The Office of Management and Budget May 29 issued final revisions to its principle guidance governing the way federal agencies go about determining whether a commercial activity should be performed by the public or private sector. The revisions to OMB Circular A-76 are intended to implement the President’s Management Agenda for a “market-based government” by creating procedures to open the nearly 850,000 full time equivalent positions that have been identified as commercial activities currently performed by government employees that are potentially obtained from the private sector. The stated purposes of these changes are to significantly expand the likelihood that federal agencies will be forced to conduct more private-public competitions and to materially reduce the timeframe for these competitions.
The changes (1) require that competitions be conducted according to FAR-based competitions using one of four methods (sealed bid, lowest price/technically acceptable, phased two step or trade off) (2) allow competitions under the two step phased approach (e.g. first phase may consider only technical factors while the second may consider cost or price realism) or trade off method to include “best value” criteria as a factor (3) allow agency tenders (the equivalent of a contractor proposal) to be excluded from competitions if the source selection authority identifies a material deficiency that cannot be corrected with a reasonable commitment of resources (4) require all standard competitions including competitions for which a solicitation has not been issued, to be completed within 12 months (rather than the current average of three years) with the possibility of a single six-month extension with OMB approval (5) provide a “streamlined” cost comparison process for functions with 65 or fewer government employee where a 90 day timeframe is established from public announcement to performance decision with the possibility of a 45 day extension (6) require a federal entity that wins an A-76 cost comparison to meet pre-determined performance standards and subject the entity to evaluation and re-competition after a set period (three to five years) (7) make clear that once contracted out such work is not subject to future cost comparisons and (8) create the right to contest an A-76 action using protest procedures found in FAR Part 7.
The final version of the changes excludes an earlier proposal to open up inter-service support agreements (ISSAs) to competition from the private sector where support services like administrative, professional and logistical effort are provided by agencies to one another on a cost reimbursement basis. While some estimate these services at up to $100 billion, the OMB states they have no idea how many such agreements exist and to incorporate changes to ISSAs would unduly delay needed changes now. Since industry stands to gain substantially in hopes of more work and federal workers stand to lose jobs, implementation of the revisions have become a hot, controversial topic (Fed. Reg 32134)
As part of its ongoing effort to streamline the FAR cost principles, the authors of the FAR have proposed numerous revisions to FAR Part 31. The FAR Council July 7 proposed to revise the cost principles addressing gains and losses on asset dispositions, material costs and maintenance and repair costs.
FAR 31.205-16, Gains and losses on dispositions or impairment of depreciable property or capital assets. The change addresses the method and timing for determining the gains and loss associated with the sale and leaseback arrangements of depreciable property. The gain or loss will now be determined at the end of the lease term or when the contractor no longer occupies the property – whichever date is later – rather than the date of the sale and leaseback arrangements. The changes are made to help ensure (1) the contractor should neither benefit or be penalized for entering into the arrangement (2) the government should reimburse the contractor the same amount as if it had retained title and (3) the government would be precluded from recovering the financing cost that are embedded in the sale price if the gain is recognized at the date of the sale-leaseback arrangement.
FAR 31.205-26, Material costs. The current paragraphs (c) and (d) would be deleted. Paragraph (c) requires adjustments for the differences in physical and book inventories be made during the period of contract performance and the change would rely on generally accepted accounting principles (GAAP). Paragraph (d) addresses specific methods of estimating material costs and the deletions are made because FAR Part 31 should address allowability of costs not methods of estimates
FAR 31.205-24, Maintenance and repair costs. The proposed rule would delete the entire cost principle. The councils say CAS adequately addresses these costs for CAS covered contractors and GAAP is sufficient for non-CAS covered contractors (Fed. Reg. 40466).
In a separate action, the FAR Council proposed a change to FAR 31.201-6, Accounting for unallowable costs. The amendment would add a new paragraph (c)(2) that would recognize the acceptability of using sampling as a method to identify unallowable costs under specific criteria. Two criteria are proposed: (1) the statistical sampling results in an unbiased sample that accurately represents the universe of data and (2) the statistical sample permits audit verification (Fed. Reg. 28108).
Finally, the FAR Council has proposed amending FAR 31.205-6, Compensation for personal services related to post-retirement benefits (PRBs). The proposal:
1. Adds language that specifies the contractor would have to give the government either a credit or cash, whichever the government elects, for refunds and credits related to plans for PRBs or other provisions. The current FAR language simply states the government will receive “an equitable share” where the share reflects the government’s previous participation in PRB costs on those contracts covered by the FAR. Similar language would be included in the revised contract clause at FAR 52.215-18, revisions or adjustments of plans for post retirement benefits other than pensions.
2. To make it consistent with CAS, change the phrase in section (k)(2) from “measure, assigned and accounted for: to “measure, assigned and allocated.”
3. Move to another paragraph (o)(2)(iii) requirements that apply to accrual costing other than terminal funding while maintaining the substance of requirements in (o)(3) through (o)(5) that address timing of recognition of the costs (Fed. Reg. 33326).
New Rule on Audit Access Rights for OTA Prototype Projects; Proposal to Waive Competition for Follow-on Production Contracts
The Defense Department passed a final rule May 20 to provide audit access rights on Other Transaction agreements (TAs) for prototype projects where the government provides funds exceeding $5 million. DOD states the new rule balances the needs to attract the widest possible private sector participation with the needs of auditing contract records to ensure compliance with contract terms. Though DOD does not usually require audits of fixed price OTAs, termination settlements on fixed price contracts based on costs will have audit access. Examples of cost type OTAs having audit access include (1) an agreement where at least one third cost is shared by a contractor (2) where payments are based on actual costs or reports generated by the contractor’s cost records or (3) where there may be a fixed price but the additional effort is based on cost projections. When an OTA includes the new DOD audit clause, the awardee must flow down the clause to subcontractors whose sub-agreement needs will exceed $5 million. Frequency of audits will be determined by the agreement officer and the audit will be conducted by either DCAA if the contractor is working on other contracts subject to CAS or FAR or an independent public accountant (IPA). An exception is provided if there is an “adverse impact” to non-traditional contractors who are defined as those not subject to CAS for at least one year who do not have another contract in excess of $500,000 subject to FAR (Fed.Reg. 27452).
In recognition of the fact many OTA participants contribute their own funds to projects, DOD is proposing a rule to continue OTA prototype projects into production without competition under certain circumstances. Production contract awards to OTA awardees without competition can occur when (1) the OTA required contractors to provide at least one third the costs of the prototype project (2) the OTA was competitively awarded and DOD evaluated the proposed quantity and target prices for follow-on production units as part of that competition (3) DOD considered the balance between contributions from contractors with the interest of the government and (4) the awardee successfully completed the prototype project (Fed. Reg. 27497).
Incorporating earlier comments to a proposed April 2000 rule, the FAR Council July 3 proposed to amend FAR Part 30 that sets the process of administering the cost accounting standards and determining the impact of accounting changes. EXPAND ON EARLIER The earlier proposed rule established a three-step sequence of submissions of cost impact statements where acceptance of the lowest step would be encouraged and where the cost impact on government contracts would be streamlined.
The changes over the earlier proposed rule include: (1) incorporating a June 2000 CAS Board final rule that added definitions for required, unilateral and desirable changes and excluded cost accounting practice changes related to external restructuring from contract price and cost adjustments (2) included the effect of “offsets” in the cost impact calculation process by separating the calculation of the cost impact from the resolution of the cost impact (3) authorizes the Cognizant Agency Federal Official (CAFO) to make a materiality determination at any point in the cost accounting process before requesting a general dollar magnitude (GDM) proposal (4) provides additional guidance on what constitutes “desirable changes” (5) revises the content of GDM and detailed cost impact (DCI) proposals (e.g. allowing broad based data as the basis for GDM proposals, projecting only larger contracts rather than all contracts for DCI proposals) to provide greater flexibility and reduce administrative effort (6) authorizes the CAFO to resolve a cost impact due to a change in accounting practice by adjusting a single contract or several but not all contracts as long as the government will not pay more in the aggregate (7) requiring the CAFO rather than COs to execute contract modifications and (8) adding a provision requiring contractors to indicate if the contract award will result in a cost accounting practice change and if so to prepare a pricing proposal using the changed practice (Fed. Reg. 40104).
Over the next few months, the Labor Department’s Office of Federal Contract Compliance Programs will schedule compliance reviews of about 2,000 of the 10,000 government contractors who responded to a recent pay survey. Developed under the Clinton Administration and initially sent to 49,000 employers in January, 2000 the survey requires respondents to submit detailed information of compensation, personnel activity and tenure of full time employees by race and gender. The labor department extended the survey for two years in January 2002 by sending it to 10,000 randomly-selected federal contractors. DOL will select 2,000 randomly selected respondents for further review. Industry has strenuously criticized the survey for having questionable value and for being burdensome while employee groups have maintained its value for determining levels of discrimination.
The Defense Contract Audit Agency issued new guidance addressing how often auditors should test both major and non-major contractors’ timekeeping practices as well as performing risk assessments at major contractor locations to determine whether to perform labor floorchecks or labor interviews. Auditors are responsible for testing the reliability of employee time records, verifying that employees are actually at work, they are performing in assigned job classifications and that time is charged to the proper cost objective – these requirements are covered under their Mandatory Annual Audit Requirements (MAAR) No. 6. The guidance states that MAAR NO. 6 can be accomplished by conducting floorchecks and/or labor interviews.
At major contractors, the decision whether to perform floorchecks or interviews or a combination of both depends on the level of assessed risk which is ascertained after performing a risk assessment specified in Chapter 6-402 of the DCAA Contract Audit Manual. For non-major contractors who are not considered “low risk” contractors MAAR No. 6 would generally be accomplished by conducting annual labor floorchecks while for low risk non-major contractors, floorchecks should be performed every three years (03-PPD-046(R).
Citing reductions in quality assurance staff, Principle Deputy Under Secretary of Defense Michael Wynn announced a new policy to reduce source/origin inspections by the Defense Contract Management Agency’s Quality Assurance (QA) staff on defense contracts valued at less than $250,000. Under the “new business plan” the contracts will not require a source/origin inspection unless it is approved by an official one level above the contracting officer who must verify that three conditions exist: (1) there are significant technical requirements (e.g. drawing, test procedures) (2) critical product features/characteristics or special acquisition concerns have been identified and (3) the contract is awarded to a manufacturer/producer or to a dealer/distributor and specific government verifications have been identified as necessary and feasible to perform. For contracts failing one or more of these conditions product quality assurance will be limited to destination inspection and/or user determinations of item fitness for use. DCMA will continue to support some inspections requirements in FY 2002 and earlier contractors but DCMA must begin significant QA changes beginning with FY 2003 contracts. DCMA may also apply the reduced QA effort on higher dollar value contracts (April 14 announcement).
Miscellaneous cost principles. The cost principle concerning transportation costs (FAR 31.205-45) has been deleted. FAR 31.205-10, Cost of money has been changed to define cost of money as an imputed cost that is not a form of interest on borrowings, is an “incurred cost” for cost reimbursement purposes and is an allowable cost provided it is measured, assigned and allocated in accordance with CAS 414.
Prompt payment under cost type service contracts. The final rule adopts the interim rule that requires an agency to pay interest penalty whenever it makes an interim payment under a cost reimbursable contract for services more than 30 days after receipt of a proper invoice from the contractor. Though effective as of May 27, 2003 it applies to any relevant contract, irrespective of contract date.
Electronic signatures. Effective June 23, 2003 FAR Part 4.5 now provides that “agencies may accept electronic signatures in connection with government contracts.” The choice of technology for electronic signatures is left to each agency (Fed. Reg. 28091).
The Small Business Administration June 4 proposed to revise its regulations to allow a small business owned and controlled by another to be eligible for funding under the SBA’s Small Business Innovation Research program. The proposed rule is not intended to change the size standard for eligibility (currently less than 500 employees) but to increase the number of eligible firms. Under the proposed rule an SBIR awardee may be either (1) a for-profit business that is at least 51 percent owned and controlled by one or more individuals who are citizens or permanent residents of the US or (2) a for profit firm that is 100 percent owned and controlled by another for-profit business that itself is at least 51 percent owned by the same categories of individuals. Under the proposed rule an applicant for an SBIR award would not need to meet the eligibility requirement when it submits its proposal but rather only at time of award. The proposed rule is intended to change the current situation where a business may not receive an SBIR if it is more than 50% owned and controller by another business – even if together with its parent company, it is below the 500 employee small business standard (Fed. Reg. 33,412, June 4, 2003).
The Office of Federal Procurement Policy Administrator Angela Styles May 30 issued guidance to federal agencies on using simplified procurement procedures and new thresholds to meet acquisition needs in urgent situations and national security emergencies. The 15 page guidance provides a general framework for responsive contracting that summarizes existing policies and creates new contracting authorities that are intended to be beneficial for meeting emergency needs.
Examples of existing tools cited include simplified open market competitions for commercial items, use of pre-qualified firms under multiple award schedule contracts, HUBZone contracts, oral solicitations, letter contracts, limited source selections and innovative contracting. New tools passed under the Homeland Security Act include application of (1) simplified acquisition procedures to any product or service in any amount (2) micro-purchase flexibilities up to $7,500 (3) simplified acquisition thresholds raised up to $200,000 for domestic awarded contracts and $300,000 outside the US ($250,000 and $500,000, respectively for DOD procurements) (4) making sole source awards to 8(a) and HUBZone small businesses in any amount when agencies elect to exempt full and open competition and (5) treating non-commercial items as commercial items for purposes of waiving accounting, compliance and other requirements. A handy table is provided in the guidance comparing current and new thresholds under emergency procurement circumstances.
The guidance also encourages use of firm fixed price contracts and firm fixed price contract with economic price adjustments as will as synopsized actions through FedBizOpps.gov to the maximum extent possible. The guidelines are available at www.acqnet.gov.
The contractor was awarded a $1.4 million contract that was suspended pending a resolution of a protest. Contract work did not commence where 10 months later the government terminated the contract for convenience. Contractor settled most of its termination for convenience settlement proposal costs but the CO rejected $387,000 for 291 days of alleged unabsorbed home office overhead stating the contractor could not use the Eichleay formula to compute the unabsorbed overhead because there had been no contract billings. (Editor’s Note. Unabsorbed overhead is the amount of overhead that cannot be absorbed because there is no direct costs expended and the Eichleay formula is computed by applying a daily overhead rate to the period of government caused delay which is derived from multiplying the total overhead during contract period by the ratio of contract billings to total company wide billings during the contract period which is then divided by the days of contract performance.) The contractor asserted it remained on standby for the ten months and was prevented from taking on additional work to absorb the overhead allocable to the contract and hence was entitled to additional compensation based on a modified Eichleay formula where it substituted contract price and anticipated contract duration for actual contract billings and actual contract performance.
A lower court sided with the government ruling even if the contractor could demonstrate it met the conditions for recovering unabsorbed overhead (i.e. government imposed delay or suspension and inability to take on other work) the contractor could not recover because its modified Eichleay formula was “not the Eichleay formula” where Courts had ruled it was the “exclusive” means to compute unabsorbed overhead on government-caused delays. However, the Appeals Court sided with the contractor noting that though the Eichleay formula is the “only” proper method to calculate unabsorbed overhead when the contractor begins contract performance, here there was no performance and therefore the Eichleay prohibitions did not apply because there was no contract billings to base the allocation on. The Appeals Court stated as long as the conditions for recovering unabsorbed overhead were present there was “no bar” against recovering unabsorbed overhead as part of a termination for convenience claim due to a government-caused delay. Though FAR 52.249-2, termination settlements does not specifically list unabsorbed overhead as a “cost” its emphasis on achieving a balance of fairness with technical adherence to FAR makes it appropriate to recover unabsorbed overhead as part of its termination settlement proposal. Accordingly, since its performance had not begun, and the government terminated the contract, Eichleay provisions do not apply and the contractor my use another reasonable allocation method to compute its unabsorbed overhead including the modified approach the contractor took. However, the Court added the Eichleay formula must still be the exclusive method when contract performance has started (Nicon Inc. v. US., 2003 WL 21339165).
(Editor’s Note. What constitutes common control over various firms conducting business together is often murky. The following case provides some light and suggests some protective actions to take to avoid problems).
General Atomics (GA) subcontracted with Alliance Staffing Associates for temporary labor services on various cost type contracts between 1992-1997 with numerous government agencies. Alliance was funded by a company which was affiliated with GA and managed by a former GA employee. GA had concluded there was no common control over Alliance and informed DCAA of this conclusion during an audit of several purchase orders for temporary staffing. The auditors found no common control between the companies. GA awarded the contract to Alliance even though its bid was $100,000 higher than other bids but negotiated the difference down to $50,000. In a separate audit, DCAA concluded this corrective action complied with its earlier recommendation.
A plaintiff in a qui tam case alleged the GA invoices included false claims from Alliance by the inclusion of profit in the payments which violated FAR 31.205-26(e) that excludes profits on sales between “divisions, subdivisions, subsidiaries and affiliates” under the common control of a contractor. In determining whether affiliation exists, the court looks to factors such as common ownership, common management and contractual relationships. The Court ruled there was no common control between GA and Alliance and hence there was no false claims. No evidence was produced showing that Alliance’s shareholders held any direct interest in GA or positions of management, employment or influence at GA or exercised any influence over GA decisions. In addition, while the president of Alliance attended GA director’s meetings and provided input into GA’s decision to outsource temporary labor she “did not transform the relationship of GA to Alliance into one of common control or ownership.” Further, the relationship between GA and Alliance was fully disclosed to DCAA and though their job is not to “ferret out fraud” it was DCAA’s responsibility to ensure GA’s contract billings complied with the FAR (United States ex. Rel. Kholi v General Atomics, 00cv1870JM(LAB).
(Editor’s Note. In Boyle v. United Technologies Corp. the Supreme Court announced that contractors who produce military equipment for the federal government are immune from lawsuits under state tort laws for damages caused by a “defective design” as long as the equipment conformed to government specifications and the contractor warned the government of any known dangers. It has been a big question whether this so-called “government contractor defense” established by Boyle in 1988 applied to federal contractors who provide services. The following helps answer that question.)
It had been known that a part (“fin spar”) on the of the UH-1 or “Huey” helicopter had caused the tailfin to separate and crash, severely injuring two Army pilots. In spite of a recommended regular inspection regime, the maintenance contractor for the Huey, at the Army’s direction, did not conduct the fin spar inspection. The pilots sued the maintenance contractor, alleging the contractor had failed to properly maintain the helicopter. In spite of the pilots’ assertions the government contractor defense applies only to procurement contracts for equipment the Courts that heard the case ruled the defense applies to service contracts also.
A commentator in the case in the June issue of the Procurement Law Advisor states the case represents an important liability protection for service contractors against tort-based lawsuits for damages. When combined with existing case law, the case holds the government contractor defense applies to non-military contract service contractors. As the Court restated a successful use of the government contractor defense is contingent on the contractor providing three elements: (1) the government approved “reasonably precise” procedures for how the service is to be performed (2) the service contractor performed the service in conformance with the government’s procedures and (3) the service contractor warned the government about any dangers in reliance on the procedures that were known to the contractor but not the government (Hudgens v. Bell Helicopters/Textron F.3d, 2003 WL 1955173).
(Editor’s Note. You would expect that since they have such a vital role in performing government contracts, subcontractors could file claims against the government. Generally, however, the only way a subcontractor can sue the government is if the prime contractor sponsors the claim. The only exception are direct subcontractor claims of two types: (1) the prime acts as a purchasing agent for the government and therefore the sub can sue the principle, the government or (2) the contract itself expressly allows direct contractor suits which is rare. The following tests whether a subcontractor can bring a claim if either the prime contract was terminated by default or the prime defrauded the subcontractor.)
The Army Corps of Engineers awarded a contract to the prime contractor for a new dock front in Pennsylvania which was eventually terminated for default by the government. The subcontractor filed a $380,000 claim directly with the Corps. arguing it could sue the government directly because of the default termination and the prime contractor had defrauded it and another subcontractor of several thousand dollars of which the government knew but failed to adequately exercise its contract administration duties. The Board ruled against the subcontractor and dismissed its claim holding that even if its allegations were true, “this case didn’t fit into any of the exceptions to the general rule.” (Coastal Drilling Inc., ASBCA No. 54023).
(Editor’s Note. Though it is often desirable to pay an outside professional only if you are successful in a claim or protest, the following demonstrates some pitfalls to recovering otherwise allowable costs when the arrangement is not properly made.)
TRS Research successfully pursued and won a protest. When it submitted a $17,425 claim for attorneys’ fees the contracting officer denied the claim because TRS (1) did not show its claimed $425 hourly rate was customary for similar services performed in the attorney’s locale and (2) failed to prove that TRS was obliged to pay the fees regardless of whether they were recovered from the government. Though TRS submitted “certification” from the attorney stating TRS was “billed” for the services and that TRS was expected to pay the invoiced amount as well as contending the $425 hourly fee was customary in its locale, there was no documents showing the fees were actually billed to TRS or that TRS had either paid or agreed to pay the fees and no survey allegedly performed by the attorney’s firm was produced verifying the contention.
The GAO rejected TRS’s claim noting that contingent fees (i.e. fees that are paid only if recovered from the government) “may not properly be reimbursed” by the government. A successful protester must prove it is obliged to pay the fees regardless of whether the fees are recovered. The GAO also rejected the claim because there was no evidence the $425 hourly fee was reasonable or customary in the locale. It stated even higher fees may be reasonable but there still must be proof that similar fees are customarily charged for that type of work and that necessary evidence might include a survey of local law firm rates or the alleged market analysis that was performed by the law firm before rates were set (TRS Research-Costs, Comp. Gen. Dec. B-290644).
Symplicity Corp. protested the award of a task order to enhance an agency’s website to TMP under its Federal Supply Schedule for “Marketing, Media and Public Information Services” arguing that two labor categories proposed by TMP were not on its schedule. The Comp. General affirmed the labor categories were not included in the schedule and concluded that products and services could not be purchased using FSS simplified procedures and instead, non-FSS products and services must be purchased using traditional competitive procedures. Even though the schedule had been pre-approved by the ordering government agency, the GAO ruled the award was improper because an agency cannot lawfully use the FSS ordering process to order services not on the vendor’s schedule contract (Symplicity Corp. Comp. Gen. Dec. B-291902).
The following is a revised memo we wrote to a client whose primarily labor intensive business is expected to increase substantially where the nature of its new contracts are will likely include a much higher percentage of direct material costs. The memo includes a sensitivity analysis where we assumed different percentages of direct labor versus materials and ODCs for the company and computed (1) indirect rates for their current indirect rate structure versus rates where a material handling rate was added and (2) the cost recoveries of the two rate alternatives given different percentages of direct labor and materials/ODCs. Though we will need to follow up after we receive a budget of expected business with cost breakdowns and then conduct a detailed sensitivity analysis of the best recoveries based on the budget, the following is a few ideas we prepared for their consideration before making any decisions. We thought some of the issues we addressed might be useful for both new contractors deciding on what their indirect cost structure should be as well as veteran contractors who may want to reexamine their current structure and consider alternatives.
General Comments
The decision on what structure to use will largely depend on the future mix of contracts, composition of direct costs on cost build up contracts and the administrative ease of alternative structures.
Your current indirect rate structure – overhead on a direct labor base, G&A on a total cost input (TCI) base – provides a balance between a substantial recovery on direct labor and a nice add on to material and other direct costs (ODCs). If future contracts where price is based on cost buildups (e.g. cost plus, fixed price and T&M where price is largely based on cost projections) are expected to require a significantly lower component of direct labor and higher component of direct material you will likely want to shift some of the indirect costs currently applied to direct labor to direct material. That will require reallocating some of your overhead costs either to a direct material handling pool or to the G&A pool. If more direct labor and less direct material is anticipated then the opposite reassignment of costs may be called for – reassignment of more G&A costs to overhead.
Current Method – Overhead and G&A
The advantages of your current method are considerable. It is an established method involving no changes and hence little need for auditors to review as well as no changes to your current method of accounting for costs. Also, the overhead rate provides for maximum recovery on direct labor and the G&A rate currently provides for a generous 20% add-on to other costs including materials. The only down sides I can think of are (1) the higher material costs will significantly lower your G&A, providing less recovery on direct labor (2) it is quite common for contracting officers (not auditors) to seek a minimal G&A allocation to materials and ODCs, often in the 0-5% range. COs are taught that a significant way to cut government expenditures is to negotiate a cap on G&A costs, especially those applied to direct subcontractor and material costs, even if higher levels are justified on a cost incurred basis and (3) as the attached sensitivity analysis indicates, once material costs exceed a certain level (around 35-40%) of your total costs, you stand to obtain more recovery with use of a material handling rate. Higher recovery occurs where there are higher percentages of material and vice versa for lower percentages.
Use of a Material Handling Rate
A material handling rate includes a pool of costs related to supporting direct material – specification requirements, communications with vendors, QA, ordering, administration, etc – applied to direct materials (subcontractor costs may also be included in the base). The advantages of using such a rate are that higher recoveries of indirect costs can occur when the material costs as a percent of total costs climb. This results from the fact that primarily costs from the overhead pool that are applied to direct labor are reassigned to a pool that is applied to direct material, decreasing indirect costs applied to labor and increasing them for material. Also, if the client seeks a significantly lower G&A rate or, worse no G&A on material, they usually don’t also go for a reduction or elimination of a material handling rate so your two ways of recovering on material costs (G&A and material handling) provides greater flexibility to recover more costs. For example, we have seen considerable effort to reduce and even eliminate G&A add-ons for material and subcontracting costs whereas on the same contracts, material handling add-ons are accepted if they are consistent with the contractors’ accounting practices.
The disadvantages of the material handling rate is that you need to (1) provide evidence and justification of the reassignment of costs (e.g. relevant personnel such as QA engineers, contract admin., accounting, etc.) in the form of timesheet visibility (2) alter your indirect rate model which likely will attract greater audit scrutiny and (3) possibly defend the new practice. Also note my assumptions in the sensitivity analysis of what costs can be included in the material handling pool may not be consistent with what you believe would be applicable. If my assumptions are inflated, then the amount of costs transferred out of overhead and into material handling decreases.
The key to a decision on Alternative 1 and 2 is what the future will likely be in terms of the percent of material over other costs that will be included in those contracts where the price is based on projected costs. If direct material costs are expected to exceed 40% of total costs of cost based contracts, the material handling rate becomes more desirable; less than that, forget it. The next question is what is the magnitude of the material handling pool you believe can be justified. If my assumptions are way off, then you would likely have a lower material handling rate so at some point the low rate would not be worth the effort. You do have considerable flexibility in what buckets (overhead, G&A, material) you dump your costs as long as the decision is reasonable, an audit trail is available (e.g. timesheets) and consistency is maintained.
Q. Though we are new to the federal government market, we have sold extensively to local and foreign government agencies. Can we take advantage of “commercial item” pricing and contracting?
A. For the benefit of our readers, use of commercial acquisition methods contained in FAR Part 12 and commercial item pricing tools available in FAR part 15 provides considerable advantages over more traditional contracting and pricing schemes. A recent article by Richard Wall and Brian Cohen of Ernst and Young in the January 28, 2003 issue of Federal Contracts addressed this issue in great detail. They concluded that under the current definition and interpretations of the FAR, products or services need to be provided or offered to the “general public” and that state, local and foreign government do not qualify. Ironically, prior definitions of the general public included offerings by state, local and foreign government – it is ironic because the federal government has expressed a desire to expand the use of commercial item pricing and contracting.
Q. We follow FAS 46 and capitalize our independent research and development costs. When we expense these costs are they allowable costs?
A. It depends on when they were incurred. If they were incurred in the same year they are claimed for government costing purposes, no problem. If they were incurred in a prior year then you may not claim them for government costing purposes. This is one of those examples of where GAAP accounting is not consistent with contracting costing. If you capitalize costs for financial reporting purposes, you may need to use “memo records” to account for them as expenses for government costing purposes.
© 2024 Government Contract Associates. All Rights Reserved.