Indirect Rate Essentials
Breakout Session # 109
Presented by Craig Stetson and Noah Leiden
July 19, 2010
Session Schedule: 11:15-12:30
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Learning Objectives
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What are Indirect Rates?
Why Indirect Rates are Important
Regulatory and Other Guidance
Indirect Rate Structures
Designing your Company’s Rate Structure
Indirect Rate Calculation Examples
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What are Indirect Rates?
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What are Indirect Rates?
• Indirect rates are computed factors or percentages
representing the ratio of selected indirect expenses to
specific elements of cost or other performance metrics
• Specific elements of cost used for calculation commonly
include direct labor, subcontracts or a combination of
various manufacturing activities; other performance metrics
may include direct labor hours or units of output or
production
• Indirect rates are applied for purposes of achieving full cost
recovery and equitable distribution of indirect expenses to
cost objectives
• Typical indirect rates are computed and associated with
fringe benefits, overhead and general & administrative type
activities
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Indirect Costs
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Not incurred for the benefit of a single objective or
contract
Incurred to support the organization or business unit as a
whole
Benefits two or more final cost objectives
Remainder of costs to be allocated after direct costs are
identified and assigned to projects
Examples include
– Depreciation on buildings and equipment
– Occupancy and Facilities
– Insurance, fringes, taxes, etc.
– General management and administration (e.g., salaries and
expenses of executive officers, human resources, legal
accounting and finance, internal audit, ethics, etc.)
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Direct Costs
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Identified solely with a particular final cost objective
Benefits only one cost objective or contract and would
not have been incurred but for the same cost objective or
contract
Costs incurred for the same purpose, in like
circumstances, must be consistently treated as direct
only or indirect only – CAS 402
Direct costs of minor amounts may be treated as indirect
when consistently applied
Examples include
– Labor performed specific to contract scope of work
– Subcontracts under specific contracts
– Material required to perform contract scope of work
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Allowable Costs
• Critical element in calculating indirect rates is
exclusion of unallowable costs from applicable
expense pools
• Allowable costs are:
– Reasonable and Allocable
– In conformity with Cost Accounting Standards and Generally
Accepted Accounting Principles
– In accordance with contract terms
– In compliance with FAR Part 31 Cost Principles
• Unallowable costs commonly derived from statue,
public policy or nature of activity
• Directly associated costs
• Potential for assessment of penalties due to inclusion
of selected unallowable costs
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Accounting for Unallowable Costs
• Appropriately identify and exclude unallowable costs
from cost representations (e.g., billings, claims,
proposals, etc.) to the Government
• Unallowable indirect costs must be excluded from
applicable expense pools; unallowable direct costs,
or other costs normally included in an allocation
base, must remain in base when calculating indirect
rates
• Identification of unallowable costs may be achieved
using various methods – original point of entry,
statistical sampling, other analytical
• Even though costs may be legitimate business
expenses, they may nevertheless be unallowable for
the government contracting purposes, e.g., interest
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Key Terminology
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Allocation Base
– Measure of activity such as direct labor dollars used to calculate
indirect expense rates and assign costs to cost objectives
Direct costs
– Costs associated solely with a specific final cost objective
Final cost objective
– Cost objective which has allocated to it both direct and indirect costs and is
a final accumulation point in the accounting system – generally a contract
Indirect costs
– Costs that cannot be identified to a particular final cost objective and that
benefit more than one final cost objective
Intermediate cost objective
– Cost objective, created for more accurate allocations, consisting of indirect
costs that are ultimately allocated to final cost objectives
Expense Pool
– Grouping of homogeneous costs identified with two or more cost objectives;
numerator of rate calculation
Indirect Rate
– Percentage result of dividing expense pool by allocation base
Total cost input (TCI)
– All costs, less general & administrative expenses; a common allocation
basis for G&A and used in related rate calculation
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Why Indirect Rates are
Important
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Contract Pricing Actions, CloseOut and On-going Compliance
• Flexibly Priced Contracts Including
– Cost reimbursable contracts
• Cost Type contract bids and incurred cost proposals
– Time & Materials contracts
• Where burdens are applied to the cost reimbursable (“Materials”)
portion of contract
• Buildup/creation of T&M hourly rates
– Fixed Price contracts
• When cost or pricing data is required during the proposal process
• When there is an Incentive Fee component
• Progress Payments based on Cost
• Contracts subject to Cost Accounting Standards (CAS)
• Contract Termination Settlement or Request for
Equitable Adjustment Proposals
• Internal Management Reporting, Budgeting and
Resource Consumption
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Contract Life Cycle
• Forward Pricing Rates
– Represents the best estimate of indirect cost rates at the time of
submission; typically used to estimate pricing of multi-year
procurements
– Used to estimate indirect costs for future periods of Government
contract work; typically agreed to with the government for a 3 to 5
year period
• Provisional Billing Rates
– Used for interim billing of costs; subject to true-up at year end
– Established by Contracting Officer or Auditor based on contractor
billing rates submission, recent evaluation of indirect rates or
Forward Pricing Rates
– Revised as necessary based on mutual agreement
– Should be updated soon after year-end
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Contract Life Cycle (cont.)
• Final Indirect Rates
– Due 6 months after year-end (Final Indirect Cost Rate Proposal)
– Final billings for completed contracts are due within 120 days after
settlement of rates
– Quick-Closeout Procedures
• Negotiated or audit-determined final rates used for
– Billing updates (impact differences in provisional rates)
– Contract close-out
– Preparation of completion vouchers (due within 120 days after
settlement of final indirect costs rates for contracts)
– Determination of final incentive/award fees
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Regulatory and Other
Guidance
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Regulatory and Other Guidance
• Federal Acquisition Regulation (FAR)
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Subpart 2.1 - Definitions
Part 31 – Contract Cost Principles and Procedures
Subpart 42.7 – Indirect Cost Rates
52.216-7 – Allowable Cost and Payment Clause
• Cost Accounting Standards (CAS)
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CAS 401 - Consistency in Estimating, Accumulating and Reporting costs
CAS 402 - Consistency in Allocating costs Incurred for the same Purpose
CAS 403 - Allocation of Home Office Expenses
CAS 405 - Accounting for Unallowable Costs
CAS 406 - Cost Accounting Period
CAS 410 - Allocation of Business Unit G&A to Final Cost Objectives
CAS 418 - Allocation of Direct and Indirect Costs
• OMB Circulars
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OMB Circular A-87 – Cost Principles for State, Local and Indian Tribal
Governments
OMB Circular A-122 – Cost Principles for Non-Profit Organizations
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Indirect Rate Structures
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Indirect Rate Structures
• Calculation
Indirect Rate = Indirect Cost Pool
Allocation Base
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Common Indirect Rate
Structures
• Fringe Benefits Rate (single or multiple rates
permitted, depending on circumstances)
• Overhead Rate (single or multiple rates
permitted, depending on circumstances)
• General and Administrative Rate (single G&A
expense rate required at segment or business
unit level)
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Fringe Rate
• Employee fringe benefit costs (e.g., payroll taxes,
vacation, sick, retirement, health care, bonus, deferred
compensation, insurance, etc.)
• Calculation
Fringe Rate =
Fringe Pool
Total Payroll Dollars
• Fringe rate can be intermediate or final
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Overhead Rate
• Management or supervision of activities or cost of certain
segments, divisions, business units, etc., that benefit more than
one project or contract, but not the business unit as a whole (e.g.,
division middle management, supervisors, project leadership
benefiting multiple projects, site rent, etc.)
• Generally costs that support performance of contract scope of
work and would not be required but for award of the contract
• Calculation
Overhead Rate =
Overhead Pool
Loaded (or unloaded) Direct
Labor Dollars
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General & Administrative (G&A)
Rate
• Management and administration costs that benefit the
business unit or company as a whole (e.g., executive
management, accounting, finance, legal, etc.)
• Costs for running the business and not necessarily
supporting contract scope of work activities
• Calculation
G&A Rate =
G&A Pool
Total Cost Input
• Other bases include value-added cost input; single element
cost input
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Other Indirect Rate Structures
• On-site Overhead Rate (s)
• Off-site Overhead Rate (s)
• Subcontractor/Material Handling Rate (s)
• Service Centers
• Home Office Allocations
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Designing Your Company’s
Rate Structure
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How to Create the Proper Rate
Structure
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Define and document operating structure
– What products or services do you provide and who buys them?
– What operating structure best aligns with delivery of products or
services – single operating entity combined with a corporate
function, separate business units under a single or intermediate
home office?
– What functional disciplines in the company exist and who do they
support?
– What are key resources consumed during typical contract
performance cycle?
– Are resources consumed proportionately across all contracts?
Define and document all costs as direct, indirect or both (CASB
disclosure statement Part III for guidance)
Look at cost-benefit theme
– Identify causal / beneficial relationships between indirect and direct
costs
– Identify cost drivers and appropriate allocation metrics
Accumulate indirect costs into logical and homogeneous groupings
(pools) based upon causal beneficial relationships
Segregate unallowable costs and remove from expense pools
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Indirect Rate Examples
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Starting Point for Cost Pools – Trial
Balance
Direct
Direct Labor
OH
Fringe
300,000
X
Subcontractor Expense
300,000
X
Direct Materials
250,000
X
Payroll Taxes
30,000
X
Insurance Expense
50,000
X
Sick, Holiday & Vacation Expense
65,000
X
Pension Contribution
25,000
X
IT Support Labor
35,000
Overhead Labor
72,500
Overhead Travel- Unallowable
$
G&A
X
X
5,000
16,000
X
G&A Labor
170,000
X
Legal & Professional Fees
10,000
X
G&A Travel Expense
8,000
X
G&A Travel Expense – Unallowable
3,000
$ 1,339,500
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U/A
X
Rent Expense (75% G&A)
Total Cost
IT SC
X
X
Fringe Rate
Pool:
Payroll Taxes
$
30,000
Insurance Expense
50,000
Sick, Holiday & Vacation Expense
65,000
Pension Contribution
25,000
Total Fringe Pool
$
170,000
$
300,000
Base:
Direct Labor
IT Support Labor
35,000
Overhead Labor
72,500
G&A Labor
170,000
Total Labor Base
$
Fringe Rate:
577,500
29.44%
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IT Service Center
Pool:
IT Support Labor
$
35,000
Fringe on IT Support Labor @ 29.44%
10,303
Total Service Center Pool
$
45,303
Base:
Overhead Personnel
5 Personnel
G&A Personnel
3 Personnel
Total Headcount Base
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Service Center Rate:
$
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5,663
Overhead Rate
Pool:
Overhead Labor
$
Overhead Travel- Unallowable (excluded from pool)
72,500
0
Fringe on Overhead Labor @ 29.44%
21,342
IT Service Center Allocation
28,314
Rent Expense
4,000
Total OH Pool
$
126,156
$
300,000
Base:
Direct Labor
Fringe on Direct Labor @ 29.44%
88,312
Total OH Pool
$
Overhead Rate:
388,312
32.49%
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G&A Rate
Pool:
G&A Labor
$
170,000
Fringe on G&A Labor @ 29.44%
50,043
IT Service Center Allocation
16,989
Legal & Professional Fees
10,000
Travel Expense
8,000
G&A Travel Expense – Unallowable (excluded from pool)
0
Rent Expense
12,000
Total G&A Pool
$
267,032
$
300,000
Base:
Direct Labor
Fringe on Direct Labor @ 29.44%
88,312
Direct Materials
250,000
Subcontractor Expense
300,000
Unallowable costs (excluding G&A)
5,000
Overhead Pool (including fringe on OH labor and Unallowable Overhead)
Total Cost Input
126,156
$
G&A Rate:
1,069,468
24.97%
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Cost Build-Up “Proof”
Direct Labor
$
Fringe Rate @ 29.44%
300,000
88,312
Overhead Rate @ 33.99%
126,156
Unallowable Overhead
5,000
Direct Materials
250,000
Subcontractors
300,000
Total Cost Input
$
G&A Rate @ 24.83%
1,069,468
267,032
Add: Unallowable G&A
3,000
Total Cost = Trial Balance
$
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1,339,500
Questions
?
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About Baker Tilly
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Founded in 1931 as a certified public accounting firm
Currently operate in six states with over 1,400 professionals
Member of Baker Tilly International, the world’s 8th largest network of
accounting firms
Headquartered in Chicago
East Region is located in Washington, D.C. with over 275
professionals
East Region provides a range of professional services including:
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Financial statement audit
Tax planning and compliance
Consulting services to private and publicly traded companies across many
industries
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Baker Tilly
Craig Stetson, Director
Craig has over 20 years of direct experience in government contract accounting, pricing,
subcontract management, regulatory and federal contract compliance, business system
implementation, and internal control oversight. His client base has included aerospace and
defense, manufacturing, construction, architecture and engineering, information and
communications, higher education, and non-profits. His experience includes, claims
preparation and negotiation; cost allowability; application of Federal Acquisition Regulation
(FAR) and OMB Circular requirements; program reviews related to internal control
sufficiency and overall self governance, accounting and business systems assessment
related to government contract compliance requirements; cost estimating, accounting and
auditing of federal contracts and grants; and, application and interpretation of Cost
Accounting Standards (CAS). Prior to Baker Tilly, Craig worked for KPMG, Deloitte &
Touché and DCAA. Craig has a MBA from California State University and a BS in
Accounting from Syracuse University.
Tel: (703) 923-8223, craig.stetson@bakertilly.com
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Baker Tilly
Noah Leiden, Director
Noah has over 20 years of experience in government contract accounting, pricing,
business system and internal control oversight, and regulatory and federal contract
compliance assisting defense, manufacturing, engineering, information and
communications, higher education, and non-profit clients. Noah earned his Bachelor of
Science in Accounting from Pennsylvania State University. He is a member of the American
Institute of Certified Public Accountants, Greater Washington Society of Certified Public
Accountants, Maryland Association of Certified Public Accountants, and National Contract
Management Association. Prior Baker Tilly, Noah worked for DCAA, KPMG, BearingPoint,
and Navigant Consulting. Noah is a member of the Consulting team in Washington D.C.
Tel: (703) 923-8321, noah.leiden@bakertilly.com
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