Limitation of Cost or Funds – The Burden Falls on You

UPDATED – June 18, 2024

When you accept a fully funded cost-reimbursable government contract, it comes along with the FAR contract clause 52.232-20, Limitation of Cost. This clause places a requirement on you to notify the Government when:

(1) The costs you expect to incur under the contract in the next 60 days, when added to all costs previously incurred, will exceed 75 percent of the estimated cost; or

(2) The total cost for the performance of the contract, exclusive of any fee, will be either greater or substantially less than previously estimated.

When you accept an incrementally funded cost-reimbursable contract it also comes along with the FAR contract clause 52.232-22, Limitation of Funds. This clause places a requirement on you to notify the Government when:

(1) You have reason to believe that the costs you expect to incur under the contract in the next 60 days, when added to all costs previously incurred, will exceed 75 percent of funds allotted to the contract; or

(2) within 60 days of when additional funds are required to continue timely performance.

Don’t Risk Missing Reimbursement!

While you are not obligated to continue performance beyond what the Government has agreed to pay, the Government is not obligated to reimburse you for costs incurred in excess of the estimated cost or funding limitations.  Beyond the risk of not being reimbursed, these clauses bring potential complications to your accounting system.

Just to be clear

In the case of a cost overrun, simply notifying the contracting officer that you have reached the 75% level is not enough. You must notify the contracting officer of the expected cost at completion and whether additional funding will be required. Even if the contracting officer states the Government is considering adding funding, exceeding the funding level is a significant risk. The contracting officer must issue a specific written statement (i.e., contract modification) to increase the funding on the contract.

In the case of a cost underrun, you are still required to notify the contracting officer. While you are not at a cost risk, you are at risk of an accounting system deficiency if you fail to notify the contracting officer. The Government wants the ability to repurpose the funding that you will not require.

The EAC—Forecasting at its Finest

It is not as simple as comparing your current cumulative billing amount to the limitation; you must maintain a reliable Estimate at Complete (EAC). An EAC is a current forecast of what the total cost are likely to be for the contracted effort. A properly developed EAC is made up of two parts:

• the costing of your incurred cost to date, and
• forecast (i.e., pricing) of the work you have remaining to complete the contracted effort. 

In considering your incurred cost there are a few key things to remember:

• Monitor Indirect Rates – You cannot simply use your provisional billing rates and assume your indirect costs are on track. You need to monitor your billing rates to your actual-to-date indirect rates plus a projection of the indirect rates at year end. If the rates are not tracking to the current billing rates, you will need to request an adjustment to your billing rates and consider the impact on the costing of your incurred cost to date. Not considering an increase or decrease in your indirect rates could result in your failure to meet the limitation reporting requirements.
• Track Scope of Work Completed (Budget vs. Actual) – The fact that you incurred 20% of the hours you forecasted, as part of your original price proposal, does not necessarily mean 20% of the scope of work was completed. For some tasks within the scope of work, less hours may be required and for others more hours will be required. This will be important in forecasting the work you have remaining to complete the contracted effort.
• Remember the Impact of Subcontractors – Your cost reimbursable subcontractors should be doing the same thing you are in terms of tracking and monitoring budget vs. actual. Your subcontract manager should be reviewing subcontract billings and forecasts of future efforts. It is best to come to an agreement with your subcontractors as to what you expect in the way of EAC reporting prior to awarding the subcontract. Yes – this meaning including in your subcontract terms similar to the limitation of cost/funds requirements in your prime contract. And NO – you cannot simply reference the FAR contract clause number (i.e., FAR 52.232-20 or 52.232-22). These are not required flowdown clauses, yet you must have similar requirements placed upon your subcontractors to meet your contractual requirements.

Indirect Cost Complication

In many cases, indirect cost can make up 50% of your estimate at competition. As stated above monitoring your rates is extremely important, that includes both the pool and the base. Often expenses in the pool can be managed through budget cuts and timely posting of incurred cost. The impact on the base can be much harder to manage. A common scenario is the Government promising the award of a new contract that has slipped quarter after quarter. The government representative setting your provisional billing rates (i.e., Administrative Contracting Officer or DCAA Auditor) are very likely to agree with the overly confident opinion of the buying command that the contract will be awarded and not want to adjust the base. This could lead to significant under billing due to the overestimated base. For smaller contractors this can result in a failure to notify the contracting officer of a cost overrun due to the final rates coming in much higher. That same government representative that did not want to increase your provisional billing rates will now say you are in non-compliance with FAR 52.232-20 or 52.232-22 and the overrun is unallowable. Yes – I am here from the Government and would like my cake and plan to eat it too.

Suggested Action: Even if the Government will not allow you to adjust your provisional billing rates or the bureaucratic process is not timely enough to allow for the rate adjustment, put a note in your submitted invoices/vouchers that there is a significant risk of a cost overrun due to a rate adjustment you are working on with the ACO/Auditor. As the procurement contracting officers do not see the invoices/vouchers, we recommend you send a letter to all impacted procurement contracting officers with a copy to the ACO with the same notification. In the case of a potential cost underrun, it may be prudent to make similar notification to limit the likelihood of an accounting system deficiency being issued based on the DCAA auditors greatest power of 20-20 hindsight.

The Estimate to Complete Process

Once you have a good understanding of your incurred cost, you must set up a process to develop an Estimate to Complete (ETC). An ETC is a pricing effort of the remaining scope of work to complete the contracted effort. In most cases, it is necessary to develop a detailed pricing of your ETC on a quarterly basis, at a minimum. While the ETC should not require a bottom-up proposal effort each quarter, a reliable and consistent process based on an explainable methodology is important. Unlike estimates for progress payments, the Government (i.e., DCAA) is not likely to audit or review your estimate, as the risk of not recovering cost is on you.

Now That You Have All the Pieces

Once your ETC is complete you can add it to your incurred cost to date to arrive at your EAC to compare to the limitations. Both SF 1408 and DFARS 252.242-7006 have a specific requirement that your accounting system include processes and controls to ensure you comply with these contract clauses, regardless of the level of risk your company may be willing to take. You want to be able to demonstrate your system complies with the contract requirements; you are doing your due diligence; and avoid the potential accounting system deficiencies discussed above.

The limitation of funds requirement is even more complex, as you are not dealing with the entire period of performance. You must be able to project likely cost for the next 60 days on a continuing basis as well as at the end of the period of performance.

Final Considerations

A few other things to consider are:

• Change orders do not automatically adjust the limitations;
• Only the contracting officer, by contract modification, can change the limitation amounts, so be careful of relying on statements from Government program office representatives; and
• For limitation of funds, if the Government does not allot all the funds, the fee can be adjusted based on the percentage of work completed.

So, the moral to the story is that even Government cost reimbursable best efforts contracts come with strings attached.

How Can Redstone GCI Help You?

Redstone GCI can assist you by reviewing your current accounting policies for compliance with FAR 52.232-20 and 52.232-22, drafting a policy or providing a template policy to address these regulations, and performing an assessment of your current practice to provide recommendations for improvement.

We assist contractors throughout the U.S. and internationally with understanding the Government’s expectations and developing accounting policies and procedures that comply with these limitation requirements.