Indirect Rates Defined
What’s in a name? We throw the names of indirect rates around as though everyone in the Government Contracting (GovCon) market understands them the same. First, Generally Accepted Accounting Principles (GAAP) has certain requirements for Job Cost Accounting. A specific naming convention for indirect rates is not one of them. You can name your indirect pool and resulting rate “Hermione.” Or “Sophocles.” Or Overhead.
The GovCon market generally defines the following indirect pools as consisting of these types of expenses:
Fringe – PTO, pay for holiday and other non-accruing time off, Employer-contributions to insurance premiums and retirement plans, Employer-paid payroll taxes (FICA, Unemployment Taxes, etc.).
Overhead – expenses for multiple, specific Jobs (or contracts) – examples are Project Management labor, production scheduling labor and software, outside testing (not unique to one contract), publications supporting direct charges to multiple contracts, training and travel for processes used on multiple contracts.
Material Overhead – expenses for multiple, specific Jobs (or contracts) caused by or benefitting from Direct Material, typically for a manufacturing or assembly provider (not a service provider) – examples are machine oil, shop rags, freight in/out (when consistently charged here* for all Jobs), “clean-up” labor, shipping and receiving labor.
Material Handling – (if consistently charged here* for all Jobs) shipping and receiving, freight in, freight out, packaging and crating
Subcontract General and Administrative (SG&A) – expenses benefitting the company as a whole for administering and managing subcontracts – examples are Subcontract Administration labor, setup and maintenance of the Procurement System, cost analyses in support of subcontract negotiations, technical evaluations in support of subcontract negotiations, labor (from any department) required to close subcontracts.
Facilities – utilities, building repairs, cleaning/maintenance, guard and other security services, depreciation of owned buildings, mortgage principle or rent, real estate and personal property taxes.
General and Administrative (G&A) – expenses for the company as a whole – examples include Accounting labor, Human Resources labor, outside legal services, setup and maintenance of the Accounting System and the Estimating (cost proposal) System, license fees, general/professional liability insurance, and labor for time in all-employee staff meetings.
GAAP requires that the base (or divisor) for an indirect pool correlate. Pool expenses must be caused by or benefit from the base. For example, Fringe could have a base of all labor dollars, all labor hours, or headcount. Remember that labor dollars are reported in the same Profit and Loss or Income Statement as the pool dollars – and are the easiest base track.
One pool may be allocated to other pools. The first pool is called an intermediate pool, because it is not allocated to final cost objectives. For example, GAAP allows Fringe to be allocated to Overhead (for Direct labor and Overhead labor) and to G&A (for G&A labor).
All pools and rates are not applicable to all companies. Non-profits typically use one Indirect Cost Rate (ICR) for everything not charged direct. The smaller the company, the fewer indirect rates are needed. The goal of the indirect rate structure is to allocate indirect expenses to Jobs (or contracts) equitably. We want a contract with (disproportionately) high Direct Labor to absorb indirect expenses caused by Direct Labor. We want a contract with high Direct Travel costs to absorb more of the indirect pool expenses that include scheduling, planning, and processing payments for trips (typically G&A). If having more indirect rates makes no significant difference in the dollars allocated to each Job – then have fewer indirect rates. More indirect rates do not yield more money from the customer, only more work for the Accounting Department. We do not increase the costs of running the business in return for zero dollars of profit. (Regulatory compliance is costly enough!)
A very small business of, say, fewer than six employees can usually implement one or two indirect rates. Customers anticipate a rate named G&A and possibly an additional one named Overhead. A very small business does not have three or more (interchangeable) Project Managers, each overseeing multiple Jobs; labor of a sole Project Manager benefits multiple Jobs, but also benefits the company as a whole. In a very small business, the Justification for (multiple Jobs) Overhead expenses can also apply to (whole company) G&A. Whatever names are used to label the indirect pools and rates, use the fewest number of rates that equitably allocate expenses among Jobs.
Yes, you can change the indirect rate structure after the company grows. This is called an Accounting Change and is allowed by GAAP (and DCAA). When a one-rate or two-rate indirect structure no longer allocates expenses well, budget a new rate structure for use on cost proposals. Then implement General Ledger changes at the start of the new budget period. Indirect rates (and ICE Model submissions, if applicable) will be calculated using the new structure.
* A cost or expense must be charged the same way – consistently – in like circumstances. For example, “shipping” may be charged to G&A for all packages weighing less than two pounds but charged direct to the Job for all shipments of two pounds or more. Package weight defines two different circumstances. For this example, shipping expenses for all packages less than two pounds must consistently be charged to a G&A account, never to an Overhead account or directly to a Job.