Thursday, April 22, 2010

Excessive Pass-Through Costs - The Indirect Allocation Base Matters

In October 2009, the FAR concils published an interim rule that limits excessive pass-through costs charged to Government contracts. This rule brings the rest of Government contracting in to conformity with DoD which has had the rule since 2007.

In November of last year, we posted a comprehensive discussion of the interim rule along with some observations and implementation advice. One of the points we made was that the allocation base for allocating G&A (or Indirect Costs) matters. To read that post, click here. We continue to field a fair number of questions on this subject so we will explain what we mean when we say that the allocation base matters.

Before continuing, it may be helpful to read our prior post on the subject.

Pass-through costs are defined in FAR as indirect costs and profit (or fee). The extent to which indirect costs are allocated to subcontracts, depends wholly on the allocation base. If the base includes subcontract costs, then indirect costs will be allocated to (added to) the amount of the subcontract. Conversely, if the allocation base does not include subcontract costs, then no indirect costs will be allocated to the subcontract.

FAR requires that indirect costs be aggregated into logical cost groupings and allocated to contracts on a basis of the benefits accruing to those contracts. In some ways, the determination of the allocation base is subjective and every Government contractor must decide on the allocation base that best allocates costs to its contracts. The Cost Accounting Standards (CAS) list three acceptable bases for allocating G&A; a total cost input base that includes all direct and indirect costs (excluding G&A), a value-added base that includes all direct costs except materials and subcontracts, and a single-element base such as direct labor costs (If you've got that big Government contractor swagger, you can probably get away with a completely different allocation base but for most contractors, using one of these three bases is advised).

Of the three allocation base methodologies, only the first include subcontract costs. So, if you allocate your G&A over a total cost input (TCI) base, you will need to be concerned with excessive pass-through costs when submitting your proposal and during contract performance. If you allocate your G&A over a value-added or single element base, you will not need to be concerned with excessive pass-through costs because no indirect costs will be allocated to subcontracts. Its that simple.

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