In a previous article, we discussed the concept of Indirect Rates and provided a simple example of a fringe benefit rate calculation. Over the years, we have found that many of our most successful clients have some of the most creative indirect rate structures imaginable. This is particularly true with General & Administrative rates, commonly known simply as G&A.
Let's begin with a definition of G&A and how it differs from overhead. The two concepts are often erroneously used interchangeably as in "we have too much overhead and it's killing our margins" when it should be that "too much G&A" is to blame. G&A consists of those expenses incurred that benefit a business as a whole and are not specific to a division or department as is overhead. Examples of G&A expenses include costs attributable to executive salaries, accounting, legal, human resources, procurement and memberships. Overhead consists of indirect costs associated with contract performance. Supervisory labor is just one example of an overhead expense. Even if your business has no project activity, you will still incur G&A expenses.
As in the case with all indirect rates, since certain costs are not directly identifiable to a cost objective (i.e., contract or grant), G&A costs must be allocated over a logical and consistent allocation base. When it comes to G&A rates, there are three options for defining your allocation base. They are:
- Single Element - this is a rarely used allocation base consisting of just one element of cost.
- Total Cost Input - this allocation base includes direct costs, other direct costs, fringe benefits, overhead and uanallowable costs.
- Value Added - this base includes all costs as does TCI except for subcontract and/or material costs. Separate cost pools are defined for material handling and subcontractor related expenses. .
So when might you choose to incorporate a Total Cost Input (TCI) versus a Value Added allocation base? The answer should become obvious if your business is engaged in manufacturing and materials comprise a significant percentage of your overall costs. In this case, it would make sense to split out materials from your G&A allocation base and create a separate material handling pool. Why would it make sense? If the amount of your typical cost of materials exceeds 30% of your G&A, for instance, then materials will significantly distort the allocation of G&A. For example, if your TCI G&A rate is 20%, and materials total $1M per month, then material costs are being burdened with G&A at a rate of $200K per month. When you consider the actual cost associated with the procurement, receipt and inventory control of direct materials, chances are it doesn't even come close to the amount of G&A dollars that are allocated to materials each month. This is appropriately known as "excessive passthrough". Therefore, a Value Added G&A will cause less distortion with a base that consists of the contents of your material handling pool added to your allocation base minus the cost of the materials themselves.
An effect of removing the cost of materials from your allocation base (i.e., denominator) will increase your G&A rate. DCAA auditors have long raised concerns about what might appear to be increased cost recovery on cost reimbursable contracts by the contractor, but when you "do the math" by applying a higher percentage of G&A rate to a smaller allocation base, you might find that your cost recovery attributable to G&A has actually decreased. In other words, you are applying a higher G&A rate to fewer total costs incurred with the most significant cost having been eliminated from the equation. Why is it called Value Added? This moniker implies that when a contractor performs the material handling (or subcontractor management) functions on behalf of the government in its performance on a contract and is therefore freeing up government personnel from involvement with purchasing and warehousing materials, then the contractor is adding value. The overarching value is that a contractor will become more competitive even with a higher G&A rate, but with less excessive passthrough of costs.
Does your cost accounting software provide the flexibility to get creative with your G&A rate? Does it have the capability to calculate and allocate indirect costs at all? If not, you should consider investing in a purpose built cost accounting software package such as SYMPAQ.