Indirect Expenses Meaning
Indirect Expenses are those expenses that cannot be assigned directly to any activity since these are completely incurred whilst 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 the 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
Types of Indirect Expenses
It is classified into three types-
- Factory Expenses – Expenses that are incurred at the time of production are labelled as factory expenses. Works overhead and factory overheads are also the other terms for indirect expenses. Examples- Depreciation charged on buildings, plant and machinery, rent and taxes, insurance, indirect labour wages, expenditure on indirect raw-materials, etc.
- Administrative Expenses – Expenses that are incurred towards administration activities are labelled as administrative expenses. Examples- Salaries, office rent, repairs and maintenance, electricity bills, office insurance, stationery and printing expenses, depreciation of furniture, etc.
- Selling and Distribution Expenses – Expenses that are incurred by the sales team are termed as selling expenses while the expenses that are incurred from the time, the product attains its completion status until the same 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 expenses 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 in nature and the same cannot be directly assigned to the manufactured goods and services. Out of all the transactions given above, all the expenses listed above 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 important 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 really challenging for organizations and the failure in doing so could even price them out of the industry. This is high because of the fact that 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 are incurred with respect to choosing whether to manufacture or buy, the minimum price that must be fixed, the quantity that must be sold in order to earn pre-determined profit numbers, etc.
- Difficulty in comparing and controlling costs- Indirect costs makes it difficult for managers to compare 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 costs and these don’t add or generate future benefit 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 costs are apportioned through arbitrary methods. This 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 object since these are absorbed by various activities.
- Identification of indirect expenses is always important 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 in nature.
- Indirect costs cannot be applied directly to the manufacturing of a particular product or service.
- The identification of indirect costs could be really tricky. A cost that is regarded as an indirect expense in one organization might be regarded as a direct cost in another.
Conclusion
Indirect costs are also known as overhead costs. These are the expenses that can be applied to multiple business activities. These expenses are indirect in nature 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 expenses, 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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