Every project needs a roof, electricity, a finance team and an audit. Those costs do not belong to one project, yet donors will fund part of them. How you share them out, and how you show your working, is called indirect cost allocation. This guide explains the idea in plain terms with a worked example.
What a donor allows for indirect costs is set by the donor agreement. Some donors allow a fixed percentage, others allow only costs you can show were incurred for the project, and some allow none. Read your agreement and confirm the treatment with your auditor.
Direct and indirect costs
| Type | Meaning | Examples |
|---|---|---|
| Direct | Can be traced to one project | A trainer's fee for a project workshop, hand pumps for a water project |
| Indirect | Supports the whole organisation | Head-office rent, finance staff, audit fee, internet |
The same item can be either. A vehicle used only on one project is direct. A vehicle shared by three projects is shared, and its cost has to be split.
Two ways donors handle indirect costs
1. A fixed rate
The agreement says indirect costs may be charged at a set percentage, for example of the direct costs. You apply the rate and do not have to show the underlying invoices. You still keep the calculation and the basis.
2. Actual shared costs
The agreement allows a fair share of real costs, which you must be able to justify. You choose a basis for sharing, apply it consistently, and keep the working.
Choosing an allocation basis
The basis should reflect how each project uses the shared cost.
| Shared cost | Possible basis |
|---|---|
| Office rent | Floor area or staff numbers used by each project |
| Finance team | Share of direct spending, or time spent |
| Utilities | Headcount |
| Shared vehicle | Kilometres or days used by each project |
| Audit fee | Share of total expenditure |
Whatever you choose, write it down, apply it the same way every period, and keep the data behind it.
A worked example
A month's shared costs are Rs 300,000. Three projects shared the office. Direct spending this month:
| Project | Direct spending (Rs) | Share |
|---|---|---|
| Project A | 1,200,000 | 50% |
| Project B | 800,000 | 33.3% |
| Project C | 400,000 | 16.7% |
| Total | 2,400,000 | 100% |
The allocation of Rs 300,000 by share of direct spending:
| Project | Allocation (Rs) |
|---|---|
| Project A | 150,000 |
| Project B | 100,000 |
| Project C | 50,000 |
The journal entry
The shared costs are first recorded in a holding account for administration costs. The allocation then moves each project's share into that project.
| Account | Project | Debit | Credit |
|---|---|---|---|
| Indirect costs charged to project | Project A | 150,000 | |
| Indirect costs charged to project | Project B | 100,000 | |
| Indirect costs charged to project | Project C | 50,000 | |
| Shared administration costs (holding) | none | 300,000 |
The holding account is cleared to zero, and each project carries its share.
Check that the budget can take it
Before you charge an allocation to a project, make sure the project budget has a line for it. If the donor approved indirect costs of a set amount, the allocation must not exceed it. Charging more than the agreement allows is a common audit finding.
A monthly routine
- Total the shared costs for the month.
- Collect the basis data (direct spending, headcount, time).
- Calculate each project's share.
- Post the allocation by journal entry.
- Check the holding account is zero.
- Keep the calculation sheet with the entry.
Common mistakes
- Changing the basis to suit the numbers. Pick it once and stay with it.
- No working kept. The entry is unsupported.
- Allocating more than the donor allows. Check the cap.
- Charging the same cost twice. Once as a direct cost and once as an allocation.
- Leaving the holding account with a balance. The allocation is incomplete.
How OneAccounts fits
OneAccounts does not allocate indirect costs automatically. You post the allocation as a journal entry, as in the example above. Journal lines can carry an activity and location, which bring the project and donor with them, so each project's share can show up in the project reports, and the entry stays in the audit log. Keep your calculation sheet with the entry.
If an automatic allocation matters to you, ask us about it before you start.
See NGO accounting software and NGO budget vs actual reporting.
Frequently asked questions
What is an indirect cost?
A cost that supports the whole organisation rather than one project, such as head-office rent or the finance team.
Can a donor refuse to fund indirect costs?
Yes. It depends on the agreement. Some allow a fixed rate, some actual shared costs, and some none.
What is the best allocation basis?
The one that best reflects how each project uses the cost, applied consistently. Time, headcount and share of direct spending are common.
Should I allocate monthly or yearly?
Monthly is better. Year-end allocations are hard to explain and harder to support.
Do I need a journal entry for each project?
Yes, one line per project. The lines are usually posted in a single entry.