Indirect cost
Learn what an indirect cost is, with Malaysian examples and a simple way to calculate your rate.
Published Wednesday 30 September 2026
Table of contents
Key takeaways
- An indirect cost supports your whole business rather than one product or project. Rent, utilities, insurance and admin salaries are typical examples.
- Separating direct and indirect costs helps you price accurately and claim tax deductions correctly. It also shows you where your money goes.
- Your indirect cost rate is total indirect costs divided by an allocation base, such as direct labour hours. It tells you how much overhead each unit of work carries.
- Reviewing indirect costs regularly helps you spot savings and protect your profit margins. Small cuts add up as your business grows.
What is an indirect cost?
An indirect cost is a shared business expense that supports your whole operation rather than one product, service or project. It keeps the lights on for everything you sell.
Picture a bakery. The flour in a loaf of bread is a direct cost because it goes into that product. The shop rent benefits every cake and loaf you sell, so it’s indirect.
Indirect costs are often called overhead costs, and the two terms are used interchangeably in everyday business language. Once you can spot them, you can plan for them.
Indirect costs vs direct costs
A direct cost ties to a specific product or job, while an indirect cost is shared across your whole business. Together they make up your total business expenses.
What are direct costs?
A direct cost is spending you can trace straight to one item or job. Direct costs feed into your cost of sales, which you subtract from revenue to find your gross profit.
You’ll usually see these direct costs:
- Raw materials and supplies used in production
- Wages for staff who work on a specific product or project
- Shipping and freight for delivering finished goods
- Equipment bought for a single job
How to tell direct and indirect costs apart
Try a quick test: “If I stopped making this product or delivering this service, would this cost disappear?” If yes, it’s direct. If the cost stays because it supports your wider operations, it’s indirect.
Say you’re a freelance graphic designer. A stock photo licence bought for one client’s brochure is a direct cost. Your internet bill is indirect because it supports every client you work with.
Types of indirect costs
Indirect costs behave differently as your workload changes. Knowing which type you’re dealing with makes budgeting much easier.
Fixed indirect costs
Fixed indirect costs stay the same however busy you are. You’ll pay them in a quiet month and in your best month alike.
Common fixed indirect costs include:
- Office or warehouse rent
- Business insurance premiums
- Salaries for administrative staff
- Annual software subscriptions
Variable indirect costs
Variable indirect costs rise and fall with your level of activity. The more you produce or sell, the more you spend.
You might see these variable costs:
- Electricity bills that climb with production volume
- Office supplies that run out faster in busy periods
- Maintenance and repairs that grow with equipment use
- Packaging materials shared across product lines
Semi-variable indirect costs
Some indirect costs have a fixed part and a variable part. These semi-variable costs take a little more effort to predict.
Your phone plan might have a set monthly fee plus extra charges when your team goes over the data limit. A company car works the same way, with a fixed lease payment and fuel costs that change with how far you drive.
Examples of indirect costs
Indirect costs appear in every corner of a small business. These are the categories you’re most likely to see in Malaysia.
Facility and property costs
These costs come with having a place to do business. Typical facility costs include:
- Rent for your office, shop or warehouse
- Utility bills for electricity, water and internet
- Assessment tax (cukai taksiran) for your local council and quit rent (cukai tanah) for the state land office
- Building maintenance, cleaning and security
Administrative costs
Administrative costs cover the people and systems that keep your business organised. You’ll often pay for:
- Salaries for office managers, receptionists and human resources (HR) staff
- Accounting and bookkeeping fees
- Legal and professional services
- Office supplies such as paper, printer ink and postage
Technology and software
Most businesses rely on technology that supports every team. Common tech expenses include:
- Cloud accounting software subscriptions
- Customer relationship management (CRM) tools
- Cybersecurity and data backup services
- IT support and hardware maintenance
Insurance and compliance
Protecting your business and your people brings its own ongoing costs. Expect to budget for these:
- General liability and professional indemnity insurance
- Employer contributions to the Employment Injury Scheme run by the Social Security Organisation (SOCSO or PERKESO)
- Business licence and permit fees
- Company secretarial and statutory filing fees
Marketing and sales overhead
Marketing that promotes your brand as a whole, rather than a single product, usually counts as an indirect cost. Brand-wide marketing spend often covers:
- Website hosting and maintenance
- General advertising and social media management
- Trade show stands and event sponsorships
- Branded stationery and signage
How to calculate indirect costs
The most common measure is your indirect cost rate, which shows how much overhead each unit of work absorbs. Follow these four steps to find yours.
1. List your indirect costs
Go through your accounts for the period, usually a full year, and pull out every shared expense. Use the examples above as a checklist so nothing slips through.
2. Add up your total indirect costs
Add every item on your list to get one total for the period. Check that you haven’t included any direct costs, as they’d inflate your rate.
3. Choose an allocation base
An allocation base is the measure you use to spread indirect costs across your work. Pick one that reflects what drives your overheads, such as direct labour hours or machine hours.
4. Divide to find your indirect cost rate
Divide your total indirect costs by your chosen allocation base to get your rate. The result is the overhead cost attached to each hour, ringgit or unit of that base.
Worked example in ringgit
Suppose your business has RM60,000 in total indirect costs for the year, and your team logs 4,000 direct labour hours. RM60,000 ÷ 4,000 hours = RM15 per direct labour hour.
Every hour of direct work therefore carries RM15 in overhead. A project that takes 20 direct labour hours picks up RM300 in indirect costs (20 hours × RM15).
Choosing an allocation base
The right base depends on how your business earns money. Here are common options and where each one fits best:
- Direct labour hours, for service businesses where staff time drives the work
- Machine hours, for manufacturing or production-heavy businesses
- Floor area, for spreading facility costs across departments
- Total revenue, for businesses with a wide mix of product lines
How to allocate indirect costs
With your total in hand, you need a method for sharing it across your products and projects. The right method shows you the true cost of everything you sell.
Equal allocation
Equal allocation is the simplest approach: you split indirect costs evenly across products or departments. It suits businesses where each area uses roughly the same share of overheads.
If you have RM12,000 in monthly indirect costs and three departments, each department takes RM4,000 (RM12,000 ÷ 3).
Proportional allocation
Proportional allocation shares indirect costs according to each area’s portion of a chosen measure, such as revenue, labour hours or units produced. If Department A earns 60% of your revenue and Department B earns 40%, they take 60% and 40% of indirect costs.
A construction business might use this method for job costing, sharing site office and equipment costs across projects by labour hours.
Activity-based costing
Activity-based costing (ABC) assigns overheads according to the specific activities that create them. It’s the most detailed of the three methods.
If customer support is a big overhead, ABC tracks how many support calls each product generates and shares the cost accordingly. It takes more effort to set up, and it gives you the clearest view of your true costs.
Overheads in inventory under MFRS 102
If you hold stock, your accounting standard affects where some overheads end up. Under Malaysian Financial Reporting Standard 102 (MFRS 102), production overheads go into inventory cost, while general administrative overheads are expensed.
Why indirect costs matter for your business
Your indirect costs shape your prices, your tax position and your ability to grow. Here’s how each one plays out.
Pricing your products and services accurately
Prices built only on direct costs can leave you undercharging. When your indirect cost rate is part of every quote, each sale helps cover your overheads as well as your materials and labour.
A margin calculator helps you check that each price still leaves room for profit.
Claiming tax deductions in Malaysia
Section 33(1) of the Income Tax Act 1967 allows expenses wholly and exclusively incurred in producing gross income, subject to exclusions in Section 39. Those exclusions cover items such as private spending and capital expenditure.
Equipment such as computers is claimed through capital allowances instead of as an expense. Recording indirect costs accurately through the year makes it easier to support your claims with the Inland Revenue Board of Malaysia (LHDN).
Making better spending decisions
When you know where your overhead goes, you can see where to cut costs and where to invest. If your technology spending grows faster than your revenue, that’s your cue to review subscriptions and tools.
Securing business funding
Lenders and investors want to see that you understand your full cost structure. A clear split of direct and indirect costs in your financial statements builds credibility and strengthens your case.
Tips for managing indirect costs
Keeping indirect costs in check protects your bottom line while you keep quality high. Start by recording every shared expense as it happens.
Accounting software lets you categorise overheads in real time, so your totals are ready whenever you need them. Ask your team to submit expense claims digitally, so staff spending lands in the right account straight away.
Review your indirect costs once a month, looking for rising bills, unused subscriptions or services you could renegotiate. These habits keep your overhead lean:
- Renegotiate supplier contracts annually for better pricing
- Combine overlapping software tools to reduce subscription fees
- Move to cloud-based tools to cut hardware and maintenance spending
- Automate repetitive admin tasks to free up staff time
- Check insurance policies each year so your cover matches your needs
Set a target indirect cost rate and track project costs against it over time. If the rate starts creeping up, you can find the cause early and correct it before it reaches your profits.
Manage your business costs with Xero
Getting on top of indirect costs is easier when every expense sits in one place. Xero’s automated bank feeds bring in your transactions, so you can code overheads to the right accounts as they arrive.
Easy-to-read reports and real-time cash flow insights show exactly where your money goes. With clear numbers ready, you can price, budget and plan for growth with confidence. Try Xero today and get one month free with a 30-day trial of all Xero features.
FAQs on indirect costs
Here are quick answers to common questions about indirect costs.
What are the 4 main types of business costs?
The four main types are direct, indirect, fixed and variable costs. Direct and indirect describe whether a cost traces to one product, while fixed and variable describe how it moves with activity. Rent, for example, is both indirect and fixed.
Are salaries a direct or indirect cost?
It depends on the work: a baker’s wages are direct, while a bookkeeper’s salary is indirect. If one person does both, split their pay by the hours they spend on each.
What is the difference between overhead and indirect costs?
In everyday use, they mean the same thing. Some businesses keep overhead for ongoing running costs like rent and use indirect cost for the wider group, including one-off shared expenses.
Can indirect costs be tax-deductible in Malaysia?
Many can if they’re incurred wholly and exclusively to earn business income. Commonly deductible items include staff costs, rent, utilities and professional fees, and your tax agent can confirm any borderline cost.
Can the same cost be direct for one business and indirect for another?
Yes, because classification depends on what the cost supports. Fuel for a courier company’s delivery runs is a direct cost, while fuel for an accounting firm’s car is indirect.
How often should you recalculate your indirect cost rate?
Recalculate it at least once a year and whenever something big changes, such as moving premises or hiring staff. An up-to-date rate keeps your quotes accurate.
Related terms
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Disclaimer
This glossary is for small business owners. The definitions are written with their requirements in mind. More detailed definitions can be found in accounting textbooks or from an accounting professional. Xero does not provide accounting, tax, business or legal advice.