Time & Materials Contracts

Q.  Could you tell me exactly what are Time and Materials and Fixed Price contracts?

A. Time-and-materials (T&M) contracts may be used for acquiring supplies or services. These contracts provide for the payment of labor costs on the basis of fixed hourly billing rates which are specified in the contract. These hourly billing rates would include wages, indirect costs, general and administrative expense, and profit. There is a fixed-price element to the T&M contract - the fixed hourly billing rates. But these contracts also operate as cost-type contracts in the sense that labor hours to be worked, and paid for, are flexible. Materials are billed at cost, unless the contractor usually sells materials of the type needed on the contract in the normal course of his business. In that case the payment provision can provide for the payment of materials on the basis of established catalog or list prices in effect when the material is furnished. These contracts also may provide for the reimbursement of material handling costs, which are indirect costs, such as procurement, inspection, storage, payment, etc. These indirect costs are billed as a percentage of material costs incurred (similar to the billing of overhead costs as a percentage of direct labor). Such material handling costs must be segregated in a separate indirect cost pool by the contractor's accounting system and must not be included in the indirect costs included as part of the fixed hourly billing rate for direct labor. It would always be prudent to obtain a pre-award audit of the contractor's accounting system to determine the adequacy of the system to properly segregate material handling costs from other overhead costs being billed with the fixed hourly rates for labor. There is a full discussion of time and materials contracts in section 2.4.3.3 of the FTA Best Practices Procurement Manual. (Revised: June 2010)



Q. The Government has issued a solicitation for a firm fixed-price contract, but the offeror has proposed the contract type be changed to time and materials. If, during negotiations, the Government agrees to this change, what is the likely result? Will there be less risk for the contractor? Will there be greater incentive on the contractor to control costs? Will the contract type have to be changed again after contract award?

A. The Common Grant Rule for governmental recipients permits the use of time and material contracts only after determining that no other contract type is suitable; and if the contract specifies a ceiling price that the contractor may not exceed except at its own risk. This is because the T&M contract has no incentive for the contractor to control costs – the more time and money spent, the more profitable it is for the contractor. Even a cost-plus-fixed-fee contract is preferable in this respect since it fixes the amount of fee dollars for performance of the contract and cost overruns do not result in more profit for the contactor.
If this was a competitive procurement and was advertised as a fixed price contract, you cannot then negotiate a T&M contract without amending the solicitation and allowing other companies to offer proposals on that basis. This represents a material change in the procurement and there could well be other firms that would have proposed on a T&M basis that did not offer proposals on a fixed price basis.
If you award a fixed price contract you will not be able to change the contract type later to a T&M contract and expect FTA to reimburse you for the added costs. FTA has a financial interest in the fixed price contract and the agency cannot give away FTA’s interest without prior FTA approval. In other words, the agency cannot later pay more for something that it had a contract for at a specified price (unless of course the agency changes the contract requirements/specification). (Revised: June 2010)


 
Q. We are trying to determine a "reasonable" material handling cost. The contractor is trying to charge their General and Administrative (G&A) expenses - but as the fixed rate is three times the amount paid the employee - it appears G&A is a part of their labor rate. What is the basis for material handling costs, i.e., what types of charges are allowed? Aren't rates usually 5-10% of the materials?

A. The Federal Acquisition Regulations (FAR) in its discussion of Time and Materials contracts at subpart 16.601 (b) (2) says that material handling costs are to include only those costs that are clearly excluded from the "labor hour rate." The labor hour rate would include direct labor cost (salary) and overhead charges (and/or G&A charges). In other words, the material handling costs must be segregated in a separate indirect cost pool from the other overhead and G&A costs. Material handling costs would typically include such functions as receiving, inspection, storage and distribution of materials. You are correct in saying that material handling rates are usually less than 10% of the material costs themselves. If the contractor does not have a separate material handling pool, you can negotiate an advance agreement in the contract requiring such a pool, as well as advance agreement on the components of the pool, and place a cap or ceiling on the rate, adjustable downward only at the time of final cost audit. You should not use a predetermined (fixed) material handling rate as this could be interpreted an impermissible cost-plus-percent-of-cost contract. If the contactor will not agree with you and continues to insist on a G&A charge that produces inequitable cost results to your agency, you could also buy the materials and furnish them to the contractor as "owner/agency furnished materials." This would void any markup though it would of course be an administrative burden for your agency. (Revised: June 2010)


 
Q. Please explain the 'make-up' of Time and Material rates. It is my understanding that no fee is to be applied to any cost other than labor. It states that material burden can be applied to material, provided that the cost is not already included in the labor rate. What about travel, can a Contractor apply any burdens to travel? Please elaborate on what can and cannot be applied to the various elements of cost.

A. You are correct in your statement that no fee or profit is allowed except as part of the fixed billing rate for direct labor hours. To fix a fee rate in the contract and allow the contractor to bill for actual costs (e.g., materials or travel) plus that rate of fee would constitute a prohibited cost-plus-percent-of-cost contract. A contractor is allowed to recover overhead costs on its direct costs, such as materials or travel, if the contractor's accounting system clearly separated the overhead costs associated with those direct costs (e.g., in a material handling overhead pool), and those overhead costs are not included in the overhead pool that is applied to direct labor costs. In other words, there must be no duplicate billing for material handling overhead costs in the rates applied to labor dollars and material dollars. The Contractor must consistently charge all contracts using the same methodology.

As far as overhead costs applied to travel, it would be highly unusual for a Contractor's accounting system to separate the overhead costs associated with direct-charge travel and apply a separate burden rate to those costs. We would think it would be virtually impossible to segregate the overhead costs for direct-charge-to-contracts travel from other types of travel such as corporate managers traveling on general business purpose trips. But if the contractor had a travel-related overhead pool that consistently billed all contracts and this overhead pool has been audited by an independent auditor and found to be proper in accordance with the FAR Part 31cost principles, then we would see it as acceptable.


 
Q. Isn't a Time and Material procurement no more than a Cost-Plus-Percent-Cost with the mark-ups reshuffled? I don't see the difference...in both scenarios, a contractor will increase profit by incurring more hours worked. Regardless if the markups are hidden in the hourly wage rates...or applied separately after the total direct labor costs are determined...the total cost is the same, and more importantly, the disincentive for the Contractor is the same: More hours will provide more profit.

A. It is correct that for both the Time and Material (T&M) and Cost-Plus-Percent-Cost (CPPC) types of contracts the contractor has a disincentive to control costs; i.e., the more effort he spends the more profitable the job becomes. The CPPC type of contract is prohibited and cannot be used when Federal funds are involved. The T&M contract is permissible but may be used only when the grantee determines that no other type of contract is suitable and the contract specifies a ceiling price that the contractor shall not exceed except at its own risk.

If you have a contractual arrangement where the contractor is being reimbursed for its actual dollar costs (whether those costs are labor, materials, travel, etc. does not matter), and there is a promise to apply a predetermined add on to those costs for overhead and/or profit, then you have an illegal CPPC situation. For example, you cannot agree with a contractor on a cost plus fixed fee contract to pay his actual labor costs plus a predetermined (fixed) overhead rate. You must provide for the ability to audit the overhead rate after the fact and adjust the billings to the actual rate incurred. Likewise, you cannot agree to pay all of the contractor's costs plus a fixed rate of profit on the actual costs incurred. Both of these examples are unlawful CPPC agreements.

You can lawfully negotiate a fixed, fully loaded (labor, overhead, profit) hourly billing rate for a given type of labor and leave the hours to be billed as a flexible amount if the uncertainties of performing the job warrant. The procurement regulations would tell you to monitor and manage this type of contract closely to be sure the contractor was performing well.   In your examples, if the agreement is negotiated up front and the hourly billing rate for labor, overhead, profit is fixed, then you have a T&M contract. If, however, only a portion of the billing rate is fixed and there are predetermined (fixed) add-ons like an overhead or profit rate that are applied to the fixed portion of the billings (e.g., the labor costs) then you have a CPPC contract. (Reviewed: June 2010)



Q. Our agency has a Time and Materials contract that has to be extended because the work has not been completed as originally anticipated. The contract is essentially in an "overrun" situation. Can we replace this contract with a Cost-No-Fee contract in order to complete the unfinished work?

A. If you have a Time and Materials (T&M) contract that you consider to be in an "overrun" condition (i.e., where the contractor has not completed the work because of problems over which he has control), we would advise trying to renegotiate the billing rates for the unfinished work so as to delete the estimated profit in the billing rates, rather than awarding a new cost-no-fee contract for the unfinished work. One of the potential problems in changing the type of contract for work originally under the T&M contract is the question of extricating the contractor from a potential loss position under the T&M contract. Someone reviewing the file in the future might well raise this question, and it could be a legitimate issue if the contractor was operating with costs above those projected when the original contract billing rates were negotiated.
(Reviewed: June 2010)


 

Q. When a company proposes Labor Categories and number of hours on a Time & Material Contract, is there a requirement to only use those categories and hours exactly as shown in the contract unless there is a contract modification?
 
A. In a T&M contract, the contract prices are stated for the hours and labor categories specified in the contract.  If the work assigned differs from that originally defined, and thus requires different categories and hours, then the parties must change the contract to add the new categories and hours, and the agreed upon prices for those particular hours.  The contractor is not free to use other categories and charge for them as the contractor sees fit.  The contractor would then be delivering items (different labor categories/hours) not called for in the contract. If the work is the same as that originally contracted for, the contractor may not charge for different categories at different rates unless there is a contract modification that reflects the agreement of both parties to the changes. (Posted: January, 2010)    
            
        
       
Q. Is it allowable to have a Time and Materials subcontract under a Firm Fixed Price Prime Contract?  Is there any prohibition against this?

A. There is no prohibition against a T&M subcontract if the prime contract is firm fixed price.  In this case it is the prime contractor that is assuming the risk that the subcontractor may not perform.  If the prime contract were cost - reimbursement, then it would be prudent for the agency to become involved, to the point of requiring consent to the subcontract, since the agency would bear the risk of non-performance (and thus cost overruns) by the subcontractor.  In the latter case the agency would want to ensure that no other type of subcontract was feasible, and also that stringent controls were in place for the prime to manage and monitor the subcontractor's work to ensure satisfactory progress. (Posted: November, 2010)