A unique aspect of government contracting is the set of rules that specify the types of costs that can be reimbursed as either allowable or allocable to a given contract. For cost reimbursement contracts and other types where downward adjustments to billings can be imposed, the rules will dictate how much a contractor gets paid. In addition, the prices set for certain firm fixed price contracts will also depend on what these rules will allow the contractor to receive. In both cases, the contractor will agree to interim billing rates or forward pricing rates and these rates will be subject to retroactive adjustments based on audits of the contractor's actual incurred costs experience for a given year.

The amounts of these readjustments are not often clear at the time of a buyer's due diligence efforts resulting in potential time bombs in the future. Incurred cost proposals for relevant years may not have been prepared. If prepared, they may not have been audited. If audited, the rates for a given year may not have been settled, where the contractor, government auditors and contracting representatives may be in the middle of resolving numerous questioned costs issues. If settled, the seller may have (inadvertently or not) not disclosed the results and the impact on relevant contracts and subcontracts.

The due diligence efforts need to identify the potential liability of these potential time bombs. An estimate of liability needs to be taken. For example, at the very least, the buyer may want to ascertain the seller's historical experiences (e.g. ratio of billed to settled costs), adequacy of financial reserves, etc.

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