Amid evolving government priorities – including the methods by which goods and services are acquired – contractors are adapting to provide customers with more products/services at less cost. One particularly valuable tool to accomplish this is to enhance the organization’s indirect rate structure for a more agile and cost-effective methodology to recover costs on government contracts.
Optimizing your indirect rate structure delivers key advantages, including:
- Costs aligned to the functions and contracts utilizing the activities.
- Consistent, best-in-class practices across the business.
- Reduced administrative requirements associated with maintaining and monitoring indirect rates, and preparing numerous Incurred Cost Proposals (ICP) and Forward Pricing Rate Proposals (FPRP).
When making these changes, government contractors are subject to regulatory requirements. However, these rules shouldn’t prevent you from implementing enhancements that ultimately improve the business and drive competitive advantage.
Regulatory Hurdles of Changing Indirect Rate Structure
For contractors subject to the Cost Accounting Standards (CAS), several regulatory requirements must be addressed when changing the indirect rate structure.
First, contractors must identify whether each of the changes will be considered a cost accounting practice change (CAPC). This is where the complexities begin because not all changes are considered a CAPC. For example, combining indirect cost pools that use the same method or technique (allocation base) to allocate costs would not be considered a CAPC. This determination is important because only changes that are a CAPC will require a general dollar magnitude (GDM) or detailed cost-impact (DCI) proposal (or potentially both), which informs the government of the prospective change in costs on CAS-covered contracts.
Once changes that are a CAPC are determined, the complexities continue with the onerous and complex requirements for preparing GDM or DCI proposals.
Recent court cases and regulatory changes have added even greater confusion to these requirements. For example, the Defense Contract Audit Agency’s (DCAA) 2023 guidance on unilateral cost accounting practice changes reignited a debate stretching across four decades on how fixed-price contracts should be accounted for in these cost impacts.
Additionally, forthcoming court decisions will determine whether changes made to FAR 30.606 in 2005 (yes, over 20 years ago) that prohibit offsetting multiple, simultaneous CAPCs are valid. Navigating these requirements and accurately preparing GDM or DCI proposals are essential because the calculations identify whether contractors might owe the government money for increased costs on CAS-covered contracts.
For government contractors that were recently part of a merger or acquisition, evaluate the pros and cons of preparing an external restructuring proposal. One of the main pros of this approach would be to avoid the GDM and DCI requirements.
Steps to Assess and Implement Indirect Rate Structure Changes
Regulatory hurdles and implementation complexity shouldn’t prevent companies from pursuing cost efficiencies. The following are key steps that can be used to evaluate the indirect rate structure that’s appropriate for your company:
- Identify your go-to-market strategy: Changes to your indirect rate structure will be made on a prospective basis, so it’s important to not just look at the structure of your company today but understand what you want to be in the future. Identifying whether your strategy includes being a service or software provider, a software developer, a manufacturer, an integrator that relies on subcontractors, or a combination of all of these, is an important step in determining the appropriate allocation methodology for indirect costs and whether a single rate segment or multiple rate segments is most appropriate.
- Centralized vs. decentralized organization: A decentralized organizational structure could be desired to segregate your commercial and government business or to drive decision-making and accountability at a lower level in your business. However, decentralization can often prevent the proper scaling of certain functions and impede consistent practices being used throughout the company. Conversely, a centralized structure can flatten the organization and allow leadership to ensure consistent practices are implemented throughout the entire organization. Evaluating the pros and cons of a centralized or decentralized structure and analyzing how indirect cost pools can be used to implement a centralized structure are key aspects of identifying the indirect rate structure appropriate for your company.
- Understand your backlog: Understanding the impact to your backlog, as well as to outstanding proposals and key upcoming pursuits, should be an integral part of the decision-making process when evaluating changes you might implement. To properly identify this impact, ensure the data in your backlog is accurate. This includes information such as the estimated costs by cost element for your contracts, whether the contract is subject to CAS, and the contract type. This information is needed to prepare not only the GDM and DCI proposals discussed previously but also to ensure you have an accurate understanding of the financial ramifications of any changes to both CAS and non-CAS-covered contracts.
- Identify cost reduction opportunities: Implementing changes to your indirect rate structure is an optimal time to determine if cost reduction initiatives could also be implemented. Utilize a blank sheet approach that includes benchmarking headcount and costs against competitors and identifying specific savings targets across every layer of the business, which can allow you to resize the organizational structure to realize cost savings.
Next Steps
Administrative requirements shouldn’t prevent CFOs from making changes that could result in agile, efficient cost structures. CrossCountry Consulting’s team of integrated government contracting experts enables organizations to understand and integrate regulatory requirements and industry best practices. With the right tools, technology, and advisory support, your company can identify the appropriate indirect rate and cost structure to minimize administrative effort and fulfill regulatory requirements associated with these changes.
To get started, contact CrossCountry Consulting today.