Excessive Pass-Through Costs - Part III

Today we conclude this three part series on the new excessive pass-through rules. Whenever a contractor expects to subcontract out more than 70 percent of the value of a contract, it must satisfy the contracting officer that it is adding value to the process. If the prime contractor is not adding value, the pass-through costs (primarily indirect costs and profit/fee applied to subcontract costs) are unallowable. Yesterday we discussed pre-contract aspects of this new rule. Today we will discuss some of the Government’s post-award emphasis.


Incurred Cost

Contractors who submit annual incurred cost submissions provide a wealth of information to the Government. For example, Schedule H (Schedule of Direct Costs by Contract/Subcontract and Indirect Expenses Applied at Claimed Rates) of the standard incurred cost submission for example gives the Government everything it needs to determine the percentage of subcontracted effort to total contract value and will readily show whether those subcontract costs were fully burdened with pass-through costs. Then, it’s a simple matter of referring to the contract to determine whether the contracting officer determined that the contractor added value to the effort. If so, auditors are being tasked to determine whether the contractor is performing the added-value functions as asserted during the initial proposal phase.

If it looks like the value of subcontract costs will exceed 70 percent of the contract value, the auditor will notify the contracting officer and request the contractor to provide a description and demonstration of the added-value by the contractor related to the subcontracted work. The auditor will then evaluate the functions to determine if the “added value” functions are consistent with the definition in the contract clause and perform testing to determine if the contractor is performing the “added value” functions and ascertain if the costs are reasonable. If not, the pass through charges applicable to the subcontracted effort will be questioned based on FAR 31.203(i).

Evaluations of Final Vouchers

During an evaluation of the final voucher, auditors will calculate the percentage of subcontract costs to the total costs of work performed. If the percentage exceeds 70 percent, the auditor will perform the steps described above. The auditor will also evaluate the functions actually performed to determine if the added-value functions are consistent with the definition in the contract clause. If the contractor cannot demonstrate its “added value” efforts, then the indirect costs (and profit) added by the contractor to the subcontracted work will be questioned as excessive pass through charges based on FAR 52.215-23 and FAR 31.203(i).

Allowability vs. Allocability

These FAR provisions create an allowability issue on excessive pass through costs, not an allocability issue. The excessive pass through costs are still allocable to a contract, but will not be paid by the Government (i.e., unallowable) if the contracting officer determines the contractor does not provide “added value” to the subcontracted portion of the work. This means that contractors cannot simply allocate their indirect cost pools over a base that excludes a particular contract. Auditors are being reminded that functions and related costs not determined excessive in accordance with FAR 31.203(i) are still subject to FAR 31.2, Allowability, Allocability, and Reasonableness and should be audited accordingly.