Indirect Rate Structure for GovCon Companies

Indirect rates are the single most consequential accounting decision a government contractor makes, and most contractors make it once, early, without much thought, and never revisit it. The structure gets set up by a bookkeeper in year one to satisfy a single cost-reimbursable award. Ten years and forty million dollars of revenue later, the same three pools are still in place, the G&A base still includes things it should not, and nobody can explain to a buyer why the overhead rate moved eleven points in two years.

What Indirect Rates Actually Are

Direct costs are the costs you can identify with a specific contract: the labor of the engineer billing to that contract, the materials consumed on it, the travel taken for it. FAR 31.202 defines them, and they are the straightforward part.

Indirect costs are everything else that supports the business but cannot be traced to one contract. The controller's salary. Rent. Liability insurance. The proposal team. FAR 31.203 governs how these are handled: they are accumulated into logical groupings called pools, and each pool is allocated across contracts using a base that bears a reasonable relationship to the costs in that pool.

An indirect rate is simply pool divided by base. A fringe pool of $1.8M over a direct labor base of $6M produces a 30% fringe rate. Every dollar of direct labor charged to a contract carries thirty cents of fringe with it.

The Standard Three-Tier Structure

Most government contractors run some version of three tiers, applied in sequence:

The Base Decision Nobody Thinks About Until It Hurts

The most common structural failure in the mid-market is the G&A base, and it shows up the moment a contractor wins its first large materials-heavy or subcontract-heavy award.

Under a Total Cost Input base, every pass-through dollar absorbs G&A. If a contractor with a 12% G&A rate wins a program requiring $4M of subcontracted effort, that subcontract now carries roughly $480K of G&A whether or not the company did $480K of general and administrative work to support it. On a competitive bid, that makes the price uncompetitive. On a cost-reimbursable award, it makes the contractor look expensive relative to peers.

The alternatives are real but each has a cost:

• Value Added base. G&A is allocated over direct labor, fringe, and overhead — excluding materials and subcontracts. This solves the pass-through problem but raises the G&A rate applied to labor, which hurts on labor-heavy competitive bids.
• Material and Subcontract Handling pool. A separate, small pool applied only to materials and subcontracts, capturing the genuine cost of procurement and subcontract administration. This is the cleanest answer for contractors with meaningful pass-through volume, and it is the one most mid-market companies should be running and are not.
• Site or segment overhead pools. Separate on-site and off-site overhead rates when the cost of performance genuinely differs by location.

Changing a base is not a bookkeeping adjustment. It changes allocation across every active contract, it requires consistency in application, and on CAS-covered contracts it is a cost accounting practice change with its own notification and equitable adjustment machinery. The right time to fix a rate structure is before it becomes load-bearing, which is to say earlier than most CEOs want to think about it.

Where the RFO Leaves This

The Revolutionary FAR Overhaul rewrote FAR Part 31 under Executive Order 14275, and agencies have implemented the model deviation text through class deviations. For rate structure purposes the news is quiet: the cost principles were streamlined and reorganized in plain language, but the allocation logic of FAR 31.203 and the selected-cost sequence at 31.205 were not substantively rebuilt. Contractors who invested in compliant accounting systems did not have to tear them up.

That said, the deviation text is not identical to the codified FAR, several specific provisions were edited, and Part 31 remains at the deviation stage rather than final rule. The practical guidance is unchanged from what it always was: read your contract's clauses, and read your cognizant agency's class deviation, rather than assuming the version you learned five years ago still governs.

Why Buyers Care More Than Contractors Expect

In a transaction, indirect rates stop being an accounting topic and become a valuation topic. Three things get examined.

Rate volatility. A buyer models forward profitability off historical rates. If overhead ran 38%, then 51%, then 43%, the buyer does not average them — the buyer prices the risk. Volatility usually traces to something structural: a pool that mixes unlike costs, a base that swings with contract mix, or an owner running personal expenses through the company and creating noise that has to be normalized out.

Unsettled years. Every fiscal year with an unaudited incurred cost submission is an open liability. If final negotiated rates come in below the provisional rates the contractor billed at, money goes back to the government. Buyers see open years as a contingent claim and respond with escrow, indemnity, or a reduction in price.

Allowability discipline. If diligence finds unallowable costs sitting in indirect pools — entertainment, lobbying, certain legal fees — the buyer does not treat it as one line item. The buyer treats it as evidence that the control environment does not catch this category of error, and expands the scope of the review.

None of these are exotic findings. They are the ordinary consequence of a rate structure that was set up to get through one award and never revisited as the company grew past it.

What Good Looks Like

A rate structure is in decent shape when the pools group genuinely similar costs, the bases reflect how those costs are actually caused, unallowables are segregated in the general ledger rather than backed out in a spreadsheet at year end, rates are monitored against provisional rates during the year rather than discovered in the spring, and someone in the company can explain the whole structure to an auditor without reconstructing it from memory.

That last test is the one most contractors fail. The structure exists, it works, and exactly one person understands it — which is a compliance risk while that person is employed and a valuation problem the moment a buyer asks about founder dependency.