The Difference Between Direct and Indirect Costs (With Examples)

Every sponsored project has both Direct and Indirect Costs. The direct costs are those that can be specifically and easily identified with a particular project or activity and are allowable under the sponsoring organizations guidelines. Indirect costs, according to the federal Uniform Administrative Requirements, Cost Principles and Audit Requirements for Federal Awards issued by the Office of Management and Budget (Uniform Guidance), are those costs that are incurred for common or joint objectives, and cannot be easily and specifically identified with a particular sponsored project, an instructional activity, or any institutional activity. These costs are also sometimes called “facilities and administrative costs (F&A)” or “overhead.” The terms indirect costs, overhead costs, and F&A costs are synonymous. These indirect costs are different than direct costs.

University indirect costs include building and equipment depreciation and use allowance; general administration; departmental, sponsored program, and sponsored project administration expenses; interest; operation and maintenance expenses; library expenses; and student administration and services expense. Most federal agencies and other sponsoring organizations pay the university for indirect costs in addition to the direct costs of a grant or contract award.

Thus, indirect costs are the related costs of using the Universitys facilities and administrative support that cannot be claimed as direct costs. Indirect costs are not profit; instead they are part of the real costs of conducting the outside funded R&D. By collecting indirect costs from sponsors, UL Lafayette is recovering those expenses. The federal government has established what costs may be charged as direct costs and what costs are considered included in indirect costs. The following summary gives a brief description of costs and whether they should be charged as direct or whether they are included in the indirect cost calculations. This list is only a summary; a comprehensive list can be found at the Uniform Administrative Requirements, Cost Principles and Audit Requirements for Federal Awards issued by the Office of Management and Budget.

To sum up, direct costs are expenses that directly go into producing goods or providing services, while indirect costs are general business expenses that keep you operating.

What is a Direct Cost vs. Indirect Cost?

Examples of direct costs

Although individual circumstances might affect whether a particular budget item is a direct or indirect cost, some types of expenses usually fall under one category or the other. Some examples of direct costs include the following:

Labor

Labor is often considered a direct cost because the amount a business spends on paying its employees can be traced directly to its payroll. For example, a factory owner might calculate the wages paid to each hourly employee, plus overtime, as a direct cost. These employees make the items or provide services to the consumer, making their wages direct costs.

Commissions

Commissions are paid to salespersons in exchange for their services, usually in addition to their regular wage. Commissions are direct costs because they can be traced to a particular individual or transaction.

Materials

The materials that are used in production are also usually categorized as a direct cost. The steel used in a factory that makes cars, for example, would be considered a direct cost because it is required to make the product being sold. In this case, it is possible to clearly identify the cost object associated with the expenditure.

Fuel

The fuel expended in creating a particular item or delivering goods and services to the consumer can be considered a direct cost because it can be affiliated with a specific product. Power specifically allocated to the production process may be a direct cost as well, depending on the nature of the product.

What are direct costs?

The direct costs of a business are expenditures that can be explicitly attached to a particular item or service. For example, equipment, materials and labor are usually considered direct costs. The amount you spend on various direct costs might change depending on market conditions, but they can still be associated with a specific measurable good. Direct costs are typically associated with measurable, tangible cost objects.

What are indirect costs?

Indirect costs are expenditures that cannot be directly linked to a cost object. These costs are often associated with overhead and other operating costs because they do not generally vary according to production and prices.

For example, a businesss rent and utilities would be considered indirect costs because they are not associated with any one particular item or service. Indirect costs are often invariable, meaning they are less likely to change based on fluctuating circumstances.

Examples of indirect costs

Here are some examples of indirect costs:

Supervisor salaries

Wages paid to managers or others not directly involved in the production process are usually considered indirect costs. A supervisors time is not necessarily spent directly creating a product or service and therefore cant be connected to a specific cost object. Wages for employees working in other administrative roles apart from production are considered indirect costs for this reason as well.

Quality assurance

Whether completed internally or commissioned by an external firm, quality control is frequently categorized as an indirect cost since these services arent linked to a specific cost object.

Telecommunications

Phone, internet and other communication expenses are usually indirect costs. These services do not create or produce an item for the consumer but are more often a part of overhead.

Facilities

Rent, utilities and other building-related expenses are also indirect costs. Facilities overhead can differ from other kinds of indirect costs because they can be variable—for instance, the price of utilities can change based on the weather.

Supplies

General office supplies are considered indirect costs if they are not associated with the production of a good or service. This differs from materials, which are direct costs because they are not combined or modified to create a final product.

Insurance

Insurance costs, including liability, fire and other disaster coverage, are not connected to a given cost object and are therefore also indirect costs. This indirect cost can vary depending on the conditions of production and standard insurance rates.

Financial services

Internal or outsourced financial services, such as accounting, payroll and tax preparation, are considered indirect costs. Although these functions are necessary to a businesss operations, they are not directly connected with a tangible cost object.

Legal fees

Legal costs associated with your business may be considered indirect costs. This might include keeping an attorney on retainer, filing legal paperwork and paying court costs. These expenditures are considered indirect because they are not involved with the production of any one item or service.

Direct vs. indirect costs

The difference between direct and indirect costs can impact your bookkeeping practices when you are compiling financial statements and tax returns. Correctly recording these categories of costs can, for instance, help you make important business decisions about products, pricing, hiring and overhead. Direct vs. indirect costs also affect the kinds of tax deductions you are eligible for, and reporting them correctly can mean the difference between an accurate tax return and an audit.

Here are some of the key differences between direct and indirect costs:

FAQ

What is the difference between indirect and direct costs?

It’s crucial to understand the difference between direct and indirect costs when pricing your products or services. Direct costs are expenses that can be connected to a specific product, while indirect costs are expenses involved with maintaining and running a company.

What are examples of direct and indirect costs?

Examples of Direct Costs and Indirect Costs

Examples of direct costs are direct labor, direct materials, commissions, piece rate wages, and manufacturing supplies. Examples of indirect costs are production supervision salaries, quality control costs, insurance, and depreciation.

What are examples of indirect cost?

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).

What determines whether a cost is direct or indirect?

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.

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