Using Blended Labor Rates to Implement New Compensation Caps - Part 1

This is a follow-up to our posting of March 18, 2015, Subject: Compensation Caps Cross the $1 Million Threshold. In that posting, we promised to discuss DCMA's (Defense Contract Management Agency) newly released guidance on blending labor rates. We did not get around to doing so as soon as we had hoped. Other news seemed more urgent. Today we rectify that situation.

The Bipartisan Budget Act of 2013 implemented a compensation limitation of $487 thousand applied to all contractor employees contracts awarded after June 24, 2014. As a result, contractors may be subject to multiple compensation limits each year beginning in 2014 until such time as all contracts issued prior to June 24, 2014 have been completed.

This "blending" concept only applies to contractors paying employees in excess of $487 thousand per year. If you are not one of those contractors, you can move on. Keep in mind however, that these are only compensation caps. These are not "reasonableness" determinations. You will still need to establish reasonableness of compensation amounts. For example, $487 thousand is most likely not going to be reasonable for a entry-level engineer.

One note of caution. This policy allowing blended labor rates applies to DoD contracts only. It is not binding on other Governmental agencies. However, we suspect that other agencies will be quite willing to accept DoD's methodologies.

Back in October 2014, the Director of Defense Pricing authorized the use of blended labor rates to help contractors avoid undue complexity and related cost to implement multiple labor rates in the same accounting period. Last January, DCMA issued guidance for implementing the blended rate approach.

DCMA's basis policy reads as follows:

The cap amount for each year should be calculated as a weighted average by blending the separate cap amounts based on the contract actions entered into before June 24, 2014 and on or after June 24, 2014. The relative percentage that the new cap contributes to the blended rates will increase over time as the business mix shifts from modifications to older contracts to new contracts. DCMA's method does not require the contractor to develop multiple sets of rates and relies on the contractor's existing cost accounting practices and processes to apply the cap to all contracts subject to FAR 31.205-6(p). Contractors will be required to demonstrate the accuracy of their calculations based on their accounting records and to provide objective, auditable support for the basis selected for forward pricing rates, interim billing rates, and final incurred cost rates. The information used to calculate the blending should be consistent in quantum and detail with the information used to calculate the proposed rate.

Next week, we will provide an example of how the blending might be calculated.