Incurred Cost Submissions using Blended Rates but No Advance Agreement Will Get Bounced

Back in April, we published a four-part series on the use of blended labor rates to implement the new $487 thousand compensation cap that applies to all employees charging to Government contracts awarded after June 24, 2014. For a comprehensive look at the blending methodology, refer to that series Part 1, Part 2, Part 3, and Part 4. The Department of Defense came up with the blending methodology as a means of streamlining implementation of the lowered compensation cap while there is a mix of contracts under the old and the new caps. As a prerequisite to using a blended approach, a contractor must enter into an advance agreement with the ACO (Administrative Contracting Officer). The advance agreement includes detailed methodologies to calculate blended rates - which differ for incurred cost proposals and for forward pricing proposals.

DCAA (Defense Contract Audit Agency) is the Government organization tasked with determining whether contractors' annual incurred cost submissions (commonly referred to as ICE) are adequate. (By the way, if you're not familiar with the incurred cost adequacy checklist, download it here). Now that contractors have begun submitting their fiscal year/calendar year 2015 incurred cost proposals, DCAA has noticed that many of them are using a blended approach to cap compensation costs. That would be fine except the Agency is also noting that some of them have been submitted without the requisite Advance Agreement.

DCAA is now instructing its auditors to reject any incurred cost proposal that uses blended rates but lacks an advance agreement:

When the proposal is determined adequate and there is no executed advance agreement, the audit team should return the proposal and require the contractor to resubmit the proposal only after executing an advance agreement with the ACO.

The guidance includes some other steps such as coordination with the contractor and/or the ACO to determine whether an advance agreement is in process and if its issuance is imminent. In that case, the auditor is allowed to wait a little while before rejecting the submission.

Rejected incurred cost submissions run the risk of becoming delinquent. If you are nearing that six-month after year-end due date, you need to request an extension of time from the ACO.

Will the use of Blended Labor Rates Create a CAS Noncompliance?

We spent a few postings last month discussing DoD's "blended rate" approach to implementing the lowered compensation cap that affects contracts awarded on or after June 24, 2014. There are different methodologies to calculating blended rates depending upon whether the rates are for forward pricing purposes or incurred cost purposes. Incurred cost blending is rather straight forward because all of the factors needed to blend two compensation caps are known. Forward pricing is not so straight forward as it requires an estimate of work to be performed in future periods. You can learn more about these blending methodologies by reading our previous coverage in Part 1, Part 2, Part 3, and Part 4.

A question was posted on DoD's official Q&A website concerning contractors who wished to implement the new $487,000 cap for forward pricing purposes in lieu of using the blended method but wished to use the blended method for incurred cost purposes. The question concerned whether such a practice would constitute a noncompliance with CAS (Cost Accounting Standard) 401, Consistency in Estimating, Accumulating and Reporting Costs.

We understand why a contractor might want to implement such a practice - its simpler and avoids Government auditors and contracting officers from tearing into and second-guessing assumptions as to how much work in future years will be on pre-June 24, 2014 contracts and post-June 24, 2014 contracts. Keep in mind however that the approach will most likely have a negative impact as fixed price contracts will be understated, cost-type contracts will have a lower fixed fee, and resulting overruns will be unfunded. Given these downsides, it might still be in a contractor's best interest to forego the forward pricing aspects of blended rates.

According to DoD, the use of a blended rate versus implementing the new cap from the outset is not a CAS 401 noncompliance because any inconsistency does not involve a cost accounting practice as defined by the CAS Board. According to CAS, a cost accounting practice is any disclosed or established accounting method or technique which is used for allocation of costs to cost objectives, assignment of cost to cost accounting periods, or measurement of cost. Either the blended rate approach or the specified amount approach is none of these three. It is not a method or technique used for allocation of costs to cost objectives, not a method or technique used for assignment of cost to cost accounting periods, and not a method or technique used for measurement of cost.

Keep in mind that the use of the blended rate methodology requires an advance agreement and potential inconsistencies such as the one described above will be sorted out during the advance agreement process.One thing it is not however, is a CAS 401 noncompliance.