Thursday, April 29, 2010

What is the Best Indirect Cost Allocation Base?

Many Government contractors or prospective Government contractors ponder the decision on what cost base to use for allocating indirect costs. Both the Federal Acquisition Regulations (FAR) and the Cost Accounting Standards (CAS) contain guidance on how to detemine the best allocation base. But both doecuments require some judgement and subjectivity to bring this about. One publication called it "...more art than science." Lets take a look.

FAR requires contractors to accumulate indirect costs by logical cost groupings (this could be one rate or multiple rates) with due consideration of the reasons for incurring such costs. The contractor shall determine each grouping so as to permit use of an allocation base that is common to all cost objectives to which the grouping is to be allocated. The base selected shall allocate the grouping on the basis of the benefits accruing to intermediate and final cost objectives. CAS 418, Allocation of Direct and Indirect Costs, has similar language. CAS 410, Allocation of G&A Expenses, is more prescriptive in its requirements. Contractors that are not subject to CAS can still look to these standards for help.

The number of indirect rates usually correlates to the size of the company. Small companies often times have a single rate. Larger companies have multiple rates such as a fringe rate, an overhead rate, and a G&A rate. A small service company (e.g. one that provides primarily labor) or an engineering firm would probably choose a direct labor base. A manufacturing company would most likely choose a total cost input base. Some contractors have to be very careful in finding a base that is common to all cost objectives. For examqple, a contractor with two contracts, one predominately labor and the other predominately subcontracted effort will have a challenge in finding a base that equitably spreads its indirect costs.

Tomorrow we will look specifically at the requirements of CAS 410 and the different bases for allocating G&A expenses.

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