Wrap Rate Variations

The appropriate wrap-rate methodology is the one that follows the contractor's unique cost accounting structure. The structure will vary. For example, some contractors add Fringes to Direct Labor when calculating their Overhead allocation base; others do not do so. Other contractors allocate G&A on a Total Cost Input base; others use a Value-Added Base or even a Single Cost Element base.

One size will not fit all and I suggest you not try to force fit all contractors into one methodology.

H2H is correct. To figure this out for your company, you first need to know how the rate was originally calculated. You must then apply that rate the exact same way. 

If that satisfies your question, stop reading here. If you want to see this concept in action, here you go...

Imagine a company with annual labor costs of $500K (we will use this as a base for overheads in this example).

They have fringe of $150K, overhead cost of $50K and G&A of $25K.  In a perfect world, they will have forecast revenues such that they recoup exactly $725K at the end of the year (this is the sum total of all their cost, but excludes profit for this example).

Fringe = $150/$500 = 30%

Overhead = $50/($150 + $500) = 7.69%

G&A = $25/($50 + $150 + $500) = 3.57%

Assume they nail their forecast labor cost of $500K. 

Wrap Option 1

(1+Fringe Rate + OH Rate) * (1+G&A Rate)

= 500 *(1+0.3 + .0769) * (1+.0357)= 713

Since it’s not equal to $725, we know this is wrong.  Adding fringe and overhead rates in this way suggests the rates are both only applied to direct cost. OH should be applied to direct plus fringe. 

Wrap Option 2

1 + Fringe Rate + OH Rate + G&A Rate

500*(1 + 0.3 + .0769 + .0357)=706

Wrong again. This implies all rates are applied only against direct. Again a violation of how they were calculated. 

Wrap Option 3

(1+ Fringe Rate)*(1+ OH Rate)*(1+G&A Rate)

= 500*(1+ 0.3)*(1+ .0769)*(1+.0357) =725

Fringe is applied against direct. OH against fringe plus direct. G&A against fringe plus direct plus OH. This is how they were calculated to create the rate, so this is correct. 

Now for the kicker...

Let’s re-calculate our rates using a different method. Same cost assumptions.  We will change the Overhead rate in alignment with Wrap Option 1:

Fringe = $150/$500 = 30%

Overhead = $50/$500 = 10%

G&A = $25/($50 + $150 + $500) = 3.57%

Now we re-apply using the new rates....

Wrap Option 1

(1+Fringe Rate + OH Rate) * (1+G&A Rate)

= 500 *(1+0.3 + .1) * (1+.0357)= 725 

We could do the same thing for Wrap Option 2. This is why H2H says that you need to understand how the rate is calculated in order to determine the “right” way to do it.

HAVING SAID THAT...Wrap Option 3 is most common because of a concept that says indirect costs should be tied to the direct costs which they’re related to. 

But that’s a whole other post...