FAR 31 Series (Part 3, Direct and Indirect Costs)

As we close in on the specific examples of allowable and unallowable costs in FAR 31.205, I wanted to discuss FAR 31.202 and FAR 31.203 dealing with Direct and Indirect costs.

Direct Costs

With direct costs, the regulation goes with an indirect approach:

“FAR 31.202(a) No final cost objective shall have allocated to it as a direct cost any cost, if other costs incurred for the same purpose in like circumstances have been included in any indirect cost pool to be allocated to that or any other final cost objective. Direct costs of the contract shall be charged directly to the contract. All costs specifically identified with other final cost objectives of the contractor are direct costs of those cost objectives and are not to be charged to the contract directly or indirectly.”

In this paragraph, the meaning is simply “direct costs shall be charged directly to the contract.”  All of this talk of final cost objectives and allocations really leads to the conversation on indirect costs and doesn’t provide any clarity to the matter.  It all comes down to where the benefit lies.  Other than accounting and finance folks, direct versus indirect costs are not a normal discussion topic.

rocketAn example of a direct cost would be the labor spent on building a NASA rocket.  To be clear, it is not the person’s salary or wages in general.  The time spent working on the rocket, specifically, or on the project deliverables, specifically, are direct costs.  It doesn’t take a rocket scientist to realize that any hours spent on things other than directly on the rocket project should be charged to something else (potentially an indirect cost).

As with all things government and/or accounting, there is an exception.  You are able to charge immaterial amounts of direct charges as indirect as long as there is a policy and procedure in place for doing so.

Indirect Costs

Indirect Costs are a little more complex.  The regulation spans paragraphs from (a) through (i) mentioning CAS right at the beginning.  But wait, you say!  I am not subject to CAS, I am only interested in knowing what FAR requires of me for indirect costs.  See paragraph (b) to start.  There are steps to this process, so go slow.

First, have you allocated all of your direct charges?  NO?!  Then get back up to the previous section and figure those out first.  Then, when you are done, come back here… (I’ll wait).

Basically, indirect costs are all the other costs of a business that must be allocated to intermediate or final cost objectives.  Intermediate cost objectives?!  Wow!  How complex is this going to get?  Hang in there, we will get through it.  Perhaps you should have paid more attention to your accounting professor the first time, but I am here to help.  Intermediate cost objectives are those that can be further allocated to one or more indirect cost pools.  An indirect cost pool is a homogenous “logical” grouping of costs.  This is not an easy task to group costs in many cases.  The structures for indirect cost pools and rates can be very cumbersome and detailed.  Some of the common indirect cost rates are Fringe, Overhead, and G&A.  I have seen companies with revenues under $10 million with as many as 10 indirect rates (very detailed and complex, but easy to audit) and as few as 1, G&A, rate.

An example of an indirect cost would be the administrative assistant, executive, or perhaps health-insurance2even the cost of medical insurance at the company building the NASA rocket.

Some of the indirect cost allocation debate really comes down to preference.  How detailed you go depends on your circumstances, but in the end must be equitable to the government.  I highly recommend getting a professional involved with a finance/accounting background if you are unfamiliar with building indirect cost structures.  There are also a lot of online resources that could help – none of which I have used nor could I endorse.

The next topic actually goes backward in the regulation – credits and accounting for unallowables.

About Marty Herbert

With 13 years of government contract administration, analysis, finance, and audit experience, I have established a firm baseline in ethics and a specialization in government contracts that has prepared me to become a subject matter expert in my field. I am currently working on enhancing government contracts management and compliance through workflow tools and product offerings - attempting to make the process proactive as opposed to reactive.
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