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Government contractors: Are you ready to prepare the incurred cost submission?

ARTICLE | March 07, 2024

Authored by RSM US LLP

Many federal government contractors are familiar with the incurred cost submission (ICS). Also known as the incurred cost proposal or ICP, this is a government contractor’s annual submission of final indirect rates.

Federal Acquisition Regulation (FAR) 16.307 states that cost-reimbursement and time and material (T&M) contracts must include FAR clauses 52.216-7 and/or FAR 52.232-7, which require contractors to submit their actual costs incurred and final indirect rates for their annual fiscal year. If your federal contracts or subcontracts have the “allowable cost and payment” clause (52.216-7), you are required to submit an ICS.

When is the incurred cost submission due?

The ICS must be submitted six months after the fiscal year-end. So if your fiscal year-end is Dec. 31, your submission is due no later than the following June 30.

Contractors can request extensions from the administrative contracting officer (ACO) for exceptional circumstances. But don’t wait until the last minute to request an extension. Missing the submission deadline will put government auditors—typically the Defense Contract Audit Agency (DCAA) —on high alert for potential risk. If a submission is more than six months late, the DCAA will recommend a decrement factor that may reduce the costs that contractors can recover.

What is needed for an ICS?

Contractors will need their financial statements, including a detailed trial balance, to which costs must be reconciled. The DCAA utilizes the Incurred Cost Electronically (ICE) module, which can be downloaded from its website. Contractors do not need to use the ICE model, but they are required to prepare an ICS using the requirements of FAR 52.216-7(d)(2)(iii)(A)–(O), which incorporates the following schedules:

  • Schedule A: Summary of all claimed indirect expense rates, including pool base and calculated indirect rate
  • Schedule B:General and administrative expenses
  • Schedule C:Overhead expenses
  • Schedule D:Intermediate indirect cost pool; allocations to final indirect cost pools
  • Schedule E:Claimed allocation bases, by element of cost, used to distribute indirect costs
  • Schedule H:Schedule of direct cost by contract, subcontract and indirect expense applied at claimed rates
  • Schedule H-1: Government participation by pool
  • Schedule I:Schedule of cumulative direct and indirect costs claimed and billed by contract and subcontract
  • Schedule J:Listing of subcontracts awarded for which contractor is a prime or upper-tier contract
  • Schedule K:Summary of each T&M and labor-hour contract
  • Schedule L:Reconciliation of total payroll per IRS Form 941 and total labor distribution costs
  • Schedule M:Listing of decisions, agreements, approvals and description of accounting and organizational changes
  • Schedule N: Certification of final indirect costs
  • Schedule O:Contract closing information physically completed in this fiscal year

Challenges for contractors

The information required for each schedule may not be housed under a single job function or even a single department. Additionally, some schedules require cumulative information that requires roll forward information from prior years.

Contractors should not underestimate the time and effort needed to compile an adequate ICS. Typically, companies have the most difficulty completing the following schedules:

  • Schedule I: Issues stemming from accurate prior year costs, cumulative billings and billing adjustments; these can have a significant impact on over/under billings.
  • Schedule J: Issues stemming from the breakout of subcontractor values and fiscal year costs incurred at the pricing action level.
  • Schedule L: Issues related to identifying and reconciling items down to an acceptable variance, which typically stem from timing differences between IRS Form 941 reporting and GL.

In addition, the DCAA says the most common errors occur on the following forms:

  • Schedule N: Signed certification not included or not signed by at least a vice president or chief financial officer
  • Schedule J: Lack of subcontractor information
  • Schedule D: Not all intermediate allocations disclosed
  • Schedule E: Unallowable (non-G&A) costs not included in G&A base
  • Schedule B: IR&D/B&P not fully burdened
  • Schedule I: Over/under billings reconciliation errors
  • Schedule O: Physically complete contracts not properly identified
  • Schedule H-1: Government participation not calculated for all final indirect rates

ICS audit risks to consider

A clean audit is always the goal, but many audits result in questioned costs. Such costs are removed from the pool, and the indirect rates are recalculated for the final report submitted to the ACO for approval.

The contractor must refund the government for any overbilled costs within 60 days after the settlement of the final indirect rates. FAR 42.709 allows the government to apply penalties and interest to any disallowed costs.

What are the most common issues of an ICS audit?

Contractors often face the following issues:

  • Adequacy: In many cases, an ICS will be rejected due to adequacy issues, further delaying a contractor's ability to finalize indirect rates. Contractors should review the DCAA’s Incurred Cost Submission Adequacy Checklist before submitting their ICS.
  • Lack of adequate supporting documentation: Contractors need to maintain adequate supporting documentation for both direct and indirect costs incurred. Auditors will disallow costs if proper support is not available, which reduces a contractor’s entitled cost recovery.
  • Allowable/allocable costs: Costs are allowable only if they are reasonable, allocable and conform to FAR 31. Additionally, FAR 52.243-2 establishes that contractors who include unallowable indirect costs in a proposal may be subject to penalties. Failure to scrub for unallowable costs—especially high-risk or gray areas—may result in paybacks to the government.
  • Employee/executive compensation: Failure to ensure that employee compensation is reasonable and under the executive compensation limit can lead to problems.
  • Bonuses: This has historically been a focal point for ICS auditors. Failure to have established policies and procedures for bonuses, and failure to make sure that they are based on employee performance, can create issues for contractors.

The takeaway

ICS audits have historically represented the largest dollar amounts that DCAA examines, so contractors need to take the ICS preparation and submission process seriously. If you are required to submit an ICS, focus on the accuracy of your information, and allow enough time to complete the process by the deadline.

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This article was written by RSM US LLP and originally appeared on 2024-03-07.
2022 RSM US LLP. All rights reserved.

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