Proper Use of FAR Overhead Rates Maximizes Cost Recovery on Government Contracts

This article was originally published on July 13, 2016

Maximize cost savings while pursuing Federal and State Contracts

Government contracts represent an attractive opportunity for Architecture and Engineering (AE) firms, especially when economic conditions prove unfavorable for commercial development. Depending on project size and duration, these projects may require an overhead audit to ensure your rates are in accordance with the Federal Acquisition Regulation (FAR). These regulations are designed to provide proper reimbursement for overhead expenses necessary to support project work, and a FAR audit can help maximize cost recovery.

Strategic approaches to FAR compliance 

If you are unfamiliar with FAR’s complexity, the terrain can be tricky to navigate. It calls for a well-structured general ledger, with the cost accounts grouped into appropriate cost pools. It also requires a detailed understanding of the concepts of reasonableness, allocability and allowability when analyzing costs that come into play when calculating your overhead rate. While some may opt to avoid diving into the regulations and use safe harbor rates supplied by the applicable federal or State agency, such estimates tend to be conservative, causing the firm to “leave money on the table.” The choice to circumvent these internal calculations also removes the opportunity to compare the firm’s FAR-compliant overhead rate to median rates within the industry. Benchmarking data by geographic region and firm size provides valuable insights on the firm’s cost efficiency and competitive advantage (or lack thereof).

Fortunately, Aldrich has the expertise to help you examine your cost structure through the lens of FAR regulation and establish systems and processes to track and monitor your overhead rate. A properly designed chart of accounts serves as a critical building block for FAR compliance. It provides the means to segregate allowed and disallowed expenses to facilitate determination of the appropriate overhead rate. It also supports billing, job profitability analysis, and comparisons to industry standards.

Effective cost allocation procedures go hand-in-hand with a proper chart of accounts. Since direct labor is the basis for determining the overhead rate, project costing and labor charging systems must provide a true and accurate accounting for direct and indirect labor costs. Compensation charged against the project must be deemed reasonable based on nationally published survey data. These expenses are subject to close scrutiny during FAR audits.

The cost allocation procedures must also support appropriate characterization of non-labor costs. Both direct and indirect costs may be charged to contracts if deemed allowable and reasonable. Direct costs are incurred specifically to satisfy the terms of the contract; indirect costs support the overall operation of the firm. Noteworthy prohibitions under FAR include advertising, bad debt, contributions, personal use of company vehicles, fines and penalties, lobbying and political activity, and interest expense. That being said, some of these costs may be claimed legitimately as contractually relevant expenses. For example, marketing costs directly attributable to the contract – e.g., bid and proposal costs – may be eligible for reimbursement. Firms may also recover a Facilities Capital Cost of Money (“FCCM”) related to fixed assets used in their operations. This calculation stands apart from the overhead computation and leverages a published interest rate determined by the U.S. Secretary of the Treasury.

A published guide by the American Association of State Highway and Transportation Officials (AASHTO) places responsibility for identifying, segregating, and removing unallowable costs from all governments on management’s shoulders. As such, management must institute appropriate internal controls to ensure that the accounting staff has the wherewithal to post all relevant transactions accurately as they occur. It is not acceptable to await the CPA’s year-end audit to uncover disallowed charges.

Management also bears responsibility for selecting a CPA to conduct the FAR audit. Due to the technical requirements of this audit, it should be performed by individuals with a working knowledge of the AE industry (e.g., trends, risk factors, operating practices, contract administration, job costing accounting and associated systems) as well as experience performing FAR audits. Such audits must be performed in accordance with Generally Accepted Government Audit Standards (“GAGAS”) which requires continuing professional education (CPE) in governmental auditing. They must also be capable of generating a report on the AE firm’s compliance with Government regulations, including FAR Part 31 and related laws as well as internal controls related to payroll, cash disbursements, and other transactions impacting the FAR overhead calculation. And, of course, they should have favorable peer reviews.

While the task at hand may seem daunting, experts are available to help you gain an understanding of your regulatory responsibilities and develop the systems, procedures, and controls to comply with them. When these things have been put in place, your bottom line can be enriched through pursuit of federal and State government contracts.