Indirect Expenses Meaning
Indirect Expenses are those expenses that cannot be assigned directly to any activity since these are completely incurred while operating a business or as a part of a business, examples of which include business permits, rent, office expenses, telephone bills, depreciation, audit, and legal fees.
Examples of Indirect Expenses
Below are examples of Indirect Expenses –
- Depreciation Expenses
- Rent Expenses
- Taxes
- Insurance
- Advertising Expenses
- Salaries to Management
- Commission paid to Agents
- Telephone Bills
- Audit Fees
- Legal Fees
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For eg:
Source: Indirect Expenses (wallstreetmojo.com)
Types of Indirect Expenses
It classifies into three types-
- Factory Expenses – Expenses that incur at the time of production are labeled as factory expenses. Works overhead and factory overheadsFactory OverheadsFactory Overhead, also called Factory Burden, is the total of all the indirect expenses related to the production of goods such as Quality Assurance Salaries, Factory Rent, & Factory Building Insurance etc. read more are also the other terms for indirect expenses. Examples- Depreciation charged on buildingsDepreciation Charged On BuildingsDepreciation of building refers to reducing the recorded cost of a building until the value of the structure either becomes zero or reaches its salvage value. In addition, it helps to map the revenue in the form of lease rental generated during the corresponding expenses.read more, plant, and machinery, rent, and taxes, insurance, indirect labor wages, expenditure on indirect raw-materials, etc.;
- Administrative Expenses – Expenses that incur towards administration activities are labeled as administrative expenses. Examples- Salaries, office rent, repairs and maintenance, electricity bills, office insurance, stationery and printing expenses, depreciation of furnitureDepreciation Of FurnitureDepreciation on furniture is the fall or reduction in furniture value or any movable asset used to make any room, office, factory suitable for desired working conditions due to wear and tear use and bypassing time.read more, etc.;
- Selling and Distribution Expenses – Expenses that incur by the sales team are termed as selling expenses Selling ExpensesThe amount of money spent by the sales department on selling a product is referred to as selling expenses. This includes expenses incurred on advertising, distribution and marketing. Because it is indirectly related to the production and delivery of goods and services, it is classified as an indirect cost.read more. In contrast, the expenses that incur from the time a product attains its completion status until it reaches its destination are regarded as distribution expenses. Examples- advertisement expenses, salaries of sales personnel, commission paid to agents, discounts given to customers, etc.
Calculate Indirect Expenses
From the following information, calculate the total indirect expenses of the company for the month ending on September 30, 2019.
- Depreciation charged on buildings and plant and machinery: $ 50,000
- Raw material purchased $1,500,000
- Direct labour cost $ 700,000
- Rent and taxes: $ 10,000
- Insurance: $5,000
- Utility expensesUtility ExpensesUtilities Expenses are the prices incurred by a Company for the usage of utilities like sewage, electricity, waste disposal, water, broadband, heating, & telephone. These are included as operating expenses in the Company’s income sheet. read more paid: $10,000
- Advertisement expenses: $ 25,000
- Salaries paid to the employees: $ 100,000
- Commission paid to agents: $200,000
Solution
Indirect expenses are the expenses that are indirect, and we cannot assign these directly to the manufactured goods and services. Out of all the transactions given above, all the expenses listed are the indirect expenses except the raw material cost and the direct labor cost as they are part of the direct expenses.
So, total indirect expenses will be calculated as follows:
- = 50,000+10,000+5,000+10,000+25,000+100,000+200,000
- Total = 400,000
Thus the total indirect expenses of the company for the month ending on September 30, 2019, are $400,000
Advantages
The different advantages related to the indirect expenses are as follows:
- Lower-level of tax liability- With indirect expenses, an organization can reduce its taxable income and hence, lower its tax liability.
- Effective product pricing- Product pricing is an essential mechanism for organizations. With indirect costs, organizations can effectively price their products, leverage their sales, and earn better revenues.
Disadvantages
The different advantages related to the indirect expenses are as follows:
- Probabilities of price-out- Managing indirect expenses could be challenging for organizations, and the failure in doing so could even price them out of the industry. It is high because, with the rise in overhead expenses, companies may feel compelled to raise the price of their products, which may ultimately price them out of the industry they operate in.
- Recurring nature- The indirect overheads are recurring in nature. These expenses will continue to incur even if the company is not earning revenues or during manufacturing downtime.
Limitations
The different advantages related to the indirect expenses are as follows:
- Irrelevant while making decisions- The management cannot make decisions based on the indirect costs that incur for choosing whether to manufacture or buy, the minimum price that must be fixed, the quantity that must be sold to earn pre-determined profit numbers, etc.
- Difficulty in comparing and controlling costs- Indirect costs make it difficult for managers to examine and control costs since it highly relies on the level of output, which keeps fluctuating at all levels.
- Exclusion of fixed costs- It has been argued by various accountants that fixed costs are period costsPeriod CostsPeriod cost refers to all those costs which are not related or tied with the production process of the company i.e., they are not assigned with any of the particular product of the company and are thus shown in the financial statement of the company for the accounting period in which they are incurred.read more, and these don’t add or generate future benefits, and hence, the same must be excluded from the products’ overall cost.
- Failure to help in the preparation of flexible budgets- Indirect expenses are of no use in the preparation of the flexible budgets since it becomes difficult to differentiate between fixed costs and variable costs.
- Failure to determine the actual cost associated with production- In real practice, indirect costsIndirect CostsIndirect cost is the cost that cannot be directly attributed to the production. These are the necessary expenditures and can be fixed or variable in nature like the office expenses, administration, sales promotion expense, etc.read more are apportioned through arbitrary methods. It ultimately impacts the product costs, and hence, the evaluation of the same becomes difficult, and the results are often unreliable.
Important Points
- They are costs that cannot be apportioned to a particular cost objectCost ObjectA cost object is a method that measures product, segment, and customer cost separately to determine the exact cost and selling price. read more since various activities absorb these.
- Identification of indirect expenses is always essential so that the same does not form a part of the temporary pricing decisions taken by the management for finalizing prices right above the products’ variable costs.
- Indirect costs can either be fixed or variable.
- Indirect costs cannot be applied directly to the manufacturing of a particular product or service.
- The identification of indirect costs could be tricky. A cost regarded as an indirect expense in one organization might be considered as a direct costDirect CostDirect costs are costs incurred by an organization while performing its core business activity and can be attributed directly in the production cost, such as raw material costs, wages paid to factory staff, power & fuel expenses in a factory, and so on, but do not include indirect costs such as advertisement costs, administrative costs, etc.read more in another.
Conclusion
Indirect costs are also known as overhead costsOverhead CostsOverhead cost are those cost that is not related directly on the production activity and are therefore considered as indirect costs that have to be paid even if there is no production. Examples include rent payable, utilities payable, insurance payable, salaries payable to office staff, office supplies, etc.read more. These are the expenses that can be applied to multiple business activities. These expenses are indirect, and hence, the same cannot be directly assigned to the manufactured goods and services. Professional fees, rent, taxes, insurance, utilities, employee salaries, advertising, office rent, depreciation, office supplies, etc. are some examples of indirect costs.
Factory expenses, administrative expensesAdministrative ExpensesAdministrative expenses are indirect costs incurred by a business that are not directly related to the manufacturing, production, or sale of goods or services provided, but are necessary for the smooth functioning of business operations, such as information technology, finance & accounts.read more, and selling and distribution expenses are the three types of indirect expenses. With the help of these expenses, organizations can minimize their cost of production, enhance their revenues, and reduce their tax burden. Organizations can also reduce their expenses by evaluating the importance of the costs of operating the business and appropriately chose the best ways to reduce the same.
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