Friday, October 25, 2013

Paying for Development Costs

When it comes to paying for intellectual property under negotiated contracts, the Government always seems to want something for nothing. Businesses might spend years and years and millions of dollars to design, develop, and patent a certain product or process. The Government comes along and want to buy it, but only wants to pay the actual cost of manufacturing. Under most costing techniques, those development costs, might not be allowed.

This is a real sticky area and extremely difficult to negotiate since there are no precedents, and the value is often at opposite ends of the spectrum for the contractor and the Government. The value is often determined by other factors - how badly does the Government want/need the item versus is the Government the only market in town or are there other alternatives (sources) for the Government. Most contracting professionals would advise contractors to seek legal counsel when it comes to such matters. FAR 31.109 would recommend these type of costs be subject to an advance agreement in order to preclude later disputes over the allowability, allocability, and especially the reasonableness of such costs.

No one would expect Microsoft to sell copies of its "Office" product (Word, Excel, Access, PowerPoint, etc.) at its production costs. What would that be, a few dollars for a DVD and a box, or nothing if the customer downloaded it? No one would expect Boeing to sell its commercial aircraft at production costs. The price of those aircraft include an amortization of development costs that were incurred long before the aircraft went into production. The same argument can be made for products that the Government buys where there was significant development effort required years before the purchase is made.

One thing that contractors should do is capture and accumulate development costs even if the costs are written off as a period expense each year. This shouldn't be too difficult with today's efficient web-based timekeeping systems and accounting software products. Once the costs are known, you at least have data to support your case. You might still argue over how many units those costs should be amortized over and how much of it the Government might have already paid for (through reimbursement of Independent Research and Development (IR&D) but at least you have a starting point from which to support your position.

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