Indirect Rates from Development to Closeout Chad Braley

Indirect Rates from Development to Closeout Chad Braley Marie Salamone

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

Who We Work With All entities receiving Federal funding 3

The Solution Model 4

Agenda • Indirect Rate Structure Development • Contractor Actions after ICP Submission and before Government Audit • Contract Close-out 5

Indirect Rate Structure Development

Organizational Considerations • What type of industry? ØGoods ØServices • How large is your organization? ØSmall ØMedium ØLarge • Does your organization have many people and facilities in multiple locations? • Do you have a large number of subcontractors? 7

Considerations – Industry (Cont. ) • Goods ØDo you have multiple product lines requiring differing support functions? ØDo you have manufacturing facilities in multiple locations? • Services ØDo you have a large number of employees working at client/customer sites? ØDo you have different service offerings requiring different support functions? ØAre your employee’s located both domestically and internationally? 8

Types of Costs • Direct Costs - Costs that can be identified specifically with a particular contract, customer order or final cost objective Ø“But for” cost –would not be incurred “but for” the existence of a specific contract, customer order or final cost objective ØAnticipated to be recoverable from the customer • Indirect Costs – Costs incurred for the common good of the organization or its employees ØBenefits more than 1 contract, order or final cost objective ØCannot be specifically identified to a particular cost objective and Impractical to identify and split 9

Benefits of Indirect Cost Allocations • Facilitates Decision Making ØHow is the company structured? ØIs the company structure changing? • Improves Competitive Advantage in Market Place ØIndirect Rate Structure positioned to win the work • Capitalizes on Thorough Budgeting Process ØHopefully already in existence… • Ensures Allowable Cost Recovery ØAnd maybe even some profit! Rate Structure MUST mirror the Organization, not limited by accounting software, customer or govt. 10

Types of Cost (cont. ) • 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: Ø can meet direct/indirect regulatory definitions, and Ø 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

Types of Indirect Rates Budgeted Rates ICS Rates Provisional Billing Rates Contract Rates Final Rates Forward Pricing Rates 12

Types of Indirect Rates (cont. ) • Budget Rates ØApproved internally for management purposes and as a basis for pricing products and services ØDCAA expects rates are prepared annually • Provisional or Contract Rates: Per FAR 42. 704 ØApproval by the contracting officer or CFAO ØRates established based on information from recent review, previous rate audits or experience ØAuditor assurance that rates are as close as possible to final indirect cost rates anticipated ØRevision by mutual agreement (AT ANY TIME), to prevent substantial over/underpayment ØTypically based on a contractor’s budget rates 13

Types of Indirect Rates (cont. ) • ICS Rates (Final Indirect Cost Rate Proposal) ØUnaudited year end rates based on actual costs incurred ØSubject to audit by DCAA or Contracting Officer’s designee ØRequired within six months of Contractor’s fiscal year end § FAR 52. 216 -7 (d)(2)(i) - Allowable Cost and Payment § FAR 52. 232 -7(b)(4) & (b)(5) - Payments under T&M and Labor. Hour Contracts ØFAR 42. 704 allows for ICS rates to become provisional rates for the fiscal period until the Contractor’s ICS can be audit and rates finalized 14

Types of Indirect Rates (cont. ) • Final Rates - FAR 42. 705 requires final determination of rates by either the Contractor officer or his assigned representative (auditor) ØAdjusted for questioned/unallowable costs identified by the auditor and Subject to Negotiation • Forward Pricing Rates - FAR 42. 17 allows for the establishment of mutually agreed to Forward Pricing Rates between the Contracting Officer and Contractor Ø Established long-term rates for use in contractor pricing efforts Ø Based on the Contractor’s long range plans and budgets Ø May be continuously negotiated/updated based on availability of most current, accurate, and complete data Ø Adequacy Check List available at DCAA. mil 15

Life Cycle of Indirect Rates Budgeted & Forward Pricing Rates Billing, Provisional Contractual Rates Actual & Final Rates 16

Acquisition Cycle - Indirect Rates Rate Strategy Forward Pricing Rates Market Research and Planning Solicitation (RFQ/RFP) Contractor Proposal Source Selection Evaluation and Award Price Negotiation Contract Performance Post-Award Review Contract Close-Out Budget Rates (RFQ/RFP) Provisional Rates ICS Rates Final Rates 17

Indirect Cost Pools & Bases Fundamental cost accounting guidelines in FAR 31. 203(c)— two parts to indirect cost allocation process: • Indirect cost pools: collected in “logical cost groupings” (individual indirect cost centers), so as to permit distribution to all final cost objectives included in an allocation base. • Allocation base: should have causal/beneficial relationship to indirect cost allocated from indirect cost pool. Examples: Facilities cost and square footage, fringe expenses and total labor, human resources and headcount, overhead and direct labor 18

Indirect Cost Pools & Bases Typical 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 19

Indirect Cost Pools & Bases Typical Cost Pools Fringe Benefits - Typically includes all cost of benefits provided to employees Overhead - Supporting functions associated with contract execution/oversight that cannot be directly identified with one contract General & Administrative (G&A) - General management & administration of company as a whole (CAS 410 -30(a)(6)). These are the costs that are incurred during the start-up and day-to-day running of the company 20

Indirect Cost Pools & Bases • Allocation base selected for identification of indirect costs by contract should: Ø Have causal/beneficial relationship to indirect cost pool Ø Result in a reasonable allocation of indirect costs to contracts Ø Be an adequate measure of resource consumption • Examples: Ø Fringe Benefits Pool: Allocation base of total labor dollars because of relationship between fringe benefit costs and labor dollars. Ø Overhead Pool: Allocation base of direct labor + fringe (three tier) or direct labor only (two tier) Ø G&A Pool: Use total costs incurred (exclude G&A expenses) as allocation base because functions in G&A represent overall management & administration of company. 21

Intermediate Cost Pools • Intermediate cost pools and service centers collect costs associated with more than one cost objective • Any indirect costs that benefit more than one of the final cost pools goes to an intermediate objective Ø For example, if an office building houses both G&A and Overhead staff, use a facilities service center to allocate the building’s rent to those final cost pools • Costs are allocated from intermediate pools to final objectives using reasonable allocation bases with causal/beneficial relationships Ø Example: Allocate a facilities service center using headcount or square footage 22

Intermediate Cost Pools Common 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 • Human Resources -- Headcount 23

G&A Allocation Bases • Companies can choose between three types of G&A allocation bases: ØTotal Cost Input includes all contract costs except G&A, including direct labor, fringe, overhead, subcontracts, materials, and other ODC’s • Method used most often ØValue-Added does not include direct material and subcontracts costs • Used when a company has or expects to have a significant amount of subcontract costs and/or materials ØSingle Input Base • Typically direct labor 24

Strategy Considerations What is important to your organization? Want a Lower G&A Rate? Want a Lower Overhead Rate? High number of subcontractors / material costs? Consider moving from a 2 Tier to a 3 Tier Structure Consider a Material Handling Rate Review costs which could be claimed as Fringe rather than Overhead 25

Unallowable Costs • FAR 31. 201 -6 – Accounting for Unallowable Costs ØRequires contractors to exclude unallowable costs from government claims or billings • FAR 31. 201 -2 – Defining Allowability Ø“A cost is allowable only when a cost complies with all of the following”: § § § Reasonable Allocable In accordance with CAS and/or GAAP Compliant with Contract Terms Allowable as defined by FAR 31. 205 26

Common Pitfalls • When changing G&A allocation bases, you must consider the impact of rate changes on existing contracts • Creating new O/H pools for new contracts or new work sites can be very dangerous Ø The administrative and systemic burdens often outweigh the benefits Ø This process can also create numerous small pools and bases that may fluctuate significantly • Be wary of your contract type mix when making changes Ø How will this effect the entire contract population? • Inability to develop reliable cost impacts when CAS covered b/c of lack of visibility into CAS contract population 27

Top 5 ICS Preparation Mistakes 1. Unallowable costs not adequately explained & not properly included in applicable base elements if incurred below the G&A level. 2. Company’s final year end trial balance does not properly reconcile to the ICS and/or discrepancies not explained. 3. Contracts are not properly classified by type on Schedule H and Schedule I. 4. Indirect Costs are not fully allocated across the contracts listed on Schedule H, creating reconciliation 5. A review of the ICS against DCAA’s Adequacy Checklist is not performed leading to an immediate rejection of the ICS. (Just b/c it was ok for the last 10 years doesn’t mean it will be this year) 28

Contractor Actions after Final Indirect Cost Rate Proposal Submission

Remember the Key Players Cognizant Federal Agency (CFA) - 48 CFR 2. 101 as the Federal agency that, on behalf of all Federal agencies, is responsible for establishing final indirect cost rates and forward pricing rates, if applicable, and administering cost accounting standards for all contracts in a business unit. Defense Contract Management Agency (DCMA) – FAR 42. 2 allows for the delegation of Contracting Officer responsibilities to the DCMA or other Contract Administration Office (CAO) and the Agency’s defined Administrative Contracting Officer (ACO). Responsibilities include final determinations regarding: • Audit findings • Provisional Rate, Final Indirect Rate, and FPRP Rates • Disclosure Statement Adequacy and CAS Compliance 30

Updating Provisional Billing Rates and Re-invoicing • FAR 42. 704 allows for adjustments to provisional billing rates when more current, accurate and complete information becomes available • Submission of a contractor’s annual ICS are the most current, accurate and complete rates, based on actual incurred costs • Contractors are recommended to request the contracting officer to approve the use of year-end ICS rates for billing purposes and “true-up” invoicing on flexibly priced contracts 31

Rescinding a Submitted ICS • Contractors have the right and responsibility to rescind and resubmit Incurred Cost Submissions when new information becomes available ØPrior Year Audit findings & resolutions § Think about it, changes in claimed rates as a result of audit require changes to prior year and cumulative claimed amounts reported on Schedule I ØErrors, Omissions, and DCAA Inadequacy determinations § Errors and omissions found by the Contractor or an auditor should be corrected to ensure the ICS is current adequate and complete § DCAA determination of inadequacy requires changes to the ICS in order for the rates to be auditable and ultimately, finalized ØAny resubmission after rescinding requires the submission to be re-certified (Signing of Sched. N) 32

Contract Close-out

Contract Close-out • Contract Close-out of Flexibly Priced Contracts requires determination of final indirect rates…. BUT that may not require an audit • FY 2018 NDAA Title VIII SEC. 803 Directs DOD to use qualified private auditors for ICS Audits to eliminate backlog by 10 -01 -20 • FY 2018 NDAA also directs DCAA to complete ICS audits within 1 year of receipt of “qualified” ICP Ø What is a qualified ICP and will it differ from established adequacy criteria in DCAA ICS adequacy checklist? We expect the adequacy checklist will remain the standard Ø Use of risk-based audit approach to recognize low-risk or low $ ICPs Ø What numeric materiality standards will be developed? Ø Will the selected private auditors be sufficiently knowledgeable in pertinent government contract and cost allowability compliance requirements? 34

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