It’s year end and your company has closed out its fiscal year. What should you do from an indirect rate standpoint? Listen to Eric Poppe, Managing Director in Cherry Bekaert’s Government Contracting practice and Rich Wilkinson, Director of Product Marketing at Unanet discuss the importance of indirect rates and the close out process.
Rate variance is consequential. It has a half-life of about a year. If the government owes you $1K in rate differential at the end of the year and you bill it immediately, you can normally expect to collect it all. If you wait until next year, however, some projects may be out of funding. A project office may push back on what they now see as a “late invoice.” The Defense Contract Audit Agency will often refuse to sign-off on it saying that the rate differential invoices should wait until contract close out (which could be three or four years).
On average, at the one-year mark, that $1k in rate variance is probably worth $500 or less. After another year, the collectability falls still further. It’s now probably worth $250 or less. The $1k example is bad enough, but what if the variance is $1M – or more?
By the way, this cycle isn’t over. There is still the dreaded Incurred Cost Submission to do to finalize the rates. But the pressure of negotiating final rates is eased a great deal if most of the variance was collected at year end. Remember, it’s a never-ending cycle. As one-year ends, another begins.
Steps for closing out the rate year:
- Calculate the (near) final rates as soon as practical after the close of the last month.
- Immediately submit a request for revised provisional rates equal to the actual rates for the year.
- Immediately bill the rate differential as a separate invoice between the last (provisional) rate billing of the year and the first vouchers of the new year.
If you haven’t already, catch up on part one and two of the series where we discuss why government contracting firms need indirect rates and where and when to start, as well as monitoring and best practices in calculating your rates:
- Indirect Rates – More than Just a Math Exercise: Part One
- Indirect Rates – Monitoring and Best Practices in Calculating Your Rates: Part Two
- Indirect Rates – Incurred Cost Submissions: Part Four
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ERIC POPPE: Hello. Welcome to Cherry Bekaert's GovCon Podcast, where we discuss current government contracting trends, compliance matters, and best practices to guide federal contractors forward.
ERIC POPPE: My name is Eric Poppe. I'm a senior manager with Cherry Bekaert, and with me today is Rich Wilkinson, Director of Product Marketing from Unanet. Rich, thanks for joining me today.
RICH WILKINSON: My pleasure, Eric.
ERIC POPPE: Today is the third podcast in our series on indirect rates and how it's more than just a math and billing exercise when doing work with the federal government. We've already covered an overview of rates and monitoring the rates. Today, we want to talk about the closeout process of the rate year.
ERIC POPPE: Before we jump in, Rich, can you give a quick background about yourself?
RICH WILKINSON: Sure, Eric. I was a Navy contracting officer and spent eight years at NAVAIR doing services and R&D. I was a working controller for 10 years, and for almost 25 years I've been in the software industry helping implement ERP systems for government contractors, the kind of contractors we're discussing today.
ERIC POPPE: You live and breathe indirect rates.
RICH WILKINSON: I've been all the way around the table. I've asked contractors for indirect rates, been asked for indirect rates, and had to produce them. Asking for them is a whole lot easier than producing them.
ERIC POPPE: To start, it's year end. We've just closed out our fiscal year as a company. What do we do from an indirect rate standpoint?
RICH WILKINSON: Let's recap. Hopefully we submitted these rates about a year ago and got them approved. We may or may not have made a mid-year course correction and revised our provisionals to stay on track. If the rates were a little off, we adjusted them and built that differential.
RICH WILKINSON: Now we come to year end and we're trying to get all the cost in. We need to scrub the books at year end. If we miss something during the year and it falls into the following month, no big deal. But if we miss something in December, it can't just fall into January. We have to go back and put it in December, and that delays things in the rate world.
RICH WILKINSON: Scrub the books, make sure nothing is in the wrong place, nothing is there that ought to be in next year, and nothing is missing that should be there. Finding something that isn't there is hard, so it helps to look at your rate statements for the last month and the month before and compare them. Check the actuals columns to see if something was present previously but is missing now.
RICH WILKINSON: Rent stands out if it's missing, and it makes a big difference. Other items include accruals, IT costs, and the ISP bill. It's easy for something like that to fall through the cracks.
RICH WILKINSON: Once costs have been scrubbed and you calculate the year-end final rates, compare them to your provisionals. In a perfect world, they'd match to two decimal places, but in reality everything will be slightly off.
ERIC POPPE: If the final rates are lower, that's an easy problem. If you catch it in November, you can spend a little more money or buy equipment. But if the rates are higher, what do you do?
RICH WILKINSON: Submit a revised provisional rate request as soon as you're finished with the scrub and have calculated those year-end rates. The day DCAA or the cognizant auditor, NIH, DOE, or whoever, approves it, bill that rate differential. That's cash in the bank. If you don't do it, it will probably sit on your balance sheet as unbilled for a year, two years, or three years.
RICH WILKINSON: If you don't do it promptly at year end, DCAA will likely want you to wait until a contract closeout, which could be three, four, or five years. Who knows if the program office will have money to fund the cost growth.
ERIC POPPE: That could also impact financial reporting. It's not just DCAA and project cost accounting; auditors who handle your financial statements will be involved. It affects tax and the balance sheet.
ERIC POPPE: You mentioned scrubbing and making sure timing is correct. Are there anomalies to look for, especially if a government contractor also does commercial work?
ERIC POPPE: Many companies set up 9000-series accounts or specific GL accounts for unallowables. That's often for expressly unallowable items, but you might have medium-risk accounts where unallowables could be commingled. Because costs can be in a gray area, sometimes allowable, sometimes unallowable depending on the nature, there needs to be a sanity check of the GL.
ERIC POPPE: Does that element belong in the rate calculations? Should it be reclassed?
RICH WILKINSON: Absolutely. When I was a working controller, we had a dozen or so accounts we started scrubbing the week after Thanksgiving. Legal bills are a prime example. If the legal work was for one purpose, it's allowable; for another, it's not.
RICH WILKINSON: We scrubbed those accounts and did reclasses as early as possible in the year. That way, at year end the only bills to consider are those in December. Waiting until December 31 to scrub a year's worth of legal bills can be onerous.
RICH WILKINSON: There's money at stake. You want those revised provisional rates now, not next week or next month.
ERIC POPPE: Marketing, public relations, employee morale. Those accounts can be in the gray area and require review. We have to jump in early.
RICH WILKINSON: It's odd, since I'm in marketing, but in GovCon we call everything BD, business development, not marketing. It matters what you call things.
ERIC POPPE: I have a short anecdote.
RICH WILKINSON: You'll love this.
ERIC POPPE: I worked for a company in Columbia, Maryland, and we had an account in our general ledger called "alcohol." DCAA found that during an audit and thought they'd found a gold mine. We used 55-gallon drums of denatured alcohol as a solvent in one of our circuit board processes. It was clearly a production material, but in the general ledger it was just labeled "alcohol."
RICH WILKINSON: It took three months to convince them. I had to take the auditors to the plant and show them the drums of denatured alcohol being used to degrease circuit boards before they would allow those costs. I guarantee that account is still on the books, but it's now called "organic solvents," not "alcohol."
ERIC POPPE: That's definitely a labeling issue.
ERIC POPPE: After calculating the year-end rates and scrubbing, there is the dreaded ICS, which six months after the end of your fiscal year you're supposed to submit. That's the hook we'll cover in the next episode.
RICH WILKINSON: That's the end of the rate cycle for determining final indirect rates. There's always contract closeout after that, but the ICS is the end of the process.
RICH WILKINSON: Remember, at year end you've started a new year, hopefully a month ago, with a new provisional set of rates for the coming year. It's a never-ending cycle: as one year ends, the next begins.
ERIC POPPE: We'll talk about the ICS next, and I'll see you on the other side.
RICH WILKINSON: Great.
ERIC POPPE: Thank you, Rich. Have a good one.
RICH WILKINSON: Thank you.
