WE GUIDE ORGANIZATIONS SELLING TO THE FEDERAL GOVERNMENT

Indirect Costs

indirect costs of business

Rate Structure

Each indirect pool encompasses Expense accounts, which benefit the company as a whole – not specifically one project. Examples of pool accounts are:

  • Insurance Premiums for the building that houses the company
  • Human Resources
  • Holiday Pay (when applicable)
  • Bank Charges (excluding unallowable interest)
  • New-hire Relocation (regardless the initial project assignment)
  • Staff Training on company-wide policies and procedures

Each indirect pool, of General Ledger accounts, is divided by a base that causes or benefits the pool accounts. Employer-paid FICA could logically be divided by (all) labor dollars, incurred for the same period of time. The FICA owed and the labor dollars owed show a direct correlation.

We analyze the company size, products and services, and contract types to recommend an indirect rate structure. For example, a small business providing services, mostly on Fixed Price contracts, can usually simplify the structure by using only two indirect rates.

  • Overhead can include all fringe benefit expenses plus all payroll-related (such as FICA) expenses; this pool can justifiably use a base of (i.e., be divided by) labor dollars. Note that this includes labor in the General and Administrative (G&A) pool.
  • G&A can include all other company-wide expenses, plus the Overhead on G&A labor; this pool can justifiably use a base of total direct costs plus Overhead (excluding Overhead in the G&A pool).

The larger or more complex the types of sales and contracts – the more indirect rates we recommend. For each named rate, dividing the pool account dollars by the base yields the rate. The same methods apply proposed rates to proposed bases, as the methods for calculating and recording (in the General Ledger) Actual Incurred Costs (AIC).

There are no limits on the number of indirect rates. A separate rate can be proposed for Fringes (with payroll-related taxes applied by a separate rate), Facilities, Information Technology, Executive Management, etc.

Indirect rates can be tiered at many levels. An Information Technology rate can apply to earned Paid Time Off (PTO); earned PTO (an Expense of the company, when earned – not when taken) can be a component of the Fringe Benefits pool, which is applied to a base of labor dollars. Long-time employees might earn more PTO than new-hires, which changes the calculation dollars and, in this example, applies expenses for Information Technology through the Fringe Benefits rate – not the G&A rate. Justification for that causal or beneficial relationship is that more Information Technology expenses are caused by long-time employees than new-hires. We recommend the simplest tiers and justifications for each client structure.   

Non-profit organizations and some other organizations, which follow OMB Circulars for segregated unallowable costs, use one Indirect Cost Rate (ICR) for the whole organization, consistently. We divide a pool of all organization-wide accounts by an applicable (direct to projects) base to calculate the ICR. The method of calculating the ICR for proposals consistently mirrors the method used to record AIC.

Approved Forward Pricing Rates

If the U.S. Government anticipates proposals or contracts with very high government-funded labor and indirect rates, the Administrative Contracting Officer (ACO) might negotiate rates for company use on all proposals and cost reimbursable invoices. Typically, the ACO requests a report from the Defense Contract Audit Agency regarding the company-proposed labor and indirect rates. With a letter from the ACO approving (negotiated) forward pricing rates, no additional calculations or justifications support individual (project) proposals. The indirect-rates work is done once, and the results used through the applicable period of time.  

Historical Accounting Records

Indirect expenses exclude those for a specific project. Examples of indirect accounts are shown, above. Some account names are shown twice, with direct and indirect natures. Examples include labor and travel. We recommend account names that distinguish these. Travel might be the account name in Cost of Goods and Services Sold, while G&A Travel might be the account name for travel to professional training, to a company-management meeting, or for other travel for the company as a whole. AIC are consistently recorded into the same account, in like circumstances.

Note that specific exclusions might be specified in the solicitation (e.g., Request for Proposal). We propose calculated indirect rates, based on historical accounting records, using the format prescribed by the solicitation requirements. The price per hour for a Labor Hour or Time and Material type of contract includes (applied) indirect expenses and profit. A cost-reimbursable type contract uses direct labor, only, segregated from each, individual (applied) indirect expense and from fee. Regardless of contract type and other solicitation instructions, history establishes a good foundation for proposed (future) indirect rates.

With significant historical accounting records, the most common method of calculating each indirect rate uses the dollars in the pool accounts divided by the base. Although the company might grow, or reduce in size, the correlation between each pool and its base remains. The rates remain approximately the same. As labor dollars increase, for the company as a whole, the employer-paid FICA increases at about the same speed. Indirect rates based on historical accounting records need not escalate each year.

Each specific account, for which extraordinary growth or reduction is anticipated, is supported with documentation explaining the reason. If winning one award will require the purchase of a highly secure building, an increase from AIC for related accounts is justified.

No Prior Basis

Some cost elements, or entire proposals, represent base costs and pool expenses with little or no historical data. To build a foundation from air, we default to competition, first.

Salaries and wages for management and administrative employees, who are not yet hired, can be estimated by industry salary guides, similar job postings, and Internet research. Salary data for a geographic area and job qualifications or duties can be purchased from suppliers, who specialize in this supporting data. Professional associations can often help gather support for a reasonable competitive-market estimate.

A solicitation (e.g., Request for Bid) for administrative purchases, to several suppliers might return competitive bids. A website (e.g., Amazon) might compare product pricing from multiple sources, which can be printed to document the lowest bidder.

With decades of cost-proposal experience, we find creative ways to support the build-up of indirect costs. We recommend indirect cost structures based on experience and customer-audit perspectives.

Our recommendations are formula-driven. Clients can change one cell in a workbook of spreadsheets, to revise all affected numbers. For example, increasing employer-paid healthcare premiums recalculates the related pool, rate, and proposed summary roll-up (with the higher, applied rate). We guide our clients to ensure sufficient documentation supports purchases that benefit the company as a whole, which cost or price analysis is the responsibility of the client, not the U.S. Government. We offer the depth and the breadth of experience to draft supportable, proposed indirect costs.