A contractor recently included escalation based on forecasted changes in the currency exchange rate between the country in which the work was going to be performed and the US Dollar. In other words, the contractor would be incurring costs in a foreign currency but reimbursed by the Government in US Dollars. In order to protect itself against a potential increase in the foreign currency relative to the US Dollar, the contractor added costs based on projected changes in the foreign exchange rate. DCAA (Defense Contract Audit Agency) questioned this forecast as an unallowable contingency under FAR 31.205-7. DCAA was correct in its application of this cost principle, in our opinion.
FAR 31.205-7 defines contingencies as a possible future event or condition arising from presently known or unknown causes, the outcome of which is indeterminable at the present time. Contingencies with estimates of future costs fall into two categories:
Costs that may arise from presently known and existing conditions, the effects of which are foreseeable within reasonable limits of accuracy. These are typically allowable.
Costs that may arise from presently know or unknown conditions, the effect of which cannot be measured so precisely as to provide equitable results to the contractor and to the Government. These should be be excluded from cost estimates.
Foreign exchange rates definitely fall into the later category and should not be included in a proposal. (If a Government contractor was able to forecast exchange rate fluctuations with reasonable accuracy, they are definitely in the wrong business). However, there are other contracting vehicles available to protect contractors in such situations. Contracting officers are able to develop a special clause that would address currency exchange adjustments. Usually such clauses swing both ways, protecting the Government's interests as well as the contractor's, depending on which way the currency fluctuates. If you encounter a situation such as this, be sure to discuss the possibility of including such a clause in your contract.