MANAGING CONTRACT COSTS

During contract performance, a contractor is generally paid by two methods—public vouchers and progress payments. Public vouchers are generally used for cost-reimbursement contracts. Progress payments apply to fixed-price type contracts. In either case, the contractor’s accounting system must be adequate to support the payment of costs incurred.

Costs included in a standard public voucher must reflect contract costs incurred both in the current period and cumulatively. Direct costs should be included as actually incurred, and the applied indirect costs should reflect a billing rate that is based on an estimate of year-end allowable actual costs or contractually established provisional costs. Any cost limitations resulting from a contractually established cost ceiling or limitations also must be reflected in the voucher. As a general rule, cost-reimbursement contracts are subject to a withholding of 15 percent of fee until the contract is completed and the contractor submits a final voucher. This reserve helps protect the government’s interest, including possible contractor overbillings. FAR 52.216-7, Allowable Cost and Payment, governs cost reimbursements.

FAR 52.232-16, Progress Payments, governs a contractor’s submittal of progress payments based on incurred costs. This contract clause requires that costs that are claimed have actually been paid or incurred, depending on the contract terms. The standard progress payment clause requires that the costs of “supplies and services” purchased by the contractor directly for the contract may be included in the progress payment claim only after actual payment by cash, check, etc. On the other hand, the clause allows costs for such items as direct labor, materials issued from inventory, and indirect costs, to be simply incurred, not necessarily paid, at the time the progress payment is submitted. It does require, however, that the contractor maintain a current payment status on those items. Government auditors will review the contractor’s historical payment records to ascertain that delinquency is not a problem. As of October 1, 1999, a proposed FAR change would remove the requirement to pay subcontractors before seeking reimbursement from the government.

With regard to the submittal of progress payment requests, the government requires that the contractor have reasonable visibility of the percentage of contract completion. This requirement illustrates the need for the contractor’s accounting system to accumulate costs by contract and to allow for visibility of actual costs incurred compared to budgeted costs. The accounting data will have to be merged with production data and engineering estimates to enable management to fully assess project status. This requirement also permits the government to see whether the contractor is incurring costs at the budgeted rate, or is in an overrun position. If the latter is the case, the request for progress payment will be reduced by the equivalent overrun percentage as the government attempts to protect itself from paying overrun dollars.

Another category of expenditures that is not reflected on the company books should be controlled. Those costs are open commitments, which are basically purchase orders that have been placed but remain unrecorded or unpaid because a vendor service has not been rendered or a product has not been received. A contractor needs to establish a system to track those open commitments and measure them along with their actual expended costs to ascertain valid cost-to-budget comparisons. Normally, open commitment costs are not included for cost reimbursement or progress payment requests. But measurement to budget and well-founded estimated costs to complete calculations must include this area of potential cost.

Cost-reimbursement contracts contain a limitation of cost clause (LOCC) to protect the government from unauthorized and unexpected cost overruns. This clause requires a contractor to notify the contracting officer in writing whenever he has reason to believe that: (1) the costs he expects to incur under the contract in the next 60 days (or an alternative number of days ranging from 30 to 90), when added to costs previously incurred, will exceed 75 percent (or an alternative percentage ranging from 75 to 85) of the estimated costs specified in the contract; or (2) the total cost for the performance of the contract, exclusive of any fee, will be either greater or substantially less than estimated. This clause is discussed in detail in Chapter 2.