Indirect Rates Models for Government Contracts & Grants - Are You Using the Right One?
At ReliAscent, we routinely see contractors and grantees that have submitted indirect rates that don’t adequately reflect their operations, don’t align with their accounting systems, and frustrate their billing processes. We find many factors contribute to this chaos, but one that consistently comes up is the confusion surrounding government or prime contractor-supplied bid instructions, math models, and on-line bid templates.
Regulatory Benefit and Curse
One can argue that cost principles found in the Federal Acquisition Regulations are both a benefit and a
curse in developing indirect rates. These rules provide general guidance and limitations in a manner that
allows tremendous flexibility in calculating indirect rates. Contractors can develop indirect rates that are
financially sound and produce competitive pricing unique to their organization. However, many of the
modelling methods chosen by contractors and dictated by government or prime contractor policy can
be inconsistent, susceptible to error, and not flexible enough.
Contract versus Grant Agencies
The best example is the incongruent approach to indirect rates used by contract agencies (e.g. DoD)
versus grant agencies such as the National Science Foundation (NSF), Department of Energy (DOE), and
the National Institutes of Health (NIH). While the DoD accepts what might be considered a conventional
approach to calculating indirect rates, grant organizations impose any number of agency peculiar cost
allowability policies that convolute and frustrate indirect rate formation. These policies may even make
bidding on grants financially undesirable for small businesses who can’t afford to disallow costs that
would otherwise be allowable in a contracting environment.
In addition, these bid policies are at times not communicated clearly and end up being a surprise during
grant negotiations. This is equally frustrating to small business research firms wishing to develop core
technology that can support the warfighter as well as other non-DoD grant agencies.
Agency Outreach
To its credit, government agencies are reaching out to first-time and other relatively new contractors
and grantees in an effort to educate them on the importance of indirect rate formation. A recent DOE
Funding Opportunity Announcement suggests what virtually all government agencies struggle with:
“Experience has shown that creating and supporting (indirect) rates can be one of the most problematic
elements of a budget, and the subsequent negotiation of costs for the project.”
As part of this outreach effort, nearly every government agency offers a mathematical model intended
to assist bidders in calculating their indirect rates. It has been our experience that these models tend to
drive applicants to a “one-size-fits-all” approach, are unclear as to the modeling options, or are
inadequate without additional modifications to the model. This puts an applicant at a distinct
disadvantage when developing competitive and realistic indirect rates.
Case Study #1 – DCAA Information for Contractors Manual
One such model consistently promoted by contracting agencies can be found in the Defense Contract
Audit Agency (DCAA) Manual 7641.90 Information for Contractors.
The warning in the first few paragraphs of the manual should alert potential bidders. “These examples
are intended solely to provide better insight into the procurement process and should not be construed
as uniform guides. Nor should this manual be considered a substitute for the applicable rules and
regulations, as not all requirements are contained herein. Each contractor must tailor its responses to its
individual situation.”
This disclaimer is particularly applicable to Enclosure 3, Figure 4 of the manual which depicts a sample
indirect rate calculation. This particular example includes a Material Handling Overhead Pool and rate.
This might mislead bidders to conclude they need a material handling pool. This type of decision should
be made based on the pricing policy of the bidder and practical considerations as to the accounting
effort rather than blindly following the example.
In addition, the pricing example in Figure 4 completely glosses over the methods used to allocate fringe
and occupancy costs to the Overhead and G&A pools.
Case Study #2 – DoD Provided Cost Models
Many of our clients are given a cost model by the DoD presumably as a way to standardize the pricing
outputs of all bidders. As with the DCAA model, there are no instructions on how to allocate fringe
benefits or occupancy costs. It also lists fringe and material overhead as separate indirect rates which
implies that a bidder must enter a rate, which is not the case.
We’ve recognize other limitations to the model including its deficiency in calculating rates when a
material handling rate is proposed, and not addressing techniques for modifying the G&A base.
Case Study #3 – DOE Models
DOE models suffer from the same problems as those above in that they don’t describe or model
methods for allocating fringe and occupancy costs or adjusting the G&A base. In addition, as a grant
organization, DOE models reflect fringe as a direct cost which may or may not be the best approach for
an applicant.
Unintended Consequences
Not having a clear and intentional plan for developing proposed indirect rates causes any number of
problems. Methods used to calculate rates, when examined by government reviewers, will likely be
scrutinized. A bidder’s failure to adequately address these questions may result in a decrement in the
negotiated price or capping indirect rates.
An inexperienced bidder may also proposed rates that don’t include all anticipated allowable costs,
making it difficult to operate profitably on a contract or grant if actual costs trend higher.
Complicating matters is having an accounting system that cannot easily calculate indirect rates to
compare with proposed rates, or a billing system that doesn’t accurately reflect negotiated indirect rate
methods.
Prime Contractor Haze
Indirect rate development can be even more convoluted as a subcontractor to a prime, where it’s
desirable to avoid disclosing indirect rates for financial and proprietary reasons. We are aware of a
number of inventive techniques subcontractors use at the suggestion of their prime contractors. These
techniques are typically very complex and require skillful analysis in order to ensure all costs are
properly proposed.
Mitigating Impacts
Fortunately, many bidders have a general idea of how much indirect costs they need to support their
organization on an annual basis and take this into account when filling out government bid models and
templates. So even though a rate structure reflected in a bid might not be the most appropriate one for
a contractor, switching to a more appropriate rate structure typically won’t change a bid or negotiated
price significantly.
For cost reimbursable contracts, the Provisional Billing Rate (PBR) proposal is the first opportunity to
make adjustments to indirect rate structures and levels. A similar annual budgeting process could
provide the same opportunity for grants. While some government officials might balk at changing
negotiated indirect rate structures, this should be acceptable as long as the financial impact compared
to the total contract or grant amount is minimal.
Conclusion
One size does not fit all when it comes to calculating and proposing indirect rates. Be wary of any
mathematical model you receive that calculates your indirect rates. Be aware that due to the flexibility of FAR cost principles, there are many techniques available for calculating indirect rates. Make sure you
pick the right one for your firm, and contact the experts at ReliAscent to help you with this important task.
Is it Time to Review Your Indirect Rates?
The ReliAscent team can not only help you establish and strategically manage your indirect rates, we even offer Free Indirect Rates Reviews to all small business government contractors and grantees. In this review, our experts review your indirect rate calculations to see if:
- Your accounting/COA easily accommodates indirect rate development
- Your organization has a clear understanding of government indirect rates
- Your indirect pools were/are set up correctly
- Your current structure has the correct bases
- Your rate structure makes sense for your business complexity and government customer, and
- Discuss forward-looking budgets and rates, and how they affect future proposals and work
Most contractors can have their rates reviewed and a free assessment in as little as 1 – 3 business days, and all our experts need is an initial brief interview and basic financial information. So, contact us today to learn more or get your review started.