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

4. 4 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

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

6. 6 Fixed Price Contractor’s PromiseBest EffortsDeliver specifics Financial Risk to ContractorLowHigh Financial Risk to GovernmentHigh ??? Cash Flow to ContractorAs Cost IncurredOn Delivery Progress Payments ------% Incurred Performance Based Payments ------Milestones (Preferred) Government AdministrationHighLow Fee or Profit FeeProfit (no limit) Cost Reimbursement Characteristics of Contract Types Best EffortSpecific Deliverable Incurred Delivery Fee Profit (no limit)

7. 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. 8 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

9. 9 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

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

11. 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. 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. 13 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

14. 14 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

15. 15 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

16. 16 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

17. 17 Costs are allowable when they meet the following atandards (FAR 31.201-2): 1.Reasonable 2.Allocable 3.In compliance with applicable cost accounting principles, practices and standards (i.e., CAS and GAAP) 4.In accordance with terms of the contract 5.Specific limitations in FAR 31.205 Allowable Costs

18. 18 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…”

19. 19 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

20. 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. 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. 22 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

23. 23 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

24. 24 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

25. 25 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

26. 26 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

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

31. 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 References for Financial Managers

32. For those interested in keeping up on the news: Government Executive http://www.govexec.com/http://www.govexec.com/ Federal Times https://poky.atpco.com/fed/https://poky.atpco.com/fed/ Defense News https://poky.atpco.com/dfn/https://poky.atpco.com/dfn/ FAR News http://www.arnet.gov/far/mailframe.htmlhttp://www.arnet.gov/far/mailframe.html DFARS News http://www.acq.osd.mil/mailman/listinfohttp://www.acq.osd.mil/mailman/listinfo DoD Early Bird http://ebird.osd.mil/http://ebird.osd.mil/ References for Financial Managers