Indirect Rates Life Cycle
Indirect Rates Life Cycle
There are 4 main states for indirect rates in the government contracting process. They are:
- Forward Pricing Rates which are estimated indirect rates for pricing,
- Provisional Rates for Billing,
- Actual Indirect Rates - based on cost incurred, and
- Final Indirect Rates
Forward Pricing Rates
Provisional Rates for Billing
Actual Indirect Rates
When closing an accounting period, actual indirect rates are calculated for that period and are utilized in closing the period. Contractors normally already know this actual dollar of any variance between provisional billing rates and actual indirect rates, because accounting systems capture the total costs incurred for a period, and also calculate the dollar amount on (provisional) indirect rates being applied to direct costs. The accounting system has an account set up for under or over applied provisional rates. For instance, if the actual rate is 20% G&A, however the provisional rate is only 15%, then there would be an underapplied indirect rate of 5%.
Here is an example where the provisional rates are substantially below the actual rates a contractor is experiencing.
| Cost Category | Cost Calculation | Rate % - Provisional | Provisional $$ | Rate % - Actual | Actual $$ | Variance | |
|---|---|---|---|---|---|---|---|
| Direct Labor | Hourly Rate | $100.00 | $100.00 | 00.00 | |||
| Fringe | DL * Fringe Rate | 35% | $35.00 | 40% | $40.00 | -$5.00 | |
| Overhead | (DL + Fringe) * OH Rate | 60% | $81.00 | 65% | $91.00 | -$10.00 | |
| G&A | (DL + Fringe + Overheat) * G&A | 15% | $32.40 | 20% | $46.20 | -$13.80 | |
| Fee | (DL + Fringe + Overhead + G&A) * Fee | 10% | $24.84 | 10% | $27.72 | -$2.88 | |
| Fully Burdened | $273.24 | $304.92 | -$31.68 |
This contractor has 100 employees working 2000 hours per year for a total of 200,000 hours per year.
| Hours | Provisional $$ | Actual $$ | Variance |
|---|---|---|---|
| 200,000 | $54,648,000 | $60,984,000 | -$6,336,000 |
FAR 42.704 provides for the Contracting Officer (CO) or other cognizant Federal Agency official or auditor the responsibility for establishing provisional billing rates. In the case demonstrated above, the contractor shall seek update provisional billing rates to align with the actual rates incurred.
Closing the Accounting Period at Actual Rates
In the example above, the contractor is obligated to close the books at actual rates, recognize the entire $60,984,000 as revenue, and bill the indirect rate variance of $6,336,000. The contractor shall have a process to bill actual rates vs provisional after the accounting period closes for the year. The rates are no longer estimated, forecasted, and therefore no longer provisional rates. They are actual rates and due to the significant variance, cannot wait for an Incurred Cost Submission to be submitted or final indirect rates to be established. This significant variance has many downstream negative effects.
Closing the Accounting Period at Provisional Billing Rates
If the contractor closes the books at Provisional Billing Rates:
- Revenue will be understated,
- There will be a significant under/over applied indirect account balance,
- Job Summary Reports (JSR's) Project Summary Reports (PSR's), and Contract Revenue Summaries (CRS's) will be significantly understated.
This could result in downstream effects, such as overrunning the contract (cost were understated), funding issues, cash and cash collection issues.