Definition: Indirect expenses are costs that benefit more than one department or cost object. In other words, indirect expenses are costs that are shared between two departments and can’t be attributed 100 percent to either department.
What Does Indirect Expense Mean?
Rent and utilities are the most common examples of indirect expenses. Companies often house multiple departments in the same building. All of the departments benefit from the building. This means that the rent, heat, electricity, and other utilities expenses all benefit the various departments. None of these expenses can be attributed to only one department.
This is why indirect expenses are usually allocated to each department or cost object (source of the expenses). Management generally tries to allocate these expenses based on the usage. For instance, rent is usually allocated by square footage. If three departments occupy the building, the overall rent expense would be allocated to each department based on their square footage.
Utility usage can be a little more difficult to allocate. Obviously, it wouldn’t be fair to allocate one third of the utility costs to each department. For instance, the office department wouldn’t use as much electricity as the manufacturing department. Instead, utilities are allocated based on perceived usage or square footage.
You might ask, “Why even allocate indirect expenses at all?” After all, the departments are all part of the same company. Indirect expenses are generally allocated to departments, so that managers can see the profitability of each department. Managers can also use this information to help judge whether to downsize the company or not.