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Overhead Rates

Frequently Asked Questions

We are planning on issuing a time and materials type of contract. We are required to request cost data as part of our negotiations with the highest ranked firm; however, the reimbursements will be based on a fixed hourly rate. Does the contractor have to submit a federally audited overhead rate considering that we are negotiating a fixed hourly rate contract?

You are not required to conduct a Federal audit of the overhead. You are required to do a cost analysis prior to negotiation and award. The easiest approach might be to have the A&E’s CPA firm advise you of the overhead rate status, being sure that the rate proposed represents a reasonable estimate of projected actual overhead costs for the contract term. You should also review the proposed direct charges with the CPA firm to be sure there are no duplicate expenses in overhead that would result in duplicate costs to you. (Revised: October, 2010)

In June 2005 I awarded a contract for a fleet/fuel management system for our facility purchased with FTA funding in the estimated amount of $650,000. This system was fully implemented and accepted in June 2006. The City would like to know if we could expand this system to other City departments using non-FTA funding. This expansion would be within the scope of work because we would be purchasing additional licenses and hardware for our Fleet Services department.

We do not believe that FTA would object or otherwise be involved in the decision to modify this contract so as to add more software licenses and related hardware units for the City. This answer is based on the fact that the City will use only local funds, and not FTA funds. If FTA funds were involved it would be a new procurement requiring a sole source justification (or re-competition) since no contract options exist to add more quantities of software licenses and related hardware. Our answer is also based on the assumption that FTA's interests (and yours also) in the basic contract would in no way be compromised by the action. (Revised: October, 2010)

Under the "Overhead Rate" question section, you answer the question of whether a grantee may impose an overhead rate cap on a consulting agreement by saying "yes." Under the A&E section, you answer the same question by saying "no." Is the real answer yes or no? Can you impose an overhead rate cap on "non-A&E" consulting agreements, but not on "A&E" agreements? If so, what exactly would a non-A&E consulting agreement be? Would it be any consulting agreement that is not for architectural, engineering, program management, or construction management services (for example an overhead rate audit consulting agreement or consultant to review contractor claims)? If you have a consultant with a "non-A&E" contract, could you impose an overhead rate cap on the consultant?

You can impose an overhead rate cap on non-A&E consulting agreements, such as services for auditing, medical, legal, contract administration and technical work of any kind except those for A&E work. You cannot impose overhead caps on contracts for A&E work, which is defined in 49 U.S.C. § 5325(d). These services are also discussed in the BPPM, Section 6.5 – Architect-Engineer Services, as is the reason why overhead caps cannot be used with A&E contracts (based on specific legislation applicable to A&E work). (Revised: October, 2010)

On FTA funded contracts, are there special auditing guidelines that state that sole proprietors can establish a fully loaded hourly rate and that grantees do not have to audit that rate as long as they can determine reasonableness of the rate? I do not have a sophisticated accounting system since one is not required by the IRS.

A grantee wants me to provide detailed overhead and profit information on a proposal where I am a subcontractor. In the past, FTA has accepted a fully loaded hourly rate.

Grantees may negotiate fixed hourly billing rates (i.e., labor hour or time and material contracts) with any firms they do business with, whether or not they are small businesses or sole proprietors. There are no special auditing guidelines for sole proprietors as distinguished from corporations. However, grantees are also required to do some form of cost or price analysis for every procurement action. 

If the contract is a sole source (non-competitive) award, then grantees are required to do a cost analysis of the contractor's estimated costs. This would include an analysis of the direct labor rates, overhead rates, other direct costs and profit. It may be that the grantee has requested this information from you in order to comply with the FTA requirement for a cost analysis in a non-competitive situation. On the other hand, if the contract is being awarded competitively, then the grantee may do a price analysis, which simply entails determining that the billing rate (price) being offered is a fair and reasonable one based on market prices being quoted by other firms for the same service on competitive procurements. In the latter case, no cost analysis is required. (Revised: October, 2010)

How do I go about finding out how much the Federally approved overhead rates are for our company? This would be used for submitting proposals to the Federal Government.

You will have to determine if there has been a recent audit of your overhead rate conducted by a Federal Government agency. Such an audit may have been in connection with the award of a Federal grant or contract, or for closing out a grant or contract that is completed. If you have never had a Federal grant or contract then you will not have an overhead rate approved, but this is not an impediment to submitting proposals to the Government. The Government will conduct a pre-award audit of your cost proposal for pricing (negotiations) purposes and also to determine the adequacy of the accounting system if this is a cost-reimbursement contract. (Revised: October, 2010)

Is a General Engineering Contractor required to use projected or audited overhead rates?

We interpret the question as pertaining to rates in the contractor’s initial price proposal for negotiating the contract. We know of no requirement for contractors to use audited rates in their proposals, or to make projections of rates, but there is a requirement that the grantee perform a cost analysis of a contractor’s proposal whenever the contract is being negotiated without adequate price competition. Since A&E contracts are always awarded under qualifications-based procurement procedures without price competition, the requirement of doing a cost analysis would prevail. Such a cost analysis must include a determination of the reasonableness of the proposed indirect rates, and this determination must take into account the latest audited rates as well as projections based on business prospects over the term of the contract. If the indirect rates have not been audited recently, an audit should be performed prior to price negotiations. If the contract award is so urgent that there is insufficient time to perform an audit, then the contract should state that the billing rate(s) being established in the contract are "provisional," and that an audit will be performed within a reasonable amount of time, and that the provisional rates will then be negotiated. This is to establish the initial contract billing rates. Beyond this you will still have to determine if you want to perform an audit of costs after completion of the contract, and include proper contract terms if you do. (Revised: October, 2010)

If a General Engineering Contractor uses projected overhead rates, and later audited rates turn out to be significantly less, is the contractor required to make an adjustment for billing purposes?

The answer to this question depends on the terms of your contract with the A&E firm. If you are using a cost-type contract (e.g., cost-plus-fixed-fee), then you should have a clause in the contract describing how final indirect costs will be determined through an audit and the clause should reference Part 31 of the FAR "Contract Cost Principles and Procedures" as the basis for determining allowable costs. The clause used in Federal cost-type contracts may be found at FAR 52.216-7 "Allowable Cost and Payment," and paragraph (d) "Final indirect cost rates" describes the process of determining final indirect rates. With respect to the definition of "allowable costs," assuming there is to be an audit, you will need to reference Part 31 of the FAR or some State or local regulations setting forth contract cost principles for determining allowable costs under cost reimbursement contracts. If, however, you use a Time and Materials type of contract or a fixed price type of contract, there normally will be no adjustment to the billing rates unless there is a specific contract clause calling for an after-the-fact audit and adjustment to rates that have been established in the contract and billed. Such rates are normally referred to as "provisional" billing rates, meaning they are subject to later audit and adjustment. There is no FAR requirement or requirement stated in FTA Circular 4220.1F that requires grantees to use cost-type contracts that would subject an A&E to a later audit of its indirect costs. If you want the authority to conduct an audit and adjust for actual costs incurred, you must structure the contract with these terms in it. (Revised: October, 2010)

Recently, we were awarded a contract to perform state work. We are a subconsultant to a general engineering consultant. They submitted an overhead rate of 127%. When I asked them if they were operating at a loss, they claimed no. Can a firm have an overhead rate of 127% and still be profitable?

We can only give our observations from personal experiences with firms that provide technical services such as engineering or architectural expertise. From our experiences an overhead rate of 127% is not abnormal for the technical services industry. However, it must be noted that merely looking at a rate, in the absence of information about how specific costs are charged (as between direct and indirect categories), can be misleading. For example, one company with an overhead rate of 127% may be much more price competitive than another company with the same overhead rate. This happens if the former company provides services to its customers that are not charged directly to the customer, while the second company may charge the customer directly for the same services and still bill the customer 127% as an overhead charge against direct labor dollars. For example, one A/E firm with an overhead rate of 127% may not bill its customers directly for CADD costs since these are included in the overhead charge of 127%, while its competitor charges its customers for CADD as direct charges to its contracts and also applies the same 127% as an overhead cost to the direct labor dollars. The same issue may apply to such things as the time of managers or supervisors, secretaries, printing, local travel, telephones, computer time, etc. Different companies may treat these types of expenses as overhead costs which are invisible to customers, or treat them as direct charges to individual customers. These different cost treatment methodologies can affect the competitive cost position of the company, and must be taken into account when evaluating the company's overhead rate. (Reviewed: October, 2010)

How do you calculate overhead rates for an entity with a single federal contract for a start-up, state-created regional authority?

What should we use as our base for allocation of indirect costs which we estimate to be 90% allocated to the federal contract and 10% to perform our G & A for non-federal activities. We have no full time employees; all personnel are consultant or contract staff.

Our advice to a newly formed organization like yours would be to work with your contracting agency counterpart (the State DOT in this case), and have their cognizant auditor review your proposed indirect cost methodology, or actually advise you as to methods they would find acceptable. This audit office should be the same one that will review your actual costs upon completion of the project. The objective of this review would be to negotiate a rather definitive "advance agreement" in your contract or grant with the State DOT that spells out the agreed upon methodology for charging both direct and indirect costs. If you go into this contract or grant without an up-front advance agreement on costing methods acceptable to both parties, you run the very real risk of having your costs questioned and/or disallowed after incurring them. This is especially true for a newly formed organization without an audit track record. This obviously represents a risk you do not want to incur. (Revised: October, 2010)

Does FTA have a set or an approved overhead rate for A&E Contracts?

FTA does not have a set or approved rate for contracts with A&E firms or any other firms. You will need to evaluate the specific firm's current and projected overhead rate, with the help of an auditor who is familiar with indirect cost pools and the cost principles for third-party contracts financed with Federal funds. Each negotiation of overhead rates will reflect that specific company's situation and the rate negotiated will be different than that of other companies. One reason for differences among companies is that they will treat their costs differently as between direct and indirect costs (overhead). For example, one A&E firm will charge CAD costs directly to contracts while another will charge CAD as an overhead cost. This difference in cost treatments can produce significantly different rates, so that a single rate for all firms would be impossible. Similarly, companies with a large current volume of work may be experiencing a low overhead rate, while another with lower current sales will have a higher rate because the fixed costs in the overhead pool must be recovered over a lower sales or direct labor base. (Reviewed: October, 2010)

In a cost plus fixed fee contract, can one negotiate a maximum overhead rate even though the overhead rates are subject to audit?

You can negotiate an advance agreement with the contractor establishing a ceiling overhead rate for any given fiscal/calendar year and state that the final overhead rate payable on the contract will be established by a final contract audit, except that in no event will the final rate payable exceed the ceiling rate(s) stipulated in the contract. In the event that the audited overhead rates are less than the rates the contractor billed you during the course of the contract, the lesser (audited) rates will be the final rates paid. (Revised: October, 2010)


Are third party contractors required to certify their yearly indirect cost rate proposals as required by FAR 42.703-2(a) Certificate of indirect costs? If not, why not?
Are third party contractors assessed penalties as discussed in FAR 42.703-2(e)? If not, why not?
Is FAR 52.242-3, Penalties for unallowable costs, a required clause for third party contracting? If not, why not?
Is FAR 52.242-4, Certification of final I/D Costs a required contract clause for third party contracts?
Is FAR 42.7 a required contract clause in FTA's Circular 4220.1F, Third party Contracting Guidelines?

FTA Circular 4220.1F requires that allowable costs under third-party contracts be determined in accordance with "Federal cost principles." Federal cost principles are defined by the FAR in Part 31 - Contract Cost Principles and Procedures. The Circular requirement is based on the common grant rule in 49 CFR § 18.22 - Allowable Costs. 49 CFR § 18.22 (b) - Applicable Cost Principles states that "For each kind or organization, there is a set of Federal principles for determining allowable costs." It goes on to prescribe the cost principles in 48 CFR Part 31 (FAR) as applying to for-profit organizations other than hospitals. This would cover grantee third-party contracts.

The problem arises because FAR Part 31- Contract Cost Principles and Procedures, as the title implies, contains both cost principles as well administrative procedures. The common grant rule and the FTA Circular both refer to the cost principles as governing the allowability of costs but neither require that the administrative procedures of FAR Part 31 be imposed on third-party contractors. It is these procedures that require the certification of indirect cost rate proposals and the penalties for submission of unallowable costs. But the procedures do not themselves determine the actual allowability of the costs.

The answer to your question, then, is that the FAR is not imposed on grantees or their third-party contractors except as certain parts may be specifically incorporated in the common grant rule and FTA Circular 4220.1F. The common grant rule and the Circular do impose FAR Part 31 on grantee third-party for-profit contractors but only to the extent of the cost principles for determining allowable costs. We do not see a requirement that the administrative requirements of FAR Part 31 (e.g., certification of proposals and penalties, etc.) be imposed on grantee contractors. This is not to say that grantees cannot develop contract provisions on their own, and use the FAR procedures pertaining to certification and penalties if they so choose, for their third-party contracts. (Revised: October, 2010)

According to the proposed vendor, they only have one competitor and do not have any information regarding industry standards for profit or overhead rates. Their overhead rate has not been audited. It is based on projected figures. They consider their profit rate to be sensitive competitive information which they would rather not make available to the governmental entity where it would be subject to the Freedom of Information Act. In such a situation, where can we obtain this information?

We are in the process of planning an engagement to conduct a cost analysis as required by FTA C 4220.1F for a sole source third party engineering services contract. We are seeking guidance regarding the requirement to obtain industry standards for the analysis of overhead rates and gross profits.

We understand this procurement action is a change order to a fixed price contract that will require the contractor to install operational software in several bus stations. FTA Circular 4220.1F requires a cost analysis whenever adequate price competition is lacking, including the case of contract modifications and change orders, "unless price reasonableness can be established on the basis of a catalog or market price of a commercial product sold in substantial quantities to the general public." Since the present action appears to involve specially designed software for this transit agency's needs, it would not appear that this can qualify as a commercial product sold in substantial quantities to the general public. But you need to make this determination.

As to the Freedom of Information Act, we do not believe that business-sensitive information such as overhead rates or the rate of profit negotiated on a contract is releasable to the public. However, you need to check on your state requirements as to what information can be protected by the contractor and grantee from release to the public.

We would suggest you attempt to obtain a cost proposal with a cost and profit breakdown from this vendor, and contact the CPA firm that audited and certified the latest financial statements. Request that firm to review the cost breakdown (labor rates, overhead, etc.) and verify that the proposed costs are indicative of the latest costs as audited. Based on the auditor's inputs, the costs can then be negotiated as well as the profit.

We are not aware of any industry standards for engineering software firms' overhead rates, and we would not expect any such data to really be meaningful because different companies charge their costs differently. This would entail a detailed knowledge of every firm's overhead pool and costing methodology. As for profit, the degree of risk being assumed by the vendor, and the complexity of the work, would be the most significant factors to be considered. We would expect the profit to be higher on a firm-fixed-price contract where the vendor is assuming responsibility for a complex operational system, in contrast with a time and materials or labor hour contract where the contractor is using "best efforts" and will be paid for all his costs.

The FTA Best Practices Procurement Manual, Section 5.2 - Cost and Price Analysis should also be read in connection with your question. (Revised: October 2010)

For a Change Order to an existing fixed price contract, can indirect costs that are part of an Engineering Pool cost structure have overhead (SG&A) and profit applied? A customer contract's language implies that according to FTA Circular C4220.1F, only overhead (SG&A) and profit can be applied to direct labor costs, insurance, tax and cost of materials. Can you tell me where to find the language in the FTA circular for this information?

FTA Procurement Circular 4220.1F, Chapter IV 2.b. (4) (P. IV-8), requires that allowable costs on contracts with “for-profit” entities be based upon the Federal Acquisition Regulation (FAR) Subpart 31.2.

FAR Subpart 31.203 – “Indirect Costs,” discuss the allocation of indirect costs to “appropriate bases,” meaning that there is flexibility in allocating indirect costs to (1) a direct labor base (e.g., overhead costs), or to (2) a total cost incurred base (e.g., G&A costs). We see nothing in the FAR Part 31.2 that would limit the allocation of all indirect costs to one particular base such as direct labor. Many companies do in fact have several indirect cost pools with different bases of allocation. Typically these would include overhead (allocated to direct labor dollars) and G&A (allocated to a total cost of sales base). Some manufacturing companies might also have a material handling overhead pool allocated on the basis of total material costs.

You should carefully review all of FAR Subpart 31.2 for a complete discussion of the allow-ability of costs on commercial contracts. (Reviewed: October, 2010)

In the FTA web page Question & Answer Section an overhead question was answered as follows:

"You can negotiate an advance agreement with the contractor establishing a ceiling overhead rate for any given fiscal/calendar year and state that the final overhead rate payable on the contract will be established by a final contract audit, except that in no event will the final rate payable exceed the ceiling rate(s) stipulated in the contract. In the event that the audited overhead rates are less than the rates the contractor billed you during the course of the contract, the lesser (audited) rates will be the final rates paid." What is the authority for this position?

Your question cites as its topic, "Architect - Engineering Contracts." The published answer you cite with your question, however, was not given in relation to A&E contracts, but for non-A&E contracts. In fact overhead rate ceilings are not permitted on A&E contracts, as indicated in another published answer at the FTA FAQ web page, which reads as follows:

You can impose an overhead rate cap on non-A&E consulting agreements, such as services for auditing, medical, legal, contract administration and technical work of any kind except those for A&E work. You cannot impose overhead caps on contracts for A&E work, which is defined in 49 U.S.C. § 5325(d). These services are also discussed in the BPPM, Section 6.5 – Architect-Engineer Services, as is the reason why overhead caps cannot be used with A&E contracts (based on specific legislation applicable to A&E work).

The authority to negotiate overhead rate ceilings on non-A&E contracts is a basic right of contracts, where two parties can agree on the type of legal consideration and on the method of compensation, as long as it is not forbidden by common law or statute (e.g., there is a statutory prohibition against cost-plus-percent-of-cost payment methods). There is no common law or statutory prohibition concerning the establishment of overhead rate ceilings on cost-type contracts, with the exception of A&E contracts.

We would point to the Federal Acquisition Regulation (FAR 16.303), which recognizes the legitimacy of cost – sharing contracts, where the contractor agrees to share in the cost of contract performance for perceived benefits to the contractor. In the overhead rate ceiling case, the contractor agrees to share in the cost of performance if the overhead costs exceed certain limits. The benefit to the contractor for assuming the risk of an overrun in the overhead costs is that the contract is awarded to him, which might not have been the case given the government’s perceived risk of a substantial overrun in overhead costs. (Posted: February, 2011)

How do I apply for or have assigned a government overhead rate for my non-profit company?

It is up to the company to develop an overhead rate and submit the data in support of the estimated rate to the government agency that is funding you (by grant, contract, etc.). The government agency providing funds to you will not assign you a rate but will negotiate a projected rate with you based on the actual and projected expenses that you submit to them for the current fiscal year. (Posted: February, 2011)

Explain the concept of indirect costs as a component of a cost/price proposal?

Indirect costs are costs that are not directly accountable to a cost object (such as a particular contract or product). Indirect costs may be either fixed or variable. Indirect costs include taxes, administration, personnel and security costs, and are also known as overhead.

Direct costs are those for activities or services that benefit specific projects, e.g., salaries for project staff and materials or equipment required for a particular project. Because these activities are easily traced to projects, their costs are usually charged to projects on an item-by-item basis.

Indirect costs are those for activities or services that benefit more than one project. Their precise benefits to a specific project are often difficult or impossible to trace. For example, it may be difficult to determine precisely how the activities of the Director of an organization benefit a specific project.

It is possible to justify the handling of almost any kind of cost as either direct or indirect. Labor costs, for example, can be indirect, as in the case of maintenance personnel and executive officers; or they can be direct, as in the case of project staff members. Similarly, materials such as miscellaneous supplies purchased in bulk-pencils, pens, paper-are typically handled as indirect costs, while materials or equipment required for specific projects (e.g., computers) are charged as direct costs.

Costs usually charged directly:

  • Project staff
  • Consultants
  • Project supplies
  • Publications
  • Travel
  • Training

Costs either charged directly or allocated indirectly:

  • Telephone charges
  • Computer use
  • Project clerical personnel
  • Postage and printing
  • Miscellaneous office supplies

Costs usually allocated indirectly:

  • Utilities
  • Rent
  • Audit and legal
  • Administrative staff
  • Equipment rental

Indirect costs are usually charged as a percentage of direct labor dollars. In computing the indirect cost percentage, the annual indirect costs are estimated by expense category and divided by the estimated annual direct labor dollars expected to be incurred during the year. The resulting percentage is then applied to direct labor dollars incurred during the year on all contracts consistently. After the fiscal year is completed, the direct and indirect costs are audited and an actual indirect cost rate is determined for the year. All billings to contracts are then adjusted to the actual rate incurred so as to avoid over or under billings to customers. There is much material available on the Internet – Google "indirect costs." (Posted: January, 2012)

Updated: Friday, March 18, 2016
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