• Test 1

Pricing Formula - Allowable Costs

New contracts that are subject to the DRA, regulations and statutory guidance

Section 20 ‘Allowable Costs’ (incorporating Section 30 (1) ) of the Defence Reform Act 2014 states:

  • The SSRO must issue guidance about determining whether costs are allowable under qualifying defence contracts and that the parties must have regard to this guidance. This guidance was issued in late January 2015 (link)
  • For cost to be allowable the parties must be satisfied that the cost is (a) appropriate, (b) attributable to the contract, and (c) reasonable in the circumstances  
  • The MOD may at any time require a contractor (prime of sub-contractor) to show that SSRO guidance and (a), (b) and (c) above have been satisfied.
  • In the event that the parties disagree (pre or post contract award) if a cost is allowable then the dispute can be referred to the SSRO for a determination as to the extent to which a particular cost can be treated as an allowable cost. SSRO may also determine that the price payable under the contract is to be revised.
  • The regulations do not make clear if corrections to a subcontract price (required as a consequence of either a failure to comply with the ‘Pricing Formula’ or as a consequence of Section 21 (PEPL)) fall to be settled directly between the contracting parties (buyer and seller) or between MOD and the subcontractor.

Section 15 ‘Pricing of Contracts’ (3) (incorporating Section 30 (1) ) of the Defence Reform Act  states:

  • That pricing of amendments to prime contract or sub-contract must follow the regulations that either cause a) the whole contract priced to be re-determined in accordance with the pricing formula or (b) that the price payable for the amendment must be determined in accordance with the formula. Regulation 14 sets out a very harsh test that needs to be passed if the whole of a QDC (prime contract) or a QSC (sub-contract). This regulation applies to all changes to QSCs (e.g. even where it is not the result of a change to the prime contract with MOD) and to the total volume contracted under the QSC (i.e. where the contract is for mixed customer use then regulations apply if qualifying contracts are expected to consume more than 50% of the value purchased)

Section 30 ‘Application of Part to qualifying sub-contracts’ of the Defence Reform Act makes it clear that there is no requirement for a sub-contractor to make Records (Section23) or, Reports (sections 24 and 25) available to a prime contractor. Furthermore the duty to report relevant events, circumstances and information (section 26) only exists between the sub-contractor and the MOD. Section 32 makes clear that penalties imposed on sub-contractors are payable directly to the MOD and not through the contracting line.

Pre-existing contracts

The arrangements for pre-existing contracts should remain unchanged (the bargain struck should remain unaltered). The arrangements for contracts that are either excluded from the regulations of where the Secretary of State has granted an exemption are unclear; e.g. will existing Government Accounting conventions guidance continues to apply?

For contracts subject to regulations prime cost estimates and overhead rates need to be established in accordance with the allowable cost regulations

For pre-existing Yellow Book contracts the SSRO stands in place of the Review Board for Government Contracts. The allowable cost arrangements in place at the time the EofI was signed should continue to apply. Special consideration should be given to the exclusion of R&D tax credits or above the line R&D credits from the cost base (i.e. not added back).

Allowable costs for new single source contracts that are not governed by the DRA, regulations and statutory guidance.

The SSRO has no authority over such contracts. Allowable cost remains to be agreed and documented; DEFCONs relating to corrections of defective pricing will be incorporated by negotiation within the contract. MOD may wish to only have one version of ‘allowable costs’ but the use of statutory guidance should only be by agreement. There is no right of reference to the SSRO for an expert binding opinion and disputes fall to be considered under DEFCON 530 (which will need to be negotiated as part of the agreed contract conditions).