Indirect Rate Essentials

2. Indirect Rate Essentials Breakout Session 806 Presented by Andrew Stowe April 8, 2009 Session Schedule: 11:30-1:00

3. Learning Objectives • Understanding Key Terminology • What are Indirect Rates? • When and Why Indirect Rates are Important • Regulations Governing Indirect Rates • Basic Indirect Rate Calculations • Designing your Company’s Rate Structure • Indirect Rate Examples

4. Understanding Key Terminology

5. Understanding Key Terminology • Base • Causal cost driver which receives benefit from a pool of costs; denominator of rate calculation • Burdens • Application of indirect costs to a project allocation metric, such as cost • Causal cost driver • A logical metric which receives the primary and equitable benefit from an indirect cost • Direct costs • Costs directly associated with a final cost objective • Final cost objective • Cost objective which has allocated to it both direct and indirect costs and is a final accumulation point in the accounting system – generally this is a contract or task • Indirect costs • Costs that cannot be identified to a particular final cost objective and that benefit more than one final cost objective

6. Understanding Key Terminology • Intermediate cost objective • Cost objective, created for more accurate allocations, consisting of indirect costs that are ultimately allocated to final cost objectives • Pool • Grouping of incurred costs identified with two or more cost objectives, but not identified specifically with any final cost objectives; numerator of rate calculation • Rate • Percentage result of dividing pool by base • Total cost input (“TCI”) • Includes all costs, both direct and indirect; allowable and unallowable; less general & administrative expenses; a common denominator of a G&A rate calculation • Unallowable costs (“U/A”) • Types of costs not reimbursable by the government specified in FAR Part 31 or contract terms and conditions

7. Key Guidance • FAR 2.101 • FAR 31.202 Direct Costs • Identified with a particular final cost objective (e.g., labor time charged to or materials purchased for performance of contract) • Cost may not be assigned to a contract or award as a direct cost if any other cost incurred for the same purpose, in like circumstance, has been allocated to a contract or award as an indirect cost • Direct costs of minor amounts may be treated as indirect costs when consistently applied

8. Key Guidance • FAR 2.101 • FAR 31.203 Indirect Costs • Incurred for common or joint objectives • Incurred to support the organization as a whole • Identified with two or more final cost objectives • Remainder of costs to be allocated after direct costs are identified and assigned to projects • Examples include: • Depreciation or use allowance on buildings and equipment • Burden on labor, insurance, fringes, etc. • General administration and general expenses (e.g., salaries and expenses of executive officers, personnel administration, and accounting)

9. Key Guidance • FAR 31.202-2 Allowable Costs • Critical element in calculating indirect rates is inclusion of only allowable costs in the rate pools • Allowable costs are: • Reasonable • Allocable • In conformity with Cost Accounting Standards and Generally Accepted Accounting Principles • In accordance with contract terms • In compliance with FAR Part 31 Cost Principles

10. Key Guidance • FAR 31.201-6 Accounting for Unallowable Costs • Exclude unallowable costs from billings, claims, or proposal applicable to Government contract • Unallowable indirect costs should be excluded from any indirect rate calculation with the exception of the G&A base • Unallowable direct costs must be included in base when calculating and allocating indirect rates • Even though costs may be legitimate business expenses, they must meet allowable criteria

11. Types of Unallowable Costs • General FAR Part 31 Criteria • Costs that do not meet the reasonableness test • Costs that do not meet the allocability requirements • Based on Public Policy • Example: Alcohol • Prescribed Limitations • Example: Executive Compensation; travel in excess of federal limits • Based on Nature of Activity • Example: Lobbying Activities, entertainment, charitable contributions, bad debt • Directly associated costs to an unallowable activity • Example: Travel for a lobbying effort

12. What are Indirect Rates?

13. Key Guidance • FAR 2.101 What are Indirect Rates? • Indirect rates are designed to provide a method for full cost recovery • Indirect rates are an equitable, logical and consistent process for allocating costs not directly associated with a single contract, project or cost objective • Indirect rates are calculated as percentages and applied to project cost/cost objectives • Typical indirect rate examples include fringe, overhead and general & administrative

14. When and Why Indirect Rates are Important

15. When are Indirect Rates Important • Key Guidance • FAR 16.307 • FAR 52.216-7 • FAR 52.216-10 • FAR 31.201& 203 • FAR 49.303-4 • FAR 52.243 • Flexibly Priced Contracts Including: • Cost reimbursable contracts • Cost Type contract bids and incurred cost proposals • Time & Materials contracts • Where burdens are applied to the cost reimbursable (“Materials”) portion of contract • Buildup/creation of T&M hourly rates • Fixed Price contracts • When cost or pricing data is required during the proposal process • When there is an Incentive Fee component • When there is a materials/ODC component • Contracts subject to Cost Accounting Standards (“CAS”) • Contract Termination Claims or Request for Equitable Adjustments (“REA”)

16. Indirect Rates in the Contract Life Cycle • Forward Pricing Rates • Represents the best estimate of indirect cost rates at the time of submission • Used to estimate indirect costs for future periods of Government contract work • Provisional Billing Rates • Used for interim billing of costs • Established by Contracting Officer or Auditor based on contractor billing rates submission, recent evaluation of indirect rates or Forward Pricing Rates • Revised as necessary based on mutual agreement • Should be updated soon after year-end • Key Guidance • FAR 45.407-3 • FAR 42.17 • FAR 52.216-7

17. Indirect Rates in the Contract Life Cycle (cont.) • Key Guidance • FAR 42.705 & 708 • FAR 52.216-7 • Final Indirect Rates • Due 6 months after year-end (Incurred Cost Submission) • Final billings for completed contracts are due within 120 days after settlement of rates • Quick-Closeout Procedures • Negotiated or audit-determined final rates used for: • Billing updates (impact differences in provisional rates) • Contract close-out • Preparation of completion vouchers (due within 120 days after settlement of final indirect costs rates for contracts) • Determination of final incentive/award fees

18. Regulations Governing Indirect Rates

19. Regulations Governing Indirect Rates • Federal Acquisition Regulation (“FAR”) • Part 31.2: • Types of costs, methods of allocation, and allowability of costs • Part 42.7: • Administration of Indirect Cost Rates • Part 52.216-7: • “Allowable Cost and Payment Clause” requires completion of an Incurred Cost Submission 6 months after the contractor’s fiscal year end

20. Regulations Governing Indirect Rates (cont.) • Cost Accounting Standards (“CAS”) • 401: Consistency in Estimating, Accumulating and Reporting costs • Requires consistent indirect rate structures throughout the contract life cycle for all contracts • 402: Consistency in Allocating costs Incurred for the same Purpose • Requires consistent allocation methodologies across contracts • 403: Allocation of Home Office Expenses • Governs allocation of home office expenses to business units • 405: Accounting for Unallowable Costs • Requires identification and segregation of unallowable costs • 406: Cost Accounting Period • Sets forth rules for changing the cost accounting period • 410: Allocation of Business Unit G&A to Final Cost Objectives • Governs the contents of the G&A pool and G&A base • 418: Allocation of Direct and Indirect Costs • Requires homogenous cost pools allocated using causal relationships

21. Basic Indirect Rate Calculations

22. Indirect Rate Structures • Calculation: Indirect Rate = Indirect Cost Pool Allocation Base

23. Typical Basic Indirect Rate Structure Elements • Fringe Rate (s) • Overhead Rate (s) • General and Administrative Rate

24. Fringe Rate • Employee fringe benefit costs (e.g., payroll taxes, vacation, sick, retirement, health care, bonus, deferred compensation, insurance, etc.) • Calculation: Fringe Rate =Fringe Pool Total Labor Dollars • Fringe rate can be intermediate or final

25. Overhead (“OH”) Rate • Management or supervision of activities or cost of certain segments of a business unit that benefit more than one project, contract or award, but not the business unit as a whole (e.g., division middle management, supervisors, project leadership benefiting multiple projects, site rent, etc.) • These are costs that would not be incurred if it was not for the awarded contract • Calculation: Overhead Rate = Overhead Pool Loaded Direct Labor Dollars

26. General & Administrative (“G&A”) Rate • Management and administration costs that benefit the business unit as a whole (e.g., accounting department, chief executive officer) • Costs for running the business • Calculation: G&A Rate = G&A Pool Total Cost Input • Other bases include value-added cost input; single element cost input

27. Advanced Indirect Rate Structure Elements • On-site Overhead Rate (s) • Off-site Overhead Rate (s) • Subcontractor/Material Handling Rate (s) • Service Centers • Home Office Allocations

28. Designing Your Company’s Rate Structure

29. How to Create the Proper Rate Structure • Cost-benefit theme • Identify the “beneficial or causal” relationship between costs and cost objectives • Identify cost objectives • Intermediate • Final • Identify direct costs associated with the cost objective • Pool indirect costs into logical groupings based upon causal-beneficial relationships • Example: fringe, overhead, G&A • Segregate any FAR Part 31 unallowable costs and remove from pools • Select Appropriate Cost Allocation Base Unit • Example: labor dollars, total cost input dollars, headcount, etc • Calculate Rate per Unit of Allocation Base • Pool / Base Units • Allocate Costs to Cost Objectives

30. Rate Structure Keys to Success • Rate structures should be suited to match a given business unit’s operations • The allocation base should be the best representation of the causal relationship between costs and cost objectives • Rate structures should be designed for: • Maximum cost recoverability • Competiveness • Intermediate allocations (e.g. service centers) can more accurately allocate costs, but increase complexity • Remember the consistency requirements

31. Indirect Rate Examples

32. Starting Point for Cost Pools– Trial Balance

33. Fringe Rate

34. IT Service Center

35. Overhead Rate

36. G&A Rate

37. Cost Build-Up “Proof”

38. Questions ?

39. Beers + Cutler • Andrew Stowe, Manager Andrew Stowe a manager with more than12 years of experience.  He focuses on assisting contractors with virtually all aspects of indirect rates, proposal preparation, contract administration, compliance and audit support.  Prior to joining Beers + Cutler, Andrew worked for international consulting firms specializing in several areas of regulatory compliance. Andrew's experience includes indirect rate development and analysis, development and management of contracts and compliance organizations, supporting litigation and bid protest matters, corporate policies and procedures, organizational risk management, cost estimating and proposal development. He is an accounting graduate of the George Mason University School of Management. Tel: (703) 923-8270, astowe@beersandcutler.com