Indirect cost
Learn what indirect costs are, see examples, and work out your indirect cost rate to price and budget with confidence.
Published Wednesday 30 September 2026
Table of contents
Key takeaways
- An indirect cost supports your whole business but can’t be traced to one product or project, like rent or admin salaries
- Telling direct and indirect costs apart helps you price accurately and claim the right tax deductions in Singapore
- To find your indirect cost rate, divide total indirect costs by an allocation base such as direct labour hours
- Reviewing indirect costs every month helps you spot savings and protect your margins as your business grows
What is an indirect cost?
An indirect cost is an expense that keeps your business running but can’t be linked to one specific product or project. It supports your operations as a whole.
Picture a bakery. The flour in each loaf is a direct cost because you can tie it to a product. The shop rent benefits every item you sell, so it’s an indirect cost.
Indirect costs are often called overhead costs. They’re a normal part of running a business, and knowing yours is the first step to pricing and budgeting well.
Indirect costs vs direct costs
Direct and indirect costs together make up your total business spending. Telling them apart helps you price accurately and keep your records in order.
What are direct costs?
A direct cost is any expense you can trace straight to a specific product or project. If you stopped producing that item, the cost would go away. Common direct costs include:
- raw materials and supplies used in production
- wages for staff who work directly on a product or project
- delivery charges for sending finished goods to customers
- equipment bought for a specific job
How to tell them apart
One question sorts most costs: “If I stopped making this product or delivering this service, would this cost disappear?” If yes, it’s a direct cost. If it would stay because it supports your wider operations, it’s indirect.
Take a freelance graphic designer. Design software used only for client projects is a direct cost, while the home internet bill supports the whole business, so it’s indirect.
Characteristics of indirect costs
Indirect costs share a few traits that make them easy to spot in your books. Look for costs that:
- can’t be traced to a single product or project
- support the whole business at once
- are often fixed or semi-variable
- keep arriving even in months with no sales
Types of indirect costs
Indirect costs behave differently as your workload changes. Knowing which type each cost is helps you plan and budget with more certainty.
Fixed indirect costs
Fixed indirect costs stay the same however busy your business is. You’ll pay them in a slow month and in your best month. Examples 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 higher they climb. Examples include:
- utility bills that increase with production volume
- office supplies that run out faster in busy periods
- maintenance and repairs that grow with equipment use
- overtime for support staff during peak seasons
Semi-variable indirect costs
Some indirect costs have both a fixed and a variable part. These semi-variable costs are harder to predict.
Your mobile plan might have a fixed monthly fee plus extra charges when your team goes over its data limit. A company vehicle works the same way, with a set lease payment plus fuel costs that change with how often it’s driven.
Examples of indirect costs
Indirect costs appear in every area of a small business. These are the categories you’re most likely to see in your accounts.
Facility and operating expenses
These are the costs of having a place to do business. They include:
- rent or mortgage payments for your office, shop or warehouse
- utility bills for electricity, water, gas and internet
- property tax and building maintenance
- cleaning and security services
Administrative costs
Administrative costs cover the people and systems that keep your business organised. You’ll usually record each one as a general business expense, such as:
- salaries for office managers and human resources (HR) staff
- accounting and bookkeeping fees
- legal and professional services
- office supplies like paper and printer ink
Technology and software
Most businesses rely on technology that supports every team. These costs 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 brings its own ongoing expenses. These include:
- public liability insurance
- professional indemnity insurance
- work injury compensation insurance, which the Ministry of Manpower (MOM) requires for manual workers and non-manual staff earning S$2,600 or less a month
- business licence and permit fees
Marketing and sales overhead
Marketing that promotes your brand as a whole, rather than one product, is usually an indirect cost. Examples include:
- website hosting and maintenance
- general advertising
- social media management
- trade show attendance and sponsorships
How to calculate indirect costs
To calculate your indirect cost rate, divide your total indirect costs by an allocation base. The rate shows how much overhead each unit of work absorbs, and you can find it in four steps:
- Add up all your indirect costs for a set period, such as a financial year.
- Choose an allocation base, such as direct labour hours or direct costs.
- Divide your total indirect costs by the allocation base to get your rate.
- Apply the rate to each job based on how much of the base it uses.
The formula looks like this:
Indirect cost rate = total indirect costs ÷ allocation base
A worked example
Say your small business has S$60,000 in total indirect costs for the year, and your team logs 4,000 direct labour hours in that time. S$60,000 ÷ 4,000 hours = S$15 per direct labour hour.
Every hour of direct work carries S$15 in overhead. A project that takes 20 direct labour hours picks up S$300 in indirect costs (20 hours × S$15).
Expressing the rate as a percentage of direct costs
You can also show the rate as a percentage of your direct costs. With S$60,000 in indirect costs and S$240,000 in direct costs, S$60,000 ÷ S$240,000 = 25%.
Each S$1 of direct cost then carries 25 cents of overhead. This version suits businesses that quote by materials and labour spend rather than hours.
Choosing the right allocation base
The best allocation base is the one that most closely drives your overhead. Common options include:
- direct labour hours, for service businesses where people’s time drives the work
- machine hours, for manufacturing or production-heavy businesses
- floor space, for spreading facility costs across departments
- total revenue, for businesses with many different product lines
How to allocate indirect costs
Allocating indirect costs means spreading them across your products, services or departments. The method you pick shapes how accurately you see the true cost of each thing you sell.
Equal allocation
Equal allocation is the simplest method: you split total indirect costs evenly across departments or products. It works best when each one uses about the same amount of overhead.
If you have S$12,000 in monthly indirect costs and three departments, each department is allocated S$4,000.
Proportional allocation
Proportional allocation spreads indirect costs based on each department’s share of a chosen measure, such as revenue or units produced. If Department A earns 60% of your revenue and Department B earns 40%, they take 60% and 40% of indirect costs.
Activity-based costing
Activity-based costing (ABC) is the most detailed method. It finds the activities that drive indirect costs and assigns costs by how much each product uses each activity.
If customer support is a large overhead, ABC tracks how many support calls each product generates and allocates costs to match. It takes more effort to set up, and it gives you the closest picture of your true costs.
Grouping costs into cost pools
A cost pool is a group of related indirect costs that you allocate using one base. You might pool rent and utilities and spread them by floor space, while pooling IT costs and spreading them by headcount.
Pooling lets you match each type of overhead to the base that best explains it, which makes your allocations fairer.
How indirect costs show up in your financial statements
Where an indirect cost lands in your accounts depends on whether it relates to making goods or running the business. That split affects when the cost reduces your profit.
Admin and selling overheads are period costs, which you expense in the period you incur them. They appear in your profit and loss statement for that month or year.
Production overheads follow a different path if you hold stock. International Accounting Standard 2 (IAS 2), adopted in Singapore as SFRS(I) 1-2, requires production overheads to be included in the cost of inventory. They then move into cost of sales when you sell the goods.
Take a furniture maker. Factory electricity sits in the value of unsold tables until they’re sold, while office rent reduces profit in the month it’s paid.
Why indirect costs matter for your business
Your indirect costs shape your prices, profit, tax bill and funding prospects. Each area below shows where knowing your overhead pays off.
Pricing your products and services accurately
Prices that cover both direct and indirect costs help you protect your profit margins. Your indirect cost rate lets you build overhead into every quote, such as adding S$15 to each billable hour in the worked example above.
Filing your taxes correctly
In Singapore, most indirect costs are deductible business expenses. The Inland Revenue Authority of Singapore (IRAS) allows a deduction when an expense is wholly and exclusively incurred in producing income, actually incurred, revenue in nature and not prohibited under the Income Tax Act 1947.
IRAS treats running costs such as rent and utilities as revenue expenses, while capital purchases like fixed assets don’t qualify as expenses. Overhead purchases from GST-registered suppliers usually carry goods and services tax (GST) at the 9% GST rate.
Tracking indirect costs all year makes your tax computation and GST returns simpler to prepare.
Making better financial decisions
When you see where your overhead goes, you can spot places to cut costs or reinvest. If technology spending grows faster than revenue, it’s a good time to review your subscriptions.
Securing business funding
Lenders and investors look for a clear grasp of your full cost structure. A breakdown of direct and indirect costs in your financial statements builds credibility and strengthens your case.
Tips for managing indirect costs
Keeping overhead under control protects your bottom line while you maintain quality. Start by recording every indirect expense as it happens, so your numbers stay current all quarter.
Review your indirect costs once a month. Monthly financial reports show which overhead lines are rising, which subscriptions sit unused and where you could negotiate a better rate.
These habits help you keep overhead lean:
- renegotiate supplier contracts every year
- combine software tools to reduce subscription costs
- move to cloud services to lower hardware and maintenance spend
- automate repetitive admin tasks to free up staff time
- review insurance policies each year so your cover matches your business
Set a target indirect cost rate and track it over time. If the rate starts to climb, you can find the cause early and adjust before it eats into profit.
Keep your indirect costs in check with Xero
Managing indirect costs is easier when all your numbers live in one place. Xero accounting software helps you categorise every expense and keep a close eye on cash flow.
Automated bank feeds and customisable reports give you a real-time view of your overhead with less manual data entry. You can then price and budget with confidence. Try Xero today and get one month free.
FAQs on indirect costs
These quick answers cover common questions about indirect costs.
What are 5 examples of indirect costs?
Office rent, utility bills, business insurance, admin salaries and accounting software subscriptions are five common examples. To find more in your own books, look for recurring payments that aren’t tied to a specific job.
Are salaries a direct or indirect cost?
It depends on the role: pay for staff who make products or deliver client work is direct, while pay for support roles like HR is indirect. If one person does both, you can split their salary using timesheets.
What is the difference between overhead and indirect costs?
People often use the terms interchangeably. Overhead usually means ongoing running costs like rent. Indirect costs can also include one-off items that aren’t tied to a product, such as a company-wide rebrand.
How do you calculate the indirect cost rate?
Divide total indirect costs by your allocation base, such as direct labour hours. Recalculate it at least once a year, or whenever your rent or headcount changes, so your quotes stay accurate.
Can indirect costs be tax-deductible?
Yes. Indirect costs such as rent and admin salaries are generally deductible when they meet IRAS rules, and GST-registered businesses can also claim input tax on the GST paid for qualifying purchases.
What are the 4 main types of costs?
The four main types are fixed, variable, direct and indirect costs. Fixed and variable describe how a cost behaves as activity changes, while direct and indirect describe whether you can trace it to a product. That’s why office rent is both fixed and indirect.
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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.