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What Is The Incurred Cost Proposal?
The incurred cost proposal (ICP) (also known as the incurred cost submission or ICS) is the annual reconciliation of actual costs incurred by a government contractor. The requirement to submit an ICS is found in Federal Acquisition Regulation (FAR) Clause 52.216-7, Allowable Cost and Payment. If this clause is included in one of your contracts, you are required to submit an ICS. Late submissions can be subject to a unilateral decision by the Contracting Officer (CO) to apply a decrement factor which will reduce reimbursement of incurred costs. For companies with a fiscal year ending December 31, 2018, the 2018 ICS will be due by June 30, 2019, six months after the close of the fiscal year.
The ICP consists of a multi-part reconciliation and calculation of:
1. All direct job costs to the general ledger (sum of the parts must equal the whole)
2. All labor to payroll tax filings (claimed labor expenses to those for which you paid employer taxes)
3. Indirect pool(s) and base(s), a summary of costs incurred by contract, other supporting schedules, and the Certificate of Final Indirect Costs
4. All costs incurred (direct and indirect) to Government billings
5. Cross-schedule reconciliation of amounts.
Submission of an incurred cost proposal is required for all cost-type contracts per FAR 52.216-7, the “Allowable Cost and Payment” clause. This clause is required for cost-plus fixed fee (CPFF), cost-plus incentive fee (CPIF), cost-plus award fee (CPAF), and time and material (T&M) contracts where material is based on reimbursement of actual costs. This requirement exists whether the clause is not listed or referenced in your contract (Christian Doctrine), which does happen from time to time. These contracts may be traditional contracts with any Federal agency or office (or subcontract with a prime in support of a Federal contract), or a grant under the Small Business Innovation Research (SBIR) or Small Business Technology Transfer (STTR) programs. Note that Phase II awards under SBIR-STTR are typically cost-type awards requiring an adequate (“approved”) accounting system and annual submission of the incurred cost proposal.
The incurred cost proposal is the ultimate reconciliation of actual costs incurred to Government billings. The Government wants to know if your budgeted (aka provisional billing) rates aligned with your actual experience. More importantly, the Government wants to know if you under-billed or over-billed each contract. Let’s be honest, they’re more concerned with the potential over-billing of a contract.
Preparation of the incurred cost proposal provides contractors with final indirect rates used for true-up invoices after rate approval by the contractor’s cognizant agency. The Defense Contract Audit Agency (DCAA) is the cognizant agency for many contractors simply because the Department of Defense (DoD) represents the lion’s share of the Federal budget and annual spending. DoD is often the only customer for many contractors or represents a significant portion of a contractor’s annual sales.
Contractors develop provisional billing rates each fiscal year based on budgets and previous actual experience. Those rates are used to invoice contracts throughout the year. Note that this process becomes more complex because:
1. Contract periods of performance rarely align with contractor fiscal years.
2. Contract duration or period of performance may exceed 12 months or a fiscal year. In other words, you may agree to provisional billing rates for more than a 12-month period. This is common for contract durations of 12 to 18 months where a contracting officer may not want to re-negotiate rates in the middle of a contract.
3. Provisional billing rates may be negotiated as a cost target.
4. Provisional billing rates may be adjusted mid-year for the win or loss of a significant contract, or for the impact of a significant cost on the budget.
All of the above lead to a situation where the contractor is billing multiple contracts at different provisional rates in the same fiscal year, further complicating the annual reconciliation.
Submit Final Invoices
Approval of final indirect rates will allow contractors to submit final (true-up) invoices for all of their cost-type contracts for the fiscal year. While this sounds good – getting reimbursed for all allowable, allocable, and reasonable costs – the reality is much different. First, reimbursement for additional costs (in the case of under-billing) assumes the Government has more money in a program to pay you and all other contractors with cost-type contracts. Second, it assumes that contractors actually receive approval of final indirect rates in a timely manner. The latter has been a point of contention with DCAA for many years. DCAA’s backlog was often measured in years (not months), causing many contractors to wait years on audit and approval – long past the completion of programs, long past the opportunity to obtain additional funding.
“The Contractor shall update the billings on all contracts to reflect the final settled rates and update the schedule of cumulative direct and indirect costs claimed and billed, as required in paragraph (d)(2)(iii)(I) of this section, within 60 days after settlement of final indirect cost rates.” FAR 52.216-7(d)(2)(v)
The approval of final indirect rates does not change any monetary ceiling, contract obligation, specific cost allowance or disallowance provided for in the contract, or availability of program funding.
Rates developed from this submission set the stage for future budgets, provisional billing rates, forward pricing rate agreement (FPRA), etc.
When Is the Incurred Cost Proposal Due?
Within six (6) months of contractor’s fiscal year end – June 30th for contractors with a calendar fiscal year end of December 31.
“The Contractor shall submit an adequate final indirect cost rate proposal to the Contracting Officer (or cognizant Federal agency official) and auditor within the 6-month period following the expiration of each of its fiscal years. Reasonable extensions, for exceptional circumstances only, may be requested in writing by the Contractor and granted in writing by the Contracting Officer. The Contractor shall support its proposal with adequate supporting data.” FAR 52.216-7(d)(2)(i)
Reminders & Notifications
You may never receive any notification from the government. The burden of responsibility is on the contractor to read the contract(s) and submit required documents. We often encounter clients who were unaware of the requirement to submit an incurred cost proposal. Many did not read or understand all of the clauses in their contract. Sometimes the oversight was due to a change in personnel and failure to properly document requirements. Other clients have been told by a contracting officer or prime contractor that they did not have to submit an incurred cost proposal.
Note that a contractor may have multiple requirements across multiple contracts or awards to submit an incurred cost proposal. You cannot rely on the feedback from a single contracting officer or prime contractor who is unaware of other contracts or awards requiring an incurred cost proposal. They may be simply providing feedback on their specific contract or award.
Another important note is the lack of a single contract management system for the Government. There is no single source of all contracts and clauses applicable to any specific contractor. In other words, there is no system triggering the Government to send any reminders or notifications regarding the requirement for an incurred cost proposal. Compliance with all contract terms and conditions is ultimately the contractor’s responsibility.
Delays & Delinquency
Once the submission becomes six (6) months overdue (one year after the end of the fiscal year) and no extension has been granted by the Contracting Officer, the DCAA auditor may provide the CO with unilateral rate recommendations. As a result, the Contracting Officer can make a unilateral determination as authorized by FAR 42.703-2(c)(1) and FAR 42.705(c)(1).
Delinquent ICPs result in rate recommendations that will be based on either (1) a decrement factor applied to indirect rates using relevant contractor historical data or (2) a company-wide decrement factor based on questioned costs at high risk contractors applied to total contract costs, if no relevant historical data exists.
Documents You’ll Need
The incurred cost proposal is a complex document and dependent on an effective accounting system to provide the necessary data. In order to complete the incurred cost proposal, you’ll need to gather several documents:
- 941 quarterly tax returns for reconciliation of total labor on Schedule L
- Accounting and organizational changes including new policies or procedures, changes in accounting software apps, changes in leadership or key personnel, etc.
- Balance sheet
- Cost of money calculations (see our calculator)
- Cumulative billing and contract closing information to aid in inception-to-date invoice reconciliation
- Contracts or contract briefs to identify contract or CLIN type, funding limits, unallowable costs, period of performance, and other details [Note that hybrid contracts (those containing CLINS of different contract types) require unique reporting on the ICP.]
- Direct Labor
- Direct Material
- Direct Travel
- Indirect Cost Pools
- Income statement
- Indirect rate schedules to aid in cross reconciliation of ICP rates to internal rates
- Job Status or Job Cost Reports with details for each cost element
- Hours and amounts billed for T&M contracts including details by labor category
- Schedule of IRAD and B&P projects
- Trial balance including cost element breakdown. A well-designed chart of accounts (see our template) goes a long way in organizing data for ease in calculation of rates.
The incurred cost proposal consists of both required and supplemental or optional schedules. These schedules are not necessarily “optional” as auditors will often request or require them as part of a formal ICP audit. We recommend completing all schedules since they will likely be required as part of an audit and because some provide additional analytical data. Some professionals simply recommend not submitting the supplemental or optional schedules until requested.
This schedule simply summarizes all indirect rates showing the total pool, total base, and rate. This schedule should automatically link the appropriate Schedules B, C, D, and E.
This schedule details G&A expenses by G/L account and carries those rates to Schedule H.
This schedule details overhead expenses by G/L account and carries those rates to Schedule H. Complete Schedule C for each overhead pool – required when contractors have multiple overhead pools for engineering and manufacturing, different operating locations, etc.
This schedule details intermediate cost pools (e.g. facilities and IT) by G/L account and carries those rates to Schedule H. Schedule D is technically optional since some contractors include occupancy or facility costs in their overhead. Contractors may have multiple Schedule Ds if they have multiple intermediate cost pools.
This schedule identifies the allocation bases for and specific G/L accounts in each indirect cost pool. This information links to Schedules A, B, C, and D.
Contractors must submit cost of money (COM) calculations for G&A and all intermediate cost pools for which they proposed COM rates.
Optional. This schedule lists the assets or categories of assets, the beginning and ending values and the distribution among the cost pools.
This schedule reconciles claimed direct costs from Schedule H to the G/L.
Optional. Summary of cost elements per job cost ledger must equal summary of cost elements per general ledger (sum of the parts must equal the whole)
This schedule summarizes all direct cost elements reported on Schedule H including IRAD and B&P.
This is one of the schedules with several hidden columns to allow for input of multiple indirect rates. We recommend deleting these hidden columns (if you are not using those indirect cost pools) and correcting any formulas. Hidden rows and formulas lend themselves to unseen errors.
Note that information is required at the pricing action level such as the task order or delivery order. If you have an IDIQ contract with 40 delivery orders, you’ll enter those as if 40 separate contracts.
This schedule summarizes the allocation of overhead and G&A among all contract types, government and commercial.
Schedule I | Schedule of Cumulative Direct and Indirect Costs Claimed and Billed by Contract and Subcontract
We consider this schedule the primary purpose of completing the incurred cost proposal – determining your under- and over-billing by contract. Does the Government owe you money, or do you owe the Government? Kind of like preparing your individual income tax return to determine if you owe or you’re getting a refund.
This schedule lists subcontracts awarded to companies for which the contractor is the prime or upper-tier contractor. These are cost-type or incentive subcontracts under flexibly-priced contracts. This does not include subcontracts under FFP contracts or FFP contracts under flexibly-priced contracts. Note that contractors are responsible for obtaining final indirect rates and final invoices from their subs.
This schedule lists hours and rates for all labor categories across all T&M and labor-hour contracts. Totals on here carry to Schedule I for cumulative billing totals.
This schedules reconciles all claimed labor costs (direct and indirect) to reported salaries and wages for tax purposes. The government wants to ensure contractors are not claiming labor expense for government contracts that they have not claimed elsewhere.
Clients often struggle with this schedule for three main reasons:
- Labor accounts are not clearly identified
- W-2 labor costs are commingled with non-labor or non-W-2 labor
- Adjusting journal entries
Schedule M | Listing of Decisions/Agreements or Approvals Affecting Direct/Indirect Cost and Description of Accounting or Organizational Changes
Contractors must list changes to the accounting system with descriptions. This includes changes in:
- Policies and procedures
- Treatment and allocation of costs
- Accounting software and systems
- Organizational changes
This certificate signed by an appropriate individual (President, CEO, CFO) represents that all costs are allowable and that the proposal does not include any expressly unallowable costs.
Schedule O | Contract Closing Information for those Contracts Which Work Effort Was Completed During the Fiscal Year
This schedule lists all contracts for which work was physically completed during the fiscal year.
Supplemental A-3* | Comparative Analysis of Indirect Expense Pools to Prior Fiscal Year - Intermediate Cost Pools
Supplemental A-4* | Comparative Analysis of Indirect Expense Pools to Prior Fiscal Year - Direct Costs
*These optional schedules (Supplemental A-1 to A-4) provide a comparative analysis in terms of dollars and percentage change from the previous fiscal year. While these are optional, they are helpful in:
- Identifying trends in rates and drivers of those rates.
- Identifying significant variances that may need explained to an auditor. These variances may result from a specific incident or contract, or could be ancillary or ripple effect from another change.
- Identifying new or missing G/L accounts in the analysis. This helps ensure you included all previously known G/L accounts and that you’re aware of any new accounts.
Supplemental B | General Organizational Information and Compensation for Certain Contractor Employees
This schedule provides general organizational data such as the SIC and NAICS codes, total sales, percentage of sales to the Government, and details on the five most highly compensated members of management. Note that these five employees may not be owners or executives within the organization. Business development personnel often end up on this schedule because of the combination of their base salary with commissions and bonuses.
Supplemental C | Identification of Prime Contracts Under Which the Contractor Performs as a Subcontractor
This schedule provides the cognizant agency information on prime contracts for which the contractor performed as a sub. This information can be cross-referenced at the prime level to ensure that all cost-type subcontracts have been finalized or closed before finalizing or closing the prime contract.
This schedule provides the contractor and auditor with key details about each contract including the prime contract number, funding limits, contract type, and modifications. This information helps auditors ensure the contractor has properly classified the contract/CLINs and not exceeded the funding limit.
An adequate incurred cost submission includes:
1. Use of the ICE Model (or similar format – see below) containing all of the required schedules.
2. Schedule N signed by an authorized party (e.g. President, CEO, CFO).
3. A contractor’s submission of all claimed costs incurred for cost type and/or T&M reimbursable government contracts, including adjustments and explanatory notes.
4. Identification of unallowable costs (voluntary deletions) and expressly unallowable costs with notes accompanying adjustments.
5. Identification, by contract, of awards containing FAR 52.242-3 – Penalties for Unallowable Costs (penalty clause).
6. Only costs determined reasonable, allocable, and allowable in accordance with GAAP, CAS, FAR, and contract provisions.
DCAA provides an incurred cost submission adequacy checklist for auditors to use in determining adequacy of the proposal. We recommend that contractors complete this as part of the preparation process to ensure adequacy before submitting files to the cognizant agency. Note that the statute of limitations on audits of incurred cost proposals begins with submission of an adequate proposal, not the date of original submission. This was a point of contention with DCAA for many years as they often did not perform an adequacy assessment for several months or years after original submission. The legal issue in the Contracts Disputes Act (CDA) is around the Government’s knowledge of a claim and the inability of the Government to know about the claim without sufficient information and details supporting the claim.
See this ThomsonReuters Briefing Paper and Apogee Consulting blog post.
DCAA recommends use of its ICE model, though it is not required. If contractors can get past the extremely poor aesthetic design of stretched logos, bright color highlights, and red text, be careful of hidden rows and columns and errors in formulas. We found so many errors in DCAA’s ICE model that we developed our own. Contractors also need to clean up a lot of preparation notes and references prior to submission. If you choose to use DCAA’s ICE template, be sure to download the most recent version where they updated some terminology and fixed some of the errors. Note that the file uses macros which we found to be extremely troublesome (finicky) in older versions.
Contractors may use their own templates or documents as long as they provide the required information.
Be sure to include an index or table of contents that cross-references all of the required schedules with supporting documentation.
Incurred Cost Audit
Audits of incurred cost proposals are now risk based according to low, medium, and high dollar values as well as other risk factors including past experience. New contractors may be at a higher risk simply because they have never submitted an incurred cost proposal. Other contractors with frequent errors, findings or issues with adequacy, may find themselves in a higher risk category.
Incurred cost audits are performed by the cognizant office which may or may not be DCAA. We find that small contractors with low risk profiles often undergo an informal desk review where auditors take a more fact-finding approach of asking questions and requesting a few documents. These reviews may last a matter of hours or days. Some of our smaller clients receive approved rates in a matter of weeks after submitting their incurred cost proposal.
We attribute a portion of their success to:
- Preparation and/or review of the proposal by a professional firm.
- Submission of a complete and accurate proposal, including all supporting documentation and optional schedules.
Common deficiencies and audit issues include:
- Failure to treat IRAD and B&P as direct
- Improper treatment of unallowable costs (segregation from cost pools and inclusion in appropriate bases)
- Insufficient documentation to support claimed costs of consultants
- Missing or incomplete information
- Proper calculation and presentation of highly-paid employees
- Proper treatment of bonuses including a written policy
- Schedule N certification not signed
MRD Audit Guidance Memos
DCAA provides audit guidance in the form of Memorandum to Regional Directors (MRDs). Always check DCAA’s website for updated audit guidance.
A word of caution about DCAA’s MRDs (and other reports) – they frequently remove documents and restructure the website. This results in relying on documents that disappear and utilizing links that eventually break.
Download a copy of all files (or use screenshots) to document your ICP.
19-PIC-005(R) Revised Policy and Procedures for Sampling Incurred Cost Proposals
18-PIC-001(R) Audit Alert on 2018 NDAA Section 803 Timeliness Requirement for Incurred Cost Adequacy Reviews and Audits
The concept of materiality guides accountants and auditors on which dollar values demand attention. Auditors primarily consider the dollar value of the item in question in comparison to the financial statement or report in general and to related transactions. The American Institute of Certified Public Accountants (AICPA) provides the following description of materiality:
- Although financial reporting frameworks may discuss materiality in different terms, they generally explain that:
- Expected to influence the economic decisions of users made on the basis of the financial statements.
- Judgments about materiality are made in light of surrounding circumstances and are affected by the size or nature of a misstatement, or a combination of both.
- Judgments about matters that are material to users of the financial statements are based on a consideration of the common financial information needs of users as a group. The possible effect of misstatements on specific individual users, whose needs may vary widely, is not considered. (AU-C 320.02)
- Misstatements, including omissions, are considered to be material if they, individually or in the aggregate, could reasonably be
DCAA published 19-PAS-003(R) “Audit Guidance on Using Materiality in Incurred Cost Audits” to guide auditors in determining materiality in an incurred cost audit.
When the financial statement audits and tax returns are finally wrapped up, it is time for those with cost reimbursable or T&M contracts to start their annual Incurred Cost Submission (“ICS”).
As a refresher, here are a few things to consider when starting to prepare your ICS during this busy time of year:
Start early. The ICS has numerous schedules which need to reconcile for the Defense Contract Audit Agency (“DCAA”) to consider it adequate.
Collect all year-end vouchers. For smaller companies, this may be an easy task. For larger companies, consider starting this effort in advance to ensure there are no major issues when completing Schedule I and Schedule O.
Reconcile your IRS Form 941s quarterly. What seems like a simple task can often turn into a tedious exercise.
Reconcile your financial statements to your trial balance. If your financial statements are compiled, reviewed or audited, consider taking the time to develop a work paper that reconciles those final statements to your trial balance. As many know, there can be differences between financial statements (i.e., GAAP) and the incurred cost submission (costing). Preparation of this reconciliation can alleviate issues down the line with the DCAA or other auditors.
Complete an Unallowable Cost Scrub. Almost all cost type contracts include FAR 52.242-3, Penalties for Unallowable Costs, which may require companies to pay penalties on expressly unallowable costs when they have been claimed in the ICS.
Depending on the size of your company, the process of removing unallowable costs from claimed costs (scrubbing) may be completed throughout the year, or as little as once before the completion of the ICS. Either way, you should focus on high-risk accounts (e.g., travel, consultant costs, business development, executive compensation, etc.) to ensure that the costs being claimed are allowable per FAR 31.205, Selected Costs, and the transactions are adequately supported.
Compare the ICS to DCAA’s Adequacy Checklist. While some companies may never have the luxury of working with timely DCAA auditors, the best practice is to ensure your submission complies with the DCAA adequacy checklist.
How We Can Help
You wouldn’t file your own tax return, why file your own incurred cost submission?
As always, Left Brain Professionals is here assist with review or preparation of the incurred cost proposal.
Additional Resources & Training
- BDO: Incurred Cost Submission (ICS)
- “Contractor Incurred Cost Proposals” by McKenna Long & Aldridge
- DCAA Audit Guidance Memos (search for “Incurred Cost”)
- DCAA Incurred Cost Electronically (ICE) Model
- DCAA Incurred Cost Proposal Adequacy Checklist
Ready for more information?
Contact us now or schedule one-on-one time to further discuss CAS and how the standards apply to your contact.