The Incurred Cost Submission

Most compliance obligations in government contracting are matters of degree. Controls can be stronger or weaker, documentation more or less complete, policies better or worse written. The incurred cost submission is not like that. It was filed by the deadline or it was not. It was determined adequate or it was returned. There is no partial credit and no interpretive room, which is precisely why it is the first thing a diligence team asks for and the thing that most reliably reveals how a contractor actually operates.

What It Is

The Allowable Cost and Payment clause at FAR 52.216-7, incorporated in essentially every cost-reimbursable contract, requires the contractor to submit a final indirect cost rate proposal within six months after the close of its fiscal year. The proposal reconciles what the contractor actually spent against what it billed at provisional rates, proposes final rates for the year, and supports those rates with the underlying cost data.

The government then audits or otherwise resolves the proposal, final rates are negotiated, and the year is closed out. Every year that has not been through this process is an open year — a year in which the contractor's revenue and the government's payment obligation are both still provisional.

What Goes In It

DCAA publishes the Incurred Cost Electronically model — universally called the ICE model — as a standard workbook contractors can use to assemble the submission. It is not mandatory in form, but the schedules it contains reflect what the auditor expects to receive, and submitting something structurally different mostly creates friction.

The schedules run through the alphabet and cover, in substance:

• Each indirect cost pool, with its constituent accounts, and the base over which it is allocated
• The calculation of claimed final indirect rates for the year
• A reconciliation of total claimed costs to the general ledger and to the financial statements
• Direct costs by contract, with cumulative allowable cost claimed against each
• A schedule of contract-level information: contract type, ceiling, period of performance, funding
• Identification of unallowable costs excluded from the proposal
• Executive compensation supporting the reasonableness of amounts claimed
• Subcontract information, including subcontract type and value
• Reconciliation of billed to claimed amounts, which is where over- and under-billing becomes explicit

The submission must also be certified. That certification is a representation by an authorized official that the proposal contains no costs that are expressly unallowable, and it is not a formality — it is the hook on which liability for knowingly claiming unallowable costs hangs.

Adequacy Is a Separate Test From Timeliness

Filing on time is necessary but not sufficient. DCAA performs an adequacy review before accepting a submission into the audit queue. An inadequate submission is returned, and the clock effectively continues to run.

The recurring adequacy failures are unglamorous:

• Claimed costs that do not reconcile to the general ledger or to the financial statements
• Missing or incomplete schedules, particularly the contract-level and subcontract schedules
• No identification of unallowable costs, or unallowables backed out in aggregate without account-level support
• Executive compensation claimed without supporting reasonableness analysis
• Cumulative allowable cost worksheets that do not agree to what was actually billed

Almost all of these trace back to the same root cause: the submission is being assembled from scratch in the spring, from a general ledger that was never structured to produce it, by someone reconstructing a year of decisions after the fact.

The Backlog Problem

Open years accumulate for reasons that are individually understandable. A finance leader departs. A year is genuinely complicated by a restructuring or an acquisition. The company is growing fast enough that current-year operations crowd out prior-year cleanup. Nobody is asking for it, so it slides.

The problem compounds in a specific way. Each year's submission depends on settled prior-year rates for its cumulative allowable cost calculations. A gap early in the sequence obstructs everything after it. A contractor that skipped one year does not have one problem — it has a chain, and clearing the chain requires working through it in order.

Meanwhile the exposure grows quietly. Every year billed at provisional rates that exceeded actuals carries a repayment obligation that nobody has computed. When the audits finally happen, several years settle at once.

Why This Is the First Diligence Request

Buyers and their quality of earnings providers ask for the incurred cost submission history early, and they ask for it because it is a fast, high-signal test.

A contractor that files on time, files adequately, and has few open years has demonstrated something that no management presentation can demonstrate: that its accounting system produces contract-level cost data reliably, that unallowable costs are identified as they are incurred rather than reconstructed later, and that finance leadership is capable of meeting a hard external deadline with a certified deliverable.

A contractor with a backlog has demonstrated the opposite, and the buyer will price it. The mechanics vary — escrow against settlement exposure, a specific indemnity, a holdback until years are closed, or in the transactions where the backlog is large enough, a reduction in the multiple applied to the whole business on the theory that the reported earnings themselves are not yet reliable.

The remedy is unglamorous and takes time, which is why it needs to start well before a process does. Clearing a multi-year backlog is a matter of quarters, not weeks, and a contractor that begins it when the banker is already engaged has left the value on the table.