04.30.10

Government Requirements and Commercial Entities: Not So Scary After All

by Eric S. Sobota

As the United States continues to expand its service-based economy and rely more heavily on technological advancements, the Federal marketplace has become more attractive to companies that have no previous sales to Federal customers. The Federal government is the largest purchaser of goods and services in the world and will continue to fulfill this role for the foreseeable future. The new economy has forced agencies to embrace technology and adapt more quickly, thereby requiring cutting edge equipment and services that weren’t typically the focus of tech companies in the past several years. To many commercial organizations, the thought of selling in this environment seemed daunting and filled with red tape. The reality is that with proper planning and some flexibility within your organization, selling to the Federal government can be a great way to bolster revenue without fear of suffocating under onerous compliance requirements.

To be successful in the U.S. Federal marketplace, however, companies must understand the rules and regulations that govern Federal procurement. To understand the laws, rules and regulations that govern the pricing, cost accounting and administration of government contracts, one must understand both the procurement methods that the government uses and the type of contract that is awarded. Then the contractor will be in a position to fully understand the rules, regulations and audit rights that the government has relative to the contract and the contractor’s systems.

Generally, the government uses three methods to purchase goods and services.  They include:

• Commercial Item Acquisition – Federal Acquisition Regulations (FAR) Part 12
• Sealed Bidding or Full and Open Competition – FAR Part 14
• Contracting by Negotiation – FAR Part 15

The government’s objective is to pay a fair and reasonable price for the goods and services that it acquires. For products and services where there are many buyers and sellers, the government will rely on the market to establish a fair and reasonable price and will use Commercial Item Acquisition. The government also uses competition to establish a fair and reasonable price in accordance with the FAR Part 14. Finally, where the government is not convinced that it can rely on Commercial Item Acquisition or Sealed Bidding to establish a fair and reasonable price, it will examine cost and pricing information and go to Contracting by Negotiation in the FAR Part 15. Negotiated procurements normally carry with them many of the rules, regulations and audit rights that govern the pricing, cost accounting and negotiation of government contracts.

In addition to understanding the procurement method that the government is using, it is important to understand the contract type awarded and the specific contract terms incorporated therein. FAR Part 16 describes in detail the types of contracts that can be awarded except for commercial items, which are detailed within Part 12. When considering the complexity of post award compliance, there are three broad categories of contract types, each with increased complexity. Those are commercial, fixed price, and flexibly priced contracts. With each broad category, the risk of budgetary overruns is shifted from the contractor to the government thereby causing the heightened compliance requirements.

Commercial item acquisitions generally require the least compliance post-award as the government uses market based pricing to determine the reasonableness of an award. GSA schedule contracts are often used to establish commercial prices and to enable the acquisition of these goods and services. One of the key requirements in these awards is the monitoring of the “Most Favored Customer” class or category in order to ensure compliance with the Price Reductions Clause. This clause requires contractors to establish a baseline of customers that are similar to the Federal Government and monitor all discounts given to those. If a discount is given to one of those customers that is greater than the discounts given to the government, that same discount must also be established in the government rates. In addition, a fee (The Industrial Funding Fee) must be included within the published prices. This fee (.75%) must be refunded to the GSA on a quarterly basis.

Fixed price contracts can take many forms ranging from fixed price per unit such as hourly, per product or solution. These contracts can have more stringent compliance requirements if the procurement is not based on adequate price competition per FAR 15, but for purposes of this article, that will not be assumed. In general the government focuses on the determination of the number of units billed for compliance purposes. For instance, if a contractor has a labor hour contract with fixed hourly rates, after the contract is awarded the scrutiny will be on the determination of the number of hours worked and not the costs associated with the fixed hourly rates themselves. Contractors will need to ensure they have adequate timekeeping practices in place. These requirements can generally be managed with simple processes and may not require any sophisticated software depending on the company’s size.

Flexibly priced procurements generally have the most complex requirements as the government bears most of the performance risk in the case of any contract overruns. The inclusion of the Allowable Cost and Payment Clause (52.216-7) requires, among other things, that contractors establish indirect rates each year through the submission of an incurred cost submission. This type of contract also typically requires the establishment of an adequate accounting system. Many smaller companies can meet these requirements through manual processes and can continue to use their existing accounting software. The general requirements are as follows:

• Proper segregation of direct costs from indirect costs.
• Identification and accumulation of direct costs by contract.
• A logical and consistent method for the allocation of indirect costs to intermediate final cost objectives. (A contract is a final cost objective).
• Accumulation of costs under general ledger control.
• A timekeeping system that identifies employees' labor by intermediate or final cost objective.
• A labor distribution system that charges direct and indirect labor to the appropriate cost objectives.
• Interim (at least monthly) determination of costs charged to a contract through routine posting of books of accounts.
• Exclusion from costs charged to government contracts of amounts which are not allowable in terms of FAR 31, Contract Cost Principles and Procedures, or other contract provisions.
• Identification of costs by contract line item and by units (as if each unit or line item were a separate contract) if required by the proposed contract.
• Segregation of preproduction costs from production costs.

Although they seem daunting, a commercial organization can meet these requirements without implementing a complex compliance organization. Many small companies can use Accounting software such as QuickBooks and still meet the criteria. For most, the establishment of accounts within the system to accommodate direct, indirect and unallowable costs is required. Training is also very important. Employees will need to understand these regulations to a certain degree and be responsible for charging their time appropriately as well as potentially reviewing expense reports and identifying the amounts that are unallowable pursuant to FAR Part 31. A contractor may also consider establishing a separate division or entity to execute Federal contracts if it makes sense. This isolates the compliance requirements for the rest of the organization and will enable maximum cost recoverability in the new entity if the right policies and procedures are enacted.

As contractors continue to grow, other requirements and system reviews may become an issue. These include the Cost Accounting Standards and DCAA audits of 10 systems including ranging from purchasing to billing, to compensation among others. This typically would not be a concern for an organization that is considering entering the Federal marketplace, but may quickly become relevant dependent upon growth. With Federal spending at all time highs, commercial organizations should focus on the viability of the sale to an Agency and not on the compliance requirements. Through the implementation of policies and procedures, these requirements are not only manageable, but easily achieved in most organizations that are able to adapt.

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