Key Details: The government contracting marketplace offers a wide variety of contract types, each with individual benefits and drawbacks. These contract vehicles specify the agreement between your business and the federal government and can cause shifts in the placement of risk. Many contractors kick off with firm-fixed-price (FFP) contracts. However, cost-plus contracts are gaining popularity. There are significant differences between these two contract types.
Outlined in Part 1 of this two part series are the differences between FFP and cost-plus contracts, the advantages of each, and the questions to ask before accepting a contract. Part 2 below describes a few of the key requirements that government contractors frequently face when competing or performing on cost-plus contracts. Please note that this list is not wholly exhaustive, for further information and expertise, contact Ryan & Wetmore today.
Requirements for Cost Plus Contracts
Contractors performing on cost-plus contract types are subject to additional requirements. These requirements ensure that the contractor has an adequate accounting system and other necessary controls in place to accurately bill for performance on a contract. Some of the requirements government contractors frequently encounter include the following:
- DCAA compliance
- Timekeeping system
- SF 1408 Preaward Survey for Prospective Contractor (Accounting System)
- Estimating system compliance
- Provisional billing rates
- Incurred cost submissions
- Funding notifications
DCAA Compliance
Government contractors who are DCAA compliant means that they have the necessary procedures and documentation to pass the DCAA audit. This audit consists of an assessment of the contractor’s compliance with guidelines and regulations including Cost Accounting Standards and the Federal Acquisition Regulation, among others. To achieve DCAA compliance, contractors must follow accounting system requirements, prepare contract briefs, submit incurred cost proposals, monitor their subcontracts, ensure price proposal adequacy, establish provisional billing rates, and prepare for real-time labor evaluations.
Additionally, businesses are encouraged to utilize accounting systems that support government contracting needs. An adequate accounting system should enable the proper set up of a chart of accounts identification and accumulation of costs to cost pools.
Timekeeping System
Government contractors must ensure an adequate timekeeping system is in place to properly allocate labor to projects both directly and indirectly. As such, your timekeeping system must be able to track both employee hours and dollars by jobs and accounts. Furthermore, government contractors must be able to reconcile the timekeeping system to the payroll system, job cost ledger, and general ledger. This means all employees must properly track hours spent on different contracts or tasks. Additionally, contractors should set up a timekeeping system whereby audit trails can be reviewed if timesheets are edited. Manager approval of timesheets and hours charged to a cost objective should also be in place.
SF 1408
The 15 procedures outlined in SF 1408 Preaward Survey are necessary for any cost type contract and are assessed before the contract award. It is important to note that this is not an audit but rather an analysis of whether your company’s accounting system can remain compliant if the contract is awarded to you. Therefore, documentation of policies and procedures is key for this item. The evaluation checklist on page 2 of the SF 1408 Preaward Survey includes 15 items that contractors should focus on when building a compliant accounting system. These items include:
- An accounting system that is in accordance with GAAP.
- An accounting system that can:
- Properly segregate direct costs from indirect costs.
- Identify and accumulate direct costs by contract.
- Logically and consistently allocate indirect costs to intermediate and final cost objectives.
- Accumulate costs under general ledger control.
- Have a timekeeping system that identifies employees’ labor by intermediate or final cost objectives.
- Have a labor distribution system that charges direct and indirect labor to the appropriate cost objectives.
- Have interim determination of costs charged to a contract through routine posting of books of account.
- Exclude unallowable costs.
- Identify costs by contract line item and by units.
- Segregate preproduction costs from production costs.
- An accounting system that provides financial information:
- As required by contract clauses concerning limitation of costs or limitation on payments.
- As required to support requests for progress payments.
- An accounting system that is designed, and records are maintained in such a manner that adequate reliable data is developed for use in pricing follow-on acquisitions.
- An accounting system that is in full operation.
Estimating System Compliance
Maintaining a reliable estimating system is essential for compliance with cost type contracts. Under DFARS 252.215-7002, an acceptable estimating system provides for a system that is maintained, reliable, and consistently applied. Additionally, the system produces verifiable, supportable, documented, and timely cost estimates. From this, the system is consistent with and integrated with the contractor’s related management systems. As such, accurately describing and documenting policies, procedures, and practices when preparing cost proposals is essential. Estimating system compliance also requires supervision, training, management review, and other procedures to ensure consistent application of estimating and budgeting techniques.
Provisional Billing Rates
Provisional billing rates are estimates of indirect rates for the coming year or period. These estimates are used on interim billings submitted to the government during the year. The process and calculation for provisional rates are highly similar to computing incurred cost submissions, which is discussed in the following section. The purpose of provisional billing rates is to ensure that billing rates throughout the year are as close as possible to the final indirect rates submitted.
To calculate provisional billing rates, contractors must first forecast revenue for the upcoming year. This is done through looking at current contracts, proposals that are expected to drop, and making assumptions on your probability of success or a win rate. These are added to the sales pipeline and are used to derive labor and materials costs that will be incurred to gain these revenue streams.
Fringe expenses, overhead, and G&A also must be projected to calculate provisional billing rates. This is done through reviewing historical expenditures and comparing that with current and future business levels. Higher amounts of potential contracts in the pipeline may also add additional costs for contractors.
It is also important to note that certain cost-plus contracts have indirect ceiling caps whereby overhead and G&A rates are limited to a specific percentage. Therefore, if rates exceed these targeted amounts, the contractor will be unable to bill / be reimbursed for the excess amounts. As such, government contracts are encouraged to evaluate price fluctuations and any potential adverse cost impacts if budget rates are not achieved.
Incurred Cost Submissions
Businesses with contracts that contain FAR 52.216-7 Allowable Cost and Payment clause must submit an Incurred Cost Submission. This applies to cost-type or time and materials contracts. The incurred cost submission determines the final actual indirect cost rates the business incurred during the fiscal year. These rates provide a basis for determining whether the contractor over-billed the government and owes the government money, or whether the contractor under-billed and the government owes them money. As such, this is an extremely crucial step for contractors. Incurred cost submissions must be submitted 6 months after the fiscal year end of a business.
The incurred cost submission covers 6 key areas:
- Presentation of cost pools and bases
- Presentation of direct costs by contract or project level
- Presentation of cumulative cost incurred, cumulative billing, and over/under billing amounts
- Presentation of all T&M (Time & Material) contracts
- Certification of final indirect costs
- Supplemental schedules that include but are not limited to subcontractor information, payroll reconciliation, and executive compensation.
As these requirements bring about a new layer of complexity, government contractors are encouraged to contact Ryan & Wetmore for further guidance and expertise.
Funding Notifications
Many government contracts may contain a cost ceiling or a negotiated price with a note that specifies an incremental funding value. Contractors are required to inform the government of actual costs incurred plus any obligations (to suppliers or for payroll) when costs reach a certain threshold of funding as specified in the contract. As such, government contractors must have an adequate accounting system for charging and allocating costs to various contracts and to track when funding limits are near.
Conclusion
Government contractors performing under cost-plus type contract contracts should understand the regulations and impacts it brings out. Furthermore, risk assessment and profit margin analysis associated with performance on cost-plus contracts should be conducted. For more information, contact Ryan & Wetmore today.
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About Peter Ryan
Partner, Co-founder, & CPA
Peter T. Ryan co-founded Ryan & Wetmore in 1988 with business partner Michael J. Wetmore. Peter provides clients with the best strategies for success. His expertise extends across various industries. Peter obtained a Master of Business Administration in Finance from the University of Baltimore and a Bachelor of Arts in Accounting from the Catholic University of America.
About Rosie Cheng
Finance Consultant
Rosie Cheng is a Finance Consultant at Ryan & Wetmore. She focuses on government contracting services and produces many of the firm’s government contracting newsletters. Rosie graduated from Georgetown University with a Master of Science in Management and from William and Mary with a Bachelor of Business Administration.