Indirect cost rates: Overview, definition, and example
What are indirect cost rates?
Indirect cost rates refer to the percentage used to allocate indirect costs—such as administrative expenses, utilities, and facility costs—to specific projects or contracts. These rates are commonly applied in government contracts, grants, and business accounting to fairly distribute costs that are not directly tied to a single activity but support overall operations.
For example, a consulting firm working on multiple government projects may use an indirect cost rate to allocate office rent and administrative salaries proportionally across all contracts.
Why are indirect cost rates important?
Indirect cost rates ensure that businesses and organizations accurately distribute overhead costs across different projects, preventing undercharging or overcharging. They are particularly important in government contracts and grants, where organizations must comply with federal cost principles to receive reimbursement for indirect expenses.
For businesses, understanding and properly calculating indirect cost rates helps improve financial transparency, supports budgeting, and ensures compliance with funding agreements.
Understanding indirect cost rates through an example
A nonprofit organization receives a federal grant to provide community services. While the grant covers program costs, the nonprofit also has indirect expenses such as office space, IT support, and general administration. To ensure these costs are covered, the organization applies an approved indirect cost rate of 15%, meaning 15% of direct program costs are allocated to overhead expenses.
In another scenario, an engineering firm secures multiple government contracts. The firm calculates its indirect cost rate based on total operational expenses, ensuring that project costs include a fair share of administrative and facility expenses. This allows the firm to recover its full costs while remaining compliant with contract regulations.
An example of an indirect cost rates clause
Here’s how an indirect cost rate clause might appear in a contract:
“The Contractor shall apply an approved indirect cost rate of [X]% to all allowable direct costs under this Agreement. This rate shall be calculated in accordance with applicable federal cost principles and subject to review by the funding agency.”
Conclusion
Indirect cost rates help businesses and organizations fairly allocate overhead costs across projects, ensuring financial accuracy and compliance with funding requirements. Properly applying and documenting these rates is essential for budgeting, cost recovery, and maintaining transparency in government contracts and grants.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.