How to Calculate Indirect Costs for Government Contracts

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Obtain detailed company financial data before beginning indirect cost calculations.
Obtain detailed company financial data before beginning indirect cost calculations. (Image: Push/Photodisc/Getty Images)

Knowing how to calculate your indirect costs for recovery on a government contract enables you to break even or make a profit on work performed. Indirect costs are business expenses you incur which do not belong to just one job. Even though the personnel processing your payroll and the rental facility of the main office have no direct association with a specific job, you need a means of recovering their costs to remain in business. Other examples of indirect costs that benefit more than one program or function include executive salaries, office equipment and legal expenses. To accurately determine your indirect cost rate you must determine which expenses fall into this category and how they apply to each job performed.

Things You'll Need

  • Financial data
  • Company accounting procedures

Review the company’s most recent annual financial data statements, using audited documents if available. If statements are not detailed, request breakdowns of all expenses from the previous year. Determine any previously used method of allocation for indirect costs and identify any established allocation bases or direct cost pools to which the indirect costs apply.

Create an accounting worksheet or electronic spreadsheet to separate direct costs and indirect costs, using the detailed breakdown. List any expense unique to a particular program as a direct cost. Accumulate costs applicable to multiple functions in a column for indirect costs.

Review regulations established by the government agency with which you contract and remove any unallowable costs and capital expenditures. If agency regulations differ significantly on allowable cost items, consider establishing new direct cost pools to avoid skewed or disproportionate rates. Segregate any expense that does not apply to all functions.

Decide the direct cost pool to which each indirect cost applies. Some indirect costs, such as executive salaries, apply to all pools, while unique expenses such as liability insurance for equipment only apply to programs requiring the cost. If no unique expenses exist, a single indirect rate may suffice; otherwise allocate indirect costs only to functions that receive a benefit from them.

Determine the allocation method you will use for distributing indirect costs to each direct cost base pool. To determine the indirect cost rate using a modified total direct cost method, divide the value of the allocated indirect costs by the total direct costs of each base pool. Indirect costs are typically expressed as percentages. To determine the percentage, multiply the result by 100.

Tips & Warnings

  • Review any previous audit reports and resolve discrepancies before calculating new indirect costs.
  • Indirect costs may include items you refer to as overhead, fringe benefits or G&A expenses.
  • Settling final payment for government contracts may require submission of an indirect cost proposal.

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