Indirect Rates (IR)

Indirect Rates are percentage-based cost rates used to allocate indirect business expenses to contracts, projects, or other cost objectives. In government contracting, they commonly include overhead, fringe, and G&A rates applied to direct labor or other approved allocation bases.

What Are Indirect Rates?

Indirect Rates are percentage-based cost rates that federal contractors use to allocate indirect business expenses to specific contracts, projects, or other cost objectives. The contractor accumulates indirect costs in defined pools (typically fringe, overhead, G&A) and divides each pool by an allocation base (often direct labor dollars for overhead, total cost input for G&A) to derive a rate.

The rate is then applied to direct cost on each contract during proposal pricing and billing. Indirect rates fall into two practical categories: provisional rates (used during the year before actuals are known) and final rates (negotiated after year-end through the Incurred Cost Submission process).

Key Characteristics

Indirect rates have several defining features. They are calculated as pool divided by base, expressed as a percentage.

A typical contractor has multiple rates: a fringe rate applied to direct labor, an overhead rate applied to direct labor plus fringe, and a G&A rate applied to total cost input. Rates are negotiated annually through forward pricing rate agreements (FPRAs) or accepted as provisional pending year-end true-up.

Final rates are settled after year-end through the ICS process, which DCAA audits on contracts above audit thresholds. Rates must comply with Cost Accounting Standards where applicable and with the cost principles in FAR Part 31. Rate movement during a contract's life affects both proposal margin and billing reconciliation.

How It Works in Government Contracting

Indirect rates operate at three points in federal contracting. First, during proposal pricing, contractors apply provisional rates to direct cost build-ups (labor, materials, subcontractors) to derive the fully burdened price.

Strong proposals reference current FPRAs or recent DCAA-validated rate history. Second, during contract performance, contractors bill at provisional rates on each invoice, with the agency paying based on the rates and the contractor adjusting later as actuals develop.

Third, at year-end true-up, contractors submit an Incurred Cost Submission comparing actual rates to provisional, and DCAA audits the submission to settle final rates and adjust prior billings. Misalignment between provisional and actual rates can create substantial billing adjustments. Our piece on proposal accuracy and compliance covers indirect rate discipline.

Real-World Example

A federal services contractor has $5 million in annual direct labor with an overhead pool of $3.75 million (75 percent overhead rate) and a G&A pool of $1.05 million on $8.75 million total cost input (12 percent G&A rate). The contractor proposes a $2 million task order with $800,000 direct labor, applying the 75 percent overhead and 12 percent G&A to derive a fully burdened $1.66 million proposal price plus profit.

During performance, actual overhead trends to 72 percent (slightly lower than provisional) because facility costs are lower than budgeted. At year-end, the contractor submits an ICS showing actual rates of 72 percent overhead and 11.5 percent G&A.

DCAA audits, the agency adjusts prior billings downward by the rate variance, and the contractor refunds approximately $24,000 on the task order. Disciplined rate tracking during the year prevented surprise at year-end.

Regulatory Framework

Indirect rates are governed by FAR Part 31 (Contract Cost Principles), particularly FAR 31.203 (Indirect costs) and FAR 31.205 (Selected costs). Cost Accounting Standards in 48 CFR Chapter 99 add precise rules for contractors above CAS thresholds.

FAR 42.7 governs final rate negotiation, and FAR 42.17 governs forward pricing rate agreements. DCAA audit procedures are in the DCAA Contract Audit Manual (DCAM). For DoD contractors, DFARS 252.242-7006 governs accounting system requirements that support rate calculation.

Why It Matters for Contractors

Indirect rate accuracy determines whether federal contractors price competitively and bill correctly. Wrong proposal rates cause lost bids or won-but-unprofitable work.

Wrong billing rates produce DCAA findings, billing adjustments, and False Claims Act exposure. Past performance evaluations reflect how cleanly contractors handle indirect rate management under the cost control factor.

Strategic contractors maintain rolling forecasts of indirect rates updated monthly, negotiate forward pricing rate agreements to lock proposal rates, and review pool composition annually for compliance. Our piece on the ROI of an AI proposal platform covers how rate discipline drives proposal velocity.

Common Misconceptions

Indirect rates are fixed once the year starts.

They are not. Provisional rates apply during the year; final rates are negotiated at year-end through ICS. Actuals vary from provisional and require billing adjustments.

All federal contractors use the same indirect rate structure.

They do not. Each contractor designs its own pool and base structure based on business model, contract mix, and CAS coverage. Schemes vary widely in complexity.

Higher indirect rates mean worse contractor.

Not necessarily. Rates reflect cost structure and business model; some industries inherently carry higher rates. The relevant question is whether rates are competitive within the contractor's market segment.

Frequently Asked Questions

What is the difference between a provisional rate and a final rate?

Provisional rates are negotiated or accepted for use during a fiscal year before actuals are known; final rates are negotiated after year-end through ICS based on actual cost incurrence. The difference between them produces billing adjustments at year-end.

What is a Forward Pricing Rate Agreement (FPRA)?

An FPRA is a written agreement between the contractor and a cognizant contracting officer establishing certain rates for use in proposals over a defined period. FPRAs reduce repeated negotiation of the same rates on each proposal.

How does DCAA audit indirect rates?

DCAA audits indirect rate submissions (ICS) on a risk-based sampling basis. Audits test pool composition, allocation base accuracy, unallowable cost exclusion, and consistency with disclosed accounting practices. Our capture management guide covers audit preparation.

What costs are unallowable in indirect rate pools?

FAR 31.205 lists unallowable costs that must be excluded from rate pools: entertainment, advertising for general firm promotion, lobbying, certain legal costs, and others. Including unallowable costs produces DCAA findings and penalty assessments.

How often should indirect rates be reviewed?

Monthly during the year for management visibility, with formal updates at quarterly variances. Forward pricing rate proposals are typically refreshed annually or whenever significant cost structure changes occur.

Strategic Importance

Indirect rate accuracy determines whether federal contractors price competitively and bill correctly. Wrong proposal rates cause lost bids or won-but-unprofitable work. Wrong billing rates produce DCAA findings, billing adjustments, and False Claims Act exposure.

Strategic contractors maintain rolling forecasts of indirect rates updated monthly, negotiate forward pricing rate agreements to lock proposal rates, and review pool composition annually for compliance. For small businesses entering cost-type contracting, disciplined rate management is essential to avoid audit findings that can disqualify them from future work.

Related Government Contracting Terms: Indirect Cost · General and Administrative Expenses · Fringe Rate · Defense Contract Audit Agency · Cost Accounting Standards · Incurred Cost Submission · Adequate Accounting System · Job Cost Code · Labor Rate