Companies receiving federal or state funding or participating in a government contract must calculate indirect costs (overhead) rates before submitting a grant proposal, or as part of a bid for a contract. This is called a “provisional” overhead rate, and is the cost you bill the government during the first year of a grant or contract.
At the end of that first year, overhead rates must be audited and adjusted within 150 days after the company’s fiscal year ends. At this time a final overhead rate for the previous year must be submitted, along with a projected rate for the current year.
If the final audited rate submitted for the previous year is lower than the original provisional rate, the company must pay the government back the difference. If the final rate is higher, the company can bill the additional amount, up to the limit of the contract or grant.
The audit of overhead expenses is governed by the complex Federal Acquisition Regulations (FAR). Unless you are prepared for this audit process, you could find that planned profits may disappear after adjustments are made for overhead.