What are Indirect Costs?

Indirect costs are business expenses that are not directly related to a particular product or function within the general operation. Costs of this type tend to have an impact on the overall operation of the business, making it very difficult to charge them to a specific department or associate them with one function. They are sometimes referred to as overhead, a term that helps to describe the broad application of these costs.

There are many examples of indirect costs that occur in both small and large businesses. General supplies for the administration of the business is one example. Items such as paper, pens, and other essentials that are utilized in the record keeping and general clerical functions of each department are often classified in this category. In like manner, services such as auditing the accounting books or the preparation of legal documents are expenses that impact the entire operation and are usually considered indirect in nature.

Several of the expenses related to the upkeep and maintenance of business facilities are considered indirect costs. Utilities such as electricity, water, and Internet access are expenses that benefit the business in general and thus are classified as overhead expenses. In like manner, the cost of renting or leasing business space is also part of the overhead costs.

There are examples of what may appear to be an indirect expenses actually being a direct cost. One example has to do with employee salaries. When the employees are performing their usual functions, they are benefiting the business as a whole; their wages and salaries are considered part of the overhead. If those same employees are assigned to a specific project that is the sole focus of their workday for a period of several days or weeks, however, their wages or salaries can be considered a direct cost, with that cost directly applied to that project.

Companies in different parts of the world handle the documentation of indirect cost allocation differently. Some choose to create a general line item that accounts for all of these expenses. Others choose to create a line item in the budgets of each department and divide the overhead among them equally. Because the revenue arms of many national governments provide specific instructions on how to classify an expense as direct or indirect, companies operating within a specific jurisdiction will adjust their classifications to comply with those instructions.