Indirect Costs
Costs that cannot be directly traced to a single product or service and must be allocated across multiple outputs using a cost driver.
What is Indirect Costs?
Indirect costs are expenditures that support business operations broadly but cannot be specifically and directly attributed to any single product, service, or project. Because they cannot be traced directly, indirect costs must be allocated to products or departments using a predetermined cost driver such as direct labor hours, machine hours, or square footage. In manufacturing, indirect costs include factory rent, utilities, equipment maintenance, and quality control salaries — collectively called manufacturing overhead. In non-manufacturing contexts, indirect costs include administrative salaries, IT infrastructure, and corporate overhead. Accurate allocation of indirect costs is essential for correct product costing, profitability analysis, and setting competitive prices.
Example
A packaging company produces three product lines in one factory. The factory's monthly indirect costs include $80,000 in rent, $30,000 in utilities, and $40,000 in maintenance — totaling $150,000 in overhead. Using direct labor hours as the cost driver, Product A accounts for 40% of hours and is allocated $60,000 in indirect costs per month. This allocation is added to direct materials and direct labor for Product A to calculate its full production cost and verify that its selling price generates an adequate margin.