Authoritative texts indicate the following factors need to be considered when developing an indirect rate structure (see "Accounting for Government Contracts Cost Accounting Standards" by Lane Anderson):

1. Organization structure. A company’s organization should be designed to meet its strategic objectives. For example, some companies organize around types of customers regardless of geographic location. The contractor’s organization is frequently reshaped to meet customer program requirements which makes a company-wide rate compatible with its organization structure.

2. Diversity of Products or Services. Companies with few products or services usually adopt simple accounting systems. The client, for all practical purposes provides only one service – systems engineering. The services are practically the same and consequently, the absence of diversity in services make two indirect pools quite sufficient.

3. Customer Mix. Doing work with the federal government is usually more expensive than for commercial customers. For example, maintaining an adequate accounting system, supporting government audits, keeping up on security requirements are all expensive. Since 85 % of the business is devoted to providing services under government contracts, the government receives the benefits of using a company-wide rate since some of its relatively high indirect costs are allocated across all work.

4. Pricing strategies. A contractor operating in a cost reimbursement environment must be able to fully recover its costs but must also maintain competitive pricing and keep a stable rate structure to adequately administer its contracts. A broad company-wide direct labor base as opposed to frequently changing labor at particular locations helps stabilize rates over a long period of time. Some of the client’s contracts extend over 10 years.

5. Administrative ease. Unduly complicating the accounting system will unnecessarily increase costs over use of a company-wide rate.

What is an Appropriate Indirect Rate Structure (Fundamental Requirement of CAS 418)

CAS 418 requires "a business unit shall have a written statement of accounting policies and practices clarifying costs as direct or indirect, which shall be consistently applied." The client complied by preparing a CASB Disclosure Statement that described its basis for classifying costs as direct and indirect which was deemed adequate by DCAA.

Next, CAS requires "indirect costs shall be accumulated in indirect cost pools which are homogeneous." The homogeneous requirement is satisfied by the fact the individual elements included in the client’s labor burden and overhead pools have the same or similar beneficial or causal relationship to its direct labor base. The homogeneity of the pools may best be demonstrated by grouping the cost elements into the following broad categories:

• Directly related payroll costs – payroll burden

• Personnel support – overhead

• Facilities and office expense – overhead

• Costs necessary for overall operation of business – G&A

Payroll related costs. Payroll taxes, health insurance, holiday, vacation, and other fringe benefits apply equally to all personnel. There is a "direct causal and beneficial relationship" of such costs to salaries and wages paid to employees.

Personnel support costs. These expenses include supervision, human resources, accounting and management information services. These services are provided on a company-wide basis and there is a direct causal and beneficial relationship between the direct labor and related support.

Facilities and office expense. The office facilities and equipment required to support system engineers are very similar because, for practical purposes, the company supplies the same type of services to all its customers. Regardless of where the employee is located, they require adequate office space and equipment. Hence there is a similar causal and beneficial relationship.

Cost related to overall operations. These costs include professional fees, general adminstration, state taxes and licenses and other minor operating expenses whose total as a percentage of direct labor and payroll burden is 3 percent. Pursuant to CAS 410, the G&A expense pool may be combined with other expenses for allocation to final cost objectives provided the allocation base used for the combined pool is appropriate for both the G&A expenses and other expenses. CAS provides that G&A expenses should be identified and requires that G&A type expenses be allocated on a base representing the total activity of the company. Both criteria are met: (1) the chart of accounts clearly identify G&A type costs and (2) total direct labor dollars reflect the total activity of this labor driven client company.

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