Understanding Indirect Rates:

Part 3 of 3

By Robert Smith, CEO of ICAT Systems

Indirect Rates can be one of the more confusing concepts for government contractors to grasp. There are nuances with respect to how indirect rates are used in cost accounting, pricing, and billing. When understood comprehensively, government contractors are equipped to better manage contracts and the business as a whole. I'll explain the role of Indirect Rates in each of these areas in this three part series.

ICAT Systems Budgeting helps plan indirect rates

The Role of Indirect Rates in Billing

Indirect rates have a role in the billing of cost-plus type contracts, and in certain circumstances, in the billing of time and materials (T&M) type contracts (when general & administrative, or G&A, can be applied to direct costs other than labor).

A distinctive characteristic of cost-plus type contracts with respect to billing is the use of provisional indirect rates. Final indirect rates are not known until all of the costs for the year are recorded and an Incurred Cost Proposal has been accepted by either DCAA or the Administrative Contracting Officer (ACO). Therefore, indirect costs are billed on cost-plus type contracts on a provisional basis, subject to final determination.

How are Provisional Indirect Rates Set?

Provisional indirect rates are agreed-upon estimates of the contractor’s final indirect rates for a particular year. A contractor must submit a Provisional Indirect Rate Proposal to either DCAA or the ACO of the contract (whichever of the two is tasked with the responsibility of determining final Indirect Rates pursuant to the contract).

A Provisional Indirect Rate Proposal will typically include reports that detail the prior year actual indirect rates, the current year-to-date indirect rates and the budget year indirect rates, where each report shows a detailed listing of the costs contained in the cost pool and the corresponding allocation base. The Provisional Indirect Rate Proposal also typically includes a narrative of significant budget assumptions used in developing the budgeted rates.

Once provisional indirect rates are established, the contractor must use them to bill the indirect costs on cost-plus type contracts.

A graph showing the Indirect Rate Variance

What to do about Indirect Rate Variances

Given that the provisional indirect rates are estimates of the final actual indirect rates, there will likely be a difference between the amount billed for indirect costs on cost-plus type contracts and the amount of indirect costs actually incurred and allocated to the cost-plus type contract. This difference is known as an indirect rate variance.

The indirect rate variance must be settled prior to the closing of the contract. Consequently, the contractor must monitor indirect rate variances and should carry either an asset (for an indirect rate variance receivable) or a liability (for an indirect rate variance payable) on its books.

Get the eBook on Indirect Rates in Government Contracting