Indirect Cost Allocation Bases - Part 2

Yesterday we began a discussion on indirect cost allcoation bases focusing on the requirements of FAR 31.203. If you missed that post, click here to read it before going on. Today we will conclude our discussion with comments on what the CAS 410 (Cost Accounting Standards) has to say about the G&A (General and Administrative) allocation base. If your company is not subject to CAS, you're not bound by these requirements. However, this standard is pretty good cost accounting in our opinion and we encourage companies to at least consider the methodologies described in the standard.

First, a definition of G&A. G&A costs represent management, financial, and other expense which is incurred by or allocated to a business unit and which is for the general management and administration of the business unit as a whole. G&A expense does not include those management expenses whose beneficial or causal relationship to cost abojectives can be more directly measured by a base other than a cost input base representing the total activity of a business unit during a cost accounting period.

According to CAS 410, the cost input base used to allocate the G&A expense pool shall include all significant elements of that cost input which represent the total activity of the business unit. The cost input base selected to represent the total activity of a business unit during a cost accounting period may be:

• Total cost input (TCI);
• Value-added cost input (excludes material and subcontract costs) or
• Single element cost input.

The determination of which cost input base best represents the total activity of a business unit must be judged on the basis of the circumstances of each business unit. So, there is definately not a "one size fits all" directive to this standard.

A value added base is best when the inclusion of material and subcontract costs would significantly distort the allocation of the G&A expense pool in relation to the benefits received, and where costs other than direct labor are significant measures of total activity.

A single element cost input base (e.g. direct labor hours or direct labor dollars) is useful where that element best representsw the total activity of a business. A single element base is not appropriate when it represents an insignificant part of the total cost of some of the final cost objectives.

Whatever allocation base you use, be aware that the Government may ask you why you chose one over another. Be prepared with your explanation and logic.

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.

Improving Profitability

It is not to hard to figure out whether you're losing money on a particular Government contract as long as you have an adequate job cost system. It is a little more difficult to figure out why the loss is occurring. Usually it comes down to poor estimating or poor cost control, or both. Contractors often fail to factor in contingencies or have a much too optimistic view of their future work which impacts indirect rates. Some contractors, upon receipt of a contract and feeling temporarily flush, will go out and buy things they shouldn't, don't need, or could lease more cheaply, hire employees before they're really needed, or misjudge the time it really takes to perform the work.  Sometimes however, cost overruns could also occur because of changed contract performance conditions which were not anticipated in the original contract solicitation.

If you find that poor estimating practices are the source of the cost overruns, you should perform a comprehensive estimating system review and implement corrective actions to ensure that estimating problems do not affect future contract profitability. If poor cost controls are the source of the cost overruns, you should identify and implement effective budget and cost controls to ensure costs are better managed.

If you are experiencing conditions that were not anticipated based on the solicitation requirements, you should consider submitting an equitable adjustment proposal. This could include differing site conditions (construction contract), delays in receipt of Government furnished materials, and government caused slowdowns, to name a few. Preparing, submitting, and negotiating an equitable adjustment proposal can be a time consuming process; however, an equitable adjustment to the contract price is the only way to recover increased contract costs due to changed conditions.

Contractors are often limited to what they can do to recover on a previously unprofitable contract; however, steps can be taken to prevent this unwanted condition for happening on future contracts. But don't wait. The time to act is now.

Here's a List to Avoid

The byline on The Project on Government Oversight's (POGO's) website states that it is an independent nonprofit organization that investigates and exposes corruption and other misconduct in order to achieve a more effective, accountable, open, and ethical federal government. We've enjoyed POGO for years, both while we worked as Government auditors and now in the private sector - especially their efforts to promote policies that will ensure effective internal control systems and ethical conduct by companies desiring to participate in the Government contracting arena.

Recently POGO updated it Federal Contractor Misconduct Database (FCMD) with a new top 100 ranking based on fiscal year 2009 data.  This is not a database of the top 100 "misconducting" contractors. It is a database of the top 100 contractors receiving Federal funds together with the number of instances of misconduct. Of the top 100 recipients, 27 have no known instances of misconduct. Eleven others have only one instance leading POGO to conclude that since many contractors have no pattern of misconduct, is  "... further evidence that we should not accept contractor misconduct as a cost of doing business".

The Government recently launched its own contractor responsibility database - the Federal Awardee Performance and Integrity System (FAPIIS). The Government's database is not publically accessible but it would be interesting to compare it to POGO's FCMD.

Visit POGO's Federal Contractor Misconduct Database here.

Is DCAA Going to Lose Some Work?

The Panel on Defense Acquisition Reform was appointed by Chairman Ike Skelton and then Ranking Member John McHugh in March 2009 to carry out a comprehensive review of the defense acquisition system. The review was motivated by a general sense among the members of the House Armed Services Committee that the Department of Defense’s (DOD) acquisition system was not responsive enough to today’s mission needs, not rigorous enough in protecting taxpayers, and not disciplined enough in the acquisition of weapons systems for tomorrow’s wars. The breadth of the problems that had recently come to light led members to conclude that a systemic examination was appropriate. The Panel took a year to perform its review, holding 14 hearings and 2 briefings covering a broad range of issues in defense acquisition. The Panel approved its interim report on March 4, 2010. The Panel received the Department’s1 views on March 11, 2010 and received additional input from the various stakeholder communities on the interim report prior to approving this final report on its findings and recommendations. The Panel issued its final report on March 23, 2010.

Among the many findings and recommendations the Panel expressed concern about the independence and effectiveness of the Defense Contract Audit Agency (DCAA). It recommended that DoD consider shifting responsibility for certification of contractor business systems outside DCAA or to independent teams within DCAA to avoid any conflict between DCAA's responsibilities for certifying the adequacy of contractor business systems and auditing the vouchers produced by those systems. To address this issue, two of the Panel members introducede H.R. 5013 which would require that business system reviews be "performed by an audit team that does not engage in any other official activity (audit-related or otherwise) involving the contractor concerned." Interesting.

Genuinely Useful Software - Part 1

Power Utility Pak Version 7 (PUP v7) is a useful collection of Excel add-ins that brings significant new functionality to Excel 2007. When PUP is installed, you can do things with Excel in a few steps that would have taken many steps to perform withoput PUP v7. Regardless of your experience level, you'll find features in PUP that can make your job easier. PUP v7 augments Excel with about 70 new commands and 53 new worksheet functions. The product is designed to work seamlessly with Excel 2007. If you still use an earlier version of Excel, try PUP v6.

If you spend your life in Excel like we do, this utility is well worth the price. While we do not use most of the added functionality, the commands and functions we do use make it a worthwhile investment. The price is $40 but quantity discounts are available. You can download a trial version at no cost.

One of our fatovite tools in PUP v7 is the "Create Workbook Contents Sheet". This utility adds a new worksheet which functions as a table of contents for quick navigation to other sheets in the workbook. You can even choose between hyperlinks or buttons to navigate to those sheets. If you have a workbook with many sheets, this is a great way to navigate. Try it the next time you prepare your ICE (Annual Incurred Cost Proposal).

To read more about PUP v7 and to download a trial version, click here.