Indirect Cost

Indirect costs in government contracting are costs that benefit multiple contracts or cost objectives and cannot be reasonably assigned to a single contract, instead being pooled and allocated to contracts through negotiated or provisional indirect cost rates such as fringe benefit rates, overhead rates, and General and Administrative (G&A) rates.

What are Indirect Costs?

The FAR and DCAA (Defense Contract Audit Agency) define and govern the treatment of indirect costs for government contractors. Common examples include salaries of management and administrative staff, rent, utilities, insurance, depreciation on company assets, corporate functions (legal, HR, finance), and fringe benefits such as health insurance and retirement contributions. These costs cannot be charged directly to any single contract because they benefit the whole company or a group of contracts. Instead, they are grouped into indirect cost pools and allocated using a formula, typically a rate applied to direct labor, direct costs, or some other base. For example, a fringe rate of 30% applied to direct labor means that for every $100 of direct labor billed to a contract, an additional $30 of fringe costs is also billed. Indirect rates are either established through forward pricing rate agreements (FPRAs) with the government, provisional rates, or final audited rates. DCAA audits contractor indirect cost structures to ensure costs are allowable, allocable, and reasonable under FAR Part 31.

Why Indirect Costs matter for government contractors

Indirect cost rates directly affect a contractor's competitive pricing position and profit margins on cost-type contracts. A firm with bloated overhead structures will have higher rates than leaner competitors, making it harder to win on cost-reimbursement contracts. Managing indirect cost pools, maintaining allowability, and accurately forecasting rate changes are core competencies for government contracting financial management.

Example

A government services contractor has a fringe benefit rate of 28%, an overhead rate of 40% on direct labor, and a G&A rate of 12% on total cost input. When pricing a contract with $1 million in direct labor, the contractor adds $280,000 in fringe, $400,000 in overhead, $40,000 in direct non-labor costs, and then applies G&A of 12% on the total before adding fee. Understanding this cost structure is essential for accurate pricing and for maintaining profitability as rates fluctuate.

Frequently Asked Questions

What is the difference between overhead and G&A?

Overhead costs (also called indirect labor or fringe) typically benefit specific divisions or groups of contracts. G&A (General and Administrative) costs benefit the entire company and are usually the last pool applied to total cost input. The two-pool distinction matters for cost accounting and for allocating costs to the correct contract.

Which indirect costs are "unallowable" under the FAR?

FAR Part 31 specifies unallowable costs, costs the government will not pay even if incurred. Common unallowable costs include advertising and marketing (with narrow exceptions), entertainment, alcohol, fines, penalties, bad debts, lobbying, interest (with exceptions), and executive compensation above government-set limits. Charging unallowable costs to government contracts is a False Claims Act violation.

What is a forward pricing rate agreement (FPRA)?

An FPRA is a negotiated agreement between a contractor and the ACO (Administrative Contracting Officer) that establishes agreed-upon indirect cost rates for future cost estimating and billing purposes. FPRAs reduce disputes over indirect costs in proposal negotiations and contract billing and are particularly valuable for frequent bidders on cost-type contracts.

Does DCAA audit indirect costs for all contractors?

DCAA primarily audits contractors with significant cost-type contract business. Fixed-price contractors may have limited DCAA audit exposure. However, contractors with incurred cost submissions (required annually for cost-type contracts) are subject to DCAA incurred cost audits that review indirect cost allocation and allowability.