Using Blended Labor Rates to Implement New Compensation Caps - Part 2

The Department of Defense has formally authorized contractors to used blended labor rates to implement the new compensation cap applicable to contracts awarded after June 24, 2014. If you missed Part 1 of this series, click here. Briefly, the Bipartisan Budget Act of 2013 established a new compensation ceiling applicable to all employees (not just the top level management) of $487 thousand. The challenge for contractors and the Government is to find a method to implement that new compensation ceiling in fiscal years where there are contracts with different ceiling amounts.

The Government would love to have contractors implement the new compensation cap on all contracts regardless of when they were awarded. This makes is easy for everyone. However, for many contractors, this would create a significant adverse impact on the bottom line. There is an option for contractor to develop discrete rates for contracts under each of the caps. For example, two G&A rates; one for pre-June 24, 2014 contract and the other for post-June 24, 2014 contracts. While this may be feasible for some contractors, it is probably very difficult to implement in most of today's accounting software or ERP systems.

The calculation of blended rates are going to be different for incurred costs and for forward pricing purposes. The incurred cost calculation is the easiest to calculate so we'll start there. There are three steps to calculating a blended rate.

1. Identify the total costs incurred for contracts awarded before and after June 24, 2014 and calculate percentages to the total
2. Identify the compensation cap applicable to both groups
3. Multiply the percentages from Step 1 by the respective compensation caps and add the results.

For example, if in 2014 a contractor incurred cost under pre-June 24, 2015 contracts of $700,000 and incurred cost under contracts that were awarded after that date, the blended rate computation would look like this:

This method prescribed by DCMA (Defense Contract Management Agency) could result in some inequities so contractors need to be cognizant of their indirect rate structure. For example, if a contractor were on a value-added G&A allocation base and all of the the post-June 24, 2014 costs were subcontract costs, the above calculation would not result in an equitable blended rate because no labor costs would be charged to post-June 24, 2014 costs and the labor charged to pre-June 24, 2014 costs would be "watered-down" by costs charged to post-June 24, 2014 contracts.

Tomorrow we will look at blended rate calculations for forward pricing purposes.