You Can’t Manage What You Can’t Measure
A key aspect of complying with government regulations is creating processes and utilizing software tools that allow your organization to be compliant. Because we all know you can't manage what you can't measure, it is important to understand the basic categories of your organization's indirect cost pools and to establish a mechanism to efficiently track employee time against these pools.
Direct costs are traceable to the production of a specific good or service. Labor and direct materials, which are used in creating a specific product or service, constitute most direct costs.
Indirect costs are those cost necessary to keep your business in operation. Indirect labor costs make the production of cost objects possible but aren't assigned to a specific product.
Indirect Cost Pools
Overhead - indirect costs incurred that are not direct costs, but that can be attributed to a specific revenue-generating project or job. Any indirect labor or expenses that can be attributed to a certain project can then be distributed across those projects based on the projects’ direct labor hours, direct labor costs, or direct material costs
Fringe costs - include employee related costs including payroll taxes, fringe benefits such as health insurance and compensated absences (vacation, holiday and sick time).
General and Administrative (G&A) Expenses. These are management, financial, and other expenses related to the general management and administration of the business. To be considered a G&A Expense, the expenditure must be incurred by, or allocated to, the general business unit. Examples of G&A Expense include:
- Salary and other costs of the executive staff of the corporate or home office.
- Salary and other costs of such staff services as legal, accounting, public relations, and financial offices
- Selling and marketing expenses
Two major types of indirect costs are accounted for in a very unique way in the government contracting environment.
- IR&D consists of contractor research and development efforts not performed under contract or grant and not required for the preparation of a specific bid or proposal, either government or commercial. IR&D is funded and managed at the contractor’s discretion from contractor-controlled resources.
- B&P is comprised of contractor efforts to prepare, submit, and support bids and proposals, either government or commercial, whether or not the bid is successful.
Contract Type Matters
To recognize the impact that changes in indirect cost rates have on both the contractor and the government, it is vital to understand the various types of contracts used in government work. In some cases, increases in indirect costs are totally or partially paid by the customer.
- A cost-reimbursement contract is used when the cost of contract performance cannot be predicted with accuracy, such as in the development of weapons systems.
- Cost-plus-fixed-fee (CPFF) contract, the contractor is reimbursed for his actual cost, subject to certain government requirements regarding allowability, plus a negotiated fixed fee.
- A cost-plus-incentive-fee contract (CPIF) is a cost-reimbursement contract that provides for a fee that is adjusted by a formula according to the relationship of total allowable costs to target costs. The target cost, target fee, minimum and maximum fee, and the fee-adjustment formula are negotiated at the outset. The fee paid to the contractor is negotiated after contract performance and final actual costs are determined, using the formula and the minimum and maximum fees.