If you have a US Government contract containing the Allowable Cost and Payment clause (FAR 52.216-7) you are required to submit an annual Incurred Cost Proposal, which may subsequently be subject to an Incurred cost audit. This clause applies mostly to cost-reimbursable contracts, such as Cost Plus Fixed Fee (CPFF) and Time and Material (T&M). An Incurred Cost Proposal, also known as an Incurred Cost Submission (ICS), or Indirect Cost Rate Proposal (ICRP), takes all the cost accounting data from a contractor’s expense accounts to calculate the actual indirect rates for the cost accounting period (the fiscal year).

Under cost-type contracts, contractors utilize a provisional billing rate throughout the year.  The intention of the Incurred Cost Proposal (ICP) is to true-up a contractor’s provisional billing rate to actual under its cost-type contracts. The actual rate is compared to what was billed and the calculated over/underbill is either credited back to the government or invoiced, respectively.

Key Takeaways

• Incurred Cost Proposals (ICPs) are mandatory for government contractors under cost-reimbursable contracts to reconcile actual costs with provisional billing rates.
• Failure to submit an accurate and timely ICP can result in financial penalties, payment delays, and increased audit scrutiny from the Defense Contract Audit Agency (DCAA).
• FAR 52.216-7 mandates ICP submissions and requires incurred costs to be allowable, allocable, and reasonable per federal regulations.
• Contract clauses play a critical role in ensuring compliance with cost allocation, reporting, and financial accountability.
• Direct and indirect costs must be properly classified to avoid disallowances and help give accurate cost recovery.
• Common ICP challenges include cost misclassification, lack of supporting documentation, incorrect indirect cost rate calculations, and missed submission deadlines.
• Best practices for a successful ICP submission include implementing a robust accounting system, reviewing past ICPs, maintaining organized documentation, conducting internal audits, and engaging expert support.
• DCAA audits require contractors to provide full transparency in cost allocation, with proper supporting documentation and adherence to compliance standards.

When Must ICPs be Submitted?

As required by the Federal Acquisition Regulation (FAR), Incurred Cost Submissions must be submitted within 6-months of the contractor’s fiscal year end. For example, a contractor who’s fiscal year is the calendar year, must submit its ICP by June 30^th of the following year. While it is not recommended, contractors may request an extension for submission of their rates, which may or may not be honored by DCAA.

Incurred Cost Submission Schedules

The proposal includes a series of Schedules from Schedule A through O, including Supplemental Schedules, which are critical in preparing for an Incurred cost audit. Some of the more impactful Schedules Include Schedule A Summary of Indirect Rates, Schedule H Summary of Direct Contract Costs, and Schedule I Cumulative Costs Claimed & Billed. Please read How to Prepare and Submit an Incurred Cost Proposal for more details on the preparation and submission process.

Upon completion, the Incurred Cost Proposal is submitted to DCAA and your Administrative Contracting Officer (ACO) for review and Incurred cost audit. DCAA uses an Incurred Cost Submission Adequacy Checklist (DCAA > Customers > Checklists & Tools > Incurred Cost Submission Adequacy Checklist) to determine if the submission is adequate for audit.  Upon acceptance, DCAA may audit the submission for compliance including accuracy of rate calculations and applications.  This is the most frequent audit performed by DCAA year over year.  Their findings routinely center on unallowable costs pursuant to FAR 31 and exceptions to exceptions to cost accounting practices used by contractors. It is therefore crucial to spend extra time reviewing accounting for FAR allowability, FAR 31 expressly unallowable costs, and other common DCAA questioned costs.

Upon resolution of any findings, DCAA will issue a formal letter establishing the final rates for that year. Based on the results of the Incurred cost audit, final bills or vouchers to the government may be prepared to close out physically complete contracts listed in the ICP.

Why Incurred Cost Proposals Matter

Government contractors operating under cost-reimbursable contracts must submit an Incurred Cost Proposal to reconcile provisional billing rates with actual indirect costs incurred. The primary objective is to assist with accurate reimbursement and improve financial transparency between the contractor and the government. Without a properly prepared ICP, contractors risk overbilling or underbilling, leading to financial discrepancies and compliance violations.

Benefits of Submitting an Accurate ICP:

• Helps contractors meet FAR 52.216-7 and DCAA requirements.
• Reduces financial risks associated with overcharging or under-recovering costs.
• Prevents potential penalties for misreported incurred costs.
• Improves relationships with government agencies, leading to better contract opportunities.

By submitting a thorough and timely Incurred Cost Proposal, contractors can avoid audit complications and enhance their standing with federal agencies.

Components of an Incurred Cost Proposal

An adequate ICP typically comprises several key schedules and supplemental information:​

• Schedule A: Summary of Indirect Cost Rate Calculation​
• Schedule B: General and Administrative Expenses​
• Schedule C: Overhead Expenses​
• Schedule D: Occupancy Expenses​
• Schedule E: Contractor's Fiscal Year​
• Schedule F: Cost of Money Factors​
• Schedule G: Government Participation​
• Schedule H: Direct Costs by Contract/Subcontract​
• Schedule I: Cumulative Direct and Indirect Costs Claimed and Billed​
• Schedule J: Subcontract Information​
• Schedule K: Summary of Hours and Amounts on Time-and-Material Contracts​
• Schedule L: Reconciliation of Total Payroll​
• Schedule M: Listing of Decisions/Agreements​
• Schedule N: Certificate of Final Indirect Costs​
• Supplemental Schedules: Additional supporting information as required​

Each schedule provides specific details about various cost elements, facilitating a comprehensive review of the contractor's incurred costs. Contractors must make certain that all supporting documentation aligns with contract clauses and provisions to avoid delays or disallowances during an incurred cost audit.

Understanding Direct and Indirect Costs

A key aspect of preparing an incurred cost proposal is properly distinguishing between direct and indirect costs. Misclassification can lead to compliance issues and disallowed costs.

Direct Costs

Direct costs are expenses directly attributable to a specific contract. These costs vary based on the contract’s scope and requirements.

• Labor Costs: Salaries and wages for employees working directly on a contract.
• Materials & Supplies: Equipment and raw materials necessary to fulfill contract obligations.
• Subcontractor Expenses: Payments made to third-party vendors performing contract-specific tasks.

Indirect Costs

Indirect costs are expenses that benefit multiple contracts and must be allocated appropriately.

• Overhead Costs: Costs associated with managing multiple contracts, such as supervisory labor, machinery depreciation, allocable facility maintenance and utilities, and similar.
• General & Administrative (G&A) Costs: Corporate expenses like HR, accounting, and executive salaries.
• Fringe Benefits: Employee-related expenses such as healthcare, retirement plans, and bonuses.

Accurate classification of costs helps meet FAR 31 regulations and supports a successful DCAA audit.

Contract Clauses and Their Importance in Cost Proposals

Government contracts include various contract clauses that dictate how costs should be classified, reported, and audited. These clauses offer consistency, transparency, and accountability in financial reporting. Contractors must carefully review the contract clauses that apply to their agreements to avoid compliance violations and potential penalties.

Key FAR Clauses and Excerpts Related to Incurred Costs

1. FAR 52.216-7 – Allowable Cost and Payment

• This clause requires contractors to submit incurred cost proposals to establish final indirect cost rates.
• Only allowable and allocable costs are reimbursed by the government.

2. FAR 31.Contract Cost Principles and Procedures (including determination of Cost Allowability)

• Defines what constitutes an allowable cost under federal contracts.
• Requires that costs must be reasonable, allocable, and compliant with contract terms.

3. FAR 52.230-2 – Cost Accounting Standards (CAS), when applicable

• Mandates that contractors follow specific cost accounting standards to give uniformity in cost allocation.
• Requires adherence to consistent cost accounting practices across multiple contracts.
• To determine if CAS applies to your contract, please see RKI’s CAS Applicability Flowchart here: CAS Applicability Flowchart (Download Available)

4. FAR 42.705-1 – Final Indirect Cost Rates

• Outlines the process for establishing final indirect cost rates used in contract closeouts.
•  Contractors reconcile indirect costs with actual expenditures.

How to Stay Compliant with Contract Clauses

• Regularly review contract clauses before and during contract performance.
• Makes accounting systems align with government cost allowability and allocation requirements.
• Maintain proper documentation and internal controls to support incurred costs.
• Work with experienced government contract accountants to navigate compliance challenges.

Understanding and applying contract clauses correctly is essential to avoiding disputes, disallowed costs, and audit findings. Proper adherence to contract provisions improves contract administration and financial integrity.

Common Challenges in Preparing an Incurred Cost Proposal

While the ICP process is crucial, it is not without challenges. Many contractors struggle with ensuring that their cost proposals meet regulatory standards. Some common challenges include:

1. Misclassification of Costs

Contractors often misclassify costs, particularly between direct and indirect expenses. Understanding the differences is critical:

• Direct Costs: Expenses directly associated with a specific contract (e.g., labor, materials).
• Indirect Costs: Expenses that benefit multiple contracts, such as rent, utilities, and administrative salaries.

To mitigate this challenge, contractors should implement robust job-cost accounting systems that clearly differentiate between cost types.

2. Lack of Proper Documentation

Incurred Cost Proposals require detailed supporting documentation, including invoices, payroll records, and subcontractor agreements. Insufficient documentation can result in audit findings and potential disallowed costs.

3. Inaccurate Indirect Cost Rate Calculations

Contractors must assist with their indirect cost rates are calculated correctly using proper allocation bases. Miscalculations can lead to rate disputes and unnecessary financial adjustments.

4. Failure to Meet Submission Deadlines

Missing the six-month submission deadline can result in withheld payments and unilateral rate determinations by the Contracting Officer (CO). Contractors should establish internal review schedules for a timely submission.

5. Unpreparedness for a DCAA Audit

Many contractors underestimate the complexity of incurred cost audits. The DCAA scrutinizes indirect costs, cost allocation methods, and supporting documentation. Proactive audit preparation minimizes compliance risks.

Regulatory Framework: FAR 52.216-7

The submission of an ICP is mandated by the Federal Acquisition Regulation (FAR) 52.216-7, titled "Allowable Cost and Payment." This clause requires contractors to submit an adequate final indirect cost rate proposal within six months following the end of each fiscal year. The proposal must detail all costs incurred under the contract and is subject to audit by the DCAA (acquisition.gov).

FAR 52.216-7 stipulates that incurred costs must be:

• Allowable: Costs must comply with FAR Part 31 regulations and specific contract provisions.
• Allocable: Costs must be assigned based on the benefit received by the contract.
• Reasonable: Costs must be ordinary and necessary for business operations.

Failure to adhere to these standards can result in penalties, disallowances, or adjustments to the final indirect cost rates, adversely affecting a contractor's profitability.

Best Practices for a Successful Incurred Cost Proposal Submission

To improve compliance with FAR 52.216-7 and avoid audit findings, contractors should adopt the following best practices:

• Implement a Robust Accounting System: Utilize government-compliant accounting software to track costs in real-time.
• Review Prior Year ICPs: Understanding past audit results can help contractors identify and correct recurring issues.
• Maintain Organized Documentation: Keeping invoices, receipts, and payroll records well-documented ensures a smoother audit process.
• Conduct Internal Audits: Regular internal reviews can help contractors identify issues before submission.
• Engage Expert Support: Consulting with an experienced government contract accounting firm can minimize compliance risks.

Improve Compliance with Expert Support

Submitting a compliant incurred cost proposal is critical for government contractors to secure payments, maintain compliance, and avoid financial penalties. By following best practices, contractors can improve their adherence to applicable FAR and CAS requirements and better prepare for incurred cost audits, making the process more efficient.

At RKI Accounting, we specialize in helping contractors develop accurate, audit-ready incurred cost proposals. If you need expert guidance on contract clauses, contract provisions, or DCAA audit preparation, contact us today to improve compliance efforts and reduce costly mistakes.

Need Help with your Incurred Cost Proposal?

Understanding, preparing, and submitting ICPs can be challenging. Please contact us here if you have any questions, or need help on your indirect rates, and we will be happy to assist you.