Monday, September 20, 2010

Budgetary Data

The overarching principal of FAR Part 15, Contracting by Negotiations, is that the contracting officer must purchase supplies and services at fair and reasonable prices. Often, indirect rates are a significant portion of the proposed amounts and therefore require audit evaluation of the contractor’s basis of estimates (e.g., budgetary data and historical costs/trends) to support the reasonableness of the rates. Contractors are generally required to follow the Table 15-2 instructions for submitting proposals as contained within FAR 15.408. Subsection II, Paragraph C of Table 15-2 provides instructions to the contractor that they must indicate how they computed and applied indirect rates while also showing trends and budgetary data with appropriate explanations to support the reasonableness of the proposed rates. Specifically, Subsection II, Paragraph C, Indirect Costs, instructs the contractor to:
Indicate how you have computed and applied your indirect costs, including cost breakdowns. Show trends and budgetary data to provide a basis for evaluating the reasonableness of proposed rates. Indicate the rates used and provide an appropriate explanation.

On August 24, 2010, DCAA issued its interpretation of this provision as an "alert" to its audit staff. DCAA stated that to comply with this provision, a contractor’s indirect rates should be based on a well-supported basis of estimate for each Fiscal Year of the proposed period of contract performance. To demonstrate reasonableness, contractors must show how they computed and applied the indirect rates while also providing supporting trend and budgetary data with appropriate explanations commensurate with the size and complexity of the contractor’s organization.

The term "...commensurate with the size and complexity of the contractor's organization" introduces a subjective element into the process. As typical when matters are left to auditor judgment, consistency in apply that guidance will suffer. Already we have seen such inconsistencies where one auditor will accept and another reject proposals that did not discretely estimate indirect rates beyond one year.

Larger contractors. The new guidance states that " would be expected that the proposed indirect rates for the first year be based on a detailed management-approved operating budget, and each subsequent period be based on adjustments to the operating budget based on strategic or long-range forecasts." The guidance further states that it is not expected that even larger contractors prepare detailed operating budgets for each fiscal year of contract performance.

Smaller contractors. The guidance acknowledges that smaller contractors often do not develop detailed budgets due to their impracticality to their organization. It is not uncommon for smaller firms to have limited budgetary data and assert that historical costs are the most appropriate basis to estimate all out year rates. In these cases, the auditors are instructed to ask the contractor for necessary trend data with appropriate explanations to support that the historical costs are the most reasonable estimates for the out year rates.

We should also point out that the level of expected detail is going to vary according to other risk factors. Two very important risk factors from an audit perspective are contract type and the amount of commercial work to which the rates are allocated. Fixed price contracts are higher risk than flexibly priced contracts because there is no "second chance" to review costs. The Government views commercial work as a significant motivator to keep indirect rates low.

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