How do I allocate indirect costs to government contracts?

Contractors typically use a cost allocation base, such as direct labor hours or total direct costs, to distribute indirect expenses proportionally across contracts. This allocation method must be consistently applied and justified.

Why is it important to accurately track and allocate indirect costs?

Accurate tracking ensures compliance with cost accounting standards (CAS), provides a realistic view of contract profitability, and supports fair pricing in government proposals. DCAA audits scrutinize indirect cost allocations.

IDC (Indirect Cost) | GovCon Glossary

IDC (Indirect Cost)

What is IDC (Indirect Cost)?

Indirect Costs (IDC) are expenses that are necessary for the overall operation of a business but cannot be directly attributed to a specific contract, project, or service. Understanding and properly accounting for IDCs is critical for government contractors when developing proposals, negotiating contracts, and ensuring compliance with federal regulations. Effectively managing IDCs is crucial for maintaining profitability and competitiveness in the government marketplace.

Definition

In government contracting, Indirect Costs are defined as expenses that benefit multiple cost objectives (e.g., contracts) rather than a single, specific one. These costs are not directly traceable to a particular project but are necessary to support the overall business operations required to fulfill government contracts. Examples include rent, utilities, administrative salaries, accounting services, and marketing expenses.

FAR Part 31, Contract Cost Principles and Procedures, provides detailed guidance on the allowability and allocability of costs, including indirect costs. Contractors must establish a clear and consistent methodology for allocating these costs to contracts, usually based on a predetermined cost allocation base like direct labor hours or total direct costs. Improper allocation of IDCs can lead to disallowed costs and potential penalties during audits by agencies like DCAA (Defense Contract Audit Agency).

Key Points

Indirect Cost Pools: IDCs are grouped into logical "pools," such as overhead, general & administrative (G&A), and fringe benefits. This allows for more accurate allocation.
Cost Allocation Base: The selection of an appropriate cost allocation base (e.g., direct labor hours, material costs) is crucial. It should accurately reflect the benefit each contract receives from the indirect costs.
DCAA Scrutiny: DCAA audits closely examine IDC allocation methods to ensure compliance with FAR and CAS (Cost Accounting Standards), if applicable.
Impact on Pricing: Indirect cost rates significantly impact the overall price of government contracts. Accurate and well-documented IDCs are essential for competitive and compliant pricing.

Practical Examples

Calculating Overhead Rate: A contractor has $500,000 in overhead costs (rent, utilities, etc.) and $1,000,000 in direct labor costs. The overhead rate is calculated as $500,000 / $1,000,000 = 50%. This rate is then applied to the direct labor costs of each contract to allocate a portion of the overhead.
G&A Allocation: A company's General & Administrative (G&A) expenses, which include executive salaries and accounting costs, total $200,000. The total sales for the year are $2,000,000. The G&A rate is 10%. A contract with $100,000 in sales would be allocated $10,000 in G&A expenses.
Audit Findings: During a DCAA audit, it is discovered that a contractor improperly allocated marketing expenses, which are generally considered unallowable, to a government contract's indirect cost pool. This leads to a disallowance of costs and potentially further scrutiny.

Frequently Asked Questions

Direct costs are easily traceable to a specific contract, like labor directly building a product. Indirect costs, such as rent or administrative salaries, support overall business operations and are allocated across multiple contracts.