Navigating the Indirect Cost Rate Maze. Chad Braley Marie Salamone

Transcription

1 Navigating the Indirect Cost Rate Maze Chad Braley Marie Salamone

2 Value Proposition Capital Edge is the country s largest independent consulting firm focusing solely on the U.S. Government contracting market. 2

3 Who We Work With All entities receiving Federal funding 3

4 The Solution Model 4

5 Contract Life Cycle Support *The graphic above is a sampling of services offered. 5

6 Course Outline Indirect Rates The Basics Indirect Rate Composition Options Indirect Rates throughout Contract Life Cycle Establishing and Understanding Corporate Strategic Objectives Challenges Developing Indirect Cost Rates Mergers and Acquisitions Indirect Rate Changes under CAS Covered Contracts To Silo or Not to Silo Decentralized Organizations Corporate Culture Hurdles 6

7 Indirect Rates The Basics

8 Three Questions Direct What is Cost? Indirect What is Cost Allocation? Pools Allocation Base What is Cost Allowability? Reasonable Allowable Allocable 8

9 Composition of Total Cost FAR Direct Costs Costs directly associated with production of a product or service (aka Variable Costs ) + Indirect Costs Costs required to support production and/or normal business operations (aka Fixed Costs ) + Cost of Money The imputed cost of investment in the business - Applicable Credits = Total Cost 9

10 Typical Direct & Indirect Costs Material Direct Labor Utilities Indirect Labor Subcontracts Rent Direct Costs Indirect Costs 10

11 Direct & Indirect Costs The regulations do not provide explicit criteria for the types of direct and indirect costs It is up to your company to define the costs that are direct vs. indirect as long as company parameters: can meet direct/indirect regulatory definitions, and ensure that costs are treated consistently as direct/indirect in like circumstances (CAS 402 Guidance) Depending on industry type, make-up of company costs, company size, etc., costs that are treated as direct by one company may be treated as indirect by another 11

12 Major Concepts Indirect Cost Pools Homogeneous Pools Beneficial or Causal Relationships Homogeneous Indirect pools must contain costs with common links Base used to allocate those pooled cost must benefit from or demonstrate to have caused the indirect costs to be incurred Allocability FAR Normally expressed as a percentage (i.e., Pool Expenses is the numerator and Allocation Base is the denominator) 12

13 Typical Indirect Pools and Allocation Bases Fringe Pool Health Insurance Vacation Total Labor Retirement Overhead Pool Indirect Labor Utilities Direct Labor Rent G&A Human Resources Total Cost Input Finance or CEO Value Added Input Base 13

14 Full Absorption Costing Material / Subcontracts General Direct Labor Overhead Selling Administrative Product Cost Period Cost Total Project Costs 14

15 Allowable Cost Criteria FAR What is Cost Allowability? Costs the Government is willing to pay for! CAS/GAAP Compliant Reasonable Allocable A cost is allowable only when the cost complies with all of the following requirements FAR 31.2 criteria and limitations Complies with terms of the contract Risks of double and treble damages, plus interest for failure to comply! 15

16 Indirect Rate Composition Options

17 Common Indirect Cost Pools Common Indirect Cost Pools Overhead Company Site Overhead Customer Site General & Administrative (G&A) Material Handling (typical when a value added G&A base is used) Fringe Benefits 17

18 Intermediate Cost Pools Typical Intermediate Cost Pools & Bases Fringe benefits -- Total labor Facilities Square footage or headcount IT Service Center -- Usage or headcount Payroll Service Center -- Paychecks or headcount Overhead Service Center -- Direct Labor & Fringe Human Resources -- Headcount These can be found in Schedule D of the ICS 18

19 Two Tiers vs. Three Tiers Two Tiers Fringe is considered an intermediate pool, allocated based on direct labor Allocated out to G&A and Overhead pools as part of their rates Overhead includes fringe on direct labor Overhead is applied on direct labor only G&A applied to the total cost input Three Tiers Fringe is a final indirect rate pool, applied to total labor Applied first before Overhead and G&A rates applied Overhead is applied on Direct Labor plus fringe on Direct Labor G&A is applied to the total cost input 19

20 Two Tiers vs. Three Tiers Fringe (allocated based on % of Total labor) Two Tier Indirect Rate Structure Overhead direct labor G&A total cost input 20

21 Two Tiers vs. Three Tiers Three Tier Indirect Rate Structure Fringe Overhead G&A Total Labor Direct Labor + Direct Labor Fringe Direct Labor + DL Fringe + Overhead + ODC s +Subcontracts 21

22 Two Tiers vs. Three Tiers Similarities The G&A rate will always be the same, because it is applied to the same base (total cost input) regardless of the structure Differences Overhead rate will be higher using two-tier system, because fringe costs are in the pool instead of the base *How to decide: How many times have you heard a customer say your O/H rate is too high? How many times have you heard a customer say to cut benefits b/c your fringe is too high? Definitely worth consideration. 22

23 G&A Allocation Bases Companies can choose between three types of G&A allocation bases: Total Cost Input includes all contract costs except G&A, including direct labor, fringe, overhead, subcontracts, materials, and other ODC s Method used most often Value-Added does not include direct material and subcontracts costs Useful when there is a significant amount of subcontract costs and/or materials Single Input Base Typically direct labor and less frequently used 23

24 Strategy Considerations What is important to your organization? Want a Lower Pass Thru on SubK? Want a Lower Overhead Rate? High number of subcontractors / material costs? Consider moving from a 2 Tier to a 3 Tier Fringe Structure Consider a Material Handling Rate Review costs which could be claimed as Fringe rather than Overhead 24

25 Common Pitfalls to Avoid When changing G&A allocation bases, you must consider the impact of rate changes on existing contracts When creating a customer site O/H, be aware of the impact to your contractor site work Creating new O/H pools for new contracts or new work sites can be very dangerous The administrative and systemic burdens often outweigh the benefits This process can also create numerous small pools and bases that may fluctuate significantly Be wary of your contract type mix when making changes How will this effect the entire contract population? 25

26 Indirect Rates Throughout Contract Life Cycle

27 Types of Indirect Rates 27

28 Types of Indirect Rates (Cont.) Forward Pricing Rates - FAR allows for the establishment of mutually agreed to Forward Pricing Rates between the Contracting Officer and Contractor Established long-term rates for use in contractor pricing efforts Based on the Contractor s long range plans and budgets May be continuously negotiated/updated based on availability of most current, accurate, and complete data Adequacy Check List available at DCAA.mil Budgeted Rates Approved internally for management purposes and as a basis for pricing products and services DCAA expects rates are prepared annually 28

29 Types of Indirect Rates (Cont.) Provisional or Contract Rates (FAR ) Approval by the contracting officer or CFAO Rates established based on information from recent review, previous rate audits or experience Auditor assurance that rates are as close as possible to final indirect cost rates anticipated Revision by mutual agreement (AT ANY TIME), to prevent substantial over/underpayment Typically based on a contractor s budget rates 29

30 Types of Indirect Rates (Cont.) ICS Rates (Final Indirect Cost Rate Proposal) Unaudited year end rates based on actual costs incurred Subject to audit by DCAA or Contracting Officer s designee Required within six months of Contractor s fiscal year end FAR (d)(2)(i) - Allowable Cost and Payment FAR (b)(4) & (b)(5) - Payments under T&M and Labor- Hour Contracts FAR allows for ICS rates to become provisional rates for the fiscal period until the Contractor s ICS can be audit and rates finalized 30

31 Types of Indirect Rates (Cont.) Final Rates - FAR requires final determination of rates by either the Contractor officer or his assigned representative (auditor) Adjusted for questioned/unallowable costs identified by the auditor and Subject to Negotiation 31

32 Life Cycle of Indirect Rates 32

33 Acquisition Cycle - Indirect Rates 33

34 Establishing and Understanding Corporate Strategic Objectives

35 Organizational Considerations What type of industry? Goods Services How large is your organization? Small Medium Large Does your organization have many people and facilities in multiple locations? Do you have a large number of subcontractors? 35

36 Considerations Industry (Cont.) Goods Do you have multiple product lines requiring differing support functions? Do you have manufacturing facilities in multiple locations? Services Do you have a large number of employees working at client/customer sites? Do you have different service offerings requiring different support functions? Are your employee s located both domestically and internationally? 36

37 Compliant Rate Structure Benefits Facilitates Decision Making How is the company structured? Is the company structure changing? Improves Competitive Advantage in Market Place Indirect Rate Structure positioned to win the work Capitalizes on Thorough Budgeting Process Hopefully already in existence Ensures Allowable Cost Recovery And maybe even some profit! Rate Structure MUST mirror the Organization, not limited by accounting software, customer or govt. 37

38 Indirect Cost Rate Challenges

39 Challenge No. 1 Mergers and Acquisitions Due Diligence Has proper due diligence been performed on existing government contracts? Are there rate caps? Are there CAS covered contracts? Are there unsubmitted/late incurred cost submission years? Are there inadequate incurred cost submissions? Are costs owed to the government on flexibly priced contracts? Incorporate or Segregate Will the acquired company be folded into the existing company? How will the acquisition impact the existing rate structure? Allowable vs. Unallowable Costs Are M&A costs captured to properly segregate allowable from unallowable? 39

40 Challenge No. 2 Rate Changes under CAS Covered Contracts Fully CAS Covered Contracts require disclosure to accounting practices including indirect rate structures Changes to disclosed practices (including changes to rates) require cost impact proposals Two types of cost impact proposals General Dollar Magnitude (GDM) Proposal (FAR d) Detailed Cost Impact (DCI) Proposal (FAR e) For Companies without CAS Covered Contracts: 1. Keep changes to a minimum - makes good business sense 2. Change rates to maintain compliance with standards 3. Cost become material because of change in business 4. If changes are necessary, change ahead of anticipation of receiving a CAS covered contract 40

41 Challenge No. 3 To Silo or Not to Silo Advantages Limits Compliance to Government Business Limits Audits and Oversight to Government Business Disadvantages Disruption to current operations Corporate culture resistance to change Sometimes difficult to get buy in until work volume increases 41

42 Challenge No. 4 Decentralized Organizations Lines of business can analyze profitability in a vacuum Bid on new work using rates which are not the most current, accurate and complete Win contracts with significantly low rate caps Bill contracts with unapproved provisional rates resulting High contract overbillings resulting in paying $$ back to the government OR High contract underbillings resulting in poor cash flow to the organization 42

43 Challenge No. 5 Corporate Culture Hurdles Establishing or changing allocation bases can impact lines of businesses differently Example: Use of headcount for IT vs. Use of No. of Licenses Allocating costs on budgeted data without using actual base data Actual data is difficult to obtain or no longer tracked Communication Challenges Between Departments Contracts and Accounting/Finance Business Development and Compliance 43

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