There are many differences of opinion and disputes about whether certain costs should be classified as direct or indirect. In addition, the use of ambiguous terms that are used interchangeably doesn't help the situation. For instance, overhead is used interchangeable in industry with burden, loading, add-on, management cost, general and administrative, factory expense, etc.
That is why I am always bugging you to document your companies definition of the terms it uses. It helps you, your staff and anyone else who has to deal with the many ways people use these terms.
You should have a Definitions section in your policies and procedures manual. This will cover you in many situations that could arise in the future that you are not even thinking about right now. It's better for you if you to be able to produce a document that confirms you have shared what you meant by the words you used in a contract or in discussions.
Consider submitting as an addendum or attachment to proposals, invoices, data deliverables, etc., a detailed description of your companies definitions of terms used. Simple, but effective!
In a previous issue we touched on the definition of Indirect Cost. In this issue I want to touch on Direct Cost. Why? Well since indirect costs are those costs left after identifying the direct cost of your company, then it seems important to understand direct costs, don't you think.
Simply stated, costs are designated as Direct Costs when they are traceable to and identified with a specific contract, product, job, or whatever you call your product or service.
In addition, you should be tracking your direct costs in detail in a job or work order cost subsidiary system that is tied to your basic general ledger accounting system. Most all popular accounting systems offer modules that can do this, including QuickBooks. They may be called by different names but they can all do this. Some software does it easier than others and some in more detail. Your budget and the complexity of your contracts should determine which software you choose.
But always start with what you have! Determine if you can use the capabilities of your existing system to incorporate the additional requirements under government contracting. Remember it's not only the software but the setup.
Now, the major categories of direct costs are: Direct Labor, Direct Materials, and Other Direct Costs. There are many variations of these categories based on each business and based on what level of detail the customer is requesting. Direct costs can have other categories that include Direct Consultants, Direct Subcontracts, Direct Travel, etc. The key is whether the cost is readily traceable to your final cost objective (job, product, work order, contract, etc).
Believe me, even the government understands that the ease with which a cost can be traced to the final cost objective (job, product, work order, contract, etc) has a great deal to do with whether the cost is considered as direct. For example, miscellaneous small parts used in the manufacture of a product may be considered too small and inexpensive to justify the cost or time required to keep track of the cost as direct. So for practical reasons, we may classify them as an indirect expense.
You notice I keep referencing the final cost objective as (job, product, work order, contract, etc). It's that repetition, repetition, repetition thing. The more you see it the more familiar you should become with it. Since the methods used to classify direct costs are very different between contractors (as it is also with indirect costs), you must set firm criteria for the designation of all costs as direct or indirect in your company. These criteria will be influenced by several factors as I mentioned before.
For example, the number and type of contracts in the company, competitive environment, personal preferences of management (that's right, you may have your own preferences, within reason that is) and the type of cost pools and bases you use.
I have an e-file called "Identifying All Costs to Pools and Bases". This is a spreadsheet that can help in developing the cost pools and bases accounting policy for your company. A hardcopy is provided to attendees at each workshop as part of the exercises. However, the electronic copy can save time (money) and frustration by not having to recreate the spreadsheet from scratch. And it is great when if you have to develop rates "Fast" and need supporting documentation.
This is one of the e-files you asked if I could make available for purchase, so I did at a nominal price. It is listed under products and is discounted to our online community subscription VIP members. It is also a part of the "MEBundle Package".
In summary, if the cost is identifiable and benefits a specific contract, then it is charged directly to that contract. If the expense cannot be readily identified with, or does not solely benefit, a particular contract, it is charged as an indirect cost and allocated to those contracts that do receive some benefit from it. Even if the benefit is not equal among all contracts.