Small Business Indirect Rates

Indirect Rates

What are “indirects”? Cost of Goods and Services Sold are direct cost elements. These include:

  • Direct Labor
  • Direct Material
  • Other Direct Costs
    • Direct Travel
    • Direct Subcontracts and 1099 Contracts
    • Direct Miscellaneous Purchases

All of the above costs are required for the deliverable end-service or end-product. These are not charged as indirect rates but charged directly to one Job (or sales contract). These are easily distinguishable from requirements on other Jobs (or sales contracts). These are incorporated into or used up in performance of that one Job.

Small Business Indirect Rates

Expenses that benefit the Company as a whole – not just one Job – are recorded in accounts of an indirect pool. Indirect Rates charge indirectly through indirect pools. Indirects form pools or “buckets” of expenses. Examples for the Labor Overhead pool are:

  • Holiday Pay
  • Paid Time Off (or Vacation and Sick Leave) Accrual
  • Employer Paid FICA
  • Employer Paid Workers’ Compensation

Examples for the General and Administrative pool are:

  • Facilities Maintenance
  • Property Taxes
  • G&A Labor (e.g., Accounting, Human Resources, Purchasing)
  • Errors and Omissions Insurance

The Company may use any indirect rates structure that best fits that unique company. Generally Accepted Accounting Principals require that each indirect pool be allocated on a causal or beneficial base. For example, labor dollars cause Paid Time Off and Employer Paid FICA. All (direct, G&A, and unallowable) labor is a valid base for calculating the Overhead indirect rate. Alternatively, Direct Material dollars would not be a valid base for a (service provider) G&A indirect rate. Property Taxes or Errors and Omissions Insurance does not increase and decrease with Direct Material dollars charged to a Job (or sales contract). Instead, a Company might use Total Cost Input for all Jobs as the base for allocating the G&A pool. Total Cost Input is Direct Material, Direct Labor, ODC, plus all indirects – such as Overhead – already allocated before calculating G&A.

For small business service providers, two indirect rates (Overhead and G&A) are sufficient. The Labor Overhead pool and rate include both employee fringe benefits and employer-paid payroll taxes. The structure may have more indirect rates – such as one for fringes and a separate one for payroll taxes; however, this should only happen with two different bases. If the same base will be used to allocate the pool – use one pool to calculate one indirect rate.

Note that manufacturers and other product providers might have accounts and expenses for machine oil, shop rags, and other product-related items. If these Company-wide expenses are significant, a separate Material Overhead pool – allocated on a base of Direct Material dollars (for all Jobs) could be added.

For small businesses, the G&A pool and rate include both facilities and other administration. The structure may have more indirect rates – such as one for facilities and a separate one for other administration; however, this should only happen with two different bases. If the same base will be used to allocate the pool – use one pool to calculate one indirect rate.

Federal government contractors must segregate allowable costs and expenses from unallowable costs and expenses. No indirect pool includes unallowable expenses. All bases include accounts by topic – both allowable and unallowable. For example, if labor represents employee time invested at a marketing booth, that labor (like the – advertising FAR 31.205-1 – booth rental) is unallowable. Still, that labor causes expenses for fringe benefits and payroll taxes. That unallowable labor is included in a Labor Overhead base of labor dollars.

Calculations

To calculate indirect rates, divide the pool by the base. Use a percentage with two decimal digits. Round to four, so that the whole number takes up two decimals and the hundredths take up two decimals. The result usually looks something like “29.49%” for Overhead and “54.22%” for G&A. Your (pool-account expenses divided by base-account costs) rate is unique to your company. This is the rate for the Company as a whole.

In our “looks like” example, the Overhead is calculated:

Fringe benefit accounts$1,500
Employer-paid P/R taxes$1,449
Company-wide pool$2,949
Direct Labor$7,000
G&A Labor$2,500
Unallowable Direct Labor$500
Company-wide base$10,000
Overhead Rate29.49%

Allocations

This cost of doing business or Company investment is then allocated to each separate Job. For example, if one sales contract incurs Direct Labor of $100.00, then (using the “looks like” example) the Overhead allocated to that contract is $29.49. If the Total Cost Input (Direct Labor of $100 + Overhead of $29.49 + Direct Material + ODC) for one sales contract sums to $200.00, then (using the “looks like” example) the G&A allocated to that contract is $108.44. The total cost for that sales contract is:

Direct Labor$100.00
Overhead$29.49
Direct Material$4.51
ODC$66.00
Subtotal$200.00
G&A$108.44
Total Cost$308.44

Note that $308.44 is Total Cost – or actual cash-money-out-the-door – not including profit or fee. The indirect rates allocate true expenses of the Company. The indirects have nothing to do with profit. Indirect expenses are merely distributed among all projects within the Company that they support.

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