If you’re a government contractor, proper cost allocation is absolutely essential to receiving and retaining government contracts. Failure to properly allocate your costs can result in you losing your ability to contract with the government at all in the future, and you may even face fines for improper bookkeeping. We’ve put together a few important reminders for all government contractors, which you should keep in mind when allocating costs on any government contract you handle.

Direct and Indirect Costs

One of the most important differentiations you need to make when allocating your contract expenses is between direct and direct costs. According to FAR, a direct cost is any expense that is specifically identified with a particular final cost objective. To determine whether a cost is direct or indirect, you should ask yourself if you would have incurred the cost if that specific contract did not exist. If the answer is no, then that expense is likely considered a direct cost. This typically includes expenses like labor, materials, contractor costs, travel, etc.

If the answer is yes, you would have incurred the cost regardless of whether or not the specific contract existed, then the expense would be considered an indirect cost. These costs are not directly identified with a single final cost objective, but rather, with multiple final cost objectives or at least a single intermediate cost objective. This includes expenses like rent, utilities, insurance, and depreciation. (Many business owners may also refer to these as overhead expenses.)

Direct costs are typically rather easy to allocate for a specific contract, but many contractors struggle with properly allocating indirect costs. The totals of your indirect costs should be allocated to each contract. Generally, this is done by creating cost pools for overhead, fringe benefits, subcontractor handling, etc. While you can determine how many cost pools you want to create, we generally recommend having more cost pools for a higher level of accuracy and transparency in your bookkeeping.

Overhead vs. G&A Costs

Both overhead and G&A (general and administrative) costs fall within the umbrella of indirect costs. However, it’s important to differentiate between these and allocate them to your contracts appropriately via your cost pools. Overhead expenses are those costs that support a specific operation or function of your company, and are typically related to fulfilling contracts (but not one specific contract). Essentially, overhead expenses exist only because your company has billable work. This can include the cost of security clearance for employees and office supplies, which you would be used in multiple contracts, but which you would not have purchased without billable work.

On the other hand G&A costs are those costs that exist regardless of whether or not you have billable work. These are essential expenses associated with the overall operation of your business, and typically include legal and accounting fees, facility costs, executive costs, and so on. It’s worth noting that employees that charge their time to administrative functions would have their hours allocated to indirect expenses as part of G&A, and not as a direct labor expense for a specific contract.

How We Can Help

Government contract accounting is more difficult than it seems, and a rigid accuracy is essential to continuing to work as a government contractor. If there is any uncertainty regarding how costs should be allocated, it’s far better to hire an accountant experienced with government contracting. At Peter WItts CPA, we specialize in working with government contractors and handling the complexities of government contract accounting. We’re experienced with all of the specifications and requirements to maintain your good standing as a contractor for the United States government.

If you work as a federal or state government contractor, or if you aspire to fulfill government contracts, reach out to Peter Witts CPA today and schedule an appointment with one of our accountants. We can review your books, help you with achieving and maintaining DCAA and FAR compliance, and provide you with the guidance and support you need to successfully work as a government contractor. Call now to schedule your initial consultation.