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trplyr

FAR 31.205-20 Interest and other financial costs

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I've been doing some research regarding when to include the progress payments clause 52.232-16 in solicitations and contracts.

FAR 32.005 Consideration for contract financing says, "(a) Requirement. When a contract financing clause is included at the inception of a contract, there shall be no separate consideration for the contract financing clause. The value of the contract financing to the contractor is expected to be reflected in either

(1) a bid or negotiated price that will be lower than such price would have been in the absence of the contract financing, or

(2) contract terms and conditions, other than price, that are more beneficial to the Government than they would have been in the absence of the contract financing. Adequate new consideration is required for changes to, or the addition of, contract financing after award....."

So, in trying to think this through, I came up with two scenarios:

1 - I issue the solicitation without the progress payment clause and I get the following offers:

Contractor A - $110,000

Contractor B - $115,000

2- I issue the solicitation with the progress payment clause and I get the following offers:

Contractor A - $109,000

Contractor B - $114,000

In scenario 2, the prices are lower because 'The value of the contract financing to the contractor is expected to be reflected in either

(1) a bid or negotiated price that will be lower than such price would have been in the absence of the contract financing,..."

In scenario 1 the prices were higher because of the absence of the contract financing.

If I made the award under scenario, does that conflict with 31.205-20 -- Interest and Other Financial Costs.?

Interest on borrowings (however represented), bond discounts, costs of financing and refinancing capital (net worth plus long-term liabilities), legal and professional fees paid in connection with preparing prospectuses, costs of preparing and issuing stock rights are unallowable (but see 31.205-28). However, interest assessed by State or local taxing authorities under the conditions specified in 31.205-41(a)(3) is allowable.

Aren't the higher costs in scenario 1 attributed to private financing?

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Hi trplyr,

I don't think you are looking at this in the right way. If you'll permit me, the price reduction flows from a change in the proposed profit, and should not be related to any change in proposed costs.

Look at it this way, if a contractor has to finance contract costs over a significant period, it probably incurs interest, which is an unallowable cost. Unallowable costs reduce the contractor's profit. So if it has to cover the unallowable cost, it needs to receive more profit. If you eliminate the contractor's need to incur the unallowable interest cost, in a competitive situation the logical outcome should be that it will propose a lower profit amount, which will reduce its proposed price to the government.

Hope this helps.

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Hi trplyr,

I don't think you are looking at this in the right way. If you'll permit me, the price reduction flows from a change in the proposed profit, and should not be related to any change in proposed costs.

Look at it this way, if a contractor has to finance contract costs over a significant period, it probably incurs interest, which is an unallowable cost. Unallowable costs reduce the contractor's profit. So if it has to cover the unallowable cost, it needs to receive more profit. If you eliminate the contractor's need to incur the unallowable interest cost, in a competitive situation the logical outcome should be that it will propose a lower profit amount, which will reduce its proposed price to the government.

Hope this helps.

I looked at your response this morning and finally the fog cleared and it all made sense. Thanks.

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I looked at your response this morning and finally the fog cleared and it all made sense. Thanks.

trplyr, you did not say what type of contract you intend to award. if it is a firm fixed price contract, what says that interest cannot be a component of the price?

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trplyr, you did not say what type of contract you intend to award. if it is a firm fixed price contract, what says that interest cannot be a component of the price?

Am I missing the boat here? Doesn't FAR 31.205-20 apply to FFP contracts?

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Am I missing the boat here? Doesn't FAR 31.205-20 apply to FFP contracts?

Of course it does, trplyr, in many (but not all) situations.

"The cost principles are applicable to the pricing of contracts, subcontracts, and modifications whenever cost analysis is performed. ... The cost principles apply to the determination, negotiation, or allowance of costs whenever required by a contract clause." (Government Contract Costs & Pricing, 1st Ed., Karen Manos, author)

See FAR 31.102.

Hope this helps.

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Of course it does, trplyr, in many (but not all) situations.

"The cost principles are applicable to the pricing of contracts, subcontracts, and modifications whenever cost analysis is performed. ... The cost principles apply to the determination, negotiation, or allowance of costs whenever required by a contract clause." (Government Contract Costs & Pricing, 1st Ed., Karen Manos, author)

See FAR 31.102.

Hope this helps.

I had a case where the actual manufacturer would not sell directly to the government. The contractor did not want to be bothered with govn't source inspection. So we got a quote from a firm that will buy the part, package IAW w/ the specs and then allow the QAR to come in and inspect the material. In this case the distributor was the only offeror. The quote was around $60,000. The buyer had no pricing history, no similar items to compare it with. So the buyer asked the distributor to provide a cost breakdown. Included in the cost breakdown was $1000 for interest. This would be unallowable, right?

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I had a case where the actual manufacturer would not sell directly to the government. The contractor did not want to be bothered with govn't source inspection. So we got a quote from a firm that will buy the part, package IAW w/ the specs and then allow the QAR to come in and inspect the material. In this case the distributor was the only offeror. The quote was around $60,000. The buyer had no pricing history, no similar items to compare it with. So the buyer asked the distributor to provide a cost breakdown. Included in the cost breakdown was $1000 for interest. This would be unallowable, right?

trplyr,

I'm a bit hesitant to answer your question directly, because I feel that I'm missing some aspects of the situation. For example, you say "The buyer had no pricing history ..." but you don't say whether the seller could have provided information other than cost or pricing data -- e..g, prices at which it had sold this item in comparable quantities and similar terms & conditions. You say "the actual manufacturer ... did not want to be bothered with govn't source inspection" but you don't address whether the item might have (or actually did) qualify as a Part 12 acquisition (commercial item).

I am pretty clear that (a) if this was a negotiated procurement and not an acquisition of a commercial item or a sealed bid, and (B) if the government used cost analysis, then yes, during negotiations the government should deduct the value of the contractor's proposed unallowable cost (e.g., unallowable interest expense) when establishing the price that the government will pay.

But this scenario reeks of a commercial manufacturer using a commercial distributor. Let me ask you this: if the manufacturer won't permit government source inspection, and its distributor cannot read the FAR well enough to know that it should not propose interest expense when justifying its proposed price, what makes you think that these two entities are going to be able to comply with any other contract term? (I'm thinking Buy American Act, Trade Agreements Act, Specialty Metals restrictions, etc.) Are you sure that they are presently responsible, including financially viable? Are you sure that Section K was accurately executed -- i.e., does this team even understand what they are executing?

I don't mean to make a "federal case" out of this. But something (actually more than one something) is raising the hairs on the back of my neck and setting off my mental alarm bells. Do you think you might discuss this with your supervisor?

Don't mean to get you all freaked-out, hope this helps.

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The crux of the ongoing dialogue between trplyr and here_2_help is the role of the cost principles in the pricing of fixed-price contracts.

When negotiating a fixed-price contract, and when the government obtains detailed cost information and performs a cost analysis, the contracting officer must apply the cost principles when developing her prenegotiation objective. (See FAR 15.406-1 concerning prenegotiation objectives. See also the Contract Pricing Reference Guides, Volume 3, Chapter 12, sections 12.3 and 12.4.) Thus, if the cost breakdown reveals that the contractor included $1,000 in its proposal for unallowable interest, the CO should exclude that amount from her prenegotiation objective. When the two parties get to the negotiation table, and if the contractor asks the CO how she arrived at the price she has put on the table, she should say something like: "My number reflects the exclusion of interest from the price, because interest is unallowable and I must comply with FAR 31.102."

The two parties may or may not discuss that further as they bargain. It would be fruitless for the contractor to argue that interest should not be excluded from the CO's objective. But it would be inappropriate for the CO to seek the contractor's assurance or confirmation upon agreement that interest is not included in the negotiated price, because FAR 31.102 says:

[A]pplication of cost principles to fixed-price contracts and subcontracts shall not be construed as a requirement to negotiate agreements on individual elements of cost in arriving at agreement on the total price. The final price accepted by the parties reflects agreement only on total price.

When the CO writes her price negotiation memorandum (see FAR 15.406-3 and the Contract Pricing Reference Guides, Volume 5, Chapter 4. section 4.3.), she will say that she negotiated interest out of the price. However, she should also say that the negotiated price reflects agreement only on the bottom line, and not on individual elements of cost. Once the contractor gets paid, it can do what it wants with the money, because the terms of the contract do not say what the contractor may use it for. So, if in trplyr's first scenario, the contractor decides to use its revenue to pay interest, that is not the CO's business. However, if the contractor must pay the interest, then its profit on the contract will be lower than it would have been if the CO had not "negotiated it out," because the only money available in the contract will be whatever profit the contractor earned.

In his initial response to trplyr, here_2_help said:

[T]he price reduction flows from a change in the proposed profit, and should not be related to any change in proposed costs.

That doesn't make sense to me. If the first scenario prices included the cost of interest, then, in accordance with the theory in FAR, the second scenario prices presumably don't, and that's why the prices in the second scenario are lower. here_2_help then went on to say:

If you eliminate the contractor's need to incur the unallowable interest cost, in a competitive situation the logical outcome should be that it will propose a lower profit amount, which will reduce its proposed price to the government.

That doesn't make sense to me either, because if progress payments eliminate the need to incur interest cost, then the proposed price should be lower due to the elimination of that cost and any proposed profit that might otherwise have been associated with that cost.

I think that what here_2_help meant is that ordinarily a knowledgeable contractor will not include interest in its proposed price breakdown, because it knows that the CO will exclude the interest from her price objective. Instead, the contractor will cover the interest by proposing a higher profit than it otherwise would have. Thus, he would attribute the lower prices in the second scenario to a reduction in profit, not a reduction in cost.

In summary: When cost principles are applied in the negotiation of fixed-price contracts, the effect of "unallowable" is that a CO must exclude the unallowable amount from her prenegotiation cost objective. Presumably, that will mean that the parties will agree to a price that is lower than it otherwise might have been, due to the elimination of the cost, but the parties need not agree that the price is lower for that reason. This is very different than the effect of "unallowable" when a contractor seeks reimbursement of incurred costs, in which case it means that if the contractor spent $1,000 on interest, the government will not reimburse if for that amount.

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The crux of the ongoing dialogue between trplyr and here_2_help is the role of the cost principles in the pricing of fixed-price contracts.

When negotiating a fixed-price contract, and when the government obtains detailed cost information and performs a cost analysis, the contracting officer must apply the cost principles when developing her prenegotiation objective. (See FAR 15.406-1 concerning prenegotiation objectives. See also the Contract Pricing Reference Guides, Volume 3, Chapter 12, sections 12.3 and 12.4.) Thus, if the cost breakdown reveals that the contractor included $1,000 in its proposal for unallowable interest, the CO should exclude that amount from her prenegotiation objective. When the two parties get to the negotiation table, and if the contractor asks the CO how she arrived at the price she has put on the table, she should say something like: "My number reflects the exclusion of interest from the price, because interest is unallowable and I must comply with FAR 31.102."

The two parties may or may not discuss that further as they bargain. It would be fruitless for the contractor to argue that interest should not be excluded from the CO's objective. But it would be inappropriate for the CO to seek the contractor's assurance or confirmation upon agreement that interest is not included in the negotiated price, because FAR 31.102 says:

When the CO writes her price negotiation memorandum (see FAR 15.406-3 and the Contract Pricing Reference Guides, Volume 5, Chapter 4. section 4.3.), she will say that she negotiated interest out of the price. However, she should also say that the negotiated price reflects agreement only on the bottom line, and not on individual elements of cost. Once the contractor gets paid, it can do what it wants with the money, because the terms of the contract do not say what the contractor may use it for. So, if in trplyr's first scenario, the contractor decides to use its revenue to pay interest, that is not the CO's business. However, if the contractor must pay the interest, then its profit on the contract will be lower than it would have been if the CO had not "negotiated it out," because the only money available in the contract will be whatever profit the contractor earned.

In his initial response to trplyr, here_2_help said:

That doesn't make sense to me. If the first scenario prices included the cost of interest, then, in accordance with the theory in FAR, the second scenario prices presumably don't, and that's why the prices in the second scenario are lower. here_2_help then went on to say:

That doesn't make sense to me either, because if progress payments eliminate the need to incur interest cost, then the proposed price should be lower due to the elimination of that cost and any proposed profit that might otherwise have been associated with that cost.

I think that what here_2_help meant is that ordinarily a knowledgeable contractor will not include interest in its proposed price breakdown, because it knows that the CO will exclude the interest from her price objective. Instead, the contractor will cover the interest by proposing a higher profit than it otherwise would have. Thus, he would attribute the lower prices in the second scenario to a reduction in profit, not a reduction in cost.

In summary: When cost principles are applied in the negotiation of fixed-price contracts, the effect of "unallowable" is that a CO must exclude the unallowable amount from her prenegotiation cost objective. Presumably, that will mean that the parties will agree to a price that is lower than it otherwise might have been, due to the elimination of the cost, but the parties need not agree that the price is lower for that reason. This is very different than the effect of "unallowable" when a contractor seeks reimbursement of incurred costs, in which case it means that if the contractor spent $1,000 on interest, the government will not reimburse if for that amount.

Vern has reached the point of the question I asked earlier. Just to be clear on one point though, there is nothing in the FAR that prohibits the contracting officer from agreeing to a price that includes interest. The key is a fair and reasonable price. if the contractor can convince the contracting officer that interest is appropriate in the circumstances, such as the contract is being financed through commercially available financing, so that progress payments will not be required from the government, thus reducing the administrative burden and cash flow burdens on the government, the contracting officer can agree to leave interest in the price, so long as the price agreed to is fair and reasonable. The contracting officer's price negotiation postion does not have to be achieved when negotiating a firm fixed price.

As a side note, interest can also be included in an equitable adjustment to firm fixed price contracts in appropriate circumstances.

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Just to be clear on one point though, there is nothing in the FAR that prohibits the contracting officer from agreeing to a price that includes interest. The key is a fair and reasonable price. As a side note, interest can also be included in an equitable adjustment to firm fixed price contracts in appropriate circumstances.

I do not agree with that. Interest is unallowable and FAR requires the CO to apply the cost principles when negotiating a fixed-price contract. I doubt that many organizations would approve a PNM in which the CO said that he'd agreed to the inclusion of interest in a price. That would be an almost certain IG write-up. There is no reason for a CO to agree to such a thing. You'll have to give us something more than your opinion to persuade me to accept what you have written.

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I do not agree with that. Interest is unallowable and FAR requires the CO to apply the cost principles when negotiating a fixed-price contract. I doubt that many organizations would approve a PNM in which the CO said that he'd agreed to the inclusion of interest in a price. That would be an almost certain IG write-up. There is no reason for a CO to agree to such a thing. You'll have to give us something more than your opinion to persuade me to accept what you have written.

Vern, you have not cited the FAR correctly. The FAR requires the contracting officer to use the cost principles when cost analysis is performed, not when negotiating a firm fixed price contract. In a competitive negotiation, price analysis may be used instead of cost analysis. In any event, the purpose of conducitng price analysis or cost analysis is to establish the government's prenegotiation position. The FAR does not require the contracting officer to agree to a price that is within that prenegotiation position. What the FAR requires is that the contracting officer reach a price that is fair and reasonable to both parties, regardless of the makeup of that price. As a practical matter, contracting officers may rarely agree to a price that includes unallowable costs, but there is nothing in the FAR that prohibits them from doing so.

Also, there is nothing that prohibits a contracting officer from agreeing to a price that includes unallowable costs when the LPTA procedure is used.

Finally, if the government states that it intends to make an award without discussions, the selected offeror's price can include unallowable costs. The key here is that its proposal offers the best value to the government with the price being determined fair and reasonable.

I stand by my statement. If you disagree, please cite me to a FAR provision that says a contracting officer cannot agree to a firm fixed price that contains unallowable costs.

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Retread:

I absolutely "cited" the FAR correctly. It goes without saying that the cost principles apply to fixed-price contracts when cost analysis is performed. That's what we've been talking about, so there's no need for you to recite that to me and no need for me to have mentioned it. Now, you said:

As a practical matter, contracting officers may rarely agree to a price that includes unallowable costs, but there is nothing in the FAR that prohibits them from doing so.

The source of our disagreement is your assertion that a CO can "agree" to the inclusion of an unallowable cost in a price. I take you to mean agree expressly. A CO need not agree on elements of cost and need not obtain the contractor's assurance that a price does not include an unallowable cost, but I do not think that any CO can expressly agree to the inclusion of an unallowable cost in a price when a negotiation is subject to the cost principles. Do you think that a PNM would pass muster if it included a statement by the CO that he or she agreed to the inclusion of unallowable interest? I don't. FAR 31.102 says that the applicable subparts of Part 31 "shall be used in the pricing" of fixed-price contracts (when cost analysis is performed). See also FAR 31.201-1(B):

While the total cost of a contract includes all costs properly allocable to the contract, the allowable costs to the Government are limited to those allocable costs which are allowable pursuant to FAR 31 and applicable agency supplements.

I do not know what "shall be used in the pricing" means if it doesn't mean that a CO cannot agree to the inclusion of unallowable costs in a negotiated price. Do you think a CO would get approval of a prenegotiation objective that encompasses express agreement to a price that includes unallowable costs? If not, why do you think that a CO can expressly agree to such a thing? The CO need not reach agreement with a contractor about what a negotiated price includes, but he simply cannot be on record as saying that he has agreed to the inclusion of an unallowable cost. Among other things, such an express agreement might affect equitable adjustments and termination settlements based on incurred costs. If a CO were to expressly agree to the inclusion of an unallowable cost in a price, the contractor could argue that it is entitled to interest in equitable adjustments and termination settlements. In any case, how can a CO assert that a price is fair and reasonable if he or she expressly agreed to the inclusion of an unallowable cost? See FAR 31.201-3(B)(3):

What is reasonable depends upon a variety of considerations and circumstances, including... (3) Generally accepted sound business practices, arm's length bargaining, and Federal and State laws and regulations.

Italics added.

If you believe that a CO can get away with expressly agreeing to the inclusion of an unallowable cost in a price, then we must part in disagreement.

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Vern, I'm with you on this. The FAR cost principles aren't "suggestions". They are "principles."

However, I'd go a bit further. 31.201-6 says costs that are expressly unallowable shall be identified and excluded from any proposal applicable to a government contract. My assumption is that this is in regard to a negotiated proposal, when cost analysis is performed.

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