Overview
FAR Subpart 42.7 establishes the policies and procedures for determining indirect cost rates, which are essential for reimbursing contractors for costs that cannot be directly attributed to a specific contract (e.g., overhead, G&A). It provides a dual-track system using billing rates for interim payments during contract performance and final indirect cost rates for the definitive settlement of costs at the end of a fiscal period.
Key Rules
- Single Agency Responsibility: To ensure uniformity and economy, a single federal agency (usually the one with the largest dollar interest) is responsible for negotiating indirect cost rates for all of a contractor’s business units. These rates are binding on all other federal agencies.
- Mandatory Certification: Contractors must submit a "Certificate of Final Indirect Costs" with their proposal. Without this certification, a proposal cannot be accepted, and an agreement cannot be reached.
- Hierarchy of Determination: Final rates are established through either a Contracting Officer (CO) determination (standard for complex or large organizations) or an Auditor determination (used when costs are easily settled or the contractor has primarily fixed-price contracts).
- Six-Month Submission Deadline: Contractors are required to submit an adequate final indirect cost rate proposal within six months after the end of their fiscal year.
- Penalties for Unallowable Costs: If a contractor includes "expressly unallowable" costs in their final proposal for contracts exceeding $1 million, they face a penalty equal to the unallowable cost plus interest. If the cost was previously determined unallowable for that contractor, the penalty is doubled.
- Quick-Closeout Procedure: To reduce administrative burden, COs can negotiate the settlement of indirect costs before final rates are set if the unsettled amounts are relatively insignificant (the lesser of $1M or 10% of the contract value).
Responsibilities
- Contracting Officer (CO) / Administrative Contracting Officer (ACO):
- Leading the Government negotiating team.
- Establishing billing rates and final indirect cost rates.
- Conducting risk assessments for quick-closeouts.
- Determining and assessing penalties for unallowable costs.
- Unilaterally establishing rates if a contractor fails to submit a certified proposal.
- Government Auditor:
- Auditing proposals and preparing advisory audit reports.
- Identifying unallowable costs and questioning costs during the audit.
- Directly establishing final rates in "Auditor determination" scenarios.
- Contractor:
- Submitting timely, adequate, and certified final indirect cost rate proposals.
- Submitting a completion invoice/voucher within 120 days of the settlement of final rates.
- Ensuring unallowable costs are excluded from proposals to avoid penalties.
Practical Implications
- Cash Flow Management: Because billing rates are temporary estimates, contractors must monitor the gap between their billing rates and actual incurred costs. Significant discrepancies can lead to large "true-up" payments or, conversely, a requirement to pay back the government, creating financial volatility.
- Audit Readiness: The requirement for an "adequate" proposal means contractors must maintain sophisticated accounting systems that can segregate costs in accordance with FAR Part 31. An inadequate proposal can delay the audit and negotiation process for years.
- Closeout Bottlenecks: The 120-day deadline for submitting final completion vouchers after rate settlement is a critical compliance milestone. Failure to meet this can result in the CO unilaterally determining the amount due, potentially to the contractor's disadvantage.
- Risk of Double Penalties: Contractors must have a robust internal review process. Including a cost in a proposal that was explicitly flagged as unallowable in a prior year’s audit triggers the "two times" penalty, which can be financially devastating for large-scale contracts.