Defense Acquisition University

American Society of Military Comptrollers

The Good, the Bad, and the UglyWhat Every Financial Manager Should

Know About DoD Contracts

Joanne MacDonald-MorrowOSD, AT&LDefense Acquisition University619-524-4822joanne.macdonald-morrow@dau.mil

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Highlights

• Contracting cycle

• Contract types

• Budgetary implications of contracting

• Explanation of various indirect cost rates

• Allowability of costs on a cost–reimbursement contract

• Pertinent contract clauses

• Contract changes

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Contracting Cycle

GovernmentContractor

Requirement

RFP / SOO

Proposal

Contract Performan

ce

Bid / No-Bid Decision

Source Selection

Negotiations

Contract Award

Contract Close-Out

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• Fixed Price Contracts

• Cost Reimbursement Contracts

– Provides for firm price or, in appropriate cases, an adjustable price

– Contractor’s profit built into price– Use when specific requirements known before

award

– Provides for payment of allowable incurred costs

– Contractor’s profit is negotiated fee– Use when uncertainties in contract performance

prevent sufficiently accurate estimate of costs for fixed-price contract

Two Families of Contracts

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Two Families of Contracts

Types Within the Families

Fixed Price FamilyFixed Price Family

Firm Fixed Price (FFP)

Fixed Price (EPA)

Fixed Price Incentive (FPI)

Types

Cost Reimbursement FamilyCost Reimbursement Family

Types

Cost Plus Fixed Fee (CPFF)

Cost Plus Incentive Fee (CPIF)

Cost Plus Award Fee (CPAF)

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Fixed Price

Contractor’s Promise Best Efforts Deliver specifics

Financial Risk to Contractor Low High

Financial Risk to Government High ???

Cash Flow to Contractor As Cost Incurred On Delivery

Progress Payments ------ % Incurred Performance Based Payments ------

Milestones (Preferred)

Government Administration High Low

Fee or Profit Fee Profit (no limit)

Cost Reimburseme

nt

Characteristics of Contract Types

Best Effort Specific Deliverable

Incurred Delivery

Fee Profit (no limit)

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Budget Implications

• How much funding is needed? – Budget to “most likely price”

•Additional funds may be needed for overruns, requests for equitable adjustments modifications, claims, and litigation judgments (unfunded)

•Final determination of cost and fee at contract close-out (for cost reimbursement contracts)

•When do you obligate funding?- Prior to telling the contractor to start work- After the fee has been determined

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FFP Negotiated Price

FP – EPA Negotiated Price (but not EPA)

FPI Target Cost + Target Profit

CPFF Estimated Cost + Fixed Fee

CPIF Target Cost + Target Fee

CPAF Estimated Cost + Base Fee + Maximum Award Fee

Budgeting for Contract Type

General Rule: Budget to Most Likely Price

Contract Type Budgeted Amount

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• Cost Objective: A contract, product, or other work unit for which cost data is desired and provisions made in the accounting system to accumulate and measure costs

• Direct Cost: A cost that can be tracked directly to one specific cost objective. Includes direct materials, direct labor and other costs traceable direct to that single cost objective.

• Indirect Cost: A cost not directly identified with one specific cost object but identified with two or more cost objectives. – Two types of indirect costs: Overhead and General and

Administrative (G&A)– Overhead costs support a specific part or function of the

company but not the entire company– G&A costs benefit the business as a whole

Contract Costs

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Indirect Cost Rates

Close-out Phase

Performance Phase

Proposal Phase

Rates Differ Depending on Phase of Contract

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Proposal Phase • These are “Future Indirect Rates”• Contractor submits to the government –

– A contract proposal per RFP– A Forward Pricing Rate proposal for:

• Direct labor rates for various disciplines • Indirect cost rates based on total estimated revenues

and indirect costs

• Government evaluates contractor proposals• Government and contractor negotiate both the

direct labor rates and indirect cost rates• “Agreed to” rates become part of the contract • Result is Forward Pricing Rate Agreement (FPRA)

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Performance Phase

• These are “Billing Rates”• Billing rates are:

– Applicable to only indirect costs– Based on estimated indirect costs (e.g.,

overhead)– Temporary and applicable during period of

contract performance – Adjusted during contract performance to

reflect indirect costs actually incurred vs. estimates

• Importance of billing rates: – Basis for invoices and payment to contractor – Reimbursement of contractor’s actual indirect

costs in timely manner

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Contract close-out takes at least 5 to 7 years after award

Contract Close-Out Phase

• These are “End-of-Performance Actual Rates”• Indirect cost pool accounts are audited to verify

allowability of costs in that pool • Valid indirect costs actually incurred are

compared to indirect costs estimated during Proposal Phase and modified during Performance Phase

• “Actual” indirect rates computed based on “actual” indirect costs incurred – subject to negotiation between government and contractor

• Final contract price is based on actual direct costs incurred plus application of “actual” indirect rates

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1. Verify contract work is physically complete

2. Obtain all forms, reports and clearances for closeout

3. Resolve all outstanding issues

4. Initiate final payment to – or collect overpayment from – contractor

5. Deobligate excess funds / request any required additional funds

6. Prepare contract completion statement

7. “Retire” contract file

Contract Close Out

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• Ambiguous wording in original contract • Funds obligated on contract have gone into

cancelled status• All vouchers not yet submitted or final payments

not yet made• Audit delays

Common Problems with Close Outs

• Complex coordination between government entities

• Reconciliation issues between government and contractor

• Final “actual” indirect rates not yet negotiated

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Answer: The government will pay all “allowable” costs

What Costs will the

There is no commercial market equivalent to the concept of “allowable” costs

• Direct costs are generally allowable if they are reasonable

• Allowability issues generally occur with indirect costs

Government Reimburse the Contractor?

On a Cost Reimbursement Contract,

Reimbursement of Expenses

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• Costs are allowable when they meet the following atandards (FAR 31.201-2):

1. Reasonable2. Allocable3. In compliance with applicable cost

accounting principles, practices and standards (i.e., CAS and GAAP)

4. In accordance with terms of the contract5. Specific limitations in FAR 31.205

Allowable Costs

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Reasonable

• Is the cost necessary to conduct routine business operations?

• Is the cost consistent with sound business practice, law and regulation?

• Does the contractor’s action (incurring a cost) reflect a responsible decision?

• Are the actions consistent with established practices (of the contractor)?

FAR 31.201-3

“…burden of proof shall be upon the contractor…”

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• Have costs been properly allocated?

• Properly assigned to appropriate indirect cost pools– Like purpose

• Allocated using an appropriate allocation base– Do the costs have a logical relationship to the base?– In reasonable proportion to the benefits received

• Were all overhead rates calculated consistenly and in compliance with the cost accounting standards?

Allocable

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Accounting Principles

• Does the contractor follow the Cost Accounting

Standards (CAS)? - Cost Accounting Standards Board- Established by Congress- Achieve uniformity and consistency

• Implemented by contract clause

• The FAR imposes similar requirements

• CAS is unique to the governmentCAS Focus: Allocating costs (cost accounting)

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Accounting Principles (continued)

• Does the contractor follow Generally Accepted Accounting Principles (GAAP)?

• The contractor’s accounting system must be adequate to allow the government to make a final cost determination

• GAAP is not unique to the government

GAAP Focus: Financial Accounting

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• Contract may contain special terms that address allowability of specific costs

• Terms can only be more restrictive – not less– Additional restrictions on allowability– Designation of otherwise allowable cost as

being unallowable

Terms of the Contract

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• Does the contractor follow the cost principles in FAR Part 31.205?

•Costs are unallowable if:

– Not a legitimate costs of doing business with the government

– Against public policy

The FAR is unique to the government

FAR Limitations

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Examples of Unallowable Costs

• Advertising• Interest (cost of money)• Entertainment• Lobby to influence legislation• Contributions• Alcoholic beverages• Losses on other contracts• “Directly associated costs”

IAW FAR Part 31.205

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• Contractor is required to notify government 60 days prior to incurring costs equal to 75% of amount obligated – Incrementally Funded Cost-Reimbursement Contracts

• Called “Limitation of Funds Clause (LOF)”– Fully Funded Cost-Reimbursement Contracts

• Called “Limitation of Cost Clause (LOC)”

• Contractor is required to notify government 90 days prior to incurring costs equal to 85% of amount obligated– Incrementally Funded Fixed Price Contracts

• Called “Limitation of Government Obligation Clause (LOGO)”

Contract Clauses that Provide Control over Unliquidated Obligations

Notification allows termination liability to be covered by unliquidated obligations on that

specific contract

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• Two formal methods to change a contract:– Supplemental Agreement: Fully negotiated

agreement on specific work, price and schedule. – Undefinitized Change Order: Tentative

agreement on work and schedule but final agreements not yet negotiated; usually has a “not-to-exceed” price.

• Informal way to change a contract:– Constructive change: government action causes

contractor to perform work differently than required by written contract

Contract Changes

Why do I need to know?

• Majority of DoD’s funding is put on contract

• Most funding problems come from contracted efforts

• Financial management personnel should understand relationship between contracts management and financial management

Questions?

Back Up

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Contract Types

Cost

Profit

0/100 Share

FFP

(PTA)

CeilingPrice

TargetProfit

Fee Adjustment Formula (Ratio)

FPIF

Target Cost

Target Cost

CPIF

TargetFee

Max Fee

Min Fee

Fee Adjustment Formula (Ratio)

Estimated Cost

Fixed Fee

100/0 Share

CPFF

Base Fee (0-3%)

Award Fee Pool

Estimated Cost

CPAFMaxFee

Base Fee

Share = The government/contractor sharing ratio for cost savings or cost overruns

•  Financial Management Regulation http://comptroller.defense.gov/fmr/

• Principles of Federal Appropriations Law (Red Book)http://www.gao.gov/legal.htm

• GAO Reports and Comptroller General Decisionshttp://www.gao.gov/subscribe/

• Defense Acquisition Portal https://dap.dau.mil

• DAU Acquisition Community Connectionhttps://acc.dau.mil/CommunityBrowser.aspx

References for Financial Managers

For those interested in keeping up on the news: • Government Executive http://www.govexec.com/

• Federal Times https://poky.atpco.com/fed/

• Defense News https://poky.atpco.com/dfn/

• FAR News http://www.arnet.gov/far/mailframe.html

• DFARS News http://www.acq.osd.mil/mailman/listinfo

• DoD Early Bird http://ebird.osd.mil/

 

References for Financial Managers