*This is Part 6 of a 6-part blog. Each part addresses the fundamental requirements and techniques for application related to the standard, and provides specific examples.
- Part 1 addressed the overall purpose of the standard, as well as the requirements/techniques for application related to direct costs.
- This Part 2 addressed the requirements/techniques for application related to indirect cost pools.
- Part 3 addressed the requirements/techniques for application related to allocation bases (with the exception of the allocation of indirect cost pools that benefit each other, which is addressed in Part 4 of this blog).
- Part 4 addressed the requirements/techniques for application related to allocation bases for the allocation of indirect cost pools that benefit each other.
- Part 5 addressed special allocations.
- This Part 6 addresses pre-determined indirect rates.
Background: This standard provides the criteria for the accumulation of indirect costs, including service center and overhead costs, in indirect cost pools. It also includes guidance relating to the selection of allocation measures based on the beneficial or causal relationship between an indirect cost pool and cost objectives. The standard covers the allocation of indirect costs for indirect cost pools other than those covered by CAS 403 (allocation of home office expenses to segments); CAS 410 (allocation of G&A expenses), and CAS 420 (allocation of “Bid & Proposal” and “Independent Research & Development” costs).
Pre-Established Indirect Cost Rates
- In accordance with CAS 418.50(g), pre-established rates may be used in allocating an indirect cost pool if the following criteria are met:
1. The pre-established rates are based on either forecasted actual or standard cost.
EXAMPLE: A contractor uses pre-established rates that are based on the prior year actual rates without consideration for forecasted events (e.g., new sales, contracts that will be completed, changes in wages/prices, etc.). This practice is in noncompliance with CAS 418, since the pre-established rates are not based on forecasted actual or standard cost.
2. The pre-established rates reflect the costs and activities anticipated for the cost accounting period except when:
a. The contracting parties agree otherwise; and
b. The contractor has written policies that are consistently applied for the establishment of these rates.
EXAMPLE: The contractor has a long and established history that indicates very little fluctuation in indirect rates. The contractor and Government have therefore agreed to the use of pre-established rates in accordance with the contractor’s established policy. Under that pre-established policy, the contractor uses an average of the prior three years actual indirect expense rates. The rates for FY 2011 through FY 2013 are shown below:
|FY 2011||FY 2012||FY 2013||Average|
The contractor therefore uses pre-established rates of 42% for General Overhead, 22% for Site Overhead, and 5% for Material Overhead. The use of these pre-established rates complies with CAS 418 because (a) the Government and contractor agreed to the use of this rate, and (b) the rate was computed in accordance with the contractor’s established policy.
3. The pre-established rates are reviewed at least annually and revised as necessary to reflect anticipated conditions.
EXAMPLE: A contractor has a written policy that requires a review of the pre-established rates every quarter, and revise them as necessary to show the anticipated new rates. This policy complies with CAS 418, although any significant variances between the old and new rates must be allocated in accordance with Item 4 below.
4. When pre-established rates are revised during a cost accounting period, any material variances accumulated at the time of the revision are allocated to cost objectives in proportion to the costs previously allocated using the pre-established rates.
EXAMPLE: For FY 2013 that begins on January 1, 2014, a contractor has a pre-established rate of 30% for its Fringe Benefits Pool, which is allocated on the basis of direct labor dollars. On July 1, 2014, the contractor revises the rate to 25% to reflect changes in the anticipated rate for the year (a difference of 5%). The total direct labor dollars incurred as of July 1, 2014, are $40,000,000. Thus, the contractor has over allocated the fringe benefit costs by $2,000,000 (5% x $2,000,000). The contractor therefore is required by CAS 418 to allocate the variance in proportion to the costs previously allocated using the pre-established rates as follows:
|Cost Objective||Direct Labor Dollars as of July 1, 2014||Difference in Rate||Allocation of Variance|
|Contract A||$12,000,000||5%||$ 600,000|
|Contract B||$10,000,000||5%||$ 500,000|
|Contract C||$15,000,000||5%||$ 750,000|
|Overhead Labor||$1,000,000||5%||$ 50,000|
|G&A Labor||$1,500,000||5%||$ 75,000|
|B&P/IR&D||$ 500,000||5%||$ 25,000|
Thus, in accordance with CAS 418, the contractor must reduce the total costs of Contract A by $600,000, Contract B by $500,000, Contract C by $750,000, Overhead by $50,000, G&A by $75,000, and B&P/IR&D by $25,000.
5. Whether or not pre-established rates are revised during the cost accounting period, all material variances at the end of the period between the pre-established and the actual rates are disposed of by allocating them to cost objectives in proportion to the costs previously allocated using the pre-established rates.
EXAMPLE: The contractor uses a pre-established rate for centralized computer services. For FY 2013, the pre-established rate is $45 per computer hour. During FY 2013, the centralized computer services pool incurred total costs of $5,000.000, with usage totaling 100,000 hours, for an actual rate of $50 per hour ($5,000,000/100,000), a $5 variance from the pre-established rate ($50-$45). The hours incurred by cost objectives and the allocation of the variance is shown below:
|Cost Objective||Computer Hours(A)||Difference in Rate(B)||Allocation of Variance(A*B)|
|Overhead Labor||5,000||$5||$ 25,000|
|G&A Labor||2,000||$5||$ 10,000|
Thus, in accordance with CAS 418, the contractor must allocate the variances by increasing the costs by $200,000 for Contract S, $150,000 for Contract T, $100,000 for Contract U, $25,000 for the Overhead pool, $10,000 for the G&A pool, and $15,000 for the B&P/IR&D pool.