Maximize A/E Overhead Rates
How A/E Firms Can Maximize Allowable Indirect Costs for Higher Government Contract Reimbursement
To maximize your overhead reimbursement on government contracts, an A/E firm must strategically increase its allowable indirect cost pool while maintaining strict compliance with FAR Part 31. By correctly identifying and segregating allowable expenses—such as fringe benefits, facility costs, and operational overhead—from unallowable ones, firms can achieve a higher, defensible overhead rate. This optimized rate ensures that for every dollar of direct labor spent on a project, the firm captures the maximum possible recovery for its actual cost of doing business, effectively increasing the total billable amount and overall project profitability.
Key Takeaways
How can an engineering firm increase their billable revenue on government contracts?
By maximizing the identification of allowable indirect costs and accurately segregating them from unallowable expenses, a firm can achieve a higher certified overhead rate that increases total contract reimbursement.
What are the most common allowable indirect costs for A&E firms seeking higher reimbursement?
The most significant allowable indirect costs typically include employee fringe benefits, facility rent and utilities, and the facilities capital cost of money associated with fixed assets.
How does a firm ensure its maximized overhead rate survives a government audit?
To withstand an audit, a firm must balance maximization with the principle of reasonableness and provide thorough documentation that justifies every expense in the indirect cost pool as necessary for business operations.
The Financial Power of the Overhead Rate
In the architecture and engineering industry, the overhead rate is not just a bookkeeping metric; it is the most significant driver of revenue for government-funded projects. When a firm secures a contract with a State DOT or federal agency, the reimbursement for indirect expenses is calculated as a percentage of direct labor. Therefore, a higher audited overhead rate directly increases the total amount a firm can bill for its services. Even a fractional increase in this rate can translate into tens of thousands of dollars in additional annual revenue, allowing the firm to reinvest in talent, technology, and infrastructure.
Strategic Cost Segregation and Identification
The journey toward a maximized rate begins with strategic cost segregation. Many firms leave money on the table because they default to conservative accounting treatments that misclassify potentially allowable expenses as unallowable. For example, while general “entertainment” is strictly prohibited, certain “employee morale” expenses or specific business meetings may be partially or fully allowable if documented correctly. By conducting a deep-dive analysis of the General Ledger, a firm can identify costs that have been buried in “miscellaneous” categories and reassign them to the appropriate indirect cost pools. This process of maximizing allowable overhead expenses ensures that the firm’s financial reporting accurately reflects the true burden of its operational costs.
“Optimizing your overhead rate isn’t about inflating numbers; it’s about ensuring your firm is fully reimbursed for the actual cost of doing business, rather than paying for legitimate expenses out of your profit.”
Leveraging Fringe Benefits and Facilities
Fringe benefits and facility costs are the “heavy hitters” of the indirect cost pool. Properly allocating items such as health insurance, 401(k) matches, and employer-paid taxes can significantly boost the overall rate. Similarly, facility costs including rent, utilities, and maintenance are foundational to the overhead calculation. A common area for optimization is the calculation of facilities capital cost of money, which allows firms to be compensated for the capital they have tied up in fixed assets like office buildings and high-end engineering equipment. When these costs are meticulously tracked and allocated, they provide a justifiable lift to the overhead percentage that agencies are willing to reimburse.
Balancing Maximization with Reasonableness
While the goal is to achieve the highest possible rate, every cost included in the pool must pass the “reasonableness” test. Government auditors look for expenses that exceed what a prudent person would pay in a competitive marketplace. If an A/E firm’s overhead rate spikes significantly without a clear business justification, it may trigger an expanded audit or a “reasonableness review” of executive compensation. Professional FAR overhead rate consulting helps firms find the “sweet spot” where the rate is maximized for profit but remains defensible under the scrutiny of an AASHTO-compliant audit. Transparency and documentation are the best defenses against the threat of disallowed costs.
The Necessity of Regular Cost Pool Reviews
Profitability is not a “set it and forget it” endeavor. As a firm grows, its spending patterns inevitably shift. For instance, a firm that recently moved into a larger office or upgraded its software suite will see a change in its indirect cost structure. Regular, quarterly reviews of these cost pools help management identify these shifts in real-time. By staying ahead of these changes, the firm can adjust its provisional billing rates to more closely align with its actual year-end costs. This proactive approach prevents the “audit shock” that occurs when a firm realizes too late that its actual overhead was much higher than what was billed, leading to under-recovery of costs.
Achieving an Optimized and Defensible Rate
An optimized rate is ultimately about fairness: it ensures the firm is fully reimbursed for the actual cost of doing business. Without a professional audit and strategic review, many A/E firms inadvertently subsidize the government by paying for legitimate business expenses out of their own profit margins. By implementing internal control testing for A/E firms and maintaining a rigorous focus on cost principles, a firm can confidently present a rate that is both profitable and compliant. This financial clarity allows firm principals to focus on what they do best—designing and engineering the world’s infrastructure—while knowing their financial foundation is secure.
Disclaimer: This article provides general information and should not be considered professional financial or tax advice. Please consult with a qualified CPA or financial advisor for guidance specific to your individual business needs.
Questions?
Missy leads Brady Ware’s AASHTO and FAR Overhead Rate Audit team. With nearly two decades of CPA experience and a background in consumer finance, she provides tax, audit, review, and compilation services, as well as business consulting.