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 circ*mstances 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 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.
| 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.
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As an expert in financial management and cost accounting, I have a comprehensive understanding of indirect costs, cost allocation, and indirect cost rate structures. My expertise is grounded in both theoretical knowledge and practical experience, having worked extensively in the field of financial analysis and project budgeting.
Now, let's delve into the key concepts mentioned in the article:
1. Indirect Costs:
- Indirect costs, as defined in the Federal Acquisition Regulation (FAR) Part 31.2, are expenses not directly linked to a single, final cost objective. Instead, they are associated with two or more final cost objectives or an intermediate cost objective.
- Indirect costs are not treated as direct costs and come into play after direct costs have been determined and charged directly to a contract or other work.
- In simpler terms, these costs are incurred for the joint benefit of multiple projects or activities and are grouped into common pools for allocation.
2. Indirect Cost Rate Structures:
- An indirect cost rate is a mechanism for fairly and efficiently determining the proportion of general (non-direct) expenses that each project will bear.
- The rate is calculated as the ratio between the total indirect costs and some equitable direct cost base.
- Indirect cost rate structures are essential for allocating indirect costs to benefiting cost objectives. These structures help ensure a just distribution of indirect costs.
3. Example of Indirect Cost Rate Computation:
- The article provides a simple example of an indirect cost rate computation, illustrating a single-rate structure.
- Indirect costs, such as vacation, holiday and sick leave, health insurance, facility rental costs, and more, are grouped into a total indirect cost pool of $174,000.
- The direct cost base, consisting of direct labor costs and other direct costs, is $400,000.
- Two indirect rates are calculated: an indirect rate based on direct labor (58.0%) and an indirect rate based on total direct costs (43.5%).
4. Components of Indirect Costs:
- Indirect costs include overhead expenses (e.g., rent and utilities) and general and administrative expenses (e.g., officers' salaries, accounting department costs).
- Fringe benefits, typically treated as indirect costs in commercial organizations, should not be included as a direct cost in personnel categories in budget forms or contract proposals.
5. Indirect Cost Base:
- The article emphasizes the importance of selecting an indirect cost base that allows for an equitable distribution of indirect costs to benefiting cost objectives.
- The indirect cost base serves as the denominator in the fraction used to calculate the indirect cost rate.
In conclusion, the article provides a comprehensive overview of indirect costs, their definition, allocation methods, and the calculation of indirect cost rates. The information is valuable for individuals involved in financial management, budgeting, and project planning, offering insights into best practices for handling indirect costs in both commercial and government contexts.
