SSRO opinion on the extent to which specified costs are Allowable Costs and other matters related to the pricing of qualifying contracts
Anonymised summary of a formal opinion on the extent to which specified costs, including costs related to risk, are Allowable Costs and on points of principle that might be applicable to the pricing of other contracts.
Documents
Details
In accordance with the procedure published in the SSRO’s referrals guidance, the document provides an anonymised summary of the SSRO’s opinion.
The SSRO was referred a request for an opinion in respect of a proposed QDC. The referral sought the SSRO’s opinion on the extent to which specified costs were Allowable Costs, as well as additional guidance to that contained in the SSRO’s Single Source Cost Standards.
The document sets out the SSRO’s key conclusions:
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Opinion on the extent to which the price risk for direct labour, materials, and technical risks included within the proposed Target Cost is an Allowable Cost: This contract may include a provision for risk in the Target Cost, where risk is borne by the contractor and where it is adequately quantified. The contract in question uses the Target Cost method, and both parties agreed on the inclusion of price risks in the contract.
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Consideration of whether the contractor will be bearing risk: It was reasonable for the Target Cost to include an amount that reflects the quantum of risks that the contractor bears, such as risk in relation to direct labour hours, materials and technical risks.
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Consideration of methods used for assessing a value for risk: While the use of the Monte Carlo analysis was an appropriate technique to use, it might be appropriate in large and complex projects to use more than one technique for the purposes of cross-validation.
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Consideration of proposed value of risk: The SSRO sought and received written assurances from both the contractor and MOD that, in their respective opinions, the costs and price risk in the Target Cost are attributable, appropriate and reasonable (AAR).
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Consideration of learning curve benefits: A portion of the price risk labour cost was not an Allowable Cost, as the taxpayer should benefit from learning curve improvements.
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Consideration of wage inflation uprating: An amount equal to the price risk cost corresponding to the higher percentage was not an Allowable Cost and calculating labour costs at 2015 Economic Conditions (ECs) using a relevant and current inflation index would be a more suitable method for calculating Allowable labour costs.
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A view on an appropriate confidence percentile range to contract at for future contracts: The SSRO did not consider it appropriate to provide an opinion on the confidence percentile range to apply to future contracts, as the appropriate confidence percentile for each contract will depend on its particular circumstance.
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An opinion on the extent to which the costs for re-work and defects and deficiencies included within the proposed Target Cost are Allowable Costs: The cost disallowed by the parties for faulty workmanship was within the bounds of reasonableness. The SSRO recommended that new and accurate measurement processes are put in place that involves the collection of current and historic re-work data by the contractor.
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An opinion on the extent to which the price risk for indirect costs included within a proposed Target Cost is an Allowable Cost: Indirect costs that are variable should be identified, proven and uplifted for direct hour uncertainty. The SSRO would require more evidence to comment on the extent to which price risk for indirect costs should be allowed.
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General observations: The SSRO noted that it was difficult to verify the price risk components presented to it in the referral due to inadequate evidence supplied and insufficient explanation of inputs by the parties.