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What is an Indirect Rate?

Calculating Indirect CostsFor those of you who are new to government contracting, and in particular cost reimbursable government contracting, the jargon can sound as strange as an unfamiliar foreign language.

In addition to a myriad of acronyms, you will hear about pools and bases, indirect tiers, indirect rates and unallowable costs. Sprinkle in incurred cost submissions, provisional rates and cost plus fixed fee and you will soon come to realize this is a very different and unique way of doing business than what you’ll typically experience while selling services and products to a commercial entity. This is driven by the federal government customer wanting to know your cost of the products and services that you provide as a basis of negotiating your profit.

Let’s take the concept of an indirect expense rate and boil it down to its purpose and try to make sense of its meaning. In the course of doing business, you are probably familiar with revenue and expense accounts that appear on your profit and loss (income) statement. Your expense accounts will consist of line items that represent both direct and indirect expenses. Direct expenses are those you can identify to a contract or project. For example, labor attributable to a billable job would be a direct expense specifically identifiable to that job. Conversely, indirect expenses including overhead and general & administrative are not identifiable to a contract or project. For example, time spent processing payroll for your staff encompasses paying not only your direct billable employees, but also your management team and other sales and administrative staff who probably don't charge their time to billable projects. Since costs incurred for this and other expenses are not directly identifiable to a contract, these expenses must be "pooled" by like kind expense types (e.g., fringe benefits, overhead and G&A). This becomes the numerator of your indirect rate calculations. Your "base" or denominator consists of related accounts that are both logical and consistent with the accounts in the pool.

For example, your fringe benefits pool includes employee payroll related expenses (i.e., taxes, insurance, paid absences) and therefore a logical allocation base will consist of company-wide salaries and wages. Your indirect rate will be expressed as a percentage as follows:

Expense Pool / Allocation Base = Fringe Rate
$295,153.52    $1,113,109.56          26.52%

Note: In the world of cost reimbursable government contracting, you will subtract unallowable costs (FAR 31.205) from your expense pool.

Once you have calculated your indirect rates for each indirect expense classification (Indirect Tier), you will have the basis for allocating indirect rates to your direct costs to yield your total actual expenses for a given project. To further the indirect rate calculation example above, the actual fringe rate of 26.52% will be applied to your total direct labor charged for an accounting period (current month) to a project. In other words, for every dollar of direct labor charged to a project, approximately 26 1/2 cents of fringe benefits will be added to the direct labor. This indirect rate will change from month to month as costs in the expense pool and allocation base will fluctuate, so it is best to allocate your year-to-date average indirect expense rates to the direct costs incurred on all of your projects.

If you are utilizing SYMPAQ in your business as a cost accounting solution, then indirect expense rates are automatically calculated at the push of a button. 

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