Indirect Cost: Definition and Example

To facilitate preparation of an indirect cost proposal, shown below are (1) some definitions of the term "indirect costs," (2) a brief discussion of indirect cost rate structures and (3) a simple example of an indirect cost rate computation.

Indirect Costs (definition extracted from FAR Part 31.2)

An indirect cost is any cost not directly identified with a single, final cost objective, but identified with two or more final cost objectives or an intermediate cost objective. It is not subject to treatment as a direct cost. After direct costs have been determined and charged directly to the contract or other work, indirect costs are those remaining to be allocated to the several cost objectives. An indirect cost shall not be allocated to a final cost objective if other costs incurred for the same purpose in like circumstances have been included as a direct cost of that or any other final cost objective.

In simpler terms, indirect costs are those costs not readily identified with a specific project or organizational activity but incurred for the joint benefit of both projects and other activities. Indirect costs are usually grouped into common pools and charged to benefiting objectives through an allocation process/indirect cost rate.

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. It is the ratio between the total indirect costs of an applicant and some equitable direct cost base.

Indirect Costs Ratio
Indirect Cost Pool
Direct Cost Base
= Indirect Cost Rate

 

Indirect costs include costs which are frequently referred to as overhead expenses (for example, rent and utilities) and general and administrative expenses (for example, officers' salaries, accounting department costs and personnel department costs).

Commercial (for-profit) organizations usually treat "fringe benefits" as indirect costs. These fringe benefits are applied to direct salaries charged to projects either through a fringe benefit rate or as part of an overhead/indirect cost rate. Therefore, fringe benefits treated as indirect costs should not be included as a direct cost in the "Personnel" category of the budget form of the grant application or on a contract proposal.

The indirect cost base or bases (that is, the denominator(s) of the fraction producing a rate) should be selected so as to permit an equitable distribution of indirect costs to the benefiting cost objectives.

Generally, indirect cost rate structures for commercial organizations follow a single, two-rate (for example, fringe and overhead rates), or three-rate (for example, fringe, overhead, and General and Administrative expense rates) system. A single rate structure is illustrated below.

Indirect Cost Pool
Vacation, Holiday and Sick Leave $30,000  
Health Insurance $18,000  
FICA Taxes $26,000  
Pension Costs $30,000  
Indirect Salaries $40,000  
Facility Rental Costs $15,000  
Equipment Depreciation $5,000  
Utilities $3,500  
Indirect Supplies $2,500  
Legal Fees $2,000  
Accounting Fees $2,000  
Total Indirect Costs $174,000  (c)
Direct Cost Base
Direct Labor Costs (Salaries and Wages excluding vacation,
holiday and sick leave)*
$300,000  a)
Other Direct Costs* $100,000  
 Total Direct Costs $400,000  (b)
Indirect Rates
Indirect Rate Based on Direct Labor 58.0%  (c/a)
Indirect Rate Based on Total Direct Costs 43.5%  (c/b)

* Includes costs associated with independent (self-sponsored) research and development (IR&D) activities.

Last Modified On: Dec 14, 2017