Indirect Costs Calculator
The overhead rate equals indirect costs divided by the allocation base. A $185,000 pool spread over $462,500 of direct labor gives a 40 percent rate, so a job with $96,000 of direct labor absorbs $38,400 of indirect cost.
| Overhead rate | 40.00% |
| Rate per unit of base | $0.4000 per $1.00 |
| Pool used | $185,000.00 |
| Base used | $462,500.00 |
| Applied to the job | $38,400.00 |
| Job base as a share of total base | 20.76% |
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Turn an indirect cost pool and an allocation base into an overhead rate, then spread that rate across jobs, contracts, and products.
Key takeaways
- The overhead rate is indirect costs divided by the allocation base, so the percentage depends entirely on how the pool and base are defined.
- FAR 31.203 requires logical cost pools and an allocation base common to the cost objectives that receive the benefit.
- Direct labor dollars, direct labor hours, machine hours, and units produced are the four bases most small firms use.
- Once a base is accepted, individual items should not be pulled out of it, because the remaining items then absorb more of the pool.
- Pool and base must cover the same fiscal period, or the rate describes no real year.
On this page
What Counts as an Indirect Cost
An indirect cost supports two or more cost objectives at the same time. Office rent, bookkeeping, liability insurance, utilities, front office staff, and machine maintenance all fit that description because no single job can claim the whole bill. A direct cost is different: it belongs to one cost objective, such as the plywood on a specific order or the hours an electrician books to one contract.
Federal cost principles draw the line in the same place. 48 CFR 31.202 says direct costs are charged to the contract they serve, and costs identified with other work are not charged to this one either directly or indirectly. The rule runs in reverse too: once a cost sits in an indirect pool, no job may book the same cost as a direct charge.
There is one practical exception. Under 31.202(b), a business may treat a small direct cost as indirect if the treatment is applied consistently and produces substantially the same result. Postage on a single invoice is the usual example. The exception is about convenience in the ledger, not about moving real money out of job costing.
The Overhead Rate Formula and the Allocation Base
Every overhead rate has the same shape, and it is a ratio rather than a number you look up:
Overhead rate = indirect cost pool / allocation base
Applied indirect cost = overhead rate x allocation base of the cost objective
The pool is the total of the indirect costs for one period, usually a fiscal year. The base is a measure with a real relationship to that pool: direct labor dollars, direct labor hours, machine hours, material dollars, or units shipped. The rate tells you how many pool dollars ride on each unit of the base.
Units matter. A pool of $180,000 spread over $450,000 of direct labor produces 0.40, which people read as 40 percent. The same pool spread over 30,000 direct labor hours produces $6.00 per hour. Both rates are correct, they answer different questions, and a 40 percent rate cannot be compared with a $6.00 rate.
The base has to be common to every cost objective that receives the benefit. If half the pool serves the retail counter and the other half serves online orders, one combined base will overcharge whichever side uses fewer labor hours. Split the pool first, then pick a base for each piece.
Worked Example 1: One Pool on Direct Labor Dollars
A 22 person cabinet shop wants a single plant-wide rate for the coming year. Its indirect pool for the year looks like this:
| Pool line item | Annual cost | Why it is indirect |
|---|---|---|
| Shop and office rent | $72,000 | Shared by every job in the building |
| Administrative salaries | $68,000 | Estimating, billing, and payroll serve all work |
| Liability and property insurance | $18,000 | Policy covers the whole operation |
| Utilities | $15,000 | No meter runs to a single cabinet order |
| Software and shop supplies | $12,000 | Consumed across jobs without a clean count |
| Total pool | $185,000 | Sum of the five lines above |
The allocation base is direct labor dollars. Payroll records show $462,500 of direct labor for the same period, so the rate is $185,000 / $462,500 = 0.40, or 40 percent of direct labor.
Job 114 carries $96,000 of direct labor and $54,000 of materials. Applied indirect is 0.40 x $96,000 = $38,400, and the full job cost is $96,000 + $54,000 + $38,400 = $188,400. In practice the rate adds 40 cents to every labor dollar, which lets the shop quote work before the year closes and the actual pool is known.
| Job 114 line | Amount | How it was computed |
|---|---|---|
| Direct materials | $54,000 | Purchase orders for this job |
| Direct labor | $96,000 | Time tickets for this job |
| Applied indirect | $38,400 | 0.40 x $96,000 |
| Total job cost | $188,400 | $54,000 + $96,000 + $38,400 |
Worked Example 2: Two Pools With Different Bases
Firms with several pools get better numbers, and the arithmetic stays simple. A fabrication shop splits its indirect costs into fringe and overhead:
- Fringe pool of $62,400 over $312,000 of direct labor gives 0.20, or 20 percent of direct labor.
- Overhead pool of $150,000 over 25,000 direct labor hours gives $6.00 per direct labor hour.
Contract B uses $85,000 of materials, $40,000 of direct labor, and 6,000 direct labor hours. Fringe applied is 0.20 x $40,000 = $8,000. Overhead applied is $6.00 x 6,000 = $36,000. The contract absorbs $44,000 of indirect cost, and its total cost is $85,000 + $40,000 + $44,000 = $169,000.
On this job the two pools work out to $44,000 / $40,000 = 110 percent of direct labor. Treat that blended figure as a check, not as a rate to reuse. The overhead pool is driven by hours, so a job with the same $40,000 of labor but only 3,000 hours would absorb $8,000 + $18,000 = $26,000 instead, and the blended percentage would drop to 65 percent.
| Contract B line | Amount | Basis |
|---|---|---|
| Direct materials | $85,000 | Supplier invoices |
| Direct labor | $40,000 | Time tickets |
| Fringe applied | $8,000 | 20 percent of direct labor |
| Overhead applied | $36,000 | $6.00 x 6,000 hours |
| Total contract cost | $169,000 | Sum of the four lines |
Rules That Govern Pooling and Allocation
Government contractors follow FAR 31.203, and its logic is a fair test for any cost system. Indirect costs are accumulated in logical groupings, and each grouping gets a base that is common to every cost objective receiving the benefit. The base should track the benefit received, not just be the largest number on the income statement.
FAR 31.203(d) also blocks a common shortcut: once a base is accepted, individual items may not be pulled out of it. Every item properly in the base carries a pro rata share of the pool, whether or not the customer accepts that item as a reimbursable cost. Removing the inconvenient line makes the rate look better and makes the number wrong.
Timing is fixed as well. For contracts outside full or modified CAS coverage, 31.203(g) sets the base period as the fiscal year used for financial reporting. Pool and base must come from the same period. A 2025 pool divided by a 2024 base produces a rate that describes no real year, and the error grows with inflation in the pool.
Consistency is the quiet rule behind all of these. The same cost goes in the same pool every period, the same base measures every job, and any change gets a written reason. Auditors and lenders both ask for that history, and a rate that jumps without explanation invites a second look at the books.
How to Pick an Allocation Base
A base earns its place when three things hold: pool costs rise and fall with it, the data is available without extra bookkeeping, and the measure is stable enough to compare across jobs. Direct labor dollars satisfy all three in labor heavy businesses. Hours do better when pay rates vary widely, because a $60 per hour engineer and a $22 per hour helper consume the same supervision and floor space per hour but different dollars.
Machine hours suit shops where equipment, power, and maintenance dominate the pool. Units shipped suit warehouses and repackaging operations. Material dollars work in distribution, though they distort when a cheap heavy item and an expensive light item need the same handling.
Service businesses often use billable hours. A design studio with a $210,000 pool and 7,000 billable hours carries $30.00 of overhead per billable hour, and that figure can be added to a project estimate one line at a time. The studio should compare the 7,000 billable hours with total paid hours, because unbilled time still consumes the pool.
Two bases in one rate usually signal a pool that should be split. Rent per square foot and supervision per labor hour are different drivers, and averaging them into one labor dollar rate hides the cost of the space a job occupies. Splitting costs a little more bookkeeping and produces numbers a project manager can act on.
The table below puts the same $185,000 pool over four different bases. Each rate is correct for its own base, and no two of them can be compared with each other.
| Allocation base | Base volume for the year | Rate on a $185,000 pool | Read the rate as |
|---|---|---|---|
| Direct labor dollars | $462,500 | 0.40 | 40 percent of direct labor |
| Direct labor hours | 18,500 hours | $10.00 | 10 dollars per direct labor hour |
| Machine hours | 12,000 hours | $15.42 | 15.42 dollars per machine hour |
| Material dollars | $740,000 | 0.25 | 25 percent of material dollars |
Divide each base volume into the pool to reproduce the third column. The 40 percent rate and the 10 dollar rate describe the same money, and a job that carries $50,000 of labor dollars at 60 hours absorbs $20,000 under the first rate and $600 under the second, which is why the unit has to travel with the number.
Mistakes That Distort the Rate
Double counting is the first failure. A cost in the pool cannot also be charged to a job as a direct cost, and FAR 31.202(a) states the rule plainly. Vehicle insurance is a frequent offender, booked to the pool and then again to the project that used the truck.
Dividing by revenue is the second. An overhead rate built on sales mixes a cost number with a price number, and the result moves whenever a discount is applied. Rates belong on a cost base, and the base should be one the business controls.
Using a stale pool is the third. A rate set eighteen months ago still divides, and the answer looks fine, but it recovers less than the business spends. Rebuild the rate once a year from the completed fiscal year, then test it against actual results at midyear and adjust the forward rate rather than the closed jobs.
Over-absorbing is the fourth. If jobs in total carry bases larger than the period base in the denominator, applied indirect will exceed the pool. That is a signal to reconcile the ledger, not a sign of extra profit. Under-absorbing shows up the same way in the other direction and usually means the pool grew after the rate was set.
Last, mixing units. A 40 percent rate applied to hours produces a number with no meaning, and a $6.00 per hour rate applied to labor dollars produces a very small one. Write the unit next to the rate on every quote, as in 40 percent of direct labor or $6.00 per direct labor hour, so nobody has to guess which pool the number came from.
Frequently asked questions
How do I calculate an indirect cost rate?
Divide the indirect cost pool by the allocation base for the same period. With a $185,000 pool and $462,500 of direct labor, the rate is 0.40, or 40 percent. Then multiply the rate by each job's base amount to get the indirect cost that job absorbs.
What counts as an indirect cost?
Costs that serve two or more jobs at once: rent, utilities, insurance, administrative salaries, accounting, and shared equipment maintenance. A cost that belongs to one job, such as the materials ordered for it, is direct. Federal rules at 48 CFR 31.202 keep the same cost from being treated both ways.
Is there a standard overhead rate for my industry?
No single number is reliable, because the rate depends on which costs sit in the pool and which base divides them. A firm that puts owner salary in the pool will show a much higher rate than one that does not, even with identical operations. Compare rates only when the pool definition and the base match.
Should I use direct labor dollars or direct labor hours?
Use dollars when pay rates are similar across the team, and hours when they are not. A shop with a $150,000 pool and 25,000 direct labor hours carries $6.00 per hour. The same pool over $300,000 of direct labor carries 50 percent, and that percentage overcharges expensive work and undercharges cheap work.
How is an overhead rate different from a markup?
A rate recovers costs the business already incurred, while a markup adds profit on top of total cost. A 40 percent overhead rate on $96,000 of labor recovers $38,400 of real cost. A 10 percent markup on a $188,400 job adds $18,840 of margin. Mixing the two in one number hides whether a job made money.
What does FAR 31.203 require for indirect costs?
The rule, issued jointly by the General Services Administration, the Department of Defense, and NASA in the Federal Acquisition Regulation, requires indirect costs to be grouped logically and allocated through a base common to the cost objectives that benefit. It also bars removing individual items from an accepted base.
Can the same cost be direct on one job and indirect on another?
No. Under 48 CFR 31.202, costs incurred for the same purpose in like circumstances must be treated consistently. If a cost is in the indirect pool, no final cost objective may also book it as a direct charge. The only relief is the minor cost provision in 31.202(b).
How often should the overhead rate be recalculated?
Once a year is the common cycle, using the completed fiscal year as the base period, which is what FAR 31.203(g) requires for contracts outside full or modified CAS coverage. A midyear review against actual results catches a pool that has drifted before the next annual rate locks in.
What happens if I remove one product line from the allocation base?
The remaining items absorb more of the pool and the rate rises. FAR 31.203(d) prohibits that kind of fragmentation once a base is accepted. If a product line genuinely consumes less overhead, split the pool and give each piece its own base instead of shrinking the shared one.
Why is applied indirect cost higher than the pool at year end?
Over-absorption happens when the bases on closed jobs add up to more than the period base used in the denominator. If jobs carried $500,000 of labor against a $462,500 base, applied indirect at 40 percent reaches $200,000 while the pool holds $185,000. Reconcile the difference before closing the books.
How do I apply two pools to a single contract?
Apply each pool with its own base and add the results. A contract with $40,000 of labor, 6,000 labor hours, a 20 percent fringe rate, and a $6.00 per hour overhead rate absorbs $8,000 + $36,000 = $44,000. Add materials of $85,000 and the total contract cost is $169,000.
Do unallowable costs belong in the pool?
For internal costing, keep every real cost of running the business in the pool, or the rate will understate what the work costs. For government contracts, FAR 31.201-6 requires unallowable costs to be identified and excluded from charges to the government, even though they remain in the accounting records.
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Fee schedules, rates and rules change without notice. Always confirm important figures with the official source before you rely on them.