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Financial Implications of Contracting for Acquisition Programs

Financial Implications of Contracting for Acquisition Programs

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Financial Implications of Contracting for Acquisition Programs

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  1. Financial Implications of Contracting for Acquisition Programs Professor Gerry Land CPA, CDFM-A Defense Acquisition University Capital & Northeast Region Fort Belvoir, VA (703) 805-3755; DSN 655-3755 E-mail: Workshop #45 2010 PDI – June 2010

  2. Workshop Topics • Basic Contracting Information • Contract Families and Types in those Families • Characteristics of Contract Types • Elements of Contract Types • Broad Policies of Contracting • Budgeting for Acquisition Contracts • Special Topics • Multi-Year Contracts • Planning for Contract Award • Unique Contract Provisions and Clauses • “Contracting” Through use of MIPRs • Management of on-going Acquisition Contracts • Summary

  3. Two Families of Contracts • Fixed Price Contracts • Provides for firm price or, in appropriate cases, an adjustable price • Contractor’s profit built into price • Use when specific requirements known before award • Cost Reimbursement Contracts • Provides for payment of allowable incurred costs • Contractor’s profit = fee • Use when uncertainties in contract performance prevent sufficiently accurate estimate of costs for fixed-price contract

  4. Fixed Price Family Cost Reimbursement Family Firm Fixed Price (FFP) Cost Plus Fixed Fee (CPFF) Fixed Price (EPA) Cost Plus Incentive Fee (CPIF) Fixed Price Incentive (FPI) Types Types Cost Plus Award Fee (CPAF) Two Families of Contracts Types Within the Families

  5. Characteristics of Contract Families Cost Reimbursement Fixed Price Contractor’s Promise Best Efforts Deliver specifics Financial Risk to Contractor Low High Financial Risk to Government High ? ? ? Cash Flow to Contractor As Cost Incurred On Delivery Progress Payments ------ % Incurred Performance Based Payments ------ Milestones (Preferred) Government Administration High Low Fee or Profit ? Fee Profit

  6. Elements of Contract Types • Firm Fixed Price (FFP) • Negotiated Price (Includes cost and profit) • Fixed Price Economic Price Adjustment (FP-EPA) • Negotiated Price (Includes cost and profit) • Price Adjustment (+ or - based on stated economic conditions) • Fixed Price Incentive (FPI) • Target Cost • Target Profit • Share Ratio (Government / Contractor) • Ceiling Price

  7. Elements of Contract Types (Continued) • Cost Plus Fixed Fee (CPFF) • Estimated Cost • Fixed Fee • Cost Plus Award Fee (CPAF) • Estimated Cost • Base Fee (< 3% of estimated cost) • Award Fee Pool • Cost Plus Incentive Fee (CPIF) • Target Cost • Target Fee • Share Ratio (Government / Contractor) • Minimum Fee • Maximum Fee

  8. FPIF CPFF Fee Adjustment Formula (Ratio) Target Profit 100/0 Share Fixed Fee Target Cost Estimated Cost CPIF CPAF FFP Max Fee Max Fee Fee Adjustment Formula (Ratio) Award Fee Pool Target Fee 0/100 Share Base Fee Min Fee Profit (PTA) Base Fee (0-3%) Ceiling Price Estimated Cost Target Cost Cost Schematics Showing Elements of Contract Types

  9. Broad Policies Relative to Contracts • Contracting Officers have relatively broad discretion in determining best type contract for a particular requirement • Contract type selected should be based on appropriate criteria • Contract should promote Government’s interests and motivate contractor to achieve objectives • Restrictions on contract types: • “Cost-Plus-Percentage-of-Cost” contracts are not authorized • Fixed Price development contracts > $25M must be approved by USD (AT&L) • Limitations on Fees for Cost Reimbursement Contracts • CPAF – Base Fee may be “0-3%” of the estimated cost • CPFF – Maximum Fixed Fee Percentages • R&D Effort: 15% • Production: 10% • Architectural & Engineering (A&E) : 6%

  10. Factors in Selecting Type Contract For Acquisition Programs • Timing on the acquisition continuum • Degree of complexity to satisfy requirement • Risk of successful performance • Shared responsibility of risk involved • Cost, schedule, performance and other incentives • Fair and reasonable prices through competition • Contracting Officer determines “best” contract type for required work effort and “most reasonable” cost to the government

  11. C A CDD CPD CPFF CPFF CPAF FPI FFP FPI FFP (LOE) CPIF FFP PDR: Preliminary Design Review CDR: Critical Design Review FRP: Full Rate Production IOC: Initial Operational Capability FOC: Full Operational Capability Defense Acquisition Management System With Emphasis on Contract Type Appropriate to Phase • The Materiel Development Decision precedes entry into any phase of the acquisition management system • Entrance Criteria met before entering phase • Evolutionary Acquisition or Single Step to Full Capability User Needs Technology Opportunities & Resources B IOC FOC Materiel Solution Analysis Technology Development Engineering and Manufacturing Development Production & Deployment Operations & Support ICD Materiel Development Decision FRP Decision Review Post PDR Assessment Post CDR Assessment AoA PDR PDR CDR or Pre-Systems Acquisition Systems Acquisition Sustainment Generally Preferred Contract Type For Different Phases Based on DoDI 5000.02; 8 Dec 08

  12. Cost and Pricing • Government policy is to pay a “fair and reasonable” price for goods and services for which a contract is awarded • One responsibility of the contracting officer is to determine the “fair and reasonable” price • Key Question: What is a “fair and reasonable” price and how is it determined?

  13. Price Analysis Cost Analysis • Fast and “cheap” to perform • Used to analyze sealed bids, small purchases and competitive proposals • Slow and costly to perform • Used to analyze sole source and, occasionally, competitive proposals Used when Purchasing: Used when Purchasing: • Standard, off-the-shelf items • Repeat buys of other items • Purchases < $500,000 • Research and Development efforts • Unique sole source items • Purchases > $500,000 Price Analysis vs. Cost Analysis Performed by Government Contracting Officer

  14. Funding Policies for Acquisition - Related Contracts • For Research and Development Efforts • RDT&E Appropriation • Incremental Funding Policy: Budget on basis of cost expected to be incurred during given fiscal year • For Production • Procurement Appropriation • Full Funding Policy: Budget on basis of all cost for specific quantity of militarily usable end items expected to be put on contract during given fiscal year

  15. Relationship Between Budgeting and Contracting • Budgeting • Accomplished well in advance of planned contract award • In compliance with funding policies of appropriation to be used • Amount based on “most likely price” of planned work effort • Funds above budgeted amount may be needed for contract modifications, overruns, requests for equitable adjustments, claims and litigation judgments; request funds when known • Contracting • Action during execution phase of the acquisition process • Upon contract award or modification, must have – and obligate – total amount of funds (budget authority) for “price” of work effort appropriate for contract type (i.e., cost reimbursement vs. fixed price) • Contract “price” = contractor’s “cost” plus company profit or fee

  16. Budgeting for Different Contract Types General Rule: Budget to Most Likely Price Contract Type Budgeted Amount FFP Negotiated Price FP – EPA Negotiated Price (not including EPA) FPI Target Cost + Target Profit CPFF Estimated Cost + Fixed Fee CPIF Target Cost + Target Fee CPAF Estimated Cost + Base Fee + Maximum Award Fee

  17. CPFF 100/0 Share Fixed Fee Estimated Cost Budgeting for a CPFF Contract • Elements of Contract: • Estimated Cost: 2,000 • Fixed Fee: 150 • Budget Estimate: 2,150 • Step One: Determine Estimated Cost • Step Two: Determine Fixed Fee • Fixed Fee Limitations: • R&D - 15% • Production - 10% • A&E - 6% • Step Three: Determine Budget Estimate Budget Estimate = Estimated Cost plus Fixed Fee

  18. CPIF Slope% 100 80/20 Target Fee 80 60 Budgeting for a CPIF Contract • Elements of Contract: • Target Cost: 1,000 • Target Fee: 80 • Maximum Fee: 100 • Minimum Fee: 60 • Sharing Arrangement: 80/20 • Target Price: • 1,080 1000 • Step One: Determine Target Cost Target Cost • Step Two: Determine Target Fee • Step Three: Determine Other Elements • Step Four: Determine Target Price Target Price = Target Cost + Target Fee • Step Five: Determine Budget Estimate Budget Estimate = Target Price

  19. CPAF Max Fee Award Fee Pool Base Fee Base Fee (0-3%) Estimated Cost Budgeting for a CPAF Contract • Elements of Contract: • Estimated Cost: 2,000 • Base Fee: 80 • Maximum Award Fee: 120 • Budget Estimate: • 2,200 • Step One: Determine Estimated Cost • Step Two: Determine Base Fee • Step Three: Determine Maximum Award Fee • Step Four: Determine Budget Estimate Budget Estimate = Estimated Cost; Base Fee; and Maximum Award Fee

  20. Budgeting for Severable Services Contracts • DoD may budget for and enter into a contract for severable services that begin one fiscal year and ends during the next fiscal year if the contract period does not exceed one year • Funds made available for a given fiscal year may be obligated for the total amount of that contract References: (1) Title 10, U.S. Code, Section 2410a (2) Comptroller General Decision B-259274 (22 May 96)

  21. Budgeting for Termination Liability On Incrementally Funded RDT&E Contracts • Unliquidated obligation on incrementally funded contract must be sufficient to cover cost of terminating for convenience (if action required) • Termination costs can not increase total budget needed • If contract terminated, termination costs to be financed from unliquidated obligations without reprogramming • Exceptions (expected to be rarely used): • Statutory Waivers: When exempted by Public Law (then budgeted on a pay-as-you-go basis) • Special Termination Cost Clause: Permitted by DFAR in fixed-price incentive and incrementally funded cost reimbursement contracts; approval requires notification of House and Senate Appropriations Committees

  22. Award Fees Background • Cost Plus Award Fee (CPAF) contract most suitable when government wants to incentivize contractor in areas other than just cost (e.g., subjective areas such as timeliness and technical performance) • Total Award Fee consists of two elements: • Base Fee (0 – 3% of estimated cost of contract minus Award Fee) • Award Fee Pool (from which contractor earns fee based on superior performance in satisfying criteria stated in Award Fee Plan) • Amount of fee actually paid is judgment decision made in accordance with criteria in Award Fee Plan • Fee to be paid contractor is a unilateral government decision; generally, decision is not subject to “Disputes” clause • Can be contentious topic for both contractor and government

  23. Periods Award Fee Pool Base Fee (0 - 3%) 3 4 1 2 5 • Commitment made before start of award period • Obligation made after end of award period (but before payment) Application of Award Fees • Elements of Award Fee • Award Fee Base (0 – 3 %) • Award Fee Pool • Evaluation Periods • Evaluation Criteria • Total Award Fee must be available at contract award • Financial actions re Award Fee • Payment action may be based on: • Specific milestones • Time periods • Combination of milestones and time periods

  24. Determination for Earning Award Fee • Criteria for earning specified in Award Fee Plan • Frequency is important to the process • Time based periods (usually 6, 9 or 12 month periods) • Milestone or event-based periods • Both time-based and milestone/event-based periods • Unearned Award Fee – How can it be used? * • FAR prohibits “rollover” of unearned award fee to future evaluation periods or events • Unearned award fee may be used by PMO or returned to higher command level for other requirements * Paragraph 16.401(e)(4), dated 14 Oct 2009

  25. Special Topics

  26. Chapter 137 of title 10, United States Code, Sec 2306C, Multiyear Services Contracts. (Originated in 2000 Authorization language) Multi-Year Service Contracts Criteria for This Type Service Contract • Must be a continuing requirement for the services • Furnishing of services will require a substantial initial investment in plant or equipment, or the incurrence of substantial contingent liabilities • for the assembly, training, or transportation of a • specialized work force • Use of such a contract will promote the best interest of the U.S. by encouraging effective competition and promoting economies of operation

  27. Chapter 137 of title 10, United States Code, Sec 2306C, Multiyear Services Contracts. (Originated in 2000 Authorization language) Multi-Year Service Contracts Type Services Appropriate for Such Contracts • Operation, maintenance and support of facilities and installations • Maintenance or modification of aircraft, ships, vehicles, and other highly complex military equipment • Specialized training necessitating high quality instructor skills (e.g., Pilot and aircrew members; foreign language training) • Base services (e.g., Ground maintenance; plane refueling; bus transportation; refuse collection and disposal)

  28. Cancellation Ceiling for Multiyear Procurement Contracts • Cancellation Ceiling may cover: • Non-recurring Costs • Recurring Cost (with approval of Agency Head and USD (C)) • Cancellation Ceiling is: • Negotiated along with other provisions of the contract • A decreasing amount each year • Not an additional amount to be budgeted • MYP contracts with Cancellation Ceiling > $100M require 30 day written notice to Congressional Defense Committees prior to award

  29. Planning for Contract Awards • Consider contract type and award timing early • Factor this information into cost and budget estimates • Avoid execution issues resulting from planned contract award in first or fourth quarter of fiscal year • Initial planning done as part of obligation plan • Consult contracting officer when preparing obligation plans • Proper planning usually results in better execution

  30. Contract Changes • Two formal methods to change a contract: • Preferred is the “Supplemental Agreement”: Fully negotiated agreement on specific work, price and schedule. • Less preferred is the “Undefinitized Change Order”: Tentative agreement on work and schedule but final agreements not yet negotiated; usually has a “not-to-exceed” price. • Constructive change: government action causes contractor to perform work differently than required by written contract • Standard changes clause: allows contracting officers to unilaterally direct changes in specification (what), shipping destination (where) and packing (how packaged); contractor may request equitable adjustment in cost and/or schedule

  31. Contract Clauses that Provide Some Control over Unliquidated Obligations • Contractor required to notify government 60 days prior to incurring costs equal to 75% of amount obligated • Incrementally Funded Cost-Reimbursement Contracts • Called “Limitation of Funds Clause (LOF)” • Fully Funded Cost-Reimbursement Contracts • Called “Limitation of Cost Clause (LOC)” • Contractor required to notify government 90 days prior to incurring costs equal to 85% of amount obligated • Incrementally Funded Fixed Price Contracts • Called “Limitation of Government Obligation Clause (LOGO)” • Notification allows termination liability to be covered by unliquidated obligations on that specific contract

  32. “Contracting” of Goods and Services through Use of MIPR • Three types of actions by which DoD activities can use Military Interdepartmental Purchase Requests (MIPRs) to obtain goods and services: • Project Orders • Economy Act Orders • Non-Economy Act Orders • A MIPR (DD Form 448) is normally used to transfer budget authority from one DoD activity (requesting agency) to another DoD activity (servicing agency) to provide specific goods or services • The servicing agency signs and returns DD Form 448-2 (MIPR Acceptance) to requesting agency to indicate agreement to provide the goods or services

  33. Project Order • MIPR must specifically state the request for goods or services is a Project Order • MIPR is then treated as if it were a contract • Funds identified on MIPR considered obligated when servicing agency signs and returns DD Form 448-2 • Three tests must be satisfied for action to be considered a Project Order: • Request must be for specific, identifiable supply, material, equipment, work or service; • Servicing agency must be capable of performing requested action; • Requested work must be started within 90 days of acceptance or by first of January of following year. References: US Code, Title 41, Section 23 and DoDI 7220.1

  34. Economy Act Order • An Economy Act Order is not treated as if it were a contract but, rather, an interagency acquisition agreement • While funds on the MIPR are normally considered obligated when accepted by servicing agency, the servicing agency is simply an extension of requesting agency • Funds on the MIPR retain original period of availability for obligation purposes • Required criteria for requesting agency to use this type order: • Required amount of funding must be available; • Head of requesting agency decides the order is in best interest of the government; • Servicing agency is capable of filling the order or getting by contract the requested goods or services; • Head of requesting agency decides ordered goods or services can not be provided as conveniently or cheaply by contract with a commercial enterprise References: US Code, Title 31, Chapter 15, Section 1535; FMR, Volume 11A, Chapter 3; and FAR at Sub-part 17.5

  35. Non-Economy Act Order Highly Controversial Method of DoD “Contracting” • Non-Economy Act Orders are for intra-governmental support where a DoD activity obtains required goods or services from a Non-DoD agency by sending funds to that servicing agency with understanding it will award a contract on its behalf. • There must be specific statutory authority to place an order with a Non-DoD agency for this type action and to pay associated fees (there are limited such statutory authorities) • Required criteria for requesting agency to use this type order: • Proper funding must be available; • The Non-Economy Act Order does not conflict with another agency’s designated responsibilities; • Requesting agency determines order is in best interest of DoD; • Servicing agency is able and authorized to provide requested goods or services • Non-Economy Act Orders are subject to same fiscal limitations as appropriation from which the funds are provided Reference: FMR, Volume 11A, Chapter 18 (new chapter as of Feb 08)

  36. Managing On-Going Contracts From Resource Management Perspective • As with other DoD entities, Acquisition Program Offices forecast obligations and expenditures in Obligation and Expenditure Plans • Acquisition Program Offices are responsible for managing obligations and expenditures associated with contracts awarded for their programs • Better (i.e., more realistic) forecasts usually result in better execution of those plans • Deviations from planned obligations and expenditures must be reported and justified to higher headquarters

  37. Managing On-Going Contracts From Contract Management Perspective • Vast majority of Program Office funding is obligated against contracts • Proper management of fiscal aspect of contracts requires close coordination with contractors • Contractors provide status reports on many contracts • Government Program Offices receive – and should use – information from contractor–provided reports and other government sources (e.g., DCMA) to help manage fiscal aspects of contracts • Poor execution of contracts usually result in loss of funds

  38. Information Available to Improve Management of On-Going Contracts • Many acquisition-related contracts require contractors to provide periodic reports reflecting status of contract work effort and costs • Earned Value Management • IAW DoDI 5000.02 (Enclosure 4, Table 5): • cost or incentive contracts valued at or greater than $20M in then-year dollars are required to implement EVMS • whenever implementation of EVMS is required on a contract, a Contract Performance Report (CPR) and Integrated Master Schedule (IMS) is a requirement of that contract • EVM related reports not required for firm-fixed price, level of effort or time and materials contracts (use must be approved by MDA) • CPR compares actual work performed on contract and actual cost incurred to planned work and budgeted cost at same point in time • Variances between plans and actuals show potential schedule slips and/or cost overruns • Cost overruns usually impact near term budget requirements

  39. - Compliance with industry EVM standard • Formal EVM system validation • Contract Performance Report • Integrated Master Schedule • Integrated Baseline Reviews • Ongoing surveillance > $50M Cost or Incentive Equal to or Above Threshold < $50M but > $20M Cost or Incentive Less Than Upper Threshold but Equal to or Above Lower Threshold • Compliance with industry EVM standard • No formal EVM system validation • Contract Performance Report (tailored) • Integrated Master Schedule (tailored) • Integrated Baseline Reviews • Ongoing surveillance • EVM optional (risk-based decision) • Cost-benefit analysis required Cost or Incentive Less Than Threshold < $20M DoD EVM Application Thresholds(DoDI 5000.02, Enclosure 4, Table 5) Contracts Thresholds Requirements

  40. Information Available to Improve Management of On-Going Contracts • Contract Funds Status Report (CFSR) • Applicable for contracts over six months in duration • Normally not required for firm fixed price contracts unless circumstances require specific funding visibility • Generally required quarterly unless contract states otherwise • Contractor-prepared report provides basic fiscal information: • Initial and adjusted contract price • Funds obligated to date • Accrued expenditures • Contract work authorized and forecast • Projected total price of contracted work • Forecast of billings to the government by period • Estimated termination costs by period

  41. Summary From Contract Management Perspective • Contracting environment is continually changing • Contracting is a team effort in partnership with contractor to meet mission needs • Fair and realistic prices under competition • Contracting Officers have broad discretion in determining contract type • Contracting requires knowledge of policy and regulations plus business judgment • Actions of contracting personnel are limited to authority delegated for specific purposes

  42. Summary From Resource Management Perspective • Acquisition program offices must follow provisions of Financial Management Regulation (DoD 7000.14-R) for fiscal matters and FAR/DFAR for contracting matters • Vast majority of budget authority provided defense acquisition programs is obligated against contracts • Resource management in acquisition program offices requires active management of fiscal aspects of contracts • Government requires some contractors – by terms of the contract – to periodically report on status of work actually accomplished and at what cost and projected data • Government can and should make maximum use of data contained in those reports to better manage execution of the program, to include management of resources

  43. QUESTIONS? Now for the DAU optional “commercial”

  44. Briefing for DAU Students • Learn. • Perform. • Succeed. #1 ’05 ’06 ’07 ’02 ’06 ’04 ’06 ’07 ’09 ’03 ’04 Jan 2010

  45. DAU Mission Provide a global learning environment to support a mission-ready Defense Acquisition Workforce that develops, delivers, and sustains effective and affordable warfighting capabilities. • Impact acquisition excellence through: • Acquisition certification and leadership training • Mission assistance to acquisition organizations • Online knowledge sharing resources • Continuous learning assets • Strategic workforce planning

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  47. Located with our Customers We are part of the community, not just a place to take classes.

  48. Learning assets at Acquisition Best Practices Clearinghouse Mission Assistance DAU Training & CL Courses Defense Acquisition Portal Acquisition Community Connection DAU Acker Library

  49. DAU’s iCatalog • Most current resource for information regarding DAU courses and the Certification & Core Plus Development Guides • Accessible from the DAU home page ( or directly at

  50. FY10 Training - Financial Management Level I Certification Level II Certification Level III Certification ACQ 101 Fundamentals of Systems Acquisition Management ACQ 201A Intermediate Systems Acquisition, Part A ACQ 201B Intermediate Systems Acquisition , Part B 25 hrs, online 37 hrs, online 5 days classroom BCF 102 Fundamentals of Earned Value Management BCF 203 Intermediate Earned Value Management BCF 205 Contractor Business Strategies BCF 301 Advanced Financial Management 15 hrs, online 9 days classroom 4 days classroom 9 days classroom BCF 103 Fundamentals of Business Financial Management BCF 106 Fundamentals of Cost Analysis BCF 211 Intermediate Business Acquisition Management 26 hrs, online 40 hrs, online 5 days classroom CLM 017 Risk Management CLM 024 Contracting Overview CLM 013 Work Breakdown Structure CLM 031 Improve Statement of Work Knowledge Based Case Based Case Based Level I “Core Plus” Courses & CL Module (See DAU iCatalog) Level II “Core Plus” Courses & CL Module (See DAU iCatalog) Level III “Core Plus” Courses & CL Module (See DAU iCatalog) Vers 10