Labor rates and wrap rates

When the government buys labor, the hourly price has to cover far more than the wage. It carries a share of payroll taxes, benefits, rent, software, accounting and every other cost of running the company, plus profit. This guide explains how that price is built, using one made-up company from start to finish. Every number in it is invented.

Direct and indirect costs#

Every cost a company has falls on one side of a line.

• A direct cost is spent for one specific contract. The hours an engineer works on that contract, a server bought for it, a trip taken for it.
• An indirect cost supports the business as a whole or more than one contract. Rent, the accounting system, the time spent writing proposals, health insurance.

Direct costs are charged to the contract they belong to. Indirect costs are gathered into groups called pools, and each pool is shared out across contracts in proportion to some measure of activity, called a base.

The rule that matters is consistency. The same kind of cost, in the same circumstances, has to be treated the same way every time. A cost cannot be direct on one contract and indirect on another because that is convenient.

DecisionWas the cost spent for one specific contract?

• Yes
  Direct costCharged directly to the contract it belongs to (e.g. project labor, specific travel, dedicated equipment).
• No
  Indirect costGrouped into an indirect pool (fringe, overhead, or G&A) and allocated across contracts over a base.

The three usual pools#

A small company commonly has three pools. The names are standard. What goes in each, and what each is divided by, is a choice the company makes and then sticks to.

Larger companies split these further, for example into separate overhead pools for work done at their own offices and at government sites. A very small company may have only fringe and G&A.

Turn pools into rates#

A rate is a pool divided by its base, over the company’s fiscal year.

Take a made-up company with these annual figures:

Fringe rate. The fringe pool is divided by all labor, direct and indirect:

210,000 / (600,000 + 100,000) = 30%

Overhead rate. This company applies overhead to direct labor plus the fringe on it:

direct labor with fringe = 600,000 x 1.30 = 780,000
156,000 / 780,000 = 20%

G&A rate. This company applies G&A to everything beneath it:

direct labor       600,000
fringe on it       180,000
overhead           156,000
base               936,000

112,320 / 936,000 = 12%

The rates only mean something together with their bases. “Our overhead is 20 percent” is not comparable with another company’s 20 percent unless both are divided by the same thing.

Build the rate for one hour#

Now price one hour of an engineer paid $60.00 an hour. Each layer is applied to the running total beneath it.

The fully burdened rate is $113.22 an hour.

1. $113.22Fee (8%)+$8.39 on total cost, bringing the fully burdened billing rate to $113.22.
2. $104.83G&A (12%)+$11.23 on all costs beneath it ($93.60), bringing running total to $104.83.
3. $93.60Overhead (20%)+$15.60 on direct labor plus fringe ($78.00), bringing running total to $93.60.
4. $78.00Fringe (30%)+$18.00 on direct labor wage ($60.00), bringing running total to $78.00.
5. $60.00Hourly wageDirect hourly wage of $60.00 for an engineer ($124,800 salary / 2,080 hours).

The wrap rate#

The wrap rate is the single multiplier that takes you from the wage to the burdened rate. It is the layers multiplied together:

1.30 x 1.20 x 1.12          = 1.7472   wrap rate on cost
1.30 x 1.20 x 1.12 x 1.08   = 1.8870   wrap rate with fee

So every dollar of wage costs this company about $1.75 to deliver, and is priced at about $1.89. Check: $60.00 × 1.8870 = $113.22.

People quote wrap rates both with and without fee. When you compare yours with someone else’s, ask which.

Conventions that change the answer#

Two companies with identical costs can show different rates, because they made different structural choices. None of these is wrong. Each has to be applied consistently.

• What overhead is applied to. Direct labor alone, or direct labor plus fringe. Applying 20 percent to $60.00 gives a different result from applying it to $78.00.
• What G&A is applied to. All costs beneath it, known as total cost input, or all costs except subcontracts and materials, known as a value-added base. The second gives a higher rate on a smaller base.
• Where paid leave goes. In the fringe pool, or left in the labor base.
• Whether fee is applied to everything. Some solicitations limit or forbid fee on travel, materials or subcontracts.

Before you trust any calculator, including one listed here, find out which conventions it uses. Check a tool’s answer shows how to test that with one round-number example.

From a salary to an hourly wage#

Rates are applied to an hourly wage, so a salary has to be converted. A full-time year is 2,080 hours: 52 weeks of 40 hours.

124,800 / 2,080 = $60.00 an hour

Nobody works all 2,080 hours on contracts. Holidays, leave and sick time come out. How you handle that is tied to the leave convention above:

• If paid leave is in the fringe pool, divide the salary by 2,080 and let the fringe rate pay for the time off.
• If paid leave is not in fringe, divide the salary by the hours actually worked, often somewhere around 1,880 to 1,920, which gives a higher hourly wage and a lower fringe rate.

Doing both at once counts leave twice. Doing neither leaves it out.

Costs the government will not pay#

On contracts priced or reimbursed on the basis of cost, a cost has to be allowable to be included. The cost principles are in FAR Part 31. A cost is allowable when it is reasonable, can properly be assigned to the contract, follows accepted accounting practice and the contract’s terms, and is not ruled out by a specific cost principle.

Some costs are ruled out whatever the circumstances. They include:

Unallowable costs still exist and still have to be paid. They come out of profit instead of going into the rates. Your accounting system needs to keep them in separate accounts so they can be left out of every pool.

When these rules apply to you#

How much of this the government looks at depends on the kind of contract.

Even on a fixed-price bid, building your rates properly tells you whether the price you are offering covers your costs.

For cost-reimbursement work, a few more things follow. You bill during the year at provisional rates agreed in advance. After the year ends you submit your actual indirect costs, and the difference is settled. Your accounting system has to be able to produce those figures. The Defense Contract Audit Agency publishes a plain-language manual for small contractors on what that takes.

1. StartProvisional rates agreedProvisional billing rates agreed in advance with the government for the fiscal year.
2. ExecutionInterim billing during yearBill indirect costs provisionally on interim vouchers as direct costs are incurred.
3. SubmissionSubmit final indirect costsCalculate and submit incurred indirect cost rate proposal after fiscal year ends.
4. SettlementAudit and rate settlementFinal rates audited/negotiated, and differences between provisional and actual costs are settled.

The Cost Accounting Standards, a further set of rules for large contracts, do not apply to contracts with small businesses.

Lay out the price table#

Section B of a solicitation lists what is being bought as numbered line items. For labor, a line usually multiplies a rate by a quantity of hours:

Things to settle before you fill one in:

• Use the solicitation’s line items, labor categories and hours, not your own. If a pricing workbook is attached, that file is the deliverable.
• Rounding. Round the hourly rate to the cent first and then multiply, unless told otherwise. Multiplying an unrounded rate gives a different total.
• Option years. Wages rise. The example applies 3 percent to the base-year rate for the option year. State the escalation you used, and apply it the way the solicitation asks.
• Wage floors. Some service contracts set minimum wages and benefits for certain job classes through a wage determination attached to the solicitation. Your base wage cannot be lower.
• What carries fee. Check whether travel and other direct costs may include fee or G&A.

Sources#

• Federal Acquisition Regulation, Part 31, “Contract Cost Principles and Procedures”, especially 31.201-2 on allowability, 31.202 and 31.203 on direct and indirect costs, and 31.205 on specific costs. Read it at acquisition.gov.
• FAR Part 16, “Types of Contracts”.
• FAR Subpart 42.7, “Indirect Cost Rates”, and clause 52.216-7, “Allowable Cost and Payment”, for billing rates and the annual settlement.
• Cost Accounting Standards, 48 CFR Chapter 99, including the small business exemption at 9903.201-1.
• Defense Contract Audit Agency, “Information for Contractors” (DCAA Manual 7641.90), at dcaa.mil.