Trade Discounts

The cost of materials under Government contracts seems pretty straight-forward. Contractors purchase raw materials, parts, sub-assemblies, components, and manufacturing supplies. Sometimes these costs are charged to inventory and other times, directly to the contract. The "reasonableness" of the prices are assured through the contractor's purchasing policies, procedures, and practices. There is, however, one little provision found in FAR 31.205-26 (Material Costs) that contractors often overlook. That provision states that contractors must adjust the cost of material for income and other credits including, among other things, available trade discounts.

Trade discounts are offered by vendors to encourage customers to pay early. They can be found on vendor invoices under the "Terms" section. For example, the term "2/10, N30" means that the customer may deduct two percent off the invoice if payment is made in 10 days. Otherwise, the full amount is due in 30 days.

Contractors are required by FAR to deduct available trade discounts from the cost of materials whether they take the discount or not. Many contractors do not take available discounts and charge their Government contracts the full amount of the invoice. Auditors are well aware of this practice and often spend a fair amount of time reviewing invoices for material costs, looking for lost discounts.

There is some relief available when the discounts are lost "without fault or neglect on the part of the Contractor, or lost through fault of the Government." If one of those events happen, the payment clauses require that contractors notify the Contracting Officer and give the reasons (see, for example, FAR 52.232-7). We heard of a case where the Contracting Officer excused the contractor from adjusting material costs for lost discounts because the vendor invoice did not arrive at the Contractor in sufficient time for it to take the discount.

Contractors should review their policies and procedures to ensure compliance with this FAR cost principle.