FAR Compliance: Safe Harbor Overhead Rate or Audit?
Consulting firms that provide engineering and design related services may choose to apply a safe harbor overhead rate in many states. The safe harbor rate generally allows new or smaller firms to use this rate while they develop a cost history, processes, and controls. A safe harbor rate is a conservative estimate of overhead costs and often does not exceed 110%. In general, the safe harbor rate offers simplified compliance, ease of use, and regulatory acceptance. However, the artificially low overhead rate offers an incentive to firms to calculate an actual audited overhead rate.
The Benefits
Firm’s that develop processes, controls, and calculate an actual audited overhead rate benefit in the following ways:
- Potential for Higher Reimbursement – Actual overhead rates typically range from 130% to 150%, depending on the firm’s size, location, and structure.
- Potential for Higher Profits – Safe harbor rates are often used to save on costs such as accounting systems, processes, and audits. However, the actual overhead rate will often lead to revenue that exceeds the costs. See the example below.
- Compliance/Credibility – An audited FAR overhead rate demonstrates compliance and enhances the firm’s credibility with contracting agencies.
- Competitive Advantage – An audited FAR overhead rate demonstrates a commitment to transparency and adherence to standards.
- Improved Financial Management – The audit process allows an independent third-party CPA to work with firms to correct and identify opportunities for more accurate financial reporting.
- Planning – Relying on a safe harbor rate will likely lead to under-recovery of costs.
A Comparison
Here’s an example of using an actual overhead rate versus the safe harbor rate, as well as the direct impact on revenue:
Company A is an engineering firm working on a government contract. They have the option to use the safe harbor rate of 110% or calculate their actual overhead rate, which turns out to be 140%.
Safe Harbor Rate Calculation
Direct Labor Costs: $800,000
Safe Harbor Overhead Rate: 110%
Overhead Costs:
$800,000 times 110% = $880,000
Total Billable Costs:
$800,000 + $880,000 = $1,680,000
Actual Overhead Rate Calculation
Direct Labor Costs: $800,000
Actual Overhead Rate: 140%
Overhead Costs:
$800,000 times 140% = $1,120,000
Total Billable Costs:
$800,000 + $1,120,000 = $1,920,000
Impact on Revenue
By using the safe harbor rate, Company A can bill the government $1,680,000. However, if they use their actual overhead rate, they can bill $1,920,000.
Difference in Revenue:
$1,920,000 – $1,680,000 = $240,000
In this example, using the actual overhead rate allows Company A to recover an additional $240,000, which can significantly impact their profitability and financial health.
Conclusion
In summary, consulting and engineering firms should carefully consider the cost/benefit of using a safe harbor rate. While easier and less expensive on the surface, the safe harbor rate may slow the growth of a start-up or small business. In the example we discussed above, $240,000 is a significant addition to revenue that provides an opportunity to reinvest in the business, clients, and overall financial health of the business.
McKonly & Asbury has a team of trained professionals that can guide you through the development of a FAR compliant overhead rate and serve your FAR overhead rate audit needs. For more information about McKonly & Asbury’s Architecture, Engineering, and Construction (AEC) experience, visit the AEC Industry Page and don’t hesitate to contact a member of the AEC team.
About the Author
Dan is a Partner and the Director of our Architecture, Engineering, and Construction (AEC) Practice, serving clients across the Mid-Atlantic. His industry focus includes architecture, engineering and construction, employee benefi… Read more
