Requirements to Classify Costs as Indirect when Allocated as Direct

Do you ever have customer requirements to classify costs as indirect when your accounting practices allocate such costs direct?

In some cases, a customer’s request for proposal (RFP) will specify that a particular cost may not be proposed, charged, allocated, or billed to the contract as a direct cost, which may create a conflict with your disclosed or established accounting practices. 

This can result in an inability to include these costs in your cost build up for fixed price contracts, or to recover these costs under your cost-reimbursable contracts. In addition, you may be found not to be compliance with:

  • Federal Acquisition Regulation (FAR) requirements and,
  • If applicable, the requirements of Cost Accounting Standards (CAS) regarding the use of consistent practices for estimating, accounting, and billing.

Some government Procuring Contracting Officers (PCOs) and upper tier contractors believe that certain costs should not be charged direct to their contract or subcontract. For example, an RFP may state: “No travel shall be charged direct to this contract.” Or the RFP may state the same requirement, but with reverse wording, such as “All program management performed on this contract shall be charged as an indirect cost.” In either case, the Procuring Contracting Officers may be creating a conflict with your disclosed or established accounting practices of allocating travel, program management, or other such costs as direct rather than indirect. As a result, the Cognizant Federal Auditor and/or Cognizant Federal Agency Official (CFA/CFAO) may subsequently determine that you are noncompliant with your disclosed or established accounting practices.

It is important to note that the U.S. government CFAO is the only individual that has the authority to determine whether a contractor is in noncompliance with disclosed or established accounting practices. In other words, the Procuring Contracting Officer does not have this authority. Therefore, when the RFP attempts to dictate accounting practices that will cause a conflict, it is important to address the issue during the pre-award process, thereby ensuring appropriate consideration during contract negotiation, mitigating potential post-award disallowances, and avoiding findings of noncompliance due to use of inconsistent estimating and accounting practices.

When the RFP requires you to classify costs in a manner conflicting with established or disclosed accounting practices, you have three options:

First, you can simply ignore the RFP requirement, follow your established or disclosed accounting practices, and include the cost in your cost proposal and/or bill the costs as reimbursable under a cost reimbursable contract. This approach creates a risk that the costs will be rejected or disallowed, and your proposal found non-responsive because the RFP stated that such costs could not be charged or allocated direct to the contract. You could argue that the RFP created a conflict and therefore the costs should be reimbursed; however, the potential risk of cost disallowance and proposal rejection, coupled with the administrative time required to address the issue with the auditor/PCO, renders this a less than desirable option.

Second, you can follow your established/disclosed accounting practice and not propose or bill the costs. While this option will avoid any noncompliance findings by the Government, it also results in your not recovering this cost based solely on the accounting practices used for allocating those costs. You may decide to proceed in this manner, recognizing upfront that the costs will not be considered in negotiating your fixed price contracts or not reimbursed under cost reimbursement contracts and adjusting projected profit margins, as necessary, to address the cost disallowance. Depending on the significance of the cost element and the burden associated with implementing a software solution to administer the deviation, in many cases, this is not the most desirable option.

Third, you can address the issue with the Procuring Contracting Officer during the pre-award stage. Potential methods to address the issue include (a) notifying the Procuring Contracting Officer that the RFP will force you to be noncompliant your disclosed or established accounting practices, and/or (b) stating that you are proposing in accordance with the RFP but reserve the right to recover the costs as direct should the CFA/CFAO determine, prior to or subsequent to contract award, that such costs must be allocated direct to the contract.

To further strengthen the position, you could also pursue contract language stating that the fixed price contract will be equitably adjusted or that the costs will be reimbursed under a cost reimbursable contract should the CFA/CFAO subsequently determine that the costs must be allocated direct to the contract.

Tips

When the RFP requires you to allocate costs in a manner inconsistent with your established accounting practices, the issue should be addressed in the pre-award stage of the contract.

  • Read each RFP closely to determine whether the solicitation contains any specific cost classification or charging criteria as a prerequisite for cost inclusion or recovery.
  • Determine the significance of cost exclusion including the potential effect on price negotiations or cost reimbursement and the benefits and costs of pursuing inclusion.
  • Notify the Procuring Contracting Officer or upper tier buyer (preferably in writing) that the RFP creates a conflict with your established/disclosed accounting practices.
  • State in the proposal that your submission complies with the RFP, but for the particular costs at issue (for example, program management travel, etc.), you reserve the right to recover the costs under the contract should the CFA/CFAO determine that such costs must be allocated direct to the contract.
  • Pursue contract language stating that the price will be equitably adjusted and/or the costs will be reimbursed under the contract should the CFA/CFAO subsequently determine that the costs must be allocated direct to the contract.

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