WIXLIB

Indirect Costs: Possiblyyour biggest contractCost Driver!Robert (Bob) L. Gustavus, CPADefense Acquisition hop # 60 PDI 2019

Why this topic .1. Increase knowledge of indirect costs – whyhave them and how do they work2. Enhance understanding – why and howindirect cost rates can change3. Realize government decisions to delay orcancel programs can impact otherprograms4. Grasp why increased indirect cost rateshave a potential negative impact on manygovernment contractsASMC – PDI 20192

ImportanceVolume of government contracts – substantialpercentage of DoD dollars are used for contractsIndirect costs represent a large part of totalcontract costsIndirect costs are important to contractors on allcontracts, but most important to government on costreimbursement contractsIndirect cost rates can change—usually higherHigher indirect cost rates usually need morefor the contractASMC – PDI 20193

Indirect Cost Rates – Why have them? Indirect rates is the way of making sure that the total cost of whateverwe build includes its FAIR SHARE of all the costs incurred in thegeneral operation of the business and not specifically applicable toany one product line, program or contract. What are you paying for when you buy a candy bar? The specifically applicable, direct costs of the candy bar itself: sugar,cocoa, preservatives, paper, ink, packaging, etc. . . . What else is included in that price? Little pieces of . . . Machinery that makes many kinds of candy Shipping department Personnel and security departments CEO’s salary Environmental clean-up projects Research into new candy bars!ASMC – PDI 2019The Overhead and G&Arates determine howmuch to include in thetotal cost of making thecandy bar or tank orplane or ship. Its fairshare.4

Language of AccountingA few basic terms andconcepts .Key to focusing on IndirectCosts Rates and how theywork.To Earn the first dollar of profit, all costsmust be recovered .Totalcosts DirectIndirectCostsTotalcosts DirectCostsCosts IndirectCostsASMC – PDI 20195

Total Costs Direct Costs Indirect CostsOverheadDirect LaborCostsCostsDirect MaterialCostsIndirect CostsGeneral & Admin(G&A) CostsOther Direct CostsASMC – PDI 20196

ContractProductionLineA contract or other work unit forwhich cost data are desired andprovisions made in the accountingsystem to accumulate andmeasure costs.ProductASMC – PDI 20197

MaterialLaborProductASMC – PDI 2019SubcontractsA cost that can be trackeddirectly to one specific costobjective. Includes directmaterials, direct labor andother costs traceable directto that single cost objective.8

A cost not directly identifiedwith one specific cost objectbut identified with two ormore cost objectives.ASMC – PDI 20199

Indirect Cost CategoriesOverhead Cost (OH): Support costs having similar causal/beneficial (homogeneous)relationship to the production function (not product) beingsupported e.g. Engineering Overhead to Direct Engineering LaborGeneral and Administrative (G&A): Support costs of doing business as a whole e.g. Human ResourcesIntermediate (or Secondary) Service Pools: Contractor’s prerogative to aggregate cost separately as deemedappropriate Costs are subsequently distributed to direct charges or primaryindirect pool (OH or G&A) e.g. Facility Use & Occupancy, Computer ServicesASMC – PDI 201910

Definition:A collection of indirect costs that aresimilar to each other.Process:Determine what makes the indirectcosts similar; put similar costs in anamed “account” (in the financialaccounting records); and allocate costpool to the benefiting cost objectives onpro rata share.Why Havethem?Putting similar indirect costs together ina pool and spreading (allocating) thosecosts to cost objectives can be done withone mathematical calculation versusmany.ASMC – PDI 201911

Engineering Overhead (includes cost of indirectCost PoolExamples: engineering labor, fringe benefits relating to thatlabor, supplies for the engineers, etc.)Material Handling Overhead (includes cost ofequipment to move materials, warehouse laborstorage, etc.)Facilities Overhead (includes cost of buildingrent and maintenance, utilities, supplies for thebuilding, etc.)General and Administrative (G&A) (includescost for senior managers, HR office, IT,controller, etc.)ASMC – PDI 201912

Allocating Intermediate Service (Secondary)Pools: Use and OccupancyScenario: A company has a single 10M “Use and Occupancy” (U&O) secondary poolwhich accumulates the rent, utilities (one meter), and security (one guard). Having asingle pool provides management insight for cost control.Recall the bases available for Secondary Pools can typically be for: Payroll Dollars, HeadCount, or Square Footage.FenceConsider the following with respect to the squarefootage for each major part of the operation: The production operation uses 1/2 of the facility. The front office group (or FOG) sitting up frontgreeting customers takes up 1/2 of the remainingspace (a total of 1/4th of the plant space). The engineers sitting behind the FOG (so as to guardtheir proprietary secrets) take up 1/2 of the remainingspace (a 1/4th of the plant space).How would you logically allocate 10M U&Ocost to specific primary pools for production,engineering, and the FOG?BuildingSole UtilityMeterEngineeringProductionFront Office Group(FOG)Guard HouseASMC – PDI 201913

Projector ExerciseASMC – PDI 2019

Projector Cost Exercise: Identifying and ClassifyingCost into Homogeneous Cost PoolsDirectIndirect OHBulbLensLabelingCaseCircuit ngInventory controlPurchasingDesignTech documTestSpec configTest equipSuper & rsSuper & ClericalMfgTrainingJigs/fixtures OHASMC – PDI 2019Indirect G&AR&DMarketingMgt. (FOG)TravelLegalCustomer svcHRFringeClericalAccountingITOffice suppliesTransTrainingIntermediateService PoolMain Plant-Utilities-Bld. Mainframe-Maintenance-Security----------------15

The Equation(O/H G&A)[Indirect Costs]PR BPool costsBase costs[Direct costs](e.g. - Direct Labor)ASMC – PDI 201916

Calculation of Indirect Cost RateIndirect Cost Rate(For a Given CostPool)* Total Indirect Costs in Given Pool*Applicable Allocation BaseExamples*Cost Pool Types* Applicable Allocation Base:Manufacturing Overhead - Direct Manufacturing Labor DollarsManufacturing Overhead - Direct Manufacturing Labor HoursEngineering Overhead- Direct Engineering Labor DollarsEngineering Overhead- Direct Engineering Labor HoursMaterial HandlingG & A Costs- Direct Materials Costs- Total Cost Other than G&AASMC – PDI 201917

Calculate the rates for each pool – with G&A rate based ona Total Cost Input basisCompany XYZ has the following direct and indirect costs:Rate Pool / BaseMaterial Handling Expense Pool 500Direct Material Cost 5,000Engineering Overhead Expense Pool 320Engineering Direct Labor Cost 400Manufacturing Overhead Expense Pool 5,200Manufacturing Direct Labor Cost 1,600Other Direct Costs (ODC) 1,000Total Cost Input 14,020General & Administrative Expense Pool 1,680ASMC – PDI 2019 500 / 5,000 10 %Mtl Hdlg Rate 10% 320 / 400 80 %80%Eng O/H Rate 5,200 / 1,600 325 %325%Mfg O/H Rate 1,680 / 14,020 12%G & A Rate 12%18

Allocation of Indirect CostsUsing rates previously calculated, develop the total cost ofa program, project or product with indicated direct costsDirect and Allocated Indirect CostsDirect Material CostBase x Rate Allocation 25.00Allocated Material Handling Expenses 2.50Engineering Direct Labor Cost 60.00Allocated Engineering Overhead Expenses 48.00Manufacturing Direct Labor Cost 50.00Allocated Manufacturing Overhead Expenses 162.50Other Direct Costs (ODC) 10.00Total Cost Input 358.00Allocated General & Administrative Expenses 42.96Total Cost for Program 25 x 10 % 2.50 60 x 80 % 48.00 50 x 325 % 162.50 358 x 12 % 42.96 400.96Applying the company-level rates for a specific project.ASMC – PDI 201919

Computation of Total Cost of A ProjectCost Accounting for Direct and Indirect CostsDirect Materials 25Materials Handling 25 x 10%Project ADirect Labor Engineering 60Direct Labor Manufacturing 50Other DirectCosts 10Cost ObjectiveDirect MaterialsDL – EngineeringDL – ManufacturingOther Direct CostsTotal Direct CostsOverheadsMaterials HandlingIndirect EngineeringIndirect Manufacturing 25.060.050.010.0 145.0Total Cost Input 358.0 2.5 48.0 162.5General & Admin Costs 42.96Project Total Cost 400.96IndirectEngineering 60 x 80%ManufacturingOverhead 50 x 325%General &Administrative 358 x 12%Applying the company-level rates for a specific project.ASMC – PDI 201920

Management of Indirect CostsFor Cost Reimbursement Contracts: Contractor is responsible for setting up indirect cost poolaccounts and managing all indirect costs incurred on Defensecontracts. Contractors are required to set up a minimum of two typesof indirect cost pools for Defense contracts: “Overhead”:supports a specific part or function of company “G&A”:supports general operations of company rather than any onespecific part. No maximum number of indirect cost pools, but ASMC – PDI 201921

Considerations for establishing indirect cost pools and determiningcost allocation basis (i.e., rates): The FAR [31-203(b)] requires indirect costs be accumulated bylogical cost groupings. The CASB states “homogeneous costs” are to be aggregated in aseparate cost pool. EVMS guidelines address indirect cost management – it is one ofnine EVM business processes. Three of the thirty-two EVMSguidelines specially cover overhead management; recording andallocating indirect costs; and analyzing indirect cost variances. Allocation of cost pools should be done on a base common to allcost objectives to which the costs will be allocated.Note: CASB Cost Accounting Standards Board (unique to Federal Government)ASMC – PDI 201922

Government allows contractors to use one or more of the followingfactors as the base to determine their indirect cost allocation rates :BaseDirect Labor Dollars,Direct Labor HoursTo DetermineManufacturing andEngineering OverheadDirect Material Dollars Material HandlingTotal Cost Input (TCI) G&A Costs(All costs except G&A)ASMC – PDI 201923

Types of CostsDirect CostsIndirect Cost PoolsIndirect CostsCost ObjectivesTotal Costs Direct Costs Indirect CostsASMC – PDI 201924

Direct CostsABCIndirect CostsASMC – PDI 201925

AIndirect CostsASMC – PDI 2019BCIndirect Cost Rate Pool/Allocation Base26

Fixed Cost Example – Allocation Base: Square FootageRate 120,00060,000 2.00@sq.ftABC20,000SQ. FT30,000SQ. FT10,000SQ. FTIndirect CostsIndirect Cost Rate Pool/Allocation Base 120,000ASMC – PDI 201927

60,000 20,000 40,000Rate 120,00060,000 2.00@sq.ftABC20,000SQ. FT10,000SQ. FT30,000SQ. FTX 2.00 @ sq.ftIndirect Costs X 2.00 @ sq.ft 120,000ASMC – PDI 2019 40,000 20,000X 2.00 @ sq.ft 60,00028

ASMC – PDI 201929

On a Cost Reimbursement Contract,What Costs will theGovernment Reimburse the Contractor?Answer: The government will pay all “allowable” costs Direct costs are generally allowable if they arereasonable Allowability issues generally occur with indirectcostsThere is no commercial market equivalent tothe concept of “allowable” costsASMC – PDI 201930

Rate Sensitivity:A matter of the BaseSo how much to include in the base? Continued performance of firm existing contracts? How about known (identified), but not yet committedbusiness? Change proposals Options? will it get funded? Follow-ons? The likelihood they get funded and chancesof winning? Factor in anything that might just be out there? Economic growth in industry BluebirdsASMC – PDI 2019Cost (with Government Involved)31