What is an Indirect Cost Rate?

//What is an Indirect Cost Rate?
What is an Indirect Cost Rate? 2017-10-05T02:39:10+00:00

Definition: Indirect cost rate is the percentage of expenses that can’t be traced back to an object that should be allocated to each cost object. In other words, it is how much of the total indirect cost pool at an organization should each of the cost objects receive.

What Does Indirect Cost Rate Mean?

What is definition of indirect cost rate? In an organization, indirect costs are those costs that do not have a direct relationship with a cost object. These costs together form what is called an indirect cost pool. The rate is the amount of the pool that each cost object is assigned. In a business, this can be helpful for budgeting and cost controlling purposes. It is also a way to determine how much of an impact a cost object has on overhead, even if there is not a direct relationship between the cost object and the cost.

The indirect cost rate formula is calculated by dividing the total indirect cost pool by the total amount of direct costs, and then multiplying that number by each cost object’s direct costs.

Let’s look at an example.

Example

In this example, the cost objects that we are looking at will be the accounting department and the human resources department. The total indirect cost pool is equal to $5,000. The human resources department has $4,000 of direct costs and the accounting department has $6,000 of direct costs. What is the indirect cost rate, and how much of the indirect cost pool should each department be assigned?

The direct costs total $10,000.

ICR = Total indirect costs / total direct costs, or $5,000 / $10,000 = 50%

To determine how much of the indirect cost pool each cost object is assigned, we just multiply the direct costs by the ICR. This gives us the following indirect costs for the two department:

Human resources = $4,000 x 50% = $2,000

Accounting = $6,000 x 50% = $3,000

Summary Definition

Define Indirect Cost Rate: Indirect cost rate means the ratio of indirect production expenses that need to be allocated to the production process or object.