Subcontractor Cost Allowability and Systems Adequacy:  New Focus and Increased Risk Thomas A. Lemmer Steven M. Masiello Au...
<ul><li>Standards for government subcontracting </li></ul><ul><li>Recent DCMA/DCAA policies and guidance </li></ul><ul><li...
<ul><li>Contractors required to compete subcontracts “to the maximum practical extent” </li></ul><ul><li>Despite Governmen...
<ul><li>Most challenged element in subcontractor cost allowability is reasonableness </li></ul><ul><ul><li>“ A cost is rea...
<ul><li>DCAA/DCMA emphasis on subcontractor cost allowability </li></ul><ul><ul><li>Second guessing teaming arrangements/p...
<ul><li>Field pricing audits </li></ul><ul><ul><li>Thresholds for DCAA field pricing audits: </li></ul></ul><ul><ul><ul><l...
<ul><li>Risks </li></ul><ul><ul><li>Disallowance of subcontract costs (either as direct costs or as part of indirect rates...
<ul><li>Increased emphasis on effective business systems (accounting, estimating, purchasing, earned value management, pro...
<ul><li>Rule applies to certain DoD contracts </li></ul><ul><li>Rule, along with FAR Subpart 44.3, provides best practices...
<ul><li>FAR § 44.202-2 requires COs to review contractors’ purchasing systems based on 13 “factors,” including: </li></ul>...
<ul><li>Overlapping requirements with purchasing system </li></ul><ul><li>The DoD business systems rule contains 17 requir...
<ul><li>What the rule means for contractors: </li></ul><ul><ul><li>Requires formal and  written  purchasing procedures and...
Subcontract Formation
<ul><li>Prime contractors possess discretion in the administration of subcontracts, including choice of contract type </li...
<ul><li>Fixed price contracts: </li></ul><ul><ul><li>Provide for a firm price or sometimes an adjustable price </li></ul><...
Types of Subcontracts (cont.) <ul><li>T&M contracts: </li></ul><ul><ul><li>Priced on the basis of direct labor hours at sp...
<ul><li>Cost reimbursement contracts </li></ul><ul><ul><li>FAR Subpart 31.2 </li></ul></ul><ul><ul><li>A cost is allowable...
<ul><li>FAR § 52.244-6, Subcontracts for Commercial Items; encourages commercial item subcontracting “to the maximum exten...
<ul><li>Commercial item determination must be documented </li></ul><ul><ul><li>Objective evidence and justification of com...
<ul><li>TINA requires certified cost or pricing data for contracts and subcontracts exceeding $700,000 unless an exception...
Subcontract Administration
<ul><li>Mandatory flowdowns: </li></ul><ul><ul><li>Commercial procurements (FAR § 52.244-6) </li></ul></ul><ul><ul><li>Non...
<ul><li>Contractors are responsible for: </li></ul><ul><ul><li>Accounting for subcontract costs appropriately and for main...
<ul><li>Prime contractors must pay subcontractors in accordance with the terms of the prime contract and subcontract </li>...
<ul><li>Thomas A. Lemmer </li></ul><ul><li>[email_address] </li></ul><ul><li>303-634-4350 </li></ul><ul><li>Steven M. Masi...
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Subcontractor Cost Allowability And Systems Adequacy

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Subcontractor Cost Allowability And Systems Adequacy

  1. 1. Subcontractor Cost Allowability and Systems Adequacy: New Focus and Increased Risk Thomas A. Lemmer Steven M. Masiello August 9, 2011
  2. 2. <ul><li>Standards for government subcontracting </li></ul><ul><li>Recent DCMA/DCAA policies and guidance </li></ul><ul><li>Business systems </li></ul><ul><li>Subcontract formation </li></ul><ul><li>Subcontract administration </li></ul><ul><li>Questions </li></ul>Subcontractor Cost Allowability
  3. 3. <ul><li>Contractors required to compete subcontracts “to the maximum practical extent” </li></ul><ul><li>Despite Government insistence to the contrary, FAR procurement requirements do not apply directly to subcontracts (i.e., FAR Parts 12, 15, 16, etc.) </li></ul><ul><ul><li>But do provide guidance for supporting reasonableness </li></ul></ul><ul><li>Subcontractors must be responsible; not suspended or debarred </li></ul><ul><ul><li>Contractor discretion in selecting/establishing subcontract relationships but must use its proper business judgment </li></ul></ul><ul><li>Lack of compliance with purchasing procedures or effective subcontract administration creates risk of unallowable subcontract costs </li></ul>Standards for Government Contracting – Subcontracts
  4. 4. <ul><li>Most challenged element in subcontractor cost allowability is reasonableness </li></ul><ul><ul><li>“ A cost is reasonable if, in its nature and amount, it does not exceed that which would be incurred by a prudent person in the conduct of competitive business” (FAR § 31.201-3(a)) </li></ul></ul><ul><ul><li>Examples, government challenges of subcontract cost allowability: </li></ul></ul><ul><ul><ul><li>Used a contract type not identified in FAR Part 16 </li></ul></ul></ul><ul><ul><ul><li>Contract was incorrectly identified as a commercial item contract </li></ul></ul></ul><ul><ul><ul><li>Relevant memorandum not in file </li></ul></ul></ul><ul><ul><ul><li>Ineffective subcontract administration/surveillance/documentation </li></ul></ul></ul><ul><ul><ul><li>Inadequate cost or price analysis </li></ul></ul></ul>Standards for Government Contracting – Subcontract Cost Reasonableness
  5. 5. <ul><li>DCAA/DCMA emphasis on subcontractor cost allowability </li></ul><ul><ul><li>Second guessing teaming arrangements/procurement decisions </li></ul></ul><ul><ul><li>Reevaluation of subcontract price reasonableness determinations </li></ul></ul><ul><ul><li>Deviations from established purchasing system practice results in unreasonable costs </li></ul></ul><ul><ul><li>Allegations of ineffective subcontract administration </li></ul></ul><ul><ul><li>Focus on lack of adequate documentation </li></ul></ul>Recent DCMA/DCAA Policies and Guidance
  6. 6. <ul><li>Field pricing audits </li></ul><ul><ul><li>Thresholds for DCAA field pricing audits: </li></ul></ul><ul><ul><ul><li>$100 million for cost-type proposals </li></ul></ul></ul><ul><ul><ul><li>$10 million for fixed price-type proposals </li></ul></ul></ul><ul><ul><li>Creates significant complications at subcontract level </li></ul></ul><ul><ul><ul><li>Prime contractor review? </li></ul></ul></ul><ul><ul><ul><li>Third-party audit? </li></ul></ul></ul><ul><ul><ul><li>No review by prime? </li></ul></ul></ul>DCMA/DCAA Policies and Guidance (cont.)
  7. 7. <ul><li>Risks </li></ul><ul><ul><li>Disallowance of subcontract costs (either as direct costs or as part of indirect rates) </li></ul></ul><ul><ul><li>Determination that purchasing systems are inadequate </li></ul></ul><ul><ul><li>Increased scrutiny of subcontractor costs included in proposals </li></ul></ul><ul><li>Mitigation </li></ul><ul><ul><li>Maintain a comprehensive and well-documented purchasing system </li></ul></ul><ul><ul><li>Keep written records justifying significant procurement decisions and price reasonableness of subcontracts </li></ul></ul>DCMA/DCAA Policies and Guidance (cont.)
  8. 8. <ul><li>Increased emphasis on effective business systems (accounting, estimating, purchasing, earned value management, property) </li></ul><ul><li>Interim rule permits withholding for any “significant deficiency” in business systems (76 Fed. Reg. 28,856 (May 18, 2011)) </li></ul><ul><ul><li>Final determination </li></ul></ul><ul><ul><li>5% per system withholding, capped at 10% </li></ul></ul><ul><ul><li>Reduction of withhold </li></ul></ul><ul><ul><li>Reevaluation/approval of system </li></ul></ul>Business Systems
  9. 9. <ul><li>Rule applies to certain DoD contracts </li></ul><ul><li>Rule, along with FAR Subpart 44.3, provides best practices for non-DoD contractors </li></ul><ul><li>DCMA/DCAA will audit DoD contractors based on these factors, so the rule may become the expectation for non-DoD contractors </li></ul><ul><li>Informal DCMA/industry discussions predict that under the DoD rule, contractors’ purchasing systems will have a high failure rate </li></ul><ul><li>Wartime commission report will likely factor into DCMA/DCAA audits </li></ul><ul><ul><li>DCAA and DCMA to speak with one voice for the government </li></ul></ul><ul><ul><li>DCAA to expand audit reports to go beyond pass/fail opinions </li></ul></ul><ul><ul><li>DCMA to develop aggressive compliance enforcement </li></ul></ul>Business Systems (cont.)
  10. 10. <ul><li>FAR § 44.202-2 requires COs to review contractors’ purchasing systems based on 13 “factors,” including: </li></ul><ul><ul><li>Is subcontract consistent with contractor’s make-or-buy program? </li></ul></ul><ul><ul><li>Was adequate price competition obtained or is its absence justified? </li></ul></ul><ul><ul><li>Is proposed subcontract type appropriate? </li></ul></ul><ul><li>The DoD rule contains 24 requirements for contractors’ purchasing systems, including: </li></ul><ul><ul><li>Adequate system description </li></ul></ul><ul><ul><li>Apply a consistent make-or-buy policy </li></ul></ul><ul><ul><li>Use competitive sourcing to maximum extent possible </li></ul></ul><ul><ul><li>Require management level justification for sole source awards </li></ul></ul><ul><ul><li>Integrated systems for tracking subcontract price/costs and administration </li></ul></ul>Purchasing Systems
  11. 11. <ul><li>Overlapping requirements with purchasing system </li></ul><ul><li>The DoD business systems rule contains 17 requirements for contractors’ estimating systems that may be applied to subcontractor proposals, including: </li></ul><ul><ul><li>Establish clear responsibility for preparation, review, and approval of cost estimates and budgets </li></ul></ul><ul><ul><li>Provide for adequate supervision throughout the estimating process </li></ul></ul><ul><ul><li>Provide for consistent application of estimating and budgeting techniques </li></ul></ul><ul><ul><li>Provide for detection and timely correction of errors </li></ul></ul><ul><ul><li>Protect against cost duplication </li></ul></ul>Estimating Systems
  12. 12. <ul><li>What the rule means for contractors: </li></ul><ul><ul><li>Requires formal and written purchasing procedures and forms </li></ul></ul><ul><ul><li>Increased subcontract administration, accounting, estimating, and compliance resources </li></ul></ul><ul><ul><li>Must maintain a data library and accessible reports of subcontract estimates and incurred cost data </li></ul></ul><ul><ul><li>Investments in integrated systems with purchasing, estimating, and accounting </li></ul></ul><ul><ul><li>Additional training and systems compliance monitoring </li></ul></ul>Impact of New Systems’ Requirements
  13. 13. Subcontract Formation
  14. 14. <ul><li>Prime contractors possess discretion in the administration of subcontracts, including choice of contract type </li></ul><ul><li>Contract types: </li></ul><ul><ul><li>Fixed price </li></ul></ul><ul><ul><li>Time and materials (“T&M”) </li></ul></ul><ul><ul><li>Cost reimbursement </li></ul></ul>Types of Subcontracts
  15. 15. <ul><li>Fixed price contracts: </li></ul><ul><ul><li>Provide for a firm price or sometimes an adjustable price </li></ul></ul><ul><ul><li>May include a ceiling price, a target price, or both </li></ul></ul><ul><ul><li>Issues: </li></ul></ul><ul><ul><ul><li>Negotiation </li></ul></ul></ul><ul><ul><ul><li>Documentation </li></ul></ul></ul><ul><ul><ul><li>Price reasonableness assessments </li></ul></ul></ul>Types of Subcontracts (cont.)
  16. 16. Types of Subcontracts (cont.) <ul><li>T&M contracts: </li></ul><ul><ul><li>Priced on the basis of direct labor hours at specified fixed hourly rates </li></ul></ul><ul><ul><li>Hourly rates include wages, overhead, general and administrative expenses, profit and the actual cost of materials </li></ul></ul><ul><ul><li>Issues: </li></ul></ul><ul><ul><ul><li>Negotiation </li></ul></ul></ul><ul><ul><ul><li>Price reasonableness assessments and documentation </li></ul></ul></ul><ul><ul><ul><li>Appropriateness of contract type </li></ul></ul></ul><ul><ul><ul><li>Confirmations of expertise for labor categories billed </li></ul></ul></ul><ul><ul><ul><li>Cost reimbursement of material costs </li></ul></ul></ul><ul><ul><ul><li>Use of higher tier rates </li></ul></ul></ul>
  17. 17. <ul><li>Cost reimbursement contracts </li></ul><ul><ul><li>FAR Subpart 31.2 </li></ul></ul><ul><ul><li>A cost is allowable when it is: </li></ul></ul><ul><ul><ul><li>Reasonable </li></ul></ul></ul><ul><ul><ul><li>Allocable </li></ul></ul></ul><ul><ul><ul><li>Consistent with GAAP/CAS </li></ul></ul></ul><ul><ul><ul><li>Consistent with the terms of the relevant prime contract </li></ul></ul></ul><ul><ul><ul><li>Not made unallowable by one of the cost principles contained in FAR Subpart 31.2 </li></ul></ul></ul><ul><ul><li>Issues: </li></ul></ul><ul><ul><ul><li>Negotiation </li></ul></ul></ul><ul><ul><ul><li>Reasonableness assessments and documentation </li></ul></ul></ul>Types of Subcontracts (cont.)
  18. 18. <ul><li>FAR § 52.244-6, Subcontracts for Commercial Items; encourages commercial item subcontracting “to the maximum extent practicable” </li></ul><ul><ul><li>If services are “of a type offered and sold competitively” and items are “of a type customarily used by the general public” then they may qualify as commercial items </li></ul></ul><ul><ul><li>Commercial item subcontracts exempt from certain requirements </li></ul></ul><ul><ul><ul><li>No TINA or cost analysis required to determine price reasonableness </li></ul></ul></ul><ul><ul><ul><li>Commercial item subcontracting is beneficial to both prime contractors and subcontractors </li></ul></ul></ul>Commercial Item Subcontracting
  19. 19. <ul><li>Commercial item determination must be documented </li></ul><ul><ul><li>Objective evidence and justification of commerciality </li></ul></ul><ul><ul><li>Procurement checklists </li></ul></ul><ul><ul><li>Training </li></ul></ul><ul><li>Possible subcontract indemnity/certification to manage risks </li></ul>Commercial Item Subcontracting (cont.)
  20. 20. <ul><li>TINA requires certified cost or pricing data for contracts and subcontracts exceeding $700,000 unless an exception applies: </li></ul><ul><ul><li>Adequate price competition </li></ul></ul><ul><ul><li>Prices are set by law or regulation </li></ul></ul><ul><ul><li>Commercial item </li></ul></ul><ul><ul><li>Waiver </li></ul></ul><ul><ul><li>Modifying a contract or subcontract for commercial items </li></ul></ul><ul><li>Price analysis is acceptable when certified cost or pricing data is not required </li></ul><ul><li>Cost analysis is required when certified cost or pricing data is required </li></ul><ul><li>Lack of field audit support </li></ul><ul><ul><li>Subcontractors often deny prime contractors’ requests for audit </li></ul></ul><ul><ul><li>Difficult to conduct cost analysis when subcontractors deny audit rights </li></ul></ul>Cost and Price Information
  21. 21. Subcontract Administration
  22. 22. <ul><li>Mandatory flowdowns: </li></ul><ul><ul><li>Commercial procurements (FAR § 52.244-6) </li></ul></ul><ul><ul><li>Non-commercial procurements: review prime contract terms </li></ul></ul><ul><li>Best practices flowdowns: </li></ul><ul><ul><li>In addition to mandatory subcontract terms, it may be appropriate to flow down certain additional clauses </li></ul></ul><ul><ul><li>Examples: </li></ul></ul><ul><ul><ul><li>Changes </li></ul></ul></ul><ul><ul><ul><li>Termination </li></ul></ul></ul><ul><ul><ul><li>Disputes (requirement to continue work) </li></ul></ul></ul><ul><li>All negotiable from a subcontractor’s perspective </li></ul><ul><li>Government focus on “usurping government rights” even if it creates a risk to prime contractor regarding flowdown implementation </li></ul>Subcontract Terms
  23. 23. <ul><li>Contractors are responsible for: </li></ul><ul><ul><li>Accounting for subcontract costs appropriately and for maintaining records, </li></ul></ul><ul><ul><ul><li>No specific documentation is necessary to support a reimbursable cost ( BearingPoint Inc. , ASBCA No. 55354, 09-2 BCA ¶ 34,289) </li></ul></ul></ul><ul><ul><li>Making changes </li></ul></ul><ul><ul><li>Ensuring subcontract compliance </li></ul></ul><ul><ul><li>Closing out subcontracts </li></ul></ul>Performance Information
  24. 24. <ul><li>Prime contractors must pay subcontractors in accordance with the terms of the prime contract and subcontract </li></ul><ul><li>Lack of available data increases risk of disallowance of subcontractor invoiced costs </li></ul><ul><ul><li>Labor rate records </li></ul></ul><ul><ul><li>Compensation system information </li></ul></ul>Invoices
  25. 25. <ul><li>Thomas A. Lemmer </li></ul><ul><li>[email_address] </li></ul><ul><li>303-634-4350 </li></ul><ul><li>Steven M. Masiello </li></ul><ul><li>[email_address] </li></ul><ul><li>303-634-4355 </li></ul>Questions

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