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10.65. Calculation of profit on negotiated contracts

  1. The policy and guidelines for the calculation of the amount of profit applicable to negotiated contracts and parts thereof with Canadian suppliers, for both goods and services are detailed in 10.65(b) to 10.65.35 Total Profit. Contracts valued under $50,000 do not require negotiation of profit under this section.
    There are differences in the guidelines for contracts with total costs between $50,000 and $249,999, and for contracts with total costs of $250,000 or more.
    For agency and resale outlets, the procedures for profit determination in 10.50.15 Price Analysis apply.
  2. When for any reason it is not possible to establish an acceptable basis of price by competition or a fair and reasonable price assessment, the price must be negotiated. The object of price negotiation is to duplicate a fair market price, while establishing a realistic division of responsibilities and risks between the contractor and Canada.
    A fair market price for non-competitive contracts for the procurement of goods or services (other than commercial goods or services) must be negotiated. The object of such negotiation is to arrive at a price which is considered to be fair and reasonable in the circumstances based upon an estimate of the costs, to be incurred in the performance of the contract, computed in accordance with the Contract Cost Principles 1031-2, plus a fair profit. A fair profit is an amount no greater than that calculated under this section.
    There are the following exceptions:
    1. Generally, all contracts placed on behalf of the Canadian Commercial Corporation (CCC). However, if the ultimate client for the CCC contract is the United States Department of Defense or National Aeronautics and Space Administration (NASA) or the United Kingdom Ministry of Defence, the profit may be calculated in accordance with this section.
    2. Contracts or parts thereof for which the price is based on catalogues, price lists or fee schedules where only discounts are subject to negotiation.
    3. Contracts for which the pricing is determined based on alternative approaches that are not addressed by Section 10.65, such as when pricing is not determined by cost plus profit or when profit is not calculated in accordance with 10.65(c). For such contracts, follow the process outlined in 10.75 Interim pricing measure.
  3. Profit levels will vary:
    1. to recognize the cost of money associated with the capital employed by the contractor in performance of the contract;
    2. to recognize the levels of general business and contractual risk assumed by the contractor in performance of the contract.
    The calculation of the amount of profit attributable to each of the above factors must normally be made in accordance with the following guidelines.

10.65.1 Return on Capital Employed

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The return on capital employed will be determined in two parts:

  1. return on fixed capital employed, and
  2. return on working capital employed.

The determination is different for contracts with total costs between $50,000 and $249,999 and for contracts with total costs of $250,000 or more. (See 10.65.10 Return on Working Capital Employed (between $50,000 and $249,999).)

10.65.5 Return on Fixed Capital Employed (between $50,000 and $249,999)

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For contracts with total costs between $50,000 and $249,999, the return on fixed capital employed is calculated as follows:

If machinery and/or equipment owned by the contractor are used on a regular basis in the manufacture of the product(s) or provision of the service(s) being acquired under the contract, an amount equivalent to 1 percent of total allowable costs will be awarded as a return on fixed capital employed.

10.65.10 Return on Working Capital Employed (between $50,000 and $249,999)

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The following rates applied to the total contract costs will be used to provide for a return on working capital employed:

  1. if there is no provision for progress payments, advance payments or milestone payments - 3 percent;
  2. if there is a provision for progress payments or milestone payments - 1.5 percent;
  3. if there is a provision for advance payments - 1.5 percent (Note: The profit factor of 1.5 percent will apply only to total costs less amount of advance payments.);
  4. if there is a provision for both progress payments and advance payments - 0 percent.

10.65.15 Return on Fixed Capital Employed ($250,000 or more)

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For contracts with total costs of $250,000 or more, the return on fixed capital employed is calculated as follows:

The provision of a return on fixed capital employed is intended not only to compensate contractors for the cost of money associated with the fixed capital employed on the contract but also to encourage investment in new capital equipment, the result of which is generally greater productivity and consequently reduced costs to Canada.

  1. For the purpose of this section, the fixed capital employed is defined as the net book value of fixed assets, less:
    1. land and any intangible assets,
    2. any fixed assets not in use such as idle plant, and
    3. any surplus value arising from re-appraisal.
  2. The determination of fixed capital employed will be as follows:
    1. Determine the percentage:
      (A/B) x 100%
      A = overhead recovery base allocated to the contract
      B = total budgeted amount of recovery base
    2. Apply the percentage in (A) to the net book value of fixed assets.
      Such determination will be performed in accordance with the format set out in Annex 10.1: Determination of Fixed Capital Employed Applicable to a Contract.
  3. The rate of return to be applied to the fixed capital employed applicable to the contract will be 1.7 times the corporate bond rate, which will be published monthly by the Policy, Risk, Integrity and Strategic Management Sector (PRISMS). The rate used will be the latest rate published at the date that the contractor's price proposal is firmed up. In the event that the published rate at the time of contract award has changed by more than one full point, up or down, this rate will be used to recompute the return.
  4. The rate used in the contractor's price proposal will be the latest figure published at the time the price proposal is submitted. In order to conform to (iii) above, it is necessary that the following clause be included in the price proposal:
    "The price quoted includes an amount of profit using a corporate bond rate of ____ percent. In the event that the corporate bond rate, as published by the Policy, Risk, Integrity and Strategic Management Sector, at the time of contract award, has changed by more than one full point, up or down from this rate, the price will be adjusted to reflect such rate."

10.65.20 Return on Working Capital Employed ($250,000 or more)

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  1. The amount of working capital employed applicable to a particular contract is defined as all allowable contract costs (exclusive of depreciation where considered significant) less contract revenue (exclusive of profit).
    For contracts with total costs of $250,000 or more, the return on working capital employed is calculated as follows:
    1. During negotiations, a schedule of the estimated net working capital for the contract, as defined above, on a month-by-month basis, will be determined and agreed to between the contracting officer and the contractor.
    2. The rate of return to be applied to the cumulative monthly amounts of working capital is defined below. However, as this is an annual rate of return, one-twelfth only of the rate is applicable to each monthly amount. For ease of calculation, the equivalent formula, to be used for determining the return on working capital employed on a particular contract, is as follows:
      (A/12) x B
      A = sum of the cumulative monthly working capital amounts
      B = prescribed rate
    3. The rate of return to be applied to working capital employed applicable to the contract will be the chartered bank prime rate. PRISMS will publish this rate weekly. The rate used will be the latest rate published at the date that the contractor's price proposal is firmed up. In the event that the published rate at the time of contract award has changed by more than one full point, up or down, this rate will be used to recompute the return.
    4. The rate used in the contractor's price proposal will be the latest figure published at the time the price proposal is submitted. The following clause must be included in the price proposal:
      "The price quoted includes an amount of profit using the chartered bank prime rate of _____ percent. In the event that the chartered bank prime rate, as published by the Policy, Risk, Integrity and Strategic Management Sector, at the time of contract award, has changed by more than one full point, up or down from this rate, the price will be adjusted to reflect such rate."
  2. Specific guidelines in regard to the cost base for purposes of all profit calculations are as follows:
    1. Direct material costs should include the costs of all materials purchased specifically for the contract together with the costs of any other materials issued specifically for the contract from the contractor's own inventories except Accountable Advance (AA) spares embodied. Direct materials must not include the value of Government Furnished (GF) nor Contract Issue (CI) materials. However, direct labour and overhead costs associated with the acquisition, stocking and handling of GF and CI materials and AA spares embodied may be included under the appropriate cost element for profit purposes.
    2. Overhead in this context includes not only plant or factory overhead, but engineering, material handling, general and administrative or any other overheads as appropriate to and allowable on the contract.
    3. All other allowable costs are those costs not considered to be direct material, direct labour or overhead but nevertheless are an appropriate and allowable direct charge to the contract. Royalty payments and the goods and services tax or the harmonized sales tax, although they may be an appropriate and allowable direct charge to the contract, must not be included for the purpose of profit calculation.

    For more information, contracting officers should consult Annex 10.2: Examples to Determine the Working Capital Employed.

10.65.25 General Business Risk

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  1. The award of profit under this factor is intended to recognize the level of effort a contractor makes in the management of all the resources required to perform the contract in an efficient and economical manner.
  2. The level of effort is considered to vary according to the elements of cost and is reflected in the following rates of profit to be applied to the costs in each element:
    1. direct materials: 1.5 percent
    2. subcontracts: 2 percent
    3. accountable advance spares embodied: 2 percent
    4. direct labour: 4 percent
    5. overhead: 4 percent
    6. all other allowable costs: 1.5 percent

10.65.30 Contractual Risk

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  1. The rates of profit to be paid for contractual risk will depend upon the basis of payment selected for each individual line item of the contract, or part thereof, and the cost base associated with each distinct basis of payment.
  2. The basis of payment determines the maximum level of profit, and requires the following consideration of different factors in arriving at the appropriate profit level.
    1. firm price and firm base price with economic price adjustments (7 percent maximum) - consider:
      1. the ability of Canada to state its requirements in the form of a well-defined specification;
      2. the ability of the contractor to convert Canada's specification into a comprehensive statement of work;
      3. the ability of Canada and the contractor to precost the statement of work;
      4. the duration of the contract and its effect on the predictability of labour and material costs and overhead distribution, taking into account whether protection in this regard is provided to the contractor by the inclusion in the contract of a provision for economic price adjustment (firm base price with economic price adjustments basis of payment);
      5. whether the final determination of the firm price takes place before or after a portion of the contract period has elapsed.
    2. fixed time rate with ceiling price (4.5 percent maximum) and without ceiling price (3.5 percent maximum) - consider:
      1. the duration of the contract and its effect on the predictability of the labour and overhead rates;
      2. if a ceiling price is included, the familiarity of the contractor with the work being performed under the contract resulting from the previous manufacture of the same or similar products, or the provision of the same or similar services;
      3. whether the final determination of the fixed time rates takes place before or after a portion of the contract period has elapsed.
    3. cost reimbursable with incentive fee (4.5 percent maximum) - consider:
      1. the degree to which the difference between the target fee and the maximum fee will provide an incentive for more effective cost control and contract performance by the contractor;
      2. whether the agreement on target costs and target fee was reached before or after a portion of the contract period has elapsed.
      To calculate the bonus on target incentive fee contracts: the maximum fee for cost reimbursable with incentive fee contracts must consist of the target fee plus an added amount which brings the total profit for the General Business Risk and Contractual Risks Factors to a maximum of 10 percent of target costs.
    4. cost reimbursable with fixed fee with ceiling price (4.5 percent maximum) and without ceiling price (1 percent maximum) - consider:
      1. the reliability of the cost estimate used for determining the fixed fee, taking into account the duration of the contract and its effect on the predictability of costs, and provided that no "swing points" at which the fixed fee will be renegotiated are included in the contract;
      2. if a ceiling price is included, the familiarity of the contractor with the work being performed under the contract resulting from the previous manufacture of the same or similar products, or the provision of the same or similar services;
      3. whether the fixed fee was determined before or after a portion of the contract period has elapsed.
    5. cost reimbursable with no fixed fee and no ceiling price (0 percent): there is no business or contractual risk.

10.65.35 Total Profit

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  1. The total allowable amount of profit must be the lowest of:
    1. sum of supportable amounts by factor; and;
    2. 20% of the total cost.
  2. The total amount of profit awarded under all factors must in no event exceed 20 percent of the total contract costs.
  3. The amount of profit for all factors should be calculated separately and included in the price of each line item with a distinct basis of payment in the contract (see examples in Annex 10.1.1: Examples to Determine the Fixed Capital Employed and Annex 10.3: Examples of Profit Calculations).