Understanding Direct and Indirect Cost in Government Contracting

For government contractors, mastering the difference between direct and indirect costs isn’t just about good bookkeeping—it’s about staying compliant, competitive, and contract-ready.

What Are Direct Costs?

Direct costs are expenses that can be specifically and clearly tied to a particular contract or project. They’re the "on-the-ground" costs that directly drive the work being performed.

Examples include:

  • Labor hours of employees working solely on a government contract
  • Materials and supplies used for that specific contract
  • Equipment purchased for contract execution
  • Travel specifically related to the contract

These costs are identifiable, traceable, and billed directly to the government contract in question.

What Are Indirect Costs?

Indirect costs support overall business operations and multiple projects at once—they’re essential but not easily assigned to a single contract.

Examples include:

  • Rent and utilities for your office
  • Administrative salaries (HR, accounting, leadership)
  • General office supplies
  • IT support systems

These costs are typically allocated using a logical and consistent methodology, often through an Indirect Cost Rate (ICR) that’s approved by agencies like DCAA (Defense Contract Audit Agency).

Why It Matters for Government Contractors

Government contracts, especially cost-reimbursable ones, require precise cost tracking and proper segregation between direct and indirect expenses. Here's why it counts:

  • Compliance with FAR & GAAP: Agencies expect clean records that follow Federal Acquisition Regulation (FAR) and Generally Accepted Accounting Principles (GAAP).
  • DCAA Audit Readiness: A clear distinction between cost types is essential for passing audits.
  • Fair and Accurate Billing: You can’t overcharge or underreport—cost clarity protects both the contractor and the agency.
  • Better Business Decisions: Understanding how resources are used across contracts supports forecasting and strategic growth.

govIRG’s Perspective

At govIRG, we help contractors embed compliant systems that clearly track direct and indirect costs—ensuring that you don’t just meet expectations, but operate with confidence. Whether it’s building your cost allocation method or setting up DCAA-compliant books, we make sure cost structures support growth and audit success.