What Is an Incurred Cost Proposal?

During the performance year, contractors bill the government using provisional indirect rates, which are estimates approved at the start of the contract. These provisional rates rarely match actual costs once the books close. The incurred cost proposal collects every dollar of cost accounting data from the contractor's general ledger, including direct labor, direct materials, subcontract costs, overhead expenses, G&A expenses, and fringe benefits, and uses that data to compute actual indirect rates for the fiscal year. The difference between what was billed at provisional rates and what should have been billed at actual rates produces an overbilling or underbilling on each flexibly priced contract. If the contractor overbilled, the difference is credited back to the government. If the contractor underbilled, the contractor may invoice for the difference.

The requirement traces back to the Allowable Cost and Payment clause, FAR 52.216-7. Any contractor whose contract incorporates this clause must submit an adequate incurred cost proposal. Flexibly priced contracts and subcontracts include: (1) fixed-price contracts described at FAR 16.203-1(a)(2), 16.204, 16.205, and 16.206; (2) cost-reimbursement contracts and subcontracts (FAR subpart 16.3); (3) incentive contracts and subcontracts where the price may be adjusted based on actual costs incurred (FAR subpart 16.4); (4) orders issued under indefinite-delivery contracts and subcontracts where final payment is based on actual costs incurred (FAR subpart 16.5); and (5) the materials portion of time-and-materials contracts and subcontracts (FAR subpart 16.6). If you are unsure whether the clause applies, check Section I of your contract, as that is where FAR 52.216-7 will appear if it has been incorporated.

FAR 52.216-7 requires contractors to submit their incurred cost proposal within six months of the end of each fiscal year in which costs were incurred. For a contractor on a calendar fiscal year (January to December), the deadline is June 30 of the following year. For a contractor with a September 30 fiscal year end, the deadline is March 31. Missing this deadline can have serious consequences. The contracting officer may reduce billing rates or establish final indirect cost rates unilaterally, and late submissions may face increased scrutiny from DCAA. While contractors can request an extension for exceptional circumstances, approval must be granted in writing by the contracting officer.

The incurred cost proposal is organized into a series of schedules, typically labeled A through O, plus supplemental schedules as needed. Schedule A is the rate summary, showing all computed indirect cost rates. Schedule B details the G&A expense pool (final indirect cost pool). Schedule C breaks down overhead expense pools (final indirect cost pools). Schedule D covers intermediate cost pools such as occupancy, fringe, or other pools allocated to final pools before rate computation. Schedule E defines the allocation bases used to compute indirect rates. Schedule F addresses facilities capital cost of money factors under CAS 414. Schedule G reconciles the contractor's books of account to claimed direct costs, with any differences explained. Schedule H lists direct costs by individual contract with indirect costs applied. Schedule I tracks cumulative direct and indirect costs claimed and billed on each contract. Schedule J provides subcontract information. Schedule K summarizes T&M and labor hour contracts with hourly rate detail. Schedule L reconciles total payroll to the general ledger using IRS Form 941 quarterly wages. Schedule M lists relevant CAS Board or contracting officer decisions, agreements, and accounting changes during the fiscal year. Schedule N is the Certificate of Final Indirect Costs, a signed certification that all costs are allowable. Schedule O provides contract closing information for physically complete contracts. Together, these schedules give DCAA and your Administrative Contracting Officer a complete picture of how costs were incurred, classified, pooled, and allocated.

Properly classifying costs as direct or indirect is one of the most important aspects of incurred cost proposal preparation. Direct costs are expenses that can be specifically identified with a single contract, such as direct labor charged to the contract, materials purchased for that contract's deliverables, and subcontractor invoices tied to contract-specific work. Indirect costs, by contrast, benefit multiple contracts or the organization as a whole and must be pooled and allocated. Overhead costs support direct contract execution, including shop supplies, indirect labor in a manufacturing facility, or depreciation on production equipment. G&A costs cover company-wide management functions like executive salaries, HR, accounting, legal, and corporate rent. Fringe benefits include employer-paid healthcare, retirement contributions, PTO accruals, and payroll taxes applied to employee compensation. Misclassifying a direct cost as indirect (or vice versa) distorts your indirect rates, can trigger DCAA questioned costs, and may result in overbilling or underbilling the government.

Under FAR 31.201-2(a), a cost is allowable only when it complies with all five requirements: (1) Reasonableness, meaning a prudent businessperson would incur the same cost under similar circumstances; (2) Allocability, meaning the cost provides a measurable benefit to the contract or cost objective being charged; (3) CAS Standards, meaning the cost complies with standards promulgated by the CAS Board, if applicable, otherwise generally accepted accounting principles and practices appropriate to the circumstances; (4) Terms of the contract, meaning the cost conforms to any limitations set forth in the specific contract terms; and (5) FAR subpart 31.2 limitations, meaning the cost complies with the cost principle categories under FAR 31.205, which define which expenses are allowable, unallowable, or conditionally allowable. Costs that fail any one of these five requirements are subject to disallowance, and penalties under FAR 42.709 can apply if expressly unallowable costs are included in the proposal.

Contractors subject to CAS must also ensure their incurred cost proposal reflects consistent cost accounting practices. CAS 401 requires that the practices used to estimate costs in proposals match the practices used to accumulate actual costs. CAS 402 prohibits allocating the same cost to a contract as both a direct charge and through an indirect pool. CAS 410 governs how G&A expenses are allocated across final cost objectives and dictates which allocation base (Total Cost Input, Value Added, or Single Element) the contractor must use. CAS 418 addresses the allocation of direct and indirect costs to intermediate and final cost objectives. Violations of CAS can result in cost adjustments, interest penalties, and increased audit scrutiny on future proposals.

Before auditing your incurred cost proposal, DCAA performs an adequacy screening using a 47-question checklist. This checklist verifies that all required schedules are present, that the schedules are internally consistent, that the Certificate of Final Indirect Costs (Schedule N) is properly signed, and that the submission contains enough detail for an auditor to begin work. If your proposal fails the adequacy review, DCAA will return it as inadequate, which means your six-month clock may have passed without a valid submission on file. Passing adequacy on the first attempt saves weeks of back-and-forth and keeps your submission timeline on track.

Once DCAA accepts your proposal as adequate, it enters the audit queue. During the audit, DCAA examines your indirect cost rate calculations, tests transactions for allowability under FAR 31.205, verifies that cost accounting practices are consistent with disclosed practices or CAS requirements, and reconciles claimed costs to your general ledger and financial statements. High-risk areas that auditors routinely focus on include executive compensation (FAR 31.205-6), travel costs (FAR 31.205-46), professional and consulting services (FAR 31.205-33), and selling expenses (FAR 31.205-38). Audit findings typically center on expressly unallowable costs that were not removed from indirect pools, inconsistent allocation practices, and insufficient supporting documentation.

Several recurring errors appear in DCAA incurred cost audits. Cost misclassification, such as charging indirect costs as direct or vice versa, distorts rates across every contract. Missing or incomplete adjustments for FAR 31.205 unallowable costs leave questioned amounts in your indirect pools. Incorrect allocation base calculations, such as including or excluding costs that should not be part of the G&A base under your elected CAS 410 method, produce rate errors that cascade through every schedule. Failure to reconcile Schedule L (payroll) to the general ledger is another frequent finding. Finally, submitting without the signed Certificate of Final Indirect Costs (Schedule N) renders the entire proposal inadequate.

Contractors with clean, well-organized submissions consistently experience faster audits and fewer findings. Start by maintaining a government-compliant accounting system that separates direct and indirect costs throughout the year, not just at submission time. Review unallowable cost accounts against every FAR 31.205 category and confirm that adjustments are in place before closing the books. Reconcile payroll, labor distribution, and subcontract costs to the general ledger before building your schedules. Use prior-year audit findings as a checklist. If DCAA questioned something last year, verify the issue has been corrected. Run the DCAA adequacy checklist against your draft submission before finalizing. Maintain supporting documentation, including invoices, timesheets, subcontract agreements, and Board of Directors meeting minutes for executive compensation, in an organized, readily accessible format.

After completing the audit, DCAA issues a report to the contracting officer with any findings and recommended rate adjustments. The contractor has the opportunity to respond to findings and negotiate disputed items. Once all issues are resolved, the contracting officer issues a final rate agreement letter that establishes the actual indirect rates for the fiscal year. These final rates are then used to calculate the settlement amount on each flexibly priced contract, producing final billings or credits that close out physically complete contracts listed in the incurred cost proposal.