Statement of Work (SOW) vs Performance Work Statement (PWS)

Two terms that are sometimes confused and often used interchangeably are "Statement of Work" (SOW) and "Performance Work Statement" (PWS). We've used the terms interchangeably ourselves. These terms are not the same and in Government contracting, carry very specific meanings. Think of it this way; PWSs are SOWs for performance-based acquisitions. Not all SOWs are PWSs.

An SOW is the portion of a Government contract which establishes and defines all non-specification requirements for contractors' efforts either directly or with the use of specific cited documents. A PWS on the other hand is a statement of work for performance-based acquisitions that describes the required results in clear, specific and objective terms with measurable outcomes. We'll explain these terms further.

Statement of Work (SOW)

 An SOW specifies the work to be done in developing or producing the goods to be delivered or services to be performed by a contractor. According to DoD, the preparation of an effective SOW requires both an understanding of the goods or services that are needed to satisfy a particular requirement and an ability to define what is required in specific, performance-based, quantitative terms. A SOW prepared in explicit terms enables offerors to clearly understand the government's needs. This facilitates the preparation of responsive proposals and delivery of the required goods or services.

After contractor selection and contract award, the contract SOW becomes the standard for measuring contractor performance. As the contracted effort progresses, the government and the contractor will refer to the SOW to determine their respective rights and obligations. In this respect, the SOW defines the contract and is subject to the interpretations of contract law. In a dispute concerning performance, rights, or obligations, clarity in defining requirements is of utmost importance.

Performance Work Statement (PWS)

The PWS states requirements in general terms of what (result) is to be done, rather than how (method) it is done. The PWS gives the contractor maximum flexibility to devise the best method to accomplish the required result. The PWS must be written to ensure that all offerors compete equally. The Government must remove any features that could restrict a potential offeror. However, the PWS must also be descriptive and specific enough to protect the interests of the Government and to promote competition. The clarity and explicitness of the requirements in the PWS will invariably enhance the quality of the proposals submitted. A definitive PWS is likely to produce definitive proposals, thus reducing the time needed for proposal evaluation.

When a contract is awarded, the PWS is legally binding upon the contract and the Government. It provides an objective measure so that both the contractor and the Government will know when increments of work are completed and payments are justified.

Example

The Government issues a solicitation for grass cutting. Under a SOW, the requirements might specify the contract cut the grass every two weeks. The contractor has to mow the grass every two weeks, whether it grew or not. Under a PWS, the requirements might specify that the grass length be maintained at a height of between one and two inches. Its up to the contractor how to meet that requirement.

The Government Can't Read Between the Lines

The Government does not have the time and resources when evaluating proposals to "clean up" offerors' submissions. It is the offerors' responsibility to submit an adequately written proposal that establishes, among a host of things, its capability and the merits of its proposed approach. Additionally, the proposal must be responsive to the evaluation terms of the submission.

A recent Comptroller General decision involving a bid protest by Wolf Creek, an affiliate of a much larger company and Government contractor, Chugach, illustrates the problem when a company assumes that the Government will put "two and two" together.

Wolf Creek submitted a bid to NASA for facilities operations and maintenance support services. In evaluating past performance, NASA assigned a "neutral" rating to Wolf Creek. Although Wolf Creek provided past performance related to seven contracts that had been performed by subsidiaries of Chugach (of which Wolf Creek was also a subsidiary), it provided no past performance information for itself.

Wolf Creek argued that it provided records of significant accomplishment by its affiliates and demonstrated the meaningful roles they would plan in contract performance. Wolf Creek noted that its past performance proposal informed NASA that it would directly use the experience of personnel who have played key management roles with the Chugach subsidiaries from which past performance was drawn.

NASA countered by stating that Wolf Creek's proposal identified no meaningful role for Chugach or any of its subsidiaries in actually performing the requirements in the PWS (Performance Work Statement) - neither with management or with other resources. Wolf Creek's proposal only described general consultation and advisory roles for its affiliates. NASA did not find this to be "meaningful" involvement. In any event, the information was not provided in Wolf Creek's past performance proposal but was tucked elsewhere into
Wolf Creek's mission suitability proposal.

GAO's job in these situations is to determine whether the agency's judgment was reasonable and consistent with the stated evaluation criteria and aplicable statutes and regulations. Citing a previous decision, the GAO stated that an agency may properly consider the experience or past performance of an offeror's affiliated companies where the firm's proposal demonstrates that the resources of the affiliated company will affect the performance of the offeror. The key here is that the affiliated company must have meaningful involvement in the project.

In this case, the GAO ruled that the record supported NASA's determination that Wolf Creek's proposal failed to show that the Chugach family of companies would contribute to Wolf Creek's performance on the PWS requirements.Therefore, GAO concluded that NASA acted reasonably.

You can read the entire decision by clicking here.

NASA's Proposal Adequacy Checklist is Final

Last October, NASA published a proposed change to its NASA FAR Supplement (NFS) that would require prospective contractors to complete a proposal adequacy checklist whenever cost or pricing data is required. Click here to read our posting about that checklist and the differences between it and the DoD proposal adequacy checklist.

That proposed change has now become a final rule and has been incorporated into the NFS under 1852.215-85, Proposal Adequacy Checklist. So now, any company submitting cost or pricing data to NASA must also complete the checklist and submit it as part of its proposal. In publishing the final rule, NASA made it clear that it only applied in situations where cost or pricing data is required. That would exclude competitive bids, commercial items, and purchases made under the simplified acquisition threshold. NASA also dispelled concerns that this checklist was overly burdensome by passing the administrative burden and shifting the associated costs directly onto the contractor. NASA responded stating that the rule does not impose additional requirements over what is already required under the conditions when certified cost or pricing data is required. It merely provides a tool to ensure compliance with FAR Table 15-2.

There will undoubtedly be some growing pains with this checklist as we've already witnessed with DoD's version. The checklist requires contractors to identify the page number of the proposal where the checklist requirement is satisfied or an explanation as to why the information is not included. Sometimes the information is too voluminous to include with a proposal. In some cases, the information would cause the proposal to exceed the page limit specified in the solicitation. Some contracting officers and contract auditors have been satisfied with the phrase "too voluminous to include but will be provided upon request" while others have taken umbrage with that kind of statement. Eventually it will all get worked out.

The checklist does not apply to subcontractors - in other words, it is not a flow-down provision. However NASA strongly encourages prime contractors to have their prospective subcontractors use the same or similar checklist. We think its a good idea and recommend contractors incorporate the checklist requirement (either DoD's, NASA's, a hybrid, or one of their own making) into its purchasing system policies and procedures.

Conditions Influencing Contractor Labor Charging Practices - Part 6

Today we conclude our series on considerations that impact the scope of an audit of labor costs. These are important facts to consider, not only for the contract auditor, but also for contractor management and supervision as they endeavor to establish controls to ensure the propriety of labor charging practices. Over the years, we have seen many cases where top management was seemingly oblivious to destructive practices going on in their organizations. If projects get completed on time and within budget, everyone is happy. If it happens over and over, everyone is ecstatic and bonuses are free-flowing. But the company should be cognizant of the possibility that someone in their organization might be running a ponzi scheme - borrowing from future contracts to "pay" a current contract.

The final three conditions that might influence contractor labor charging practices are (i) customer mix, (ii) labor charging versus estimating, and (iii) fixed-price sole-source follow-on contracts (wow, three hyphens in the same title).

Customer mix

Many (perhaps most) contractors have both DoD and non-DoD contracts. DCAA (Defense Contract Audit Agency) and DCMA (Defense Contract Management Agency) are primarily interested in DoD contracts. Non DoD agencies often opt out of contract audit and once contractors realize this, might not apply the same rigorous labor charging controls over non DoD contracts as they do with DoD contracts. The contract auditors are guided to coordinate with non DoD agencies to see if they will pay for audit services on a reimbursable basis.

Labor charging versus estimating

Auditors are advised to consider whether an evaluation in this area may reveal that the contractor is charging certain categories of labor directly to Government contracts contrary to the manner in which the cost was
reflected in the bid proposal or the treatment accorded commercial contracts. The auditor is instructed to ascertain the reason for any divergence in policy. Such practices should be further analyzed.

Fixed-price sole-source follow-on contracts

Contractors may be motivated to charge effort allocable to commercial work to their sole-source contracts in order to increase the cost of these contracts, which are then used as a basis for projecting the cost of follow-on work.

Index to previous posts in this series

Part 1 - Contract mix and overrun contracts

Part 2 - Restructuring and significant changes to charging patterns

Part 3 - Reorganizations, adjusting journal entries, and budgetary controls

Part 4 - Contract definition, contract provisions, and funding caps

Part 5 - Related contracts and offsite locations

Conditions Influencing Contractor Labor Charging Practices - Part 5

This week we're continuing our series on risk factors affecting audits of labor costs faced by contract auditors. These factors are examples of situations that auditors need to be cognizant of when planning their review of labor costs. The existence of these conditions should give an auditor pause to consider whether they need to, perhaps, increase the level of testing over whatever baseline they've established given other risk factors, including "materiality".

Today we will cover (i) related contracts and (ii) offsite locations. Tomorrow we will conclude the series.

Related/Similar Cost-Type and Fixed-Price Procurement

This situation is fairly common and occurs when procuring agencies award contracts for the same or similar items using different contract types. For example, the Government may award a cost type contract for some developmental effort and a fixed price contract for production of the product that is being developed. Is such situations, it is often difficult to determine when development effort ends and production begins. Sometimes development continues well in to the production cycle. From an auditor point of view, it represents a high risk condition and will be closely monitored. This situation can often result in some form of "labor accounting by funding," i.e., labor cost to the contracts involved are charged based on contract funding and ceilings regardless of where they are incurred.

Offsite Locations

Significant amounts of labor costs may be incurred at contractor offsite locations where little or no audit effort has been expended. Auditors are accustomed to working at the contractor facility where the books and records are maintained. Sometimes that facility is where the contract is performed but in many cases, work is performed elsewhere; in remote, offsite, foreign, or military facilities where there is no auditor presence. In such cases, the auditor is required to determine if an assist audit is required based on the level of risk at the offsite location. If the labor at these offsite locations is significant, the auditor will most likely coordinate with an audit office near that offsite location to perform floorchecks or labor interviews. In some complex, sensitive, or high risk situations, it may be more timely, efficient, and effective for the primary site auditors to perform the offsite labor floor checks/interviews. In these situations, teaming among the primary site and offsite auditors should be considered.

As a side note, it is interesting sometimes to wonder about the factors that contribute to determining whether the auditors choose to perform the labor interviews themselves or farm it out to an office in closer proximity to the offsite location. For offsite locations in Hawaii, lower 48 auditors cannot trust the auditors assigned to the office there in Hawaii to perform their high risk labor interviews. On the other hand, auditors in Afghanistan are completely trustworthy.

Conditions Influencing Contractor Labor Charging Practices - Part 4

Today we present the fourth of six parts in our series on what contract auditors consider to be high risk conditions when reviewing labor costs. Although these conditions are not conclusive in and of themselves, the mere existence of such conditions should lead the auditor to devise specific audit tests to determine the propriety of related labor charges. Today we focus on CD contracts, contract provisions in general and accounting by funding.

As a general rule, auditor initiative, imagination, and yes, even intuition are important ingredients during assessments of possible labor accounting improprieties.

Contract Definition (CD) Contracts 

Contract Definition (CD) Contracts are generally fixed-price contracts for a short duration. They are usually awarded to several contractors who will compete for a major follow-on prime contract. The procurement activity will use the results delivered under the CD contracts to help define exactly what it wants in the prime contract and then issue an informative RFP. Since the contractor's performance on the CD contract will have a direct bearing on its chance of winning the prime, there may be a tendency to spend more than the established contract value. Therefore CD contracts are highly susceptible to labor mis­charging and the auditor should evaluate to make sure all allocable effort is being charged.

Contract Provisions 

Any contract or contract modification may contain certain provisions which increase the incentive for labor mischarging. A common example of such a provision is one which puts ceilings on certain cost elements or rates. Similarly, Time-and-Materials/Engineering and Technical Services contracts may include task order funding ceilings which are enforceable when contract language so provides. These ceilings prohibit the contractor from recovering any costs incurred above these preestablished limits. The existence of costs incurred in excess of ceiling limitations should alert the auditor to possible improper cost transfers. Another example of a contract provision which increases the risk of labor mischarging is a "Cost Sharing Clause." Such clauses may require the contractor to deliver goods and/or services at no costs to the Government.

Labor Accounting by Funding 

Labor accounting by funding is the controlled management and charging of labor costs to cost objectives on the basis of available funding rather than where the labor efforts are actually performed. Time-and-Materials/Engineering and Technical Services contracts possess a risk of labor accounting by funding. The availability of contract funds often controls where labor costs are charged. To the extent that this practice is
employed, the procedures utilized in risk and vulnerability analysis will have to be adjusted because extensive labor accounting by funding often results in no "red flag" conditions since all cost objectives will show labor costs at or below funded levels. The auditor must be alert to this type of situation and consider factors other than cost in determining the existence or extent of this practice. For example, a review of recent deliveries made on Government contracts could reveal that no labor costs were charged to a contract during the period when deliveries occurred.

As a general rule, auditor initiative and imagination are important ingredients during assessments of possible labor accounting improprieties.

Conditions Influencing Contractor Labor Charging Practices - Part 3

We are continuing our series today on risk factors associated with Government contractor labor charging practices. You can read the previous installments by following these links: Part 1 and Part 2. As we indicated, there are a lot of perceived risks in labor charging. Its the one cost element that doesn't have a lot of independent or third party support associated with it. For material costs, contractors can provide purchase requests, purchase orders, invoices, and receiving documents. For subcontracts, contractors can provide copies of subcontract agreements as well as other performance related information. For labor costs however, the only thing a contractor can provide is a timesheet and the veracity of that timesheet depends solely on the internal control policies, procedures, and practices that the contractor employees.

Today we're going to cover three more "risk" areas that auditors are attuned into while designing procedures to test the propriety of labor charges to Government contracts. These are reclassifications, adjusting journal entries, and budgetary controls.

Reorganization/Reclassification of Employees

Auditors are instructed to analyze the organizational structure of the contractor to determine if it permits inconsistent treatment of similar labor. In some instances, reorganizations and reclassifications are implemented to achieve an accounting objective that was not possible under the previous structure. Sufficient review should be performed to determine if the changes will have an impact on Government contract costs.

Adjusting Journal Entries/Exception Reports (Labor Transfers) 

Auditors will design tests to determine if there are any unusual labor transfers made via adjusting journal entries. Adequate rationale and supporting documentation should be available for all significant labor transfers. Evaluations in this area require the auditor to be knowledgeable about how adjusting entries are put into the system, either manually and/or by computer. If some significant entries appear to be more than just normal corrections, the Government risk and vulnerability is high and the area should be reviewed.

Budgetary Controls 

Many contractors operate management systems that require strict adherence to budgetary controls. If the system is inflexible, labor charges may have a tendency to follow the identical route of the budgeted amounts, especially if managers' bonuses or incentives are determined based on performance against some predetermined budget. Rigid budgetary control systems can result in predetermined labor charges. In our experience, this is one of the highest risk areas for not only auditors, but contractors themselves. Many times, contractor management simply don't know what's going on out in the plant.

Conditions Influencing Contractor Labor Charging Practices - Part 2

In yesterday's posting, we began a series on risk factors that contract auditors consider when beginning any evaluation of labor costs. Unfortunately, the tone of the audit guidance and the prevailing attitude of many auditors presuppose that Government contractors will deviate from accurate labor hour recording when certain conditions exist. That's not the case at all. Nevertheless, all auditors, whether they be contract auditors or financial statement auditors, will develop a set of risk factors to help them determine how much attention, focus, or testing they need to devote to certain areas.

Yesterday we discussed the first two factors, contract mix and overrun contracts. Today we'll address two more, restructuring costs and significant increases in labor accounts.

Restructuring Costs

Most companies, at one time or another, will go through some form of restructuring - it just goes with the ebb and flow of business cycles. In the DoD world, the Department attempts to cap the amount of costs that can be charged to its contracts for restructuring activities (DFARS 231.205-70). As actual restructuring expenditures near the negotiated restructuring cost ceiling, there is a risk that restructuring costs may be mischarged to other accounts. The auditor is advised to determine if the incurred and projected restructuring costs are near or in excess of the negotiated ceiling.

Significant Increases in Direct/Indirect Labor Accounts

This heading should probably read "significant changes" instead of "significant increases". Downward trends are just as "interesting" to an auditor as upward trends. Auditors are fond of trend analysis. Trend analysis may disclose instances where charges to direct or indirect labor accounts have increased significantly. Auditors are required to perform sufficient analysis to determine the nature of the increase (or decrease). The auditor should evaluate changes in procedures and practices for charging direct/indirect cost for consistency with generally accepted accounting principles, the applicable contract cost principles, and any applicable Cost Accounting Standards requirements.

The auditor should also perform comparative analysis of sensitive labor accounts. When the comparative analysis indicates a possible misclassification of direct labor cost or some other condition that cannot be adequately explained, the auditor should pursue the matter further, (e.g. the contractor may be misclassifying direct contract costs to selling and marketing or IR&D/B&P costs.) Analysis in this area may satisfy the man­datory annual audit requirements relating to changes in charging direct/indirect cost (MAARs 7) and analysis of sensitive labor accounts (MAARs 8). An example of a sensitive labor account is standby labor. Standby labor is generally defined as the unproductive time caused by and limited to idle time, capability retention, and waiting for special customer security clearance.

Conditions Influencing Contractor Labor Charging Practices - Part 1

Over the next few days, we are going to be discussing a number of factors that DCAA (Defense Contract Audit Agency) calls "conditions influencing contractor labor charging practices". That's just a nice way of saying "labor charging fraud". In deciding whether to continue, expand, or terminate reviews of labor costs, auditors consider a number of factors that may influence management decisions. None of these factors are conclusive individually but taken as a whole, help auditors understand the risks associated with recorded labor costs.

In reviewing labor costs, auditors are directed to consider a number of factors in developing a risk profile of the contractor. Evaluation of these factors may identify areas where the potential for labor mischarging is high. When the risk is high, the auditor is also tuned into the possibility of fraud, and should be conducting audit tests accordingly.

DCAA has identified 15 risk factors that auditors should consider in developing audit procedures for review of labor costs. Today we will cover the first two; contract mix and overrun contracts

Mix of Contracts

Auditors should determine the Government contract mix (cost vs. fixed-price/commercial). A contrac­
tor whose contracts are all fixed-price or all cost-type would have relatively little incentive to mischarge between contracts. On the other hand, a contractor with a mix of cost-type and fixed-price/commercial work would generally have a much greater motivation to charge effort allocable to fixed-price or commercial work to a cost-reimbursable contract.

Overrun Contracts 

When contract costs have exceeded or are projected to exceed contract value, contractors may divert these excess costs to other cost objectives such as indirect labor, overhead accounts, other contracts, etc. The auditors may request contractors provide them a listing of all contracts that are currently in an overrun position or projected to be in an overrun position. The auditors might also request this information from the ACO, particularly when they feel the contractor is not as forthcoming as it should.

Alliance Northwest Conference and Workshop - March 13, 2014

The 2014 Alliance Northwest Conference is right around the corner. If you haven't been to one of these or haven't been to one in awhile, its time to come and take a look.

The 2014 Alliance Northwest Conference is the largest business-to-government conference in the Pacific Northwest. The event features speakers, workshops, and match-making sessions with Government agencies and prime contractors.

It is geared to new and existing businesses interested in selling to the Government and/or to prime contractors. It is also a place wither prime contractors as well as Government agencies seek to reach small and diverse businesses to help meet their small business subcontracting goals.

You can read more about the conference and sign up for it here.

Representatives from Pacific Northwest Consultants will be there. Drop by our booth and say hello. Terry Nuzzo, PNWC's Chief Executive Member, will be presenting in one of the workshops - Financial Accounting Standards for Government Contractors at 1:30 pm.

CAS 410 - What Are Special Allocations?

Cost Accounting Standard (CAS) 410 provides criteria for allocating general and administrative (G&A) costs to final cost objectives (e.g. contracts) and provides guidelines for the type of expenses that should be included in the G&A expense pool. For a more detailed look at this standard, read our prior posting on the subject.

One of the key considerations in allocating G&A expenses is determining the most appropriate allocation base - one that will achieve a causal/beneficial relationship between the final cost objectives and the costs to be allocated to those final cost objectives. Commonly used allocation bases include the total cost input (TCI) allocation base, the value-added allocation base, and the single (cost) element allocation base. The decision on appropriate allocation base should be carefully considered because it will impact the recovery of costs under Government contracts. But sometimes, a single allocation base just won't do and that's why CAS has the 'J' clause.

The so-called 'J' clause (named because its found in CAS 9904.410-50(j)) follows:

Where a particular final cost objective in relation to other final cost objectives receives significantly more or less benefit from G&A expense than would be reflected by the allocation of such expenses using a base determined pursuant to paragraph (d) of this subsection, the business unit shall account for this particular final cost objective by a special allocation from the G&A expense pool to the particular final cost ojbective commensurate with the benefits received. The amount of a special allocation to any such final cost objective shall be excluded from the G&A expense pool ... and the particular final cost objective's cost input data shall be excluded from the base used to allocate this pool.

These 'J' clause allocations are used a lot be larger contractors and not so much by smaller contractors. Part of the reason is that larger contractors have the knowledge and sophisticated accounting and job costing system to satisfy the Government (auditors) that special allocations are necessary in order to achieve a fair and equitable allocation of costs. In our opinion, the special allocation should be used a lot more than it is.

Auditors are naturally suspicious whenever they see a 'J' clause allocation. Some contractors have abused the clause for various reasons; perhaps to "buy-in" on a certain contract. DCAA's audit guidance on this subject reflects these known risk areas:

For a given final cost objective to qualify for special treatment, a significant difference in its beneficial or causal relationship to G&A expense, as compared with the relationship of other final cost objectives to G&A expenses, should be apparent and supported. Because G&A expense, by definition, is for the general management and administration of the business unit as a whole, special allocations should generally be limited to unusual circumstances outside the normal operations and activities of the business. The special allocation should be identified to a particular final cost objective. A need for special allocation to a class of contracts or type of situation would indicate that the allocation base being used is not representative of the total activity of the business unit during a typical cost accounting period. 

Contractors (and prospective contractors) should at least consider whether a special allocation (or a 'J' clause allocation) would improve the allocation of costs to contracts and other final cost objectives.

Executive Order - Minimum Wage for Contractors

This is a follow-up to our posting from January 31st wherein we discussed the President's promise from his State of the Union message to issue an executive order increasing the minimum wage for contract employees to $10.10 per hour.

Yesterday, the President made good on that promise and issued an Executive Order that will increase the minimum wage on contracts issued after January 15, 2015 (about a year from now). You can read the entire Executive Order here, if so desired. Between now and then, regulations (e.g. the FAR) will need to be revised to reflect the order.

Only in Washington can someone say with a straight face that raising the minimum wage will reduce costs. In his Executive Order, the President stated that raising the minimum wage will indeed reduce costs:

This order seeks to increase efficiency and cost savings in the work performed by parties who contract with the Federal Government by increasing to $10.10 the hourly minimum wage paid by those contractors. Raising the pay of low wage workers increases their morale and the productivity and quality of their work, lowers turnover and its accompanying costs, and reduces supervisory costs. These savings and quality improvements will lead to improved economy and efficiency in Government Procurement.

Any real savings to be realized by this new minimum wage  is extremely doubtful and the increased costs will, of course, be borne by the American taxpayer. What, you thinks contractors are going to pay the increased costs out of their profits?

A couple of other aspects to this Executive Order that were not know at the time the President made his State of the Union speech include:

1. The minimum wage requirement flows down to all subcontractors, even those down to the third, fourth, fifth, etc tiers. 
2. The $10.10 rate is indexed each January by the Consumer Price Index for Urban Wage Earners and Clerical Workers. However the rate cannot go down if the Index goes down.

Material Costs - Part 3

For the past two days, we've been discussing the FAR Part 31 coverage of material costs and how those costs should be accounted for under Government contracts. Today we will conclude this series by discussing two final concepts; materials issued from inventory and materials acquired from affiliated companies, organizations, or subsidiaries.

When materials are issued from inventory, any generally recognized method of pricing such material is acceptable. It could be FIFO, LIFO, Weighted-Average, or something else. Whatever method is chosen however, must be applied consistently across the company. A contractor cannot use one method for Government contracting and another for commercial work. Additionally, the method must achieve equitable results. We've never encountered a situation where a selected methodology would not result in equitable results but we suppose it could happen. Suppose a contractor using the LIFO (last-in, first-out) method has three units in inventory at $100 each and buys a fourth for $1,000. The contract calls for one unit so under the LIFO method, the contractor charges the contract $1,000. The Government could look at that and think that there is some inequity in the practice. The ultimate decision will come down to the contracting officer's determination.

Allowance for all materials, supplies and services that are sold or transferred between any divisions, subdivisions, subsidiaries, or affiliates of the contractor under a common control shall be on the basis of cost incurred by that affiliate. In other words, the affiliate should not be charging a profit on the cost of the transfers.

There are exceptions however. Allowances may be at price (as opposed to cost) when three conditions are met:

1. It is the established practice of the transferring organization to price inter-organizational transfers at other than cost for commercial work of the contractor or any division, subsidiary or affiliate of the contractor under common control and
2. The item being transferred qualifies for an exception under FAR 15.403-1(b) and 
3. The contracting officer has not determined the price to be unreasonable.

Those exceptions listed under FAR 15.403-1(b) include:

• When the contracting officer determines that the prices agreed upon are based on adequate price competition
• When the contracting officer determines that prices agreed upon are based on prices set by law or regulation
• When a commercial item is being acquired
• When a waiver has been granted
• When modifying a contract for commercial items.

When commercial items are transferred at a price based on a catalog or market price, the contractor should adjust the price to reflect the quantities being acquired (e.g. provide for quantity discounts) and may also adjust the price to reflect the actual cost of any modifications necessary because of contract requirements.

Practically speaking, there is not too much that can go wrong when purchasing materials for a contract. Purchases are very straight-forward transactions. Contractor's need to ensure that they maintain an adequate paper trail that includes:

1. Purchase request
2. Purchase order
3. Receiving documentation
4. Vendor invoice
5. Payment records

Material Costs - Part 2

Yesterday we began a discussion on the FAR (Federal Acquisition Regulations) cost principle on Material Costs; FAR 31.205-26 by defining the types of material costs covered by the standard. Suffice it to say, that if the cost does not meet the definition as set forth in the standard, you need to find another cost principle to consider the allowability of costs. Too often, contractors and the Government try to force fit a particular cost item into a particular standard to proclaim allowability or non-allowability, whatever the case may be. Don't do it. Such arguments waste everyone's time.

So far, we have learned that material costs (as defined in the standard) are allowable under Government contracts along with the costs of getting them to the plant (or construction site) and that contractors can purchase more than the contract requirements to allow for spoilage, waste, etc, if reasonable and supportable, of course. Today we will focus on some of the prescribed accounting treatment.

Contractors must adjust the costs of material for income and other credits, including available trade discounts, refunds, rebates, allowances, and cash discounts, and credits for scrap, salvage, and material returned to vendors. Essentially, if the contractor derives any income, however represented, from purchasing materials, the cost of those materials must be reduced.

Secondly, the adjustments can be handled in one of two ways. The contractor can credit the contract(s) directly, or charge the credits to an indirect expense pool for allocating over a broad range of contracts.

Thirdly, if the contractor can demonstrate that its failure to take available cash discounts was reasonable, it does not have to credit the contract for lost cash discounts. Auditors, of course, cannot conceive of any situation where lost cash discounts are reasonable and indeed, modern Accounting software helps to ensure that available discounts are readily and easily identified. However, there could be situations where not taking discounts is reasonable.

Fourth, reasonable adjustments arising from differences between periodic physical inventories and book inventories may be included in arriving at costs. Those adjustments must be made to the proper period. This most often involves write-downs of inventory. Its rare when physical inventory exceeds book.

Tomorrow, we will discuss materials issued from inventory and materials transferred between divisions.

Material Costs - Part 1

Whenever "material costs" are discussed, it is usually in the context of a contractor's purchasing system - a system that should be designed and operated in such a manner as to ensure that the contractor (and therefore the Government) is obtaining fair and reasonable pricing of the materials it buys or the subcontracts it awards. DFARS (DoD FAR Supplement) 252-244-7001 lists 24 different criteria that contractors must meet in order to have an adequate purchasing system.

But beyond the 24 criteria found in DFARS, there are provisions in FAR Part 31 cost principles that concerns the allowability of material costs. In the context of FAR 31.205-26, material costs include not only the cost of the item(s) but the total cost to get those parts to the contractor's facility. These include::

1. Raw materials
2. Parts
3. Sub-assemblies
4. Components
5. Manufacturing supplies
6. Inbound transportation
7. In-transit insurance

The next provision that FAR adds is a reminder that allowable costs not only include the material items that go in to the end product, but also include (FAR states that contractors "shall include"):

• Reasonable overruns
• Spoilage
• Defective work

This is important because contractors many times overlook these elements and auditors, when they see them in a proposal, try to question the costs (e.g. why are you proposing 13 windows for this building when the specs call for only 12?). For proposal purposes however, its a bit tricky to prepare defensible estimates of what these costs will be. Obviously, historical experience is the best indicator but many companies will not have the ability to accumulate and calculate such factors. Alternatively, there might be some industry standards available to approximate these loss factors.

Tomorrow we will review how FAR requires contractors to account for material costs.

QuickBooks or QuickBooks Online?

Many, perhaps most, Government contractors use a version of QuickBooks to process accounting transactions, compile job costs (i.e. costs by contract), summarize data needed to calculate indirect expense rates, and prepare billings. Many use the basic QuickBooks by itself while others have purchased "add-ons" that make Government-centric tasks a little more efficient. Whether stand-alone or paired with add-ons, QuickBooks fulfills the essential accounting needs required for Government contracting.

Recently, Intuit, the makers of QuickBooks, have been aggressively marketing their on-line version of QuickBooks. At a recent conference, a QuickBooks representative reported that Intuit is spending more than 70 percent of its research and development efforts into the on-line version of QuickBooks as the company believes that is the future of accounting products. This undoubtedly means that we will not be seeing many new features for the desktop versions and little, if any, compelling reasons to purchase frequent upgrades.

Many of our clients have asked us about converting from the desktop to the on-line version of QuickBooks. There are certainly advantages to operating in the "cloud". One big advantage is that you are no longer tethered to the desk to perform your accounting functions. Get yourself a $200 "Chromebook" and you can access your complete accounting records from wherever you have an internet connection. Another big advantage is the automatic backups. You data is always safe. Sure, you could perform regular backups yourself but who does that? Really? A third advantage to using the on-line version is there is no longer a need to pass around huge data files. You can "invite" your accountant into your accounting data.

While there are distinct advantages to the on-line version, there are also some drawbacks. First, based on our own experiences, the on-line version does not seem as crisp as a desktop version on a computer with a fast processor. There is a noticeable lag time even with fast internet connections. Second, the on-line version does not have the sidebar showing open windows. In the desktop version, you can go to any open window with one click. In the on-line version, you have to use the back and forward browser buttons. Intuit has a work-around - just open multiple browser windows. Perhaps that works for some but it is certainly not as elegant as the desktop structure. Thirdly, the on-line version does not have a "jobs" feature. This could be a fatal flaw for any contractor that is currently using "jobs" in their desktop versions. The on-line version does have the "class" feature but not the "job" feature. Finally, anyone using an add-on product to QuickBooks will not have that feature with the on-line version.

If you're just getting started in Government contracting and you have one or a few contracts, and you want to use QuickBooks, try the on-line version. If you're a current desktop user, you might just want to continue in that vein. Perhaps in a short period of time, especially with all the R&D effort that Intuit is pumping into its on-line version, the features of the on-line version will catch up with the desktop.

Don't Rely on Just Any Old Government Employee for Direction

Contracting officers have the authority to enter into, administer, or terminate contracts and make related determinations and findings. Contracting officers may bind the Government only to the extent of the authority delegated to them. Contracting officers shall receive from the appointing authority clear instructions in writing regarding the limits of their authority. Information on the limits of the contracting officers' authority shall be readily available to the public and agency personnel (FAR 1.602-1).

Contracting officers are responsible for ensuring performance on all necessary actions for effective contracting, ensuring compliance with the terms of the contract, and safeguarding the interests of the United States in its contractual relationship. In order to perform these responsibilities, contracting officers are allowed wide latitude to exercise business judgment. Among those responsibilities are

• Ensure sufficient funds are available for obligation
• Ensure that contractors receive impartial, fair, and equitable treatment
• Request and consider the advice of specialist in audit, law, engineering, information security, transportation, etc.

Contracting officers may also delegate some of their contract administration functions and responsibilities to an Administrative Contracting Officer (AC). In DoD, ACO's are part of the Defense Contract Management Agency (DCMA).

The top level responsibility rests with the Contracting Officer. Anything delegated must be delegated in writing.

Here's where problems arise. Sometimes there are Government employees running around acting like they have a lot of authority. These could be Contracting Officer Representatives, Contracting Officer Technical Representatives, inspectors, quality control people, and sometimes even auditors. Be very careful when you follow their advice or take some kind of contractual action based on their requests, demands, directions, or assurances. 

Beware when you comply with such direction. The person making the request/demand may not have the authority to do what he/she just did. It could be a construction project where an inspector tells you to place the door here instead of there. If he didn't have the authority to make that change, you will not prevail in an equitable adjustment for increased costs. This happens a lot in depot level maintenance contracts where someone on the Government's side has to decide whether particular work is included in the basic contract or represents "over and above" work that should be compensated. If a contractor relies upon direction from an individual that does not have the authority to bind the Government, the chances of prevailing in a dispute are diminished.

In the old days, courts (including the Board of Contract Appeals) were inconsistent in deciding whether the contractor acted in good faith in relying on a Government representative's actions. However, in a 2007 Federal Circuit Court decision (Winter v. Cath-dr/Balti Joint Venture), that former "flexibility" was sharply limited.

For more information on this, follow this link.

New Retirement Plans for Government Contractors

Okay, so this post is not strictly about Government contracting but it is something that Government contractors should be aware of and should encourage their employees to participate in. It's the President's new retirement savings program he announced at last month's State of the Union address. It's called 'myRA'.

The concept is pretty simple. Employees can have as little as $5 taken out of each paycheck and deposited into a Government bond fund. By deducting money from paychecks before workers receive them, the investments will steadily grow without any decision making required. After that, it works much like a Roth IRA - keep the money in for a minimum amount of time and the earnings can be withdrawn tax-free. Like Roths, there are wage thresholds above which employees will not be eligible to participate.

There's good and bad to this program. The good is that it requires very little up-front investment - $25 to open the account and as little as $5 after that. Also, since the Government controls the investment, there are no fees to be paid to brokerage firms and investment advisers. Secondly, investors will never lose their principle, unlike stocks and mutual fund values.

The bad part is that the returns on Government bonds have always been anemic. Right now, the returns are under two percent. Most investment advisers believe that even with their fees, they can achieve greater returns. 

About 40 percent of workers don't have any kind of retirement plan and more than 50 percent of American's are not saving enough money to maintain the standard of living they enjoy during their working life. Social Security is not going to be enough - workers need to save for retirement. In the scheme of things, this new 'myRA' isn't going to solve the problem of insufficient retirement by itself, but is a step in the right direction.

Accounting for Work Breaks

How should paid work breaks be accounted for and still be Government compliant?

We recently had a client ask that question and suggested the options of (i) tracking the time as an indirect charge (similar to vacation time), and (ii) charging the time using the time charge code of the surrounding jobs.

We replied that we believe the choice was theirs.

Time charging should accurately reflect the work performed.  The keys here are accuracy (not necessarily precision) and reasonableness (i.e., industry norms and effectiveness).  Contractors should have reasonable effective timekeeping procedures to ensure labor hours are accurately recorded and then applied to the applicable charge codes (i.e., jobs).

Nearly all of our clients charge short duration (i.e., 15 minute) paid breaks as a direct charge to the job that was worked on just prior to and/or just after the break in a consistent and unbiased manner.  We believe this is reasonably accurate most of the time.

However, there are contractors that accumulate unproductive paid break time as an indirect expense and then allocate those minutes over a base that includes all of the hours worked during the day or during the pay period.  One such contractor is a very large manufacturer that has many small jobs.  Production line employees sometimes work less than 20 minutes on a job and it is not uncommon to find situations where employees work on ten or more cost objectives (jobs) in a given day.  Adding a 15 minute break to a 20 minute job would significantly distort the time charged to that job. Employees scan bar codes to clock in and out of each job.  The time needed for any particular job varies significantly depending on the complexity of the product being made.  Due to its circumstances, the contractor chose to expend more effort to create a more precise allocation of the unproductive paid break time.

Ultimately, it comes down to a business case and determining what's reasonable in the circumstances. Most auditors we know would agree.

If you want to discuss your particular situation, contact Dave Koeltzow (Kelso) at 360-910-4146 or email him at dkoeltzow@pacificnwc.com.

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