New audit guidance was issued to alert auditors of significant new rules affecting T&M and LH contracts (see the second quarter issue of the DIGEST that detailed these changes). The guidance is a good summary of the recent changes, should alert contractors to where they can expect to have added audit scrutiny and ensure they have good documentation available (e.g. make sure hours billed or claimed are backed up by subcontractor and affiliate timekeeping records, labor categories are consistent with contract specified labor categories).

• Background
The guidance refers to the February 2007 Federal Acquisition Circular (FAC) 2005-15 amending the FAR Subpart 16.6, T&M and LH Contracts, and identifies the specific sections of the FAR that are changed.  FAR 16.601 expanded the definition of “hourly rate” to “the rate(s) prescribed in the contract for payment of labor that meets the labor category qualifications of a labor category specified in the contract that are performed by the contractor, performed by the subcontractors or transferred between divisions, subsidiaries, or affiliates of the contractor under common control.”  (We will refer to the later category as affiliates.)

FAR 16.601(c)(2)(ii) requires noncommercial contracts awarded without adequate price competition to specify separate fixed hourly rates for each category of labor to be performed by the contractor, subcontractor and affiliates.  In addition, a new DFARS 252.216-7002, Alternative A requires competitively awarded DOD T&M/LH contracts to also include separate hourly rates by labor category for the prime contractor, each subcontractor and each affiliate.  Blended rates are not permissible on DOD noncommercial contracts. 

For non-DOD noncommercial contracts that are competitively awarded FAR 52.216-29 now allows pricing and billing prime subcontract and intercompany rates as either separate rates or blended rates.  FAC 2005-15 also revised FAR Part 12.207, Special Requirement for the Acquisition of Commercial Items – Contract Type, to permit use of blended rates on commercial contracts.  FAR 52.212-4 addresses the new contract terms and conditions covering commercial T&M and LH contracts. 

• Guidance
Incurred Cost Audits and Contractor Billing Reviews. The guidance reminds its auditors that during incurred cost audits and reviews of contract billing covering T&M and LH contracts, they are to review contract briefs to ascertain the applicable contract clause.  FAR 52.232-7, Payment Under T&M and LH Contract, was revised to allow for payment to be made in accordance with the labor categories specified in the contract that are performed by the contractor, subcontractors and affiliates.  Payments of materials now include subcontracts for supplies and incidental services for which there are no labor categories specified in the contract.  Payments for materials are subject to FAR 52.216-7, Allowable cost and payment. 

Audit procedures to follow include verifying claimed/ billed labor rates to the contractual rates by labor category and auditing them for allowability, allocability and reasonableness. Audit procedures covering labor hours should include selectively verifying that claimed or billing prime, subcontract and affiliate labor hours are supported by the applicable timekeeping records or invoices identifying the labor hours worked by labor category specified in the contract.  For example, billed subcontract labor should be supported by subcontractor invoices/ timekeeping records evidencing the hours expended by labor category.  Auditors are also to ensure that the claimed/billed direct labor effort meets the labor category qualification specified in the contract.  For non-DOD competitively awarded contracts, the contract may use blended rates.  (The term “blended” indicates the rate applies to multiple entities and does not necessarily mean the rates must be based on a weighted calculation.) Auditors still need to reconcile claimed hours to supporting contractor labor records which should include evidence of prime, subcontractor and/or intercompany hours worked by labor category.

Forward Pricing Audits. The guidance states that for forward pricing audits of T&M/LH pricing actions, auditors should selectively verify the subcontract and affiliate direct labor is proposed and supported using separate hourly labor rates and are not intended as part of the prime contractor’s labor rates. The subcontract labor rates, separately proposed by the prime contractor, should include the prime’s subcontract costs and applied indirect cost and profit. In addition, affiliate labor rates should not include profit of the transferring organization – the exception applies to commercial items where price is market established and presumably does include profit -but may include profit for the prime contractor.

The remaining portion of the guidance summarizes the significant revisions made to sections of the FAR and DFARS for related T&M/LH contracts which are useful to review but too detailed to recount here (07-PPD-023(R). 

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