I am commonly asked questions about what is the proper accounting for direct and indirect costs under government contracts. This is also a very common problem that contractors face with DCAA, where costs are questioned because the DCAA claims costs are not recorded in accordance with these standards. Often contractors need help with complying with this rule, notably FAR 31.202 and FAR 31.203. I outline these requirements and provide recommendations on how to best meet these requirements.
FAR 31.202 and FAR 31.203 as well as the government’s accounting system requirements stipulate that contractors must consistently charge costs direct and indirect. First,lets define these terms as they may apply to a government contract.
Direct Costs: Direct costs are defined as follows.A direct cost is any cost that can be identified specifically with a particular final cost objective.(FAR 31.202) In layman’s terms this means a direct cost is one that can be assigned to one project or contract and only one. Typically the cost was required to perform the scope of work or necessary to perform the scope of work. The key term is can be identified to one contract or project.
Indirect Costs: An indirect cost is any cost not directly identified with a single, final cost objective, but identified with two or more final cost objectives or an intermediate cost objective. (FAR 31.203). In layman’s this means any cost that is not assignable or identifiable to one contract or project.
Consistency: The idea that the contractor be consistent in charging costs direct or indirect is underscored in both of these regulations. Matter of fact, this is where contractors have conflicts with DCAA. In such cases the DCAA makes claims that the contractor has not consistently charged costs direct or indirect suggesting the contractor is double dipping the government. In layman’s terms this means the cost incurred for under same purposes and like circumstances must consistently charge this cost type. This does not mean that a cost label such as supplies cannot be charged direct in some cases and indirect in others. Account names do not control. Purpose controls. For example, supplies purchased specifically for a project can be charged direct. Whereas, supplies purchased for the accounting department should be charged indirect. Although the account has the same name, its purposes were different. On the one hand, a supply was purchased specifically for acontract and the other was purchased to perform an indirect function, accounting. These are costs incurred in different circumstances. But keep in mind, once a contractor decides a certain treatment it must consistentlly apply this practice. For example, in this example, all supplies purchased specifically for a contract or project must always be charged direct. Contractors can not modify the cost charging practice on different contracts. The policy must be applied consistently on all projects. For example, project management cannot be charged direct on one contract and indirect for others.
Sounds straight forward right. Hardly. Certainly for most costs this is straight forward. But there are always exceptions, where the dividing line is not clear. In these cases, the purpose of the cost must be considered carefully and apply the above definitions.
Suggestions:
It is important that contractors establish a policy on direct versus indirect costs. This policy will define the criteria it uses to charge costs direct and indirect. It may also even outline which cost types are charged direct and indirect as well as the circumstances where a cost may be charged direct and indirect. Obviously, the accounting practice must consistently follow this policy.
When asked questions about charging a cost direct or indirect I always refer the contractor to the following questions. Is the cost required for the contract or necessary for contract performance? Is the cost identifiable to one contract or project? Is it your practice to charge this cost incurred in similar circumstances on other projects direct? If the answer is yes to all these questions, then it is a direct cost. For all others it is indirect.
It is important that accounting personnel be trained and well versed in these concepts and apply these concepts consistently in recording its costs. Accounting personnel, when drilled by DCAA, must be able to consistently articulate and substantiate its cost accounting practices regarding direct and indirect costing.
Consistently applying these concepts is very important to be successful as a government contractor performing contracts based on cost or pricing data, negotiated contracts or under contracts where the contract price or billings are based on cost. Failure to consistently apply these rules will likely place the contractor in a negative position with DCAA or the contracting officer. It is just a matter of time.
