Wrap Rates 101:
Every government contractor must understand how costs are built, measured, and recovered. A wrap rate represents the true cost of performing work — combining direct labor with the indirect expenses that keep a company running. FAR and CAS provide the framework for determining which costs are allowable, how they must be allocated, and how contractors ensure their accounting systems remain compliant and auditable. A solid grasp of these fundamentals forms the foundation for compliant, competitive pricing.
Wrap Rate Fundamentals & Compliance
What is a Wrap Rate?
If you are new to Government Contracting pricing, the concept of a “Wrap Rate” might seem a bit foreign. In plain terms, a wrap rate is a factor that contractors add on top of an employee’s hourly wage when estimating costs for a project. The multiplier ensures that all costs for the contractor are captured. This not only includes that person’s salary but also the additional costs your business incurs to keep the lights on and support employees.
These additional costs — collectively called indirect costs — include employee benefits such as health insurance and paid leave, office rent and utilities, information technology, management salaries, accounting and administrative functions. Because these expenses benefit multiple contracts rather than a single project, government rules require you to accumulate them in pools and allocate them across contracts on a rational basis. The wrap rate spreads those pooled costs over direct labor to ensure you recover them.
A wrap rate is typically expressed as a number like 1.50 or 2.20, meaning that for every $1 of direct labor, the contractor charges $1.50 or $2.20. A cost wrap excludes fee/profit (only covers fringe, overhead and General and Administrative (G&A) costs), while a price wrap adds a fee or profit margin on top. Knowing your wrap rate allows you to price services competitively and still meet cost recovery requirements.
Indirect Rates & Accounting Systems
In the federal marketplace, every contractor — regardless of size — must demonstrate that their pricing reflects real, supportable and auditable costs. Indirect rates are the mechanism that allows this, and your indirect rate structure is inseparable from your accounting system.
Unlike commercial work, where pricing is market-driven, government contracts often require cost-reimbursable pricing. To compete on these contracts, companies must have an accounting system that has received an adequacy determination — either through a DCAA pre-award survey or DCMA approval.
A compliant accounting system must:
Segregate direct and indirect costs
Accumulate and allocate costs consistently
Maintain reliable timekeeping and internal controls
Produce detailed job-cost and indirect-rate reports that trace from source transaction to invoice
In short, your accounting system is the engine, and your indirect rates are the gears. Both must mesh perfectly to maintain audit compliance and cost realism.
Direct Labor (DL) Costs vs Salary
In GovCon accounting, it’s critical to draw the distinction between salary and direct labor, as the two are not equal. For exempt or salaried employees, annualized salaries will include pay for paid time off (PTO), while annualized direct labor costs only account for productive costs to the contract. The same holds true for non-exempt employees, except note the hourly direct labor rate will equal the hourly pay rate — any paid time off is outside a non-exempt employee’s hourly rate. Let’s draw a couple examples to illustrate:
Bob is an Engineering Technician and earns an hourly rate of $40/hr. Bob receives 10 paid holidays and 10 paid vacation days per year, and charges contracts for the remainder of his hours. Therefore, Bob works 1920 hours per year on the contract (2080 - 10 holidays × 8 hours + 10 vacation days × 8 hours). Bob’s DL rate is $40/hr, and his annualized DL is $76,800. Bob’s annual salary is $83,200.
Abby earns an annual salary of $104,000. Abby also receives 10 paid holidays and 10 paid vacation days per year, and charges contracts for the remainder of her hours. Therefore, Abby’s DL rate is $50/hr ($104,000 / 2080 hours), and her annualized DL is $96,000 ($50/hr × 1920 hours).
*For calculation of annual salaries, GovCon typically uses 2080 hours (52 weeks x 40 hrs/week).
The PTO costs that compose the difference between the annualized salary are captured in indirect costs.
Understanding Indirect Rate Costs & Allocations
To understand wrap rates and the intricacies of how they operate in strategic pricing, we must first understand indirect costs and their allocation. Indirect rates are calculated using the concept of “pools” and “bases”. As previously mentioned, indirect costs are necessary expenses that cannot be directly identified with a specific contract. They are accumulated in cost “pools” and allocated across contracts by dividing by the allocation “base”:
Indirect pools are the grouping of similar and like costs with the same “objective” or purpose. There are generally three major components of indirect cost pools that compose the wrap rate:
Fringe Costs. Fringe benefits include paid leave, health insurance, payroll taxes, retirement plans and other employee benefits. These costs are necessary for retaining a skilled workforce and are allocated across contracts using a fringe rate.
Overhead (OH) Costs. Overhead covers expenses that support contract performance but are not directly attributable to a single project. Examples include facility rent, utilities, office supplies, information technology, training, quality assurance and supervision.
General & Administrative (G&A). G&A includes corporate‐level expenses such as executive management, accounting, human resources, legal services and corporate licenses. These costs support the overall business.
Bases for indirect cost pools are based on a causal or a beneficial relationship — i.e. there must be a logical connection between the costs incurred (pool) and the allocation amount (base).
Fringe expenses are causal by direct labor, in that healthcare, PTO, payroll taxes, etc. are the result of direct labor. Therefore, direct labor is considered the base for fringe. Direct labor and fringe — those activities collectively required to deliver contract work — represent the base for overhead costs, which are incurred in support of direct performance. G&A expenses capture company-wide support functions for the overall business, and these costs are applied over a broad business-level base to ensure that all contracts absorb an equitable share of enterprise management expenses.
Contractors must decide how to pool indirect costs and how to ensure allocations are compliant. Companies have flexibility in how they structure their pools and bases, but for the vast majority of Government contractors, their indirect costs are structured like above. In some instances, contractors may combine fringe and overhead costs into a single rate. Or, in a similar manner, contractors may structure their cost pools such that the base for overhead is direct labor (vs. direct labor and fringe). Regardless of the structure a contractor chooses, a critical factor for indirect rate compliance with DCAA is that the costs are consistently classified and aggregated.
Regulatory & Compliance Considerations
CAS Disclosure Statement (DS-1)
In the landscape of indirect rate compliance, few documents carry more weight—or more risk—than the CAS Disclosure Statement (DS-1). For mid- to large-sized contractors, it’s the contractor’s formal commitment to the government detailing how costs are built, where they reside, and how they’re distributed. Once filed, it becomes the foundation for rate integrity, guiding both internal consistency and audit defensibility.
What It Is: A formal, legally binding statement of a contractor’s cost accounting practices. It defines how costs are measured, accumulated, and allocated — detailing the exact composition of every indirect cost pool (Fringe, Overhead, G&A, etc.) and the allocation base applied to each.
Who Files: A DS-1 is required when a contractor becomes CAS-covered — typically upon award of a CAS-covered contract meeting the threshold (e.g., a single award ≥ $50 million, or multiple awards exceeding $50 million in the preceding accounting period).
Why It Matters: Once deemed adequate by the Administrative Contracting Officer (ACO) at DCMA, the Disclosure Statement becomes the binding baseline for cost accounting. Contractors must follow the practices disclosed — consistently and without deviation.
Switching from a Total Cost Input (TCI) to a Value-Added (VA) base, or altering pool composition without prior approval, constitutes CAS noncompliance, which can trigger cost disallowances, penalties, and audit findings.
Indirect cost and rate compliance is governed by the Federal Acquisition Regulation (FAR) and the Cost Accounting Standards, and this affects how wrap rates are calculated and applied. FAR Part 31 contains cost principles addressing allowability, reasonableness and allocability of costs. Only costs deemed allowable under FAR are reimbursed. The Cost Accounting Standards (CAS) are a set of nineteen standards set forth by the Cost Accounting Standards Board (CASB) to promote uniformity and consistency in cost accounting for negotiated defense contracts.
Both FAR and CAS shape how an accounting system must behave. While FAR applies to all Government contracts and defines cost allowability, reasonableness, and allocability, CAS applies on a contract-by-contract basis, prescribing standards for measuring and allocating costs. Whether CAS-covered or not, contractors must apply consistent, equitable allocation practices to meet FAR 31.203(b).
Failure to comply with these regulations can lead to disallowed costs, penalties and loss of contracting opportunities. Maintaining proper documentation and regularly reviewing indirect cost practices reduces audit risk.
There are two main auditing agencies:
Defense Contract Audit Agency (DCAA) audits contractors’ accounting systems, proposals, forward pricing rates and incurred costs. DCAA performs pre‑award surveys of accounting systems, forward pricing labor and overhead rates and CAS disclosure statements. It also audits business systems and provides negotiation assistance.
Defense Contract Management Agency (DCMA) administers contracts, ensuring that the government receives quality goods or services on schedule and at reasonable cost. DCMA provides contract administration services, advises on solicitations and monitors performance.
Forward Pricing Rates, Billing Rates & Actuals
Indirect rates are based on the contractor’s fiscal year. For the pricing and estimation of future business costs, contractors will create forward pricing rates. Forward pricing rates are the result of the budget forecast process. Generally, companies begin by calculating expected revenue from existing revenue streams, factored recompetes and expected new business. From this estimate, expected direct labor costs and the resultant indirect rate costs are derived, factoring in planned changes to business operations.
Contractors will generally provide DCAA/DCMA with the forecasted indirect rates in a Forward Pricing Rate Submission. A “submitted” rate is a contractor’s proposed rate awaiting evaluation. After initial review, DCAA/DCMA may provide the contractor with a Forward Pricing Rate Recommendations (FPRRs) and, after full review, a Forward Pricing Rate Agreements (FPRAs). Contractors are required to resubmit a Forward Pricing Rate Submission to DCAA/DCMA upon any change in business operations (i.e. merger/acquisition, restructuring, etc.) that will have a material impact on the calculation of the forward pricing rate. Recent history shows that most contractors do not arrive at FPRAs due to workload concerns at DCAA/DCMA and operate with Forward Pricing Rate Submissions or FPRRs.
DCAA/DCMA may provide provisional billing rates that differ from forward pricing rates. After the close of the company’s fiscal year, an Incurred Cost Submission is completed. An incurred Cost Submission is the final calculation of the actual indirect rates. The actual indirect rates are then used to make final adjustments on contracts with cost-type CLINs that were performed during the fiscal year. Depending on variances between actual and forecasted billing rates, this may result in the contractor receiving additional payment or reimbursing the Government for overpayment.
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