Limitation of Costs and Limitation of Funds - Part III

For the past couple of days, we've been discussing the Limitation of Costs and Limitation of Funds clauses that appear in cost reimbursable Government contracts. In Part I, we discussed the fundamental requirements of the two similar clauses. In Part II, we discussed the data and analysis required to comply with clauses. We also indicated that the ability to comply is one of the evaluation factors when the Government comes in to perform a pre-award accounting system survey of your company. Failure to demonstrate the ability to comply can make the difference between winning and losing a bid.

Today we want to address the issue of indirect rates. Indirect rates are used in determining historical costs and in estimating the monthly "spend rate". One question we're asked frequently concerns the appropriate rate to use in these calculations. Contractors typically have different indirect expense rates for different purposes. There's nothing wrong with this practice. It's not like having multiple sets of books. Its simply necessary given the vagaries of Government contracting. For example:

• Actual rates - these are the final year-end rates or the rates calculated at some interim period. It could be a monthly, three, six, or nine month period.
• Forecasted rates - these are rates used in estimating future contracts. These rates are heavily influenced by the size of a particular bid. A large contract will typically reduces indirect rates. Forecasted rates should not be used to book or bill costs.
• Billing rates - these are rates that have been approved by the Government for billing purposes. They should represent the contractors best estimate of the final year-end rates. Contractors have a duty to monitor these rates and revise them as appropriate.
• Booking rates - In a perfect world, booking rates and billing rates should be the same. However, the process for adjusting billing rates and obtaining Government approval is cumbersome, time consuming, and subject to the whims of auditors (like when they make arbitrary reductions to "protect the Government's interests"). Sometimes contractors find that the billing rates no longer reflect the best estimate of the final year-end rates but, for various reasons, cannot get the Government to approve revised billing rates. In these cases, contractors must use a more realistic set of rates in order to reasonably estimate contract costs for Limitation of Costs and Limitation of Funds purposes.

There's a certain amount of judgment involved in determining which rates should be used for Limitation of Costs/Limitation of Funds analyses. Commonly for purposes of calculating incurred costs, completed years should be calculated using "actual rates" while current year costs should be calculated using "billing rates" or "booking rates", whichever is the most accurate estimate of the final year end rates. Future year costs should be calculated using "forecasted rates" where the allocation bases can be estimated with a reasonable degree of certainty.