose benefitting more than one cost objective, and not readily assignable to the cost objectives specifically benefitted, without effort disproportionate to the results achieved. To facilitate equitable distribution of indirect expenses to the cost objectives served, your organization may need to establish a number of pools of indirect costs.

What are indirect costs?

Moreover, they offer a chance to compare budgeted vs actual indirect costs, allowing for necessary adjustments to be made to safeguard profit margins. The allocation base is the chosen measure or standard used to distribute indirect costs among various projects, tasks, or phases within those projects. Absorption is the method in which all project costs, both direct (like materials and labor) and indirect (like office rent or project management fees), are allocated to specific construction tasks or phases.

Similarly, materials such as miscellaneous supplies purchased in bulk—pencils, pens, paper—are typically handled as indirect costs, while materials required for specific projects are charged as direct costs. Indirect costs include expenses such as the salaries of the project manager and administrative staff, renting office space to manage the project, and insurance and legal fees. As we describe the types of indirect costs above, they are commonly general administrative expenses. Therefore, the double entries of indirect costs or indirect expenses in the income statement are the same as other expenses. An indirect cost rate is simply a device for determining fairly and expeditiously the proportion of general (non-direct) expenses that each project will bear.

Direct Costs vs. Indirect Costs: What Are They, and How Are They Different?

Some types of indirect costs such as insurance, licensing, or materials can vary significantly with market conditions. Regularly revisiting these ensures that a construction firm isn’t caught off guard by unexpected surges or drops in expenses. Indirect costs, on the other hand, are more closely tied to on-site construction activities but not to the actual materials or labor.

Indirect cost refers to an incurred expense that cannot be directly attributed to a business’s product or service. While it is common for direct costs to be variable, it should be noted that direct costs are not always necessarily variable costs. Continuous monitoring of direct and indirect expenses provides valuable insights into the efficiency of business operations to identify areas for improvement and cost optimization.