Tuesday, October 25, 2011

Limitation of Costs and Limitation of Funds - Part II

In yesterday's posting, we introduced two clauses that appear in cost-type contracts that require contractors to notify the Government as it's actual cost approach the amount that has be funded for work under the contract. Under a cost-reimbursable contract, the Government has no liability to reimburse costs that exceed the amount funded and the contractor has no responsibility to continue performance once contract funds are exhausted.

In order to make meaningful comparisons of actual costs to the amount(s) funded, contractors need systems that can provide that information. The accounting software cannot do it all unless contractors are prepared to shell out big bucks for an "enterprise" system (e.g. Deltek Costpoint). For small contractors however, the cost of those systems is prohibitive. The good news is that most accounting software plus Excel plus discipline will work just fine

Lets take a look at what it takes to meet the requirements of the Limitation of Costs clause. The clause requires that contractors notify the Government 90 days before incurring 75 percent of estimated contract costs. Calculating 75 percent of contract costs is easy. Figuring out when you will arrive at that figure is more challenging. There are a number of approaches one could take. Any approach however requires the following data:

  • the monthly budget for the contract
  • incurred cost to date
  • schedule of commitments (open purchase orders), including subcontracts
  • future "spend" rate

The purpose of the monthly budget for this analyses is to track "actual" costs against budgeted costs so that variances can be analyzed and corrective actions can be taken if needed. Variances will affect future spending, one way or another.

"Commitments" are often overlooked by contractors. Businesses issue purchase orders for goods and services. The cost of purchases made under those orders however, are not booked until an invoice is received. Therefore, contractors need to factor unfilled orders (or, commitments) into their analyses.

The future spend rate should be calculated by month and reflect management's best estimate of how progress is to proceed on the contract. It is perhaps one of the most challenging aspects of the Limitation of Cost analysis.

Tomorrow we will look at the impact that indirect expense rates have on this analysis.

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