A government contractor has to deal with strategic costing and strategic pricing very effectively in order to make correct business decisions. If you do not know the requirements for indirect rates, direct and indirect costs and the strategic calculation of direct and indirect cost rates, then your business will not thrive. Your proposals will be unprofitable and you will not get paid what you should on the government contract work performed. It all starts with understanding the fundamentals of strategic costing and pricing.
A Government Contractor’s Accounting System is required to be a logical and consistent method for the allocation of indirect costs to intermediate and final cost objectives. So first we need to understand costs.
Direct Costs per FAR 31.202, are any costs that can be specifically identified with a particular final cost objective.
Direct Costs must include the total expenditures, including costs of contract administration directly assignable to the specific end product or result achieved. Direct costs include direct labor, direct materials, direct Subcontracts and Other Direct Costs.
Indirect Costs per FAR 31.202, are those incurred for common or joint objectives and cannot be specifically identified with a particular final cost objective because of the nature of the cost involved. These costs are generally allocated on some readily determinable standard which is fair and equitable as determined by management officials who have authoritative responsibility for both direct and indirect costing matters .
A cost must be either direct or indirect, and must be treated consistently. The purpose of indirect rates is to allocate indirect costs to final cost objectives on some readily-determinable basis. A government contractor’s indirect rate structure must mirror their Company and will be different for each Company. Your cost structure should not be dictated by the Government or a Prime Contractor and it is important that it reflects your business because you must be able to defend your allocation of costs to final cost objectives on a consistent basis through beneficial, causal relationships.
Some examples of rates to consider when coming up with your cost structure are, direct and indirect rates, Fringe benefit rates, Overhead rates, Client site and Company site Rates, SG&A Rates, Value Added Rates, Material Handling Rates, and Major Subcontractor Rates.
Total Time Accounting requires the accounting period to be divided into cost-allocation periods in which total costs are allocated equally to each unit of production for the period. This applies to salaried Individuals working more than the standard 80 hours. This is required by FAR 52,237-10 and preferred by DCAA as it utilizes an effective rate versus a standard hourly rate. It is important that all proposed labor hours and recorded labor hours utilize total time accounting and you must be consistent.
All indirect costs must be cost-effectively identified so you can properly allocate them to final cost objectives when strategically costing and pricing your government contracts work.
Unallowable costs are not reimbursed by the Government. Your accounting system must allow for the identification and segregation of unallowable costs. There are penalties for including unallowable costs, so remember to keep track of these and treat them correctly when calculating indirect rates
FAR 31.201 states that the amount proposed for profit or fee shall represent the contractor’s best estimate of what it has earned on recent similar Government contracts valued at approximately the same amount. Pricing history is one method used to support estimated profit/fee rationale. However, actual results under other Government contracts are more relevant than pricing history when developing estimated future costs because they contain information about the costs associated with the technical approach proposed. Do not overlook proposing profits.
Cost realism is critical in proposal development. The government’s responsibility in ensuring cost realism is to ensure that estimated costs are realistic for the work to be performed; that they do not exceed what the contractor can reasonably expect to incur for an acceptable contract performance; and, if necessary, that any proposal exceeding available appropriations be identified as such prior to award.
The contracting officer has a duty of candor in determining whether a proposed price is fair and reasonable, and therefore realistic. If a submitted price appears too high or low, the contracting officer will likely compare it with prices in other proposals – if available. Remember to price strategically and realistically when submitting your government contracts proposal, understanding that strategic pricing is important to get the desired profit.
The contractor must supply adequate proof to the government so that it can trust the information as current, accurate, and complete. The burden of proof lies with the contractor in establishing the reasonableness of proposed costs.
Government audits are conducted for compliance with terms and conditions of a government contract. The purpose of an audit is to provide reasonable assurance that the contractor’s financial records are accurate, complete, properly authorized, and correctly dated or timed. Such audits are performed by the Defense Contract Audit Agency (DCAA) which has authority under Federal Acquisition Regulation 49.202-1(c) to examine all books, documents, papers, and records that directly or indirectly relate to expenses incurred or revenues generated under Government contracts
Understanding the strategic calculation of direct and indirect rates is very important because they are used to determine your overall profitability on a job, if you are profitable you get paid, if not you don’t get paid. At the end of it, strategic costing and strategic pricing is about knowing enough about your business that you can justify what your company did or did not do in order to maximize profitability on every contract. Strategic costing and strategic pricing are essential to any contractor and are strategic tool to help you will succeed in the long run.
If you have any questions about strategic costing or strategic pricing, reach out to your PBMares representative or the Government Contracting Team.