Direct and Indirect Costs
By Cindy Walker
Outline
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Definition of direct and indirect costs
Benefits of differentiating costs
Explanation of the two costs
How to find the costs
Real world example
Exercise
Summary
Suggested readings
What are direct and indirect costs?
• Direct costs are costs that can easily be traced to a
specific project or activity.
• Indirect costs are costs that can not be easily
traced to a specific project or activity.
Benefits of differentiating costs
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More accurate forecasting
Reduced overspending
Understanding trade-offs
Learning the true cost of projects/activities
Pricing
Let’s practice!
Determine if the following are direct or indirect costs:
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2.
3.
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5.
6.
7.
8.
Assembly line worker Direct
Manager of a paper company Indirect
Electricity Indirect
Alarm sales rep Direct
Chef for a gourmet dinner Indirect
Office space Indirect
Microscope for a chemist Direct
Postage for a FedEx package Direct
Common direct costs
• Project materials
• Project staff
Common indirect costs
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Office supplies
Utilities
Rent
Administrative staff
What to remember
• When identifying an activity, service, or product
as a direct or indirect cost, it is important to
remain consistent.
• Example: If labor is considered a direct cost for
one project, it must continue being considered a
direct cost.
Finding the direct cost
1. Is the cost incurred from a certain project or
activity?
2. Can I easily trace the cost to a specific project or
activity?
3. Will the cost disappear once the project or
activity is finished?
Finding the indirect cost
1. Case-by-case allocation
2. Indirect cost rate
Case-by-case allocation
• Find the actual usage of the indirect cost in
question
• Disadvantage: DIFFICULT!!
Indirect cost rate
Formula:
Total Indirect Costs
Indirect Cost Rate
Total Direct Costs
Indirect cost rate (cont.)
• To find the indirect costs for Project A:
Project A’s
Direct Costs
Indirect
Cost Rate
Project A’s
Indirect Costs
Real world example
• Company XYZ has costs totaling $15,000. If Function
A has direct costs of $7,000 and Function B has direct
costs of $4,000, what are the indirect costs of
Function A and Function B?
Real world example (cont.)
• $4,000/$11,000 = 0.3636 or 36.36%
• Function A: $7,000*0.3636 = $2,545.20 indirect
costs
• Function B: $4,000*0.3636 = $1,454.40 indirect
costs
Exercise
• Project A has direct costs of $400, Project B has
direct costs of $500, and Project C has direct costs
of $900. If all of these projects combined has a
total cost of $3,000, what is the amount of indirect
costs for Project B?
Project B’s Indirect Costs: $333.35
Summary
• Direct costs relate specifically to a project while
indirect costs relate on a broader scale.
• Consistently identify an activity as either a direct or
indirect cost.
• Distinguish the type of cost through three questions.
• Solve for indirect costs through case-by-case
allocation or an indirect cost rate.
Suggested readings
• Gordon, L. A. and M. P. Loeb. 2001. Distinguishing
between direct and indirect costs is crucial for
internet companies. Management Accounting
Quarterly (Summer): 12-17.
• Accounting for Dummies by John Tracy
• SBIR Basics: The Numbers (Accounting, Costs,
Rates, Audits, and More) by Lea Strickland
• http://www.umdnj.edu/rimweb/rim_cfp/indexcfp.htm