An indirect cost is an expense related to more than one product, project, or department. They’re the expenses that go toward the overall operation of your business with benefits to multiple departments or products. Since multiple areas of the business use and benefit from the costs, you can’t assign them to one specific item the way you can with direct costs, such as raw materials you use to make a product.
Examples of Indirect Costs
An example of an indirect cost is the rent you pay for your office building. It’s a necessary expense, but it’s not tied to any single product, since the building houses all of your business operations. But you still need to account for rent in the price of your goods because the rent expense is a cost of doing business. Tools like hammers and screwdrivers are indirect costs in the construction industry because you may use them in several projects. If you work in the retail industry and your employees oversee several different products, your labour expenses can be an indirect cost as well. Other examples include office expenses, utilities, phones, internet, accounting expenses, legal fees, and salaries for administrative personnel.
Allocating Indirect Costs
You can allocate indirect costs to the different areas or products they relate to or support. By allocating indirect costs, you assign a small part of the overall cost to several different projects, products, etc. To figure out how much should go where, you must first select cost drivers. Cost drivers are measurements that tell you how to allocate expenses. Square footage could be a cost driver for the indirect cost of rent. If you use 60% of your office’s square footage to make a specific product, you can include 60% of the indirect cost of rent into the pricing of that specific product. By assigning indirect costs, you can obtain better information to help you make decisions. Consider monitoring your indirect costs and evaluating how to allocate them to best assess the costs of producing each good or providing each service.
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