fixed costs

Unlike indirect costs, you do not divide direct costs among different departments or projects. You must know your business’s direct and indirect costs when pricing products and updating your accounting books so your records are accurate. 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. 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.

What is the difference between direct costs and indirect costs?

Direct costs are a cost that can be easily traced to a specific product or service while indirect costs cannot be easily traced.

Generally it will be assigned to all departments based on the number of square feet each department occupies. Indirect costs include supplies, utilities, office equipment rental, desktop computers and cell phones. Much like direct costs, indirect costs can be fixed or variable. Fixed indirect costs include expenses such as rent; variable indirect costs include fluctuating expenses such as electricity and gas. Indirect costs are costs that are not directly accountable to a cost object .

Costing Definitions

So, this factory is producing phones, perhaps a touchscreen phone. The raw materials in that phone are items like batteries, the screen, all the screws used to keep the phone together. Those would be examples of direct materials that are directly used in the production process. The first two definitions we’re going to look at are direct costs and indirect costs.

  • One are the fixed indirect costs, which are unchanged for a particular project or company, like transportation of labor to the working site, building temporary roads, etc.
  • In general, compensated absences are to be accrued in the period in which they are earned rather than when they are paid.
  • Direct costs are those which can be identified specifically with a particular sponsored project and which can be directly assigned to such activities, relatively easily and with a high degree of accuracy.
  • Simply put, there are costs that the Federal government has said it won’t pay for.

However, in a larger businesses, it can be very difficult to understand which costs are necessary, if they are legitimate to the operations of the company and how they contribute to the success of the business. As a result, overhead or indirect costs can become excessive and may be unnecessary. Managing the indirect costs is an important part a manager’s job. Fixed costs are expenses that are the same regardless of how many goods or services you produce. The grant also includes money for indirect costs, such as building space and utility bills. These are defined in the same way as described for the other fields, including a grant.

Terms Similar to Indirect Costs

You won’t know these numbers exactly—you just do the best you can with imperfect information, and refine it as you Indirect cost definition and meaning more in the future. You will get better at estimating numbers as you accrue more history, but for now – do the best you can. We know that direct materials are directly used in the production process. Now, we use disinfectant in the production process, but it’s not actually incorporated into the product. So, by a process of elimination, we can’t use direct materials as an answer, because we’re not actually putting disinfectant directly into the product. Cost centres can be broken up between production cost centres and service cost centres.

products accounting is a form of managerial accounting that aims to capture a company’s total cost of production by assessing its variable and fixed costs. To determine if a cost should be classified as either a direct or indirect cost, the question to ask is whether the cost is directly needed to create and develop the product/service. Salary of a production supervisor who oversees the full manufacturing process of a company’s entire product line encompassing many different products. The manager’s salary does not change based on how much product the factory makes and sells.

Classifying direct and indirect costs for proper accounting

Special arrangements and alterations costs incurred specifically for a Federal award are allowable as a direct cost with the prior approval of the Federal awarding agency or pass-through entity. For example, factory overhead costs can be apportioned to each unit produced by the total number of products manufactured, or based on the number of hours it took to manufacture each product. This helps a company to calculate the overhead cost per unit so that prices can be set accordingly to ensure a profit is made on each product even after incorporating all indirect expenses. While direct costs can be easily attributed to a single cost object, indirect costs need to go through an allocation process to be assigned to a product, service, project, department, or other cost object. Indirect costs are not directly involved with the costs incurred in the creation of a product. Learn the definition of indirect costs, view examples, and explore how indirect costs vary for different companies. If you want to determine your indirect cost rate, you need to use cost allocation.


This is a cost that we cannot directly attribute to a unit produced or to a service provided. If we take the same example of the chocolate bar; what if that factory has security outside, guarding the factory every night? We can’t really relate that cost of providing security back to each bar produced. Very simply, a direct cost is a cost that can be directly related to a unit produced or a service provided. Let’s think of the very basic example of a chocolate bar factory.

Unallocated indirect expenses are reported as operating expenses to calculate operating profit. Indirect labor cost relates to roles that facilitate the ability of a business to make sales, but do not actually directly deliver the product or service, including management, administration and marketing staff. Examples of direct expenses include manufacturing materials, direct materials, and direct labor. Let’s say, Company M pays a fixed rent of $5000 every month for a factory. However, 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.

  • For instance maintenance on a HVAC system may improve the air quality in many laboratories and offices in one building.
  • We therefore disregard this indirect cost, once again imparting a potentially conservative bias to our value estimates.
  • In an example of a car manufacturer, the materials like steel, plastic or glass used in the car production line are classified as direct costs.
  • It is possible to justify the handling of almost any kind of cost as either direct or indirect.

Finally, we show the entire independent research & development (IR&D) budget to be unallowable. If we were submitting to the other agencies that does allow IR&D, then it would be moved to the Indirect column. If the fee does include a profit factor to the affiliate, the allowable part of the fee is limited to that portion which represents the cost to the affiliate exclusive of any profit factor. The refinanced interest costs are not allowable because the building was originally purchased on September 1994. Had the building been purchased on or after September 29, 1995, these costs could have been allowed.