How to Design Your Indirect Rate Structure

The design of your indirect rate structure will have a significant impact on your company’s profitability, efficiency, and growth prospects. A poorly-designed indirect rate structure could have several negative consequences, to include:

Less than full recovery of your company’s indirect expenses through your billings to both federal and commercial customers
Lower profit or even a financial loss that jeopardizes the continued existence of your company
Painful audit adjustments from DCAA or other federal auditors resulting in large reimbursements paid to the federal government
Loss of productive time to handle federal audits which is better spent on business development and delivery of services and products
Loss of current federal contracts due to non-compliance with FAR and CAS regulations
Inability to bid on future federal contracts due to a non-compliant indirect rate structure
Low win-ratio on contract bids due to non-competitive bid rates that could have been optimized using GovBooks
Inability to obtain bank financing or paying too much for financing due to poor financial performance

SAMPLE INDIRECT RATE STRUCTURES

The following indirect rate structures are meant to serve as examples for instructional purposes only and do not represent our advice for your particular company. However, these examples are the most common indirect rate structures that are deployed by federal contractors, but please keep in mind that your company may decide that additional customization is required, with additional pools and service centers.

Three-tier, total cost input

Use case: When labor is the primary cost element such as in a service company. On cost plus invoices, the fringe rate is displayed. The overhead rate will lower than with a two-tier structure (see below) but the the g&a rate and overall multiplier will be the same.

Three indirect pools are utilized to allocate indirect expenses to cost objectives, fringe, overhead and g&a (general and administrative).
The base of the fringe pool is comprised of all labor costs.
The base of the overhead pool is comprised of direct labor, b&p labor, ir&d labor and unallowable labor and the allocated fringe costs.
The base of the g&a pool is comprised of all costs (total cost input) excluding the g&a pool itself.

Two-tier, total cost input

Use case: When labor is the primary cost element such as in a service company. On cost plus invoices, the fringe rate is not displayed because fringe costs associated with direct labor is a component of the overhead pool. The overhead rate will be higher than a three-tier structure but the g&a rate and overall multiplier will be the same.

Two indirect pools are utilized to allocate indirect expenses to cost objectives, overhead and g&a (general and administrative).
The fringe pool is used to allocate fringe costs to the overhead and g&a pool.
The base of the overhead pool is comprised of direct labor, b&p labor, ir&d labor and unallowable labor.
The base of the g&a pool is comprised of all costs (total cost input) excluding the g&a pool itself.

One-tier, total cost input

Use case: A simple method of allocation which can be used if the company has only one contract. In the case of more than one contract, this method should only be used if the resulting allocation of indirect expenses to each contract is substantially the same as the two-tier or three-tier method.

One indirect pools is utilized to allocate indirect expenses to cost objectives, the g&a (general and administrative) pool.

All fringe and overhead expenses are included in the g&a pool.
There is no overhead pool.
The base of the g&a pool is comprised of all costs (total cost input) excluding the g&a pool itself.

Value-added

Use case: When non-labor cost elements such as materials or subcontracts comprise a large portion of direct costs, and the application of g&a would result in an unfair allocation to them, a value-added structure can remove these cost elements from the g&a base and instead receive a different allocation of indirect costs related specifically to the direct cost element.

Can be utilized with three, two or one-tier pools.
The value added pool consists of expenses that are incurred to handle a given cost element, such as subcontractors, materials, ODCs or travel.
Sometimes referred to as a handling pool.
The base of the value-added pool is the cost element that is being handled, such as subcontract costs.
The base of the value-added pools is excluded from the g&a base.
The value added pool is included in the g&a base.

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