Defense Acquisition University

1. Defense Acquisition University American Society of Military Comptrollers The Good, the Bad, and the Ugly What Every Financial Manager Should Know About DoD Contracts Joanne MacDonald-Morrow OSD, AT&L Defense Acquisition University 619-524-4822 joanne.macdonald-morrow@dau.mil

2. 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

3. Requirement Negotiations Source Selection Contract Award RFP / SOO Contract Close-Out Contract Performance Bid / No-Bid Decision Proposal Contracting Cycle Government Contractor

4. Two Families of Contracts • Fixed Price 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 • Cost Reimbursement Contracts • 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

5. Firm Fixed Price (FFP) Cost Plus Fixed Fee (CPFF) Cost Reimbursement Family Fixed Price Family Fixed Price (EPA) Cost Plus Incentive Fee (CPIF) Types Types Fixed Price Incentive (FPI) Cost Plus Award Fee (CPAF) Two Families of Contracts Types Within the Families

6. Characteristics of Contract Types Cost Reimbursement Fixed Price Best Effort Specific Deliverable Contractor’s Promise Best EffortsDeliver 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 FeeProfit (no limit) Incurred Delivery Profit (no limit) Fee

7. 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

8. Budgeting for Contract Type Contract Type Budgeted Amount 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 General Rule: Budget to Most Likely Price

9. Contract Costs • 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

10. Proposal Phase Close-out Phase Performance Phase Indirect Cost Rates Rates Differ Depending on Phase of Contract

11. 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)

12. 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

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

14. 7. “Retire” contract file 6. Prepare contract completion statement 5. Deobligate excess funds / request any required additional funds 4. Initiate final payment to – or collect overpayment from – contractor 3. Resolve all outstanding issues 2. Obtain all forms, reports and clearances for closeout 1. Verify contract work is physically complete Contract Close Out

15. Common Problems with Close Outs • 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 • Final “actual” indirect rates not yet negotiated • Complex coordination between government entities • Reconciliation issues between government and contractor

16. Reimbursement of Expenses On a Cost Reimbursement Contract, What Costs will the Government Reimburse the Contractor? Answer: The government will pay all “allowable” costs • Direct costs are generally allowable if they are reasonable • Allowability issues generally occur with indirect costs There is no commercial market equivalent to the concept of “allowable” costs

17. Costs are allowable when they meet the following atandards (FAR 31.201-2): Reasonable Allocable In compliance with applicable cost accounting principles, practices and standards (i.e., CAS and GAAP) In accordance with terms of the contract Specific limitations in FAR 31.205 Allowable Costs

18. Reasonable FAR 31.201-3 • 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)? “…burden of proof shall be upon the contractor…”

19. Allocable • 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?

20. 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 government CAS Focus: Allocating costs (cost accounting)

21. 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

22. Terms of the Contract • 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

23. FAR Limitations • 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

24. Examples of Unallowable Costs IAW FAR Part 31.205 • Advertising • Interest (cost of money) • Entertainment • Lobby to influence legislation • Contributions • Alcoholic beverages • Losses on other contracts • “Directly associated costs”

25. Contract Clauses that Provide Control over Unliquidated Obligations • 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)” Notification allows termination liability to be covered by unliquidated obligations on that specific contract

26. Contract Changes • 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

27. 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

28. Questions?

29. Back Up

30. FPIF CPFF Fee Adjustment Formula (Ratio) Target Profit 100/0 Share Fixed Fee Target Cost Estimated Cost CPIF CPAF FFP Max Fee Max Fee Fee Adjustment Formula (Ratio) Award Fee Pool Target Fee 0/100 Share Base Fee Min Fee Profit (PTA) Base Fee (0-3%) Ceiling Price Estimated Cost Target Cost Cost Contract Types Share = The government/contractor sharing ratio for cost savings or cost overruns

31. References for Financial Managers •   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 Decisions • http://www.gao.gov/subscribe/ • Defense Acquisition Portal • https://dap.dau.mil • DAU Acquisition Community Connection • https://acc.dau.mil/CommunityBrowser.aspx

32. 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/