Indirect Cost - What's The Deal?

We all must understand Indirect Cost and Rates! It is part of the foundation of our profitability and audit exposure. We cannot learn too much on this subject, but we must learn the right way.

The word Indirect confuses so many. Why? Because it is often a matter of preference, within certain guidelines, as to when a companies cost is considered indirect versus direct.

Let's see if we can define what an Indirect Cost is in its simplest form. Now remember, once we define it then we should document our definition.

This becomes one more part to our policies and procedures manual (You should have a section that is titled definitions).

Definition: Indirect Cost - After Direct Costs have been determined, Indirect Costs are those remaining. Simple isn't it? These remaining indirect costs are to be allocated to two or more final cost objective (contracts, jobs, products, etc.).

So you see, if a cost is going to be charged direct to a final cost objective (contracts, jobs, products, etc.) then it cannot be considered an indirect cost (typically).

And if we are going to consider a cost as indirect then it will be allocated to two or more final cost objectives (contracts, jobs, products, etc.).

An example would be Local Travel. My policy states that local travel is an indirect cost and is charged to Overhead or G&A (General and Administrative) based on what the local travel is in support of. See paragraph below for more.

The key is that you document the policy you decide is best for your company. Document in writing what types of costs and in what type of situations you identify a cost as Indirect versus Direct.

Again, for example, your policy should start with defining Indirect Costs in your company using the description above as a guide.

Next you might state that Travel costs are generally charged as an indirect cost when they are incurred locally or within 50 miles of corporate headquarters. All other Travel would be considered Direct Travel to be charged to a specific final cost objective (contracts, jobs, products, etc.).

This would be considered a financial and/or cost accounting policy. And so goes indirect costs and policies and procedures.