Excessive Pass-Through Costs - Part II

Today we continue our discussion on excessive pass-through costs. The impetus behind this new rule was Section 866 of the Duncan Hunter National Defense Authorization Act for Fiscal Year 2009. The Act required that the FAR be amended to minimize excessive pass-through charges by contractors (or lower-tier subcontractors) that add no or negligible value to the subcontracted work.


Generally, the determination as to whether the functions a contractor performs relative to the subcontract provides “added value” to the contracting effort and that there are no excessive pass-through charges is made at the time of contract award. The contracting officer (and the auditors, if the proposal is being audited) reviews the ratio of subcontract value to total proposed price. If greater than 70 percent, they will then review to see if the contractor adequately demonstrated that it would provide “added value”. If the contracting office is satisfied that the prime is adding value to the subcontract, he/she will make a determination to that effect and also insert the following into the actual contract:

The Government will not pay excessive pass-through charges. The Contracting Officer has determined that there will be no excessive pass-through charges, provided the Contractor performs the disclosed value-added functions.

Sometimes however, contractors change the amount of subcontract effort after contract award such that it exceeds 70 percent of the total cost of work under the contract. This can happen for a variety of reasons – overcapacity in the contractor’s facility, more cost effective to buy than to produce in-house, or shortage of skilled workers, to name a few. When this happens, contractors must notify the contracting officer in writing of the revised cost of the subcontract effort. The notification must include verification that the contractor will provide “added value” (FAR 52.215-23(c)). If after review of the contractor submitted data the contracting officer concludes that excessive pass-through charges exist, the Government has a contractual mechanism to recoup those costs. On cost-type contracts, billings will be reduced. On fixed-price contracts, the Government will be entitled to a priced reduction. The FAR clause does not specify how these reductions are to be computed and negotiated but we would expect guidance will be forthcoming.

 

Price Proposals

 

When evaluating price proposals where subcontract costs exceed the 70 percent threshold, DoD auditors are being instructed to perform sufficient testing to determine FAR compliance. Specifically, auditors are being told to:

1. Ensure the contractor’s proposal includes a description of the contractor’s “added value” as required by FAR 52.215-22.
2. Evaluate the reasonableness of the contractor’s description and supporting documentation of the “added value” to assess whether the contractor is in compliance with the requirements set forth in FAR 52.215-23.

If the “added value” description is not included, contractors face potential estimating deficiencies. Auditors are being instructed to consider such a proposal to be inadequate. That will certainly slow down the acquisition process as the proposal is returned for revision.

 

The more significant concern however is that auditors are also being instructed to consider such an omission to be an estimating system deficiency and to consider issuing an estimating system deficiency report. This could jeopardize contractors’ success in future solicitations and it could possibly result in temporary billing withholds on existing contracts when the new business system rules become final.

 

Tomorrow we will conclude this series with some comments on incurred costs and final vouchers.