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What is an indirect cost rate?

By the EMPOBase team · · 4 min read

Short answer

An indirect cost rate is a percentage that lets a grant pay its fair share of organization-wide costs that serve many projects, such as management, finance and office running costs. You set it by dividing indirect costs by a chosen base, often direct costs, then apply it to each grant. Donors set their own caps and rules, so check each agreement.

Key points

  • Indirect costs serve many projects and cannot be traced to one without a rule.
  • The rate is indirect costs divided by a base, such as direct costs.
  • Each donor may cap the rate, change the base or reject the method.
  • Keep the calculation and the support; a rate nobody can explain will be challenged.

What are indirect costs?

Some costs clearly belong to one project, such as the field staff or the training venue. These are direct costs. Others serve the whole organization: the finance team, the director, audit fees, office rent, accounting software and HR support. These are indirect costs, sometimes called overheads or administration.

You cannot say that one project caused all of the finance team’s work. But the projects could not run without it. An indirect cost rate is a way to share that cost fairly.

How is the rate calculated?

The basic formula is simple:

Indirect cost rate = indirect costs ÷ base

The base is a measure that grows as projects grow. Common choices are total direct costs or direct staff costs. Your donor agreement may name the base.

A worked example, with numbers for illustration only:

  1. Your organization’s indirect costs for the year are 120,000.
  2. Total direct costs are 800,000.
  3. Rate = 120,000 ÷ 800,000 = 0.15, or 15%.

If a grant has direct costs of 100,000, it can recover 15,000 in indirect costs at this rate, if the donor allows it.

What goes into the pool?

Decide which costs count as indirect, and apply the same decision each year. Typical items:

  • Management and leadership time not charged to projects.
  • Finance, HR, IT and administration staff.
  • Audit and legal fees for the organization as a whole.
  • Office rent and utilities for shared space.
  • Software that serves the whole organization.

Anything charged directly to a project should not also sit in the pool. Counting a cost twice is a classic audit finding. A short chart of accounts that separates direct from indirect accounts makes this much easier.

How do donors treat the rate?

Practices differ. Some donors accept a rate you calculate and support. Some set a fixed cap for all grantees. Others limit it to certain cost types or ask you to show your calculation. Laws and donor rules also differ between countries.

So, for each grant:

  1. Read the agreement for the rate, the base and the cap.
  2. Note what you may and may not include.
  3. Apply the rate only to costs the agreement allows to be in the base.
  4. Record the rate used, and its source, on the grant file.

How do you apply the rate in practice?

Most teams use one of two approaches:

  • Recover as you go. Each month, calculate the indirect share of that month’s direct costs and post it to the grant.
  • Recover at period end. Calculate the share quarterly or yearly and post one entry.

Either way, post it as a clear entry with its own account, so the grant ledger shows the recovery separately from direct spending. Related ideas are covered in allocating shared costs and in cost centers.

What do you do when the rate does not cover your costs?

Many NGOs find that donor caps are below their real indirect costs. The gap does not disappear. It must be paid from unrestricted funds or from donors that allow higher rates. Track the gap each year. If it is large, it is evidence for a conversation with donors, and for your own budget planning.

What should you keep for audit?

Keep a short file with the year’s calculation, the list of accounts in the pool, the base used, the donor’s rule and the postings. An auditor will test whether the same cost was both charged directly and recovered through the rate.

How often should you revisit the rate?

Calculate it again at least once a year, using the latest full year of costs and an agreed base. If your indirect costs jump, for example after a new audit requirement or an office move, check the rate sooner. Keep each year’s calculation so you can show how the rate changed and why.

Be consistent about which costs sit in the pool. If you move a cost from direct to indirect, or the reverse, note the date and the reason. Auditors look at consistency more than at the exact percentage. A rate that is lower than a donor’s cap but well supported is safer than one at the cap that nobody can explain.

Where EMPOBase fits

EMPOBase’s Finance module includes Cost Allocation, and indirect-cost recovery posts as a journal in the ledger. Your finance team chooses the rate and the base, and the posting keeps its project, grant and budget line, so it shows in budget vs actual. EMPOBase does not decide which rate a donor will accept, and the ledger is not statutory accounting. Check each donor agreement yourself. Read more in the documentation.

Questions people ask

Is an indirect cost rate the same as overhead?

The idea is close. Different donors use different words, such as overhead, administration or indirect recovery. Use the term in each agreement and check how it defines allowed costs.

Can we charge a rate that is higher than the donor allows?

No. Charge up to the agreed cap. Costs above it need another source, such as unrestricted funds.

What if our real indirect costs are higher than the rate?

The shortfall must be covered by other funds. Track it each year, because a gap that keeps growing may mean your rate or your funding mix needs a review.