What are Indirect Costs?

Indirect costs are costs used by multiple activities, and which cannot therefore be assigned to specific cost objects. Examples of cost objects are products, services, geographical regions, distribution channels, and customers. Instead, indirect costs are needed to operate the business as a whole. Indirect costs do not vary substantially within certain production volumes or other indicators of activities, and so are considered to be fixed costs.

How to Use Indirect Costs

It is useful to identify indirect costs, so that they can be excluded from short-term pricing decisions where management wants to set prices just above the variable costs of products. This is an important issue when a customer wants the lowest possible price on a special order. If indirect costs were to be included in a short-term price derivation, the seller would be quoting an excessively high price, which might result in an order being lost.

Examples of Indirect Costs

Indirect expenses are most commonly associated with the administrative functions of a business. Examples of the indirect costs located in the administrative area are as follows:

Accounting and legal expenses
Administrative salaries
Office expenses
Rent
Security expenses
Telephone expenses
Utilities

There are also indirect costs in the production area, such as the depreciation on production equipment and the rental cost associated with production facilities.

Direct Costs vs. Indirect Costs

Direct costs are directly associated with cost objects, such as a product, product line, project, or sales region. They are usually variable costs. Direct labor and direct materials are the two most common direct costs. This is not the case with an indirect cost, which is not associated with a cost object, and is more likely to be a fixed cost.

Terms Similar to Indirect Costs

Indirect costs incurred in manufacturing operations are known as manufacturing overhead, while indirect costs incurred in the general and administrative area are known as administrative overhead.