LACCD Contractors
Overview of Federal Acquisition
Regulation (FAR) Part 31
Contract Cost Principles and
Procedures
www.kroll.com
Presenter:
James J. Check, CPA
Managing Director, Kroll
Government Contractor Advisory Services
jcheck@kroll.com
703-796-2870
www.kroll.com
Government Contractor Advisory Services
provided by Kroll
Contract Cost Accounting and Pricing
Claims Pricing and Support
Regulatory Compliance Reviews
Special Investigations
Financial Accounting and Reporting Consultation
Process and Control Assessments
Commercial Pricing and GSA Multiple Award Schedule
Contracting
Expert Testimony
-
-
-
Kroll
3
Agenda
1.
2.
3.
4.
5.
Kroll
Applicability of FAR Part 31
Cost Allowability / Allocability
Direct / Indirect Costs
Selected Cost Principles
Indirect Rates
4
Applicability of FAR Part 31
 Fixed-price contracts
– Applicable subparts of FAR Subpart 31 used when cost analysis
is performed or a specific contract clause requires the
determination or negotiation of costs
 Cost-type contracts
– In general, applicable principles and procedures in FAR Subpart
31.2 should be used for cost-reimbursement contracts to:
 Determine reimbursable costs
 Negotiate indirect cost rates
 Settle costs of cost-reimbursement terminated contracts
 Other price revisions or contract modifications
Ref: FAR 31.102, 31.103 and 31.105
Kroll
5
Composition of Total Cost
 Total cost of a contract includes:
– Standard costs properly adjusted for applicable variances
– Direct costs
– Indirect costs allocable to the contact
– Allocable cost of money pursuant to FAR 31.205-10
– Allocable credits deducted
 Allowable costs are limited to those defined under FAR Part 31
 “In ascertaining what constitutes a cost, any generally accepted
method of determining or estimating costs that is equitable and is
consistently applied may be used.”
Ref: FAR 31.201-1
Kroll
6
Allowability vs. Allocability
 Costs are allowable to the extent they are reasonable, allocable and
determined to be allowable under FAR 31.201 “Composition of Total Cost”,
FAR 31.201-2 “Determining Allowability”, FAR 31.201-3 “Determining
Reasonableness” and as specifically determined under FAR 31.205
“Selected Costs”.
 “Allowability” refers to whether or not the Government will pay for a
particular cost incurred in connection with government contracts.
 “Allocability” refers to how costs are assigned to a contractor’s work; all
costs are either directly allocable or indirectly allocable to a particular
cost objective.
Kroll
7
Determining Allowability
 Characteristic of a cost that permits its inclusion in a contract, and
depends on …
– Reasonableness
– Allocability
– CAS, GAAP, appropriate under circumstances
– Terms of the contract
– Any FAR Subpart 31.2 limitations
Ref: FAR 31.201-2
Kroll
8
Determining Reasonableness
 Recognized as ordinary and necessary
 Accepted sound business practices, arm’s length bargaining, and
Federal and State laws and regulations
 Contractor’s responsibilities to the Government, other customers,
owners of the business, employees, the public at large
 Significant deviations from contractor’s established practices
Ref: FAR 31.201-3
Kroll
9
Determining Allocability
 Cost is incurred specifically for the contract
 Benefits both the contract and other work-distributed in reasonable
proportion to the benefits received
 Cost is necessary to the overall operation of the business
– Although no direct relationship to any particular cost objective
can be shown
Ref: FAR 31.201-4
Kroll
10
Credits
 Applicable portion shall be credited to the Government as a cost
reduction or cash refund
– Income
– Rebate
– Allowance
– Other credit
Ref: FAR 31.201-5
Kroll
11
Advance Agreements
– Advance agreements on the treatment of special or unusual
costs, including statistical sampling methodologies at 31.201-6(c)
are preferred but not required nor affect the reasonableness,
allocability or the allowability under the specific cost principles in
FAR Subparts 31.2, 31.3, 31.6 and 31.7
– Advance agreements may be negotiated either before or during a
contract but should be negotiated before incurrence of the costs
involved.
– An agreement cannot contradict the treatment of costs as set out
in FAR Part 31
Ref: FAR 31.109
Kroll
12
Direct vs. Indirect Cost
 Direct cost: Related to a particular cost objective and can be traced to it in
an economically feasible way.
– Defined as “any cost that is identified specifically with a particular final
cost objective.” (FAR 2.101)
– Direct Labor
– Direct Materials
– Other Direct Costs
 Indirect cost: Costs remaining to be allocated after direct costs have been
determined and charged directly to the contract or other work.
– Defined as: “any cost not directly identified with a single, final cost
objective, but identified with two or more final cost objectives or with at
least one intermediate cost objective.” (FAR 2.101)
– Allocated to the cost objective.
Ref: FAR 2.101, 31.202 and 31.203
Kroll
13
Direct vs. Indirect Cost (cont.)
Direct Costs – FAR 31.202
 The contractor is responsible for defining the types of costs that it will
account for as direct costs
– Costs normally defined as direct costs
 Material and subcontract costs
 Manufacturing direct labor and direct project performance labor for
service firms
– Costs defined as direct costs by some companies, yet as indirect by
others:
 Manufacturing engineering labor
 Project management labor
 Quality Assurance
 Defining what is accounted for as a direct cost involves balancing the
accuracy of the cost accounting and the administrative burden/cost
Kroll
14
Direct vs. Indirect Cost (cont.)
Indirect Costs – FAR 31.203
 Indirect costs are normally allocated to the products or projects that benefit
from these costs
 Usually grouped into common pools and charged to benefiting objectives
through an allocation or indirect cost rate
 The allocation base attempts to allocate indirect costs to the product or
project based on the relative benefit received
Kroll
15
Accounting for Indirect Costs
 Allocation of Indirect Costs – Understanding the Balancing Act
– The best form of cost accounting must reflect a cost-benefit
analysis:
– The required level of accuracy of the cost accounting approach
– The cost and complexity of achieving the various levels of accuracy
– The materiality of the cost to the total cost of the product or service
 Written policy
– Policy defines what is a direct or an indirect cost
– Policy must be applied consistently
Kroll
16
Accounting for Indirect Costs (cont.)
 Homogeneity
– Accumulate indirect costs in homogeneous pools
– Indirect costs are homogeneous if the activity they represent has the
same (or similar) casual or beneficial relationship to the final cost
objective
– Allocation in reasonable proportion to causal or beneficial
relationship
– Costs in an indirect cost pool shall be allocated to a cost objective
based on an appropriate measure of resource consumption
Kroll
17
Accounting for Unallowable Costs
 Expressly unallowable: mutually agreed cost, directly associated cost
– Exclude from billing, claim or proposal
– When an unallowable cost is incurred,
 Directly associated costs are unallowable
 Costs specifically designated as unallowable
– Written decision of the contracting officer
 FAR 31.201-6 (c)(1) reads: “The practices for accounting for and the
presentation of unallowable costs must be those described in [CAS 405],
Accounting for Unallowable Costs.”
– Statistical sampling may be acceptable
 Unbiased sample, reasonable representation of the sampling universe
 High dollar or high risk transaction separately reviewed
 Statistical sampling permits audit verification
Ref: FAR 31.201-6
Kroll
18
Accounting for Unallowable Costs (cont.)
 Penalties for unallowable indirect costs for contracts over $650,000:
– Amount of the disallowed costs allocated to contracts
 Penalty is two times the amount if the indirect cost is determined
unallowable before proposal submission
– Interest on the paid portion of the disallowance
– Additional administrative, civil, and criminal penalties
– Not necessary for unallowable costs to have been paid to the contractor
in order to assess a penalty
 All costs allocated to a CAS contract must comply with CAS 405 including:
– Home office costs
– Service center costs
– Costs charged from other segments
– G&A departments
Ref: FAR 42.709
Kroll
19
Categorization of Selected Costs
 Expressly unallowable
 Generally allowable if reasonable and allocable
 Generally allowable to % or $ thresholds specified
 Allowable or unallowable based on purpose of expenditure
Kroll
20
Expressly Unallowable Costs
Cost Principle
Kroll
Exceptions/Other Reference
Bad Debts
None
Contributions or donations
Community service activities (FAR 31.205-1(e)(3))
Entertainment costs
None
Fines and penalties
When required by the contract (FAR 31.205-15)
Interest & other financial costs
Interest on tax penalties caused by the Gov't.
(FAR 31.205-41(a)(3))
Losses on other contracts
None
Goodwill
None
Executive lobbying costs
None
Costs of alcoholic beverages
None
21
Construction and architect-engineer contracts
– Generally, follows the cost principles detailed in FAR 31.2
– Specifically noted in paragraph (d):
 Advance agreements as set in FAR 31.109 are preferred to
set expectations between the contractor and the government
 Actual cost data for ownership and operation cost of
equipment should be used, if available. If not:
- Use predetermined schedules of construction equipment
use rates
- Maintenance and repairs to rental equipment is
unallowable
 Costs incurred at the job site incident to performing the work
are allowable as direct or indirect costs
Ref: FAR 31.105
Kroll
22
Selected Cost Principles
 Costs Reviewed:
– 31.205-1: Public Relations & Advertising
–
–
–
–
–
–
–
–
–
–
Kroll
Costs
31.205-6: Compensation for Personal
Services
31.205-7: Contingencies
31.205-10: Cost of Money
31.205-13: Employee Morale, Health &
Welfare
31.205-14: Entertainment Costs
31.205-17: Idle Facilities & Idle Capacity
Costs
31.205-18: IR&D and B&P Costs
31.205-20: Interest & Other Financial Costs
31.205-22: Lobbying & Political Activity
Costs
31.205-25: Manufacturing & Production
Engineering Costs
– 31.205-26: Material Costs
– 31.205-32: Precontract Costs
– 31.205-33: Professional & Consultant
–
–
–
–
–
–
–
–
–
Service Costs
31.205-34: Recruitment Costs
31.205-35: Relocation Costs
31.205-36: Rental Costs
31.205-38: Selling Costs
31.205-40: Special Tooling & Special
Test Equipment Costs
31.205-43: Trade, Business, Technical &
Professional Activity Costs
31.205-46: Travel Costs
31.205-47: Costs Related to Legal &
Other Proceedings
31.205-52: Asset Valuations from
Business Combinations
23
Public Relations & Advertising
(FAR 31.205-1)
 Generally UNALLOWABLE except the following areas:
– Specific job recruiting
– Acquiring scarce items or disposing of scrap
– Costs required by contract
– Responding to inquiries on company policies and activities
– Communication with public, press, stockholders, etc.
– Liaison with media re: matter of public concern
– Other minor areas (community service drives, plant tours, etc.)
– Costs to Promote Aerospace Exports (PL 100-202)
 UNALLOWABLE costs include:
– Models, gifts, souvenirs
– Entertainment
– Hospitality suites for entertainment
– Alcoholic beverages
Kroll
24
Compensation For Personal Services
(FAR 31.205-6)
 Compensation is generally ALLOWABLE if reasonable and includes:
–
–
–
–
–
–
–
–
Kroll
Salaries and wages
Fringe benefits
Bonus and incentive compensation
Stock options
Pension plans
Deferred compensation
Severance pay
Compensation incidental to business acquisitions
25
Compensation For Personal Services
(FAR 31.205-6) (cont.)
 Compensation must be reasonable
 Tests of reasonableness include:
– Firms of the same size
– Firms in the same industry
– Firms in the same geographic area
– Firms which engage in non-Government work
– Costs for comparable services from outside sources
 Closely held business scrutinized for distribution of profits to owners
 When challenged - offsets considered between allowable elements of
compensation package within same job grade or level
 The Office of Management and Budget (OMB) annually sets maximum
allowable median compensation amounts for all senior executives. For
fiscal 2008, this is set at $612,196.
Kroll
26
Compensation For Personal Services
(FAR 31.205-6) (cont.)
Bonuses, Incentive Pay & Stock Options
 Must be based on an established plan, policy or employer/employee
agreement
 When paid in stock:
– Valued at fair market value on measurement date
 May be deferred:
– Based on current or future services
 Based on production, cost reduction or efficient performance
Kroll
27
Compensation For Personal Services
(FAR 31.205-6) (cont.)
Severance Pay (Dismissal Pay)
 For involuntary termination
 ALLOWABLE if required by:
– Law
– Employer-employee agreement
– Established policy
– Circumstances of the particular employment
 Normal turnover allocable to ALL contractor’s work
 Accruals for abnormal or mass severance pay are NOT allowed but actual
payments are judged on a case by case basis
Kroll
28
Contingencies
(FAR 31.205-7)
 Historical costing
– Generally UNALLOWABLE
– May be ALLOWABLE in some cases (e.g., terminations) to recognize
minor unsettled factors
 Future costing
– Includable in cost estimates if conditions are known and foreseeable
(e.g., cost of rejects/defective work)
– Must exclude if not measurable (e.g., outcome of pending litigation)
 Should be separately disclosed for negotiation purposes
Kroll
29
Cost of Money
(FAR 31.205-10)
 Generally ALLOWABLE provided it is measured, assigned, and allocated
to contracts, or measured and added to the cost of capital assets under
construction.
 Actual interest cost in lieu of the calculated imputed cost of money is
UNALLOWABLE.
 ALLOWABLE imputed cost determined by applying a cost-of-money rate to
facilities capital under construction or employed in contract performance.
 Cost-of-money rate is based on interest rates specified by the Secretary of
the Treasury under Public Law 92-41.
 Cost-of-money need not be entered on contractor’s books of account -
memorandum records should be utilized.
 Must be specifically identified or proposed in cost proposal.
Kroll
30
Employee Morale, Health & Welfare
(FAR 31.205-13)
 Activities designed to improve working conditions, employer-employee
relations, employee morale and performance
 ALLOWABLE costs can include:
– House publications; health clinics and wellness/fitness centers
– Company-sponsored sports teams; employee counseling services
– Certain food and dormitory services losses; award dinners,
compensation or recognition awards
 UNALLOWABLE costs include gifts to employees, tickets to sports events,
greens fees, membership dues and most recreation costs
Kroll
31
Entertainment Costs
(FAR 31.205-14)
 Entertainment includes:
– Amusement
– Diversions
– Social activities
– Any other directly associated costs:







Tickets to shows or sports events
Meals
Lodging
Rentals
Transportation
Gratuities
Membership in social, dining, or country clubs or other organizations
having the same purposes
 Entertainment Costs are expressly UNALLOWABLE. These costs are
NOT ALLOWABLE under any other cost principle.
Kroll
32
Idle Facilities & Idle Capacity Costs
(FAR 31.205-17)
 Costs of idle facilities or idle capacity include:
– Maintenance
– Repair
– Housing
– Rent
– Other related costs:
 Property taxes
 Insurance
 Depreciation
 "Facilities" means plant or any portion thereof (including land integral to the
operation), equipment, individually or collectively, or any other tangible
capital asset, wherever located, and whether owned or leased by the
contractor.
 "Idle capacity" means the unused capacity of partially used facilities.
 "Idle facilities" means completely unused facilities that are excess to the
contractor's current needs.
Kroll
33
Idle Facilities & Idle Capacity Costs
(FAR 31.205-17) (cont.)
 Costs of idle facilities are UNALLOWABLE unless the facilities:
– Are necessary to meet fluctuations in workload
– Were necessary when acquired and are now idle because of changes
in:





Requirements
Production economies
Reorganization
Termination
Other causes which could not have been reasonably foreseen
 Costs of idle facilities are ALLOWABLE for a reasonable period, ordinarily
not to exceed 1 year
 Costs of idle capacity are ALLOWABLE provided the capacity is necessary
or was originally reasonable and is not subject to reduction or elimination by
subletting, renting, or sale, in accordance with sound business, economics,
or security practices.
 Note: Any costs to be paid directly by the Government for idle facilities or idle capacity reserved
for defense mobilization production shall be the subject of a separate agreement.
Kroll
34
IR&D and B&P Costs
(FAR 31.205-18)
 Independent research & development (“IR&D”) costs include:
– Basic research
– Applied research
– Development
– Systems and other concept formulation studies
 Bid & proposal (“B&P”) costs are the costs incurred in preparing, submitting,
and supporting bids and proposals on potential contracts
 IR&D and B&P costs are generally ALLOWABLE if allocable and
reasonable
 Exceptions include:
– Deferred IR&D costs
– Cooperative arrangements
Kroll
35
Interest & Other Financial Costs
(FAR 31.205-20)
 The following interest & other financial costs are UNALLOWABLE:
– Interest on borrowings
– Bond discounts
– Costs of financing and refinancing capital
– Legal and professional fees paid in connection with preparing
prospectuses
– Costs of preparing and issuing stock rights
 Exception: interest assessed by State or local taxing authorities under the
conditions specified in the FAR is ALLOWABLE.
Kroll
36
Lobbying & Political Activity Costs
(FAR 31.205-22)
 Costs associated with the following lobbying activities are
UNALLOWABLE:
– Attempts to influence elections through contributions, endorsements or
publicity
– Attempts to influence Federal or state legislation through publicity,
propaganda or liaison activities
 The following activities are exceptions to above rules:
– Presenting technical and factual information on a topic directly related to
performance of contract
– Any activity specifically authorized by statute to be undertaken with
funds from contract
– Lobbying to directly reduce contract costs
Kroll
37
Manufacturing & Production Engineering Costs
(FAR 31.205-25)
 ALLOWABLE costs of manufacturing and production engineering include:
– Developing and deploying new or improved materials, systems, processes,
methods, equipment, tools and techniques that are or are expected to be
used in producing products or services
– Developing and deploying pilot production lines
– Improving current production functions
– Material and manufacturing producibility analysis for production suitability
and to optimize manufacturing processes, methods, and techniques
 Costs NOT included in this cost principle are the following:
– Basic and applied research effort related to new technology, materials,
systems, processes, methods, equipment, tools and techniques
– Development effort for manufacturing or production materials, systems,
processes, methods, equipment, tools, and techniques intended for sale
– Where manufacturing or production development costs are capitalized or
required to be capitalized under the contractor's capitalization policies
Kroll
38
Material Costs
(FAR 31.205-26)
 Material Costs are ALLOWABLE subject to the following requirements:
– Costs adjusted for credits (e.g., trade discounts, rebates, refunds)
– Reasonable Inventory adjustments
 Interorganizational transfers -- at actual cost or price -- using the
following limitations:
– Meets FAR 15.403-1(b) exemption
– Established practice of price transfer
– Contracting officer determines reasonable
Kroll
39
Precontract Costs
(FAR 31.205-32)
 Incurred before effective date of contract
 Pursuant to the negotiation
 Activity is necessary to comply with proposed delivery schedule
 Precontract costs are ALLOWABLE to the extent that they would have
been ALLOWABLE if incurred after the date of the contract
Kroll
40
Professional & Consultant Service Costs
(FAR 31.205-33)
 Costs are ALLOWABLE except for:
– Services to improperly obtain information or data
– Services to improperly influence the selection of sources for contract
–
–
–
–
Kroll
awards
Services resulting in violation of any statute or regulation prohibiting
improper business practices
Services which are not consistent with the scope of the services
contracted
Services associated with defense or prosecution of claims against the
Government
Services connected with patent infringement litigation (unless provided
for in contract)
41
Professional & Consultant Service Costs
(FAR 31.205-33) (cont.)
 The following should also be considered in determining allowability of
service costs:
– Nature of service rendered in relation to that required
– Necessity of contracting for service
– Past pattern of acquiring services
– Impact of Government contracts on contractor’s business
– Whether services can be performed more economically by employment
rather than contracting
– The qualifications of the individual rendering the service and adequacy
of the contractual agreement for the service
– Adequate support of work performed
 Details of agreement
 Invoices supporting time spent and nature of services provided
 Work product
Kroll
42
Recruitment Costs
(FAR 31.205-34)
 ALLOWABLE costs include:
– Help-wanted advertising
– Employment offices
– Educational testing programs
– Travel costs for employees to recruit personnel
– Employment agency fees - not in excess of standard commercial rates
 UNALLOWABLE costs include:
– Advertising which does not describe specific positions or is not relevant
to recruitment
Kroll
43
Relocation Costs
(FAR 31.205-35)
 Certain costs ALLOWABLE with certain limitations:
– Travel for family and effects
– Closing costs on disposition of old home
– House hunting costs not to exceed 60 days for employee and 45 days
for spouse/dependants, etc.
 Certain costs UNALLOWABLE:
– Loss on sale
– Costs related to purchasing a new home
– Continuing mortgage principal payments on old residence being sold,
etc.
 *Note: If the relocated employee resigns within 12 months, the contractor must credit
or refund the relocation costs to the Government.
Kroll
44
Rental Costs
(FAR 31.205-36)
The following costs are ALLOWABLE:
 Rental costs under operating lease if rates are reasonable considering:
– Rental costs of comparable property
– Market conditions in the area
– Type, life expectancy, condition and value of property rented
– Alternatives available
 Rental costs under sale and leaseback arrangement - cost of ownership
 Related party rent - cost of ownership
Kroll
45
Selling Costs
(FAR 31.205-38)
 Direct selling costs are ALLOWABLE if reasonable.
 Direct selling efforts are those acts or actions to induce particular customers
to purchase particular products or services of the contractor.
 The costs of direct selling efforts incurred in connection with a significant
effort to promote export sales of products normally sold to the U.S.
government are allowable.
 Costs UNALLOWABLE under another cost principle are NOT
ALLOWABLE as selling costs
Kroll
46
Special Tooling & Special Test Equipment Costs
(FAR 31.205-40)
 The cost of special tooling and special test equipment used in performing
one or more Government contracts is ALLOWABLE and shall be allocated
to the specific Government contract or contracts for which acquired, except
that the cost of:
– Items acquired by the contractor before the effective date of the contract (or
replacement of such items); and
– Items which the contract schedule specifically excludes, shall be ALLOWABLE
only as depreciation or amortization
Kroll
47
Trade, Business, Technical & Professional Activity Costs
(FAR 31.205-43)
 The following types of costs are ALLOWABLE:
– Memberships in trade, business, technical, & professional organizations
– Subscriptions to trade, business, professional, or other technical periodicals
– When the principal purpose of a meeting, convention, conference,
symposium, or seminar is the dissemination of trade, business, technical or
professional information or the stimulation of production or improved
productivity, costs of:
 Organizing, setting up, and sponsoring the meetings, conventions,
symposia, etc.;
 Attendance by contractor employees, including travel costs; and
 Attendance by individuals who are not employees of the contractor,
provided -(i) Such costs are not also reimbursed to the individual by the employing
company or organization; and
(ii) The individual's attendance is essential to achieve the purpose of the
conference, meeting, convention, symposium, etc.
Kroll
48
Travel Costs
(FAR 31.205-46)
 Generally ALLOWABLE if reasonable (meet Federal Travel Regulation per
diems)
 Advance agreements must be obtained for costs above federal rates
 General travel expenses are ALLOWABLE as an indirect cost - contract
travel is a direct charge
 Costs of contractor owned or leased aircraft are limited to standard airfare -
must be fully documented and justified
Kroll
49
Costs Related to Legal & Other Proceedings
(FAR 31.205-47)
 Costs incurred in connection with any proceeding brought by Federal, state,
local or foreign government for failure to comply with laws or regulations are
UNALLOWABLE if:
– The proceeding results in a criminal conviction
– The contractor if found liable
– The contractor is debarred or suspended
– A contract is voided, rescinded, or terminated for default
– Disposition by consent or compromise if the proceeding could have
resulted in any of the above.
Kroll
50
Asset Valuations from Business Combinations
(FAR 31.205-52)
 For tangible capital assets, when the purchase method of accounting for a
business combination is used, whether or not the contract or subcontract is
subject to CAS, the ALLOWABLE depreciation and cost of money shall be
based on the capitalized asset values measured and assigned, if allocable,
reasonable, and NOT otherwise UNALLOWABLE.
 For intangible capital assets, when the purchase method of accounting for a
business combination is used, ALLOWABLE amortization and cost of
money shall be limited to the total of the amounts that would have been
allowed had the combination not taken place.
Kroll
51
Other Selected Costs
Expressly Unallowable
Generally Allowable if
Reasonable &
Allocable
Generally Allowable to
% or $ Thresholds
Specified
Allowable or
Unallowable Based on
Purpose
31.205-3: Bad Debts
31.205-4: Bonding Costs
31.205-11: Depreciation
31.205-19: Insurance &
Indemnification
31.205-8: Contributions
or Donations
31.205-12: Economic
Planning Costs
31.205-16: Gain/Loss on
Disposition/ Impairment
of Depreciable Property
31.205-27: Organization
Costs
31.205-15: Fines &
Penalties
31.205-21: Labor
Relations
31.205-30: Patent Costs
31.205-23: Losses on
Other Contracts
31.205-28: Other
Business Expenses
31.205-31: Plant
Reconversion
Kroll
31.205-49:
Goodwill
31.205-29: Plant
31.205-37: Royalties & 52
Indirect Rates
www.kroll.com
The Basic Approach
 Indirect Costs
– Indirect costs are identified with two or more final cost objectives OR
an intermediate cost objective. Allocated to the cost object.
– Usually grouped into common pools and charged to benefiting
objectives through an allocation or indirect cost rate.
– Indirect cost rate determines the proportion of general (non-direct)
expenses that each project will bear.
Indirect Cost Pool
=
Direct Cost Base
Kroll
Indirect Cost Base
54
The Basic Approach (cont.)
 The data accumulated in the direct cost accounting system is used for
two purposes:
– Track actual direct costs of each project or contract
– Track the total amount of certain types of direct costs so those total
amounts can be used as an allocation base for indirect costs
 Home Office Costs
– Incurred by corporate group or intermediate management group and
allocated to the benefiting business units
– Allocation hierarchy (under CAS)
 Directly identified to the benefiting unit
 Homogenous pool allocated on a causal/beneficial relationship
 Residual on a three factor formula
Kroll
55
The Basic Approach (cont.)
 General Management and Administration Costs:
– Cost for the general management and administration of the entire
business unit
– Includes general business unit expenses and general home office
costs allocated to the business unit
 Overhead Costs
– All other costs that are not accounted for as direct costs of the
contract
– Pooled homogeneously and allocated on a causal/beneficial
relationship
Kroll
56
ABC CORPORATION
Accounting Information for Indirect Cost Rates
Category of Costs
Direct Materials
Other Direct Costs
Direct Labor - Engineering
Direct Labor - Manufacturing
Indirect Labor
Engineering
$150,000
Manufacturing $300,000
Fringe Benefits (direct and indirect labor)
Purchasing Costs
Engineering Overhead
Manufacturing Overhead
General & Administrative
Home Office Expense
Amount*
$2,500,000
250,000
550,000
1,200,000
450,000
612,500
250,000
385,000
2,700,000
1,012,500
90,000
$10,000,000
* No unallowable costs included.
Kroll
57
ABC CORPORATION
Fringe Benefit Rate
Kroll
Elements of the Cost Pool
Fringe Benefits
Amount
$612,500
Elements of the Base
Direct Labor - Engineering
Direct Labor - Manufacturing
Indirect Labor
Total Base Costs
$ 550,000
1,200,000
450,000
$2,200,000
Fringe Benefit Rate Calculation:
Fringe Benefits Pool
Labor Base
$612,500
$2,200,000= 27.84%
58
ABC CORPORATION
Single Indirect Rate
Elements of the Cost Pool
Indirect Labor
Fringe Benefits
Purchasing Cost
Engineering Overhead
Manufacturing Overhead
General & Administrative
Home Office Expenses
Total Indirect Expenses Pool
Amount
$ 450,000
612,500
250,000
385,000
2,700,000
1,012,500
90,000
5,500,000
Elements of the Base
Direct Labor- Engineering
Direct Labor- Manufacturing
Total Base Cost
550,000
1,200,000
1,750,000
Indirect Rate Calculation
Indirect Expense Pool
Direct Labor Base
5,500,000 = 314.29%
1,750,000
Kroll
59
ABC CORPORATION
Multiple Indirect Rates
Fringe Benefits Included in the Allocation Base
Elements of the Engineering Cost Pool
Engineering Overhead
Engineering Indirect Labor
Fringe Benefits at 27.84%
Total Engineering Pool
Elements of the Base
Direct Labor - Engineering
Related Fringe Benefits @ 27.84%
Total Base Costs
Engineering Overhead Rate Calculation
Indirect Expense Pool
Direct Labor Base
Kroll
Amount
$385,000
150,000
41,760
576,760
$550,000
153,120
$703,120
$576,760
= 82.03%
$703,120
60
ABC CORPORATION
Multiple Indirect Rates
Fringe Benefits Included in the Allocation Base
Elements of the Manufacturing Cost Pool
Manufacturing Overhead
Manufacturing Indirect Labor
Fringe Benefits at 27.84%
Total Manufacturing Pool
Amount
$2,700,000
300,000
83,520
$3,083,520
Elements of the Base
Direct Labor - Manufacturing
Related Fringe Benefits @ 27.84%
Total Base Costs
Manufacturing Overhead Rate Calculation
Indirect Expense Pool
Direct Labor Base
Kroll
$1,200,000
334,080
$1,534,080
$3,083,520
= 201.00%
$1,534,080
61
ABC CORPORATION
Multiple Indirect Rates
Material Handling
Elements of the Pool
Purchasing Costs
$250,000
Base Elements
Direct Materials
$2,500,000
Rate
Expense Pool
Base
Kroll
10.00%
62
ABC CORPORATION
Multiple Indirect Rates
General and Administrative Rate
Elements of the Cost Pool
General & Administrative Costs
Home Office Allocations
Total Expense Pool
Amount
$1,012,500
90,000
$1,102,500
Elements of the Base
Direct Materials
Materials Handling Costs @ 10%
Direct Labor -- Eng. + Manuf.
Overheads, Fringes + Indirect Labor
Other Direct Costs
Total Cost Input Base
$2,500,000
250,000
1,750,000
4,147,500
250,000
$8,897,500
G&A Rate Calculation
Total G&A Expense Pool
Total Cost Input Base
Kroll
$1,102,500 = 12.39%
$8,897,500
63
Any questions?
www.kroll.com