Procurement Support Services Sector

Public Services and Procurement Canada

PRACTITIONER’S GUIDE FOR

PROCUREMENT PRICING

2023-1

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TABLE OF CONTENTS 
0 INTRODUCTION ..................................................................................................................................... 4 
0 GUIDE ORGANIZATION: PRICING IN CANADA ................................................................................... 6 
1 Overview of Key Pricing Considerations ........................................................................................... 8 
2 Pricing Approach ............................................................................................................................ 10 
3 Pricing Principles ............................................................................................................................ 11 
0 KEY PRICING CONSIDERATIONS ...................................................................................................... 13 
1 Managing Pricing Throughout the Acquisition Lifecycle ................................................................. 14 
2 Engaging Expert Advice ................................................................................................................. 16 
3 Documenting and Justifying Key Pricing Decisions in the Contract ................................................ 18 
4 Developing a Validation Strategy.................................................................................................... 20 
5 Capturing and Tracking Lessons Learned ...................................................................................... 24 
0 PRICING APPROACH .......................................................................................................................... 25 
1 Basis of Payment ........................................................................................................................... 26 
1.1 Fixed Price ............................................................................................................................... 31 
1.2 Fixed Time/Unit Rate ............................................................................................................... 38 
1.3 Cost Reimbursable .................................................................................................................. 41 
1.3.1 Cost Reimbursable With No Fee ....................................................................................... 45 
1.3.2 Cost Reimbursable with a Fixed Fee ................................................................................. 47 
1.3.3 Cost Reimbursable with Target Cost/ Incentive Fee ......................................................... 49 
1.3.4 Cost Reimbursable with Fee Based on Actual Costs ........................................................ 68 
1.4 Provisional Price Basis of Payment ......................................................................................... 71 
2 Economic Price Adjustments (EPAs) and Foreign Currency Adjustments (FCAs) ......................... 80 
3 Ceiling Price and Limitation of Expenditure .................................................................................... 85 
4 Incentives ....................................................................................................................................... 86 
4.1 Technical Performance Incentives ........................................................................................... 91 
4.2   Schedule Performance Incentives ......................................................................................... 97 
4.3   Award Fees .......................................................................................................................... 101 
4.4  Non-Financial Incentives ....................................................................................................... 110 
5 Pricing Approach Selection .......................................................................................................... 111 
5.1 Summary Table of Basis of Payment Types .......................................................................... 112 
5.2 Summary Table of Incentive Types........................................................................................ 120 
0 PRICING PRINCIPLES ....................................................................................................................... 123 
0.1 Cost-Based Pricing Principles ................................................................................................... 125 
0.2 Commercial Pricing ................................................................................................................... 127 
1 Principles for Establishing the Cost Base ..................................................................................... 130 
1.0 Contract Cost Principles, SACC 1031-2 ................................................................................ 133 

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5.1.1 Costing Standard ................................................................................................................... 135 
5.1.2 Cost Accounting Practices (CAP) Submission ....................................................................... 136 
5.2 Profit Principles ............................................................................................................................ 138 
5.2.1 Negotiated Profit Element: Capital Employed ........................................................................ 143 
5.2.1.1 Return on Working Capital Employed ............................................................................. 145 
5.2.1.2 Return on Fixed Capital Employed .................................................................................. 158 
5.2.2 Negotiated Profit Element: General Business Risk ................................................................ 172 
5.2.3 Negotiated Profit Element: Contractual Risk .......................................................................... 178 
5.3 Alternative Pricing Strategies ....................................................................................................... 196 
6.0 ANNEXES ........................................................................................................................................... 198 
ANNEX 1: Firm Price Basis of Payment ............................................................................................. 199 
ANNEX 2: Costing Standard .............................................................................................................. 202 
Annex 2A: Costing Process ............................................................................................................ 259 
Annex 2B: Contract Costing Rates ................................................................................................. 260 
Annex 2C: Cost Management ......................................................................................................... 266 
ANNEX 3: Contact Information ........................................................................................................... 270 
ANNEX 4: Process Steps for Cost Accounting Practices (CAP) Submission ..................................... 271 
ANNEX 5: Discussion Papers ............................................................................................................ 272 
Annex 5.1 Background: Contract Pricing in Canada ....................................................................... 272 
Annex 5.1.1 Discussion Paper - Financial Accounting vs. Cost Accounting ................................ 272 
Annex 5.1.2 Discussion Paper - Rules-Based Vs. Principles-Based Standards ......................... 280 
Annex 5.1.3 Discussion Paper - Accrual Vs. Cash Based Accounting ........................................ 284 
Annex 5.2 Performance Management Discussion Papers .............................................................. 287 
Annex 5.2.1 Discussion Paper - Contract Incentives to Encourage and Reward Enhanced Value to 
Canada ....................................................................................................................................... 287 
Annex 5.2.2 Discussion Paper - Measures to Manage Contractor Non-Compliance or 
Unacceptable Behaviour ............................................................................................................. 301 
Annex 5.2.3 Discussion Paper - Liquidated Damages ................................................................ 322 
Annex 5.2.4 Discussion Paper - Managing Long-Term Contractual Relationships ..................... 324 
Annex 5.3 Costing Discussion Papers ............................................................................................ 333 
Annex 5.3.1 Discussion Paper - Sales and Marketing................................................................. 333 
Annex 5.3.2 Discussion Paper - Executive Compensation and Bonus ........................................ 342 
Annex 5.3.3 Discussion Paper – Asset Valuation ....................................................................... 347 
Annex 5.3.4 Discussion Paper – Transfer Pricing ....................................................................... 352 
Annex 5.3.5 Discussion Paper – Production Capacity and Indirect Costs Allocation .................. 359 
Annex 5.3.6 Discussion–Paper - Research and Development Costs .......................................... 368 
Annex 5.3.7 Discussion Paper – risk and cost considerations for socio-economic and 
environmental benefits policies and programs – UNDER REVIEW............................................. 380 
Annex 5.4 Pricing Discussion Papers ............................................................................................. 381 
Annex 5.4.1 Discussion Paper – Alternative Approaches to Cost-Based Pricing ........................ 381 

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Annex 5.4.2 Discussion Paper – Baseline Profit Methodology for Consideration ........................ 392

ANNEX 6: Tools and Templates ......................................................................................................... 394

Annex 6.1 Profit Determination Template ....................................................................................... 394

Annex 6.2 Applicable Rates for Profit Determination Table ............................................................ 394

Annex 6.3 Contractual Risk Assessment Tool ................................................................................ 394

ANNEX 7: Glossary ............................................................................................................................ 395

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1.0 INTRODUCTION

Pricing is a fundamental enabler to the achievement of best possible value in a procurement. Effective pricing

begins with the development of a pricing strategy that closely aligns with the overall procurement strategy to

ensure pricing decisions are in accordance with the procurement’s objectives and priorities. To achieve this

alignment, it is essential that a pricing strategy is developed early on in the procurement process and before

actual sourcing occurs, which will then need to be managed throughout the life of the procurement.

The world of procurement is rapidly changing and evolving and, as a result, the procurement community is

increasingly being called upon to think both differently and more strategically to achieve desired procurement

outcomes and to maximize value for Canadians. As a result, in order to effectively manage pricing it is

important to ensure:

• pricing objectives are aligned with the procurement objectives to maximize the value achieved;

• the pricing strategies are monitored and evaluated throughout the lifecycle of a contract;

• pricing is focused on desired contract performance outcomes; and

• good working relationships are maintained among all stakeholders (e.g., Public Services and

Procurement Canada (PSPC), federal government departments/agencies and contractors).

Purpose and Objectives of Practitioner’s Guide for Contract Pricing

The Practitioner’s Guide for Procurement Pricing (the Guide) is not intended to prescribe pricing to contracting

officers but rather to aid them in the application of their professional judgement when making pricing

decisions. Given that pricing within a contract is highly dependent on the nature of the procurement, the

Guide has been developed to outline both the variety of options available and the flexibility that contracting

officers have in building a comprehensive pricing strategy. For example, in developing a pricing strategy, the

contracting officer would need to consider such things as whether to accept a cost, when and how to apply

one or multiple types of bases of payment and how to include incentives tailored to the specific circumstances

of a given procurement.

In addition to the pricing approaches outlined in the Guide, it is important to stress that contracting officers

are encouraged to employ alternative pricing approaches not currently incorporated in this Guide. In fact, this

Guide outlines a process to share and document procurements that use alternative approaches to those

included in the Guide so that they can be considered in future iterations of this Guide for the benefit of the

entire procurement community.

The Guide is intended to be used as a tool to develop effective pricing. As such, the desired objectives of the

Guide are to:

• provide a better understanding of pricing with the Government of Canada and why it is important.

• provide clear and relevant pricing options available to contracting officers.

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• provide guidance to determine best pricing options, including their associated potential benefits,

risks and related processes based on the nature of the procurement.

• outline the key steps, considerations and tools contracting officers should consider as they develop

a contract pricing strategy.

• provide guidance on key process considerations to help increase the clarity, consistency and

transparency of pricing decisions.

• promote the use of alternative pricing approaches and the recommended process to document and

capture lessons learned.

Please note throughout the Guide the term ‘contractor’ will refer to both current and future contractors doing

business with the Government of Canada.

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2.0 GUIDE ORGANIZATION: PRICING IN CANADA

The Practitioner’s Guide for Pricing (the Guide) is applicable for both market pricing and negotiated pricing

as detailed below.

Market Pricing: The price is assessed and established when there exists sufficient competition to obtain more

than one competitive bid and price comparison. It is important to stress that Canada makes every effort to

ensure that the price of goods and services is determined by the market through competition.

Negotiated Pricing: Occurs when a contract requires any type of price negotiation such as pricing a non-

competitive contract, price negotiations in a competitive contract subsequent to the award for specific pricing

aspects, contract amendments, and use of incentives involving costs and contract extensions.

• Cost-Based Pricing: The price is established based on the contractor’s cost plus a profit margin

above the cost.

• Alternative Pricing Strategies: The price is established by applying an alternative method to cost-

based pricing. While the Guide does not contain specific guidance on specific alternatives, it does

contain details in Section 5.3 (Alternative Pricing Principles) on the process to follow in the event an

alternative strategy is being pursued.

There are instances where price cannot be established through competition. In those situations, cost-based

pricing is most commonly used. With that said, that does not mean that there are not alternative pricing

strategies available to contracting officers.

Understanding How the Guide is Organized

The Guide is organized based on the following three concepts to support the contracting officers in the

development of a procurement pricing strategy:

1) Key Pricing Considerations: are key pricing considerations and practices that should be employed

where applicable when managing pricing throughout each stage of the acquisition lifecycle.

2) Pricing Approaches: are approaches used to determine how a contractor will be compensated and

includes consideration of the basis of payment and incentive options.

3) Pricing Principles: are principles that are to be applied to all scenarios in which price negotiations

are required and involve the establishment of a cost-base, profit levels and price.

Table 2.0.a. below outlines the overall structure of the Guide as well as the core concepts presented within

the Guide and their applicability to market and negotiated pricing.

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Table 2.0.a.: Pricing Elements of the Guide

Market Price

Negotiated Price

Key Pricing

Considerations

• Manage pricing throughout the

Acquisition Lifecycle: monitor,

review and evaluate

• Engage expert advice

• Document key components of

pricing decisions in a contract

• Develop validation strategies

• Capture and track lessons

learned

• Manage pricing throughout the

Acquisition Lifecycle: monitor, review

and evaluate

• Engage expert advice

• Document key components of pricing

decisions in a contract

• Develop validation strategies

• Capture and track lessons learned

Pricing

Approaches

• Basis of payment

• Incentives

• Basis of payment

• Incentives

Pricing

Principles

• The price is assessed and

established through a

comparison to other competitive

bids

• Any subsequent price

negotiation requires the

application of Pricing Principles,

Negotiated Price

• Establishment of cost-base

• Development of an appropriate profit

• Alternative pricing strategies

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2.1 OVERVIEW OF KEY PRICING CONSIDERATIONS

In order to effectively manage a pricing strategy throughout the acquisition lifecycle and to ensure it

successfully meets the procurement’s objectives, contracting officers should consider:

1. managing pricing throughout the acquisition lifecycle: monitor, review and evaluate.

2. engaging expert advice, as needed.

3. documenting and justifying all key pricing decisions and incorporate them in the contract.

4. developing a validation strategy.

5. capturing and tracking lessons learned.

1) Manage Pricing throughout the Acquisition Lifecycle: Monitor, Review and Evaluate

A pricing strategy should be established early in a procurement and then regularly reviewed, monitored and

evaluated throughout the entire acquisition lifecycle. This is particularly important because changes in

contract requirements, amendments, risk factors, timeframes, original estimates and expectations will all

have an impact on the performance of the pricing decisions made at the outset of a contract.

The regular evaluation and management of pricing strategies within a procurement will ensure that the

requirements of Canada have been met, will help build long-term collaborative relationships with industry,

and are essential to optimizing value to Canada. See Section 3.1 (Managing Pricing through the Acquisition

Lifecycle) for further details and guidance.

2) Engage Expert Advice, as needed

Pricing decisions can be complex and may require that contracting officers engage experts with knowledge

and experience in such areas as:

• the development of pricing strategies;

• benchmarking tools; and

• price validation and technical validation.

For example, for support regarding pricing decisions and the development of pricing strategies, early

engagement of the Price Advisory Group (PAG) within PSPC is recommended. See Section 3.2 (Engaging

Expert Advise) for further details and guidance on when and how to access this expertise.

3) Document, Justify and Incorporate in the Contract

An essential principle to managing a successful pricing strategy is clear documentation of the strategy, the

rationale for the strategy as well as details on how it is intended to be carried out. This would include:

• a formal record of decision for the key components of the pricing strategy including the selection of

basis of payment;

• incentives;

• profit levels;

• validation strategy;

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• limits and parameters on costs, acceptance of costs not generally accepted; and

• any other deviations from current pricing guidance and the cost-benefit analysis carried out in the

decision making process.

Documenting the key decisions related to the pricing strategy and formally incorporating them in contract

documents is essential to be able to seamlessly transition procurement files from one contracting officer to

another, to minimize pricing disputes and to ensure there is a common understanding of the pricing strategy

by all stakeholders. See Section 3.3 (Documenting and Justifying Key Pricing Decisions in the Contract) for

further details and guidance.

4) Validation Strategy

A pricing strategy also requires management of the risk factors in a contract and with a contractor. A validation

strategy should be developed to address a number of potential risks including the:

• reasonability of the price;

• accuracy of cost estimates or costs being claimed;

• actual levels of profit being earned;

• achievement of incentives;

• ability of a contractor’s system to appropriately track costs; and

• ability of a contractor’s system to appropriately track data related to the achievement of incentives.

The validation strategy should be clearly communicated to all stakeholders and can be comprised of various

validation tools such as should-cost analysis, benchmarking and assurance services.

It is recommended that contracting officers seek advice and guidance from the Assurance Services Group to

develop an effective validation strategy. The Assurance Services Group is a unit within PSPC’s Procurement

Support Services Sector devoted to providing contracting officers with advice on Pricing.

See Section 3.4 (Developing a Validation Strategy) for further details and guidance on when to access this

expertise.

5) Capturing and Tracking Lessons Learned

Capturing and tracking lessons learned is vital to ensure the guidance provided remains relevant and

evergreen, and to continuously inform contracting officers of opportunities and best practices in procurement

pricing. Contracts applying alternative pricing strategies should be sent to the Procurement Support Services

Sector (PSSS). PSSS will review contracts and supporting information for considerations of future guidance

and lessons learned to ensure the Guide remains relevant and evergreen.

Please Note

• When an alternative pricing strategy is used in a contract, please provide a copy of the contract

detailing the strategy to the Procurement Support Services Sector by email at:

TPSGC.padgamtp-appbipm.PWGSC@tpsgc-pwgsc.gc.ca

• See Section 3.5 (Capturing and Tracking Lessons Learned) for further details and guidance.

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2.2 PRICING APPROACH

The Pricing Approach determines how a contractor will be paid for the services or goods provided. The

approach requires consideration of the various types of bases of payment in conjunction with the use of

incentives when added value is created in order to strategically align pricing to the priorities and objectives

of a procurement. See Section 3.4 (Developing a Validation Strategy) of the Guide for further details on the

pricing approaches available.

Basis of Payment

The basis of payment in a contract defines how a price will be built to compensate a contractor in a contract.

It reflects such things as the commodity, the duration of the contract and how adequately the requirement is

defined.

The Guide outlines the basis of payment options that are available to contracting officers (fixed price, fixed

time/unit rate, cost reimbursable, and provisional price). Specifically, Section 4.1 (Basis of Payment) of the

Guide:

• defines each basis of payment;

• outlines when to consider using a particular basis of payment;

• identifies the factors contracting officers should consider in selecting the most appropriate basis of

payment; and

• provides examples of how a particular basis of payment functions in practice.

Incentives

Based on the nature of the procurement, an incentive can act as a powerful tool that financially or non-

financially motivate or encourage contractors to achieve higher levels of performance to maximize the value

to Canada.

When appropriately structured, incentives can allow Canada to share in cost savings or focus the contractor

on the areas of critical importance to a procurement such as costs and technical performance and schedule

performance. See Section 4.4 (Incentives) for further details and guidance.

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2.3 PRICING PRINCIPLES

As previously mentioned, there are instances where a contract will require price negotiation (e.g., where

competition is not possible or where price negotiations take place in competitive contracts to incorporate

amendments and contract extensions). Cost-based pricing is most commonly applied in those types of

situations. Alternative approaches, however, are also available.

Section 5.0 discusses the establishment of the cost-base and the development of a profit.

Section 5.3 provides details on the process to follow in the event an alternative strategy is being pursued.

Establishment of the Cost-Base

Establishing a cost base is the first step in building the price for cost-based pricing. The Guide is structured

to assist contracting officers through the process of determining an acceptable cost, which requires careful

consideration of the following factors: Attribution, Appropriateness and Reasonability. These factors are

outlined in the Costing Standard. The process outlined in the Costing Standard, Cost Accounting Practices

(CAP) Submission is designed to assist contracting officers in exercising their professional judgement to

assess the acceptability of the costs in the contract. See Section 5.1 (Principles for Establishing the Cost

Base) and Annex 2 (Costing Standard) for further details and guidance.

Development of a Profit

Once the cost-base is established, the next step is to develop an acceptable profit. Profit refers to the financial

gain achieved by the contractor to provide goods and services to Canada. Section 5.2 (Profit Principles)

provides guidance on the profit development process.

Alternative Pricing Strategies

The Guide currently lays out Pricing Principles related to cost-based pricing. Alternative pricing measures

such as outcome based pricing or value-based pricing may be pursued. In the event an alternative pricing

strategy is used, please provide a copy of the contract and contract details to the PSSS (TPSGC.padgamtp-

appbipm.PWGSC@tpsgc-pwgsc.gc.ca). This will ensure lessons learned from the use of alternative

approaches are incorporated in future iterations of the Guide.

Figure 2.3.a. below provides an overview of these pricing elements and of their interconnectivity. More

detailed descriptions are provided in subsequent sections of the Guide.

Figure 2.3.a.: Procurement Pricing In Canada

Pricing

Approach

Value to Canada

Contract

Type

Determinati

Market

(Competitive)

Negotiated

(Competitive & Non-Competitive)

Basis of

Payment

Non-Financial

Incentives

Cost Based

(Compliance with Costing

Principles and Profit Policy)

Incentives

Market Based

(Competitive

Market/Multiple Bidders)

Alternative Base for

Pricing

Building a

Price

Fixed Price

Cost

Reimbursabl

Provisional

Price

Alternative

Approaches

Award Fees

Schedule

Performance

Key Pricing

Considerations

Manage pricing

throughout

acquisition

lifecycle

Engage expert

advice

Document and

incorporate

pricing

decisions in

contract

Develop

validation

strategy

Capture and

track lessons

learned Pricing

Principles

Technical

Performance

Fixed

Time/Unit

Rate

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3.0 KEY PRICING CONSIDERATIONS

Key pricing considerations are in place to ensure that a pricing strategy is effective. To that end, a pricing

strategy must support the achievement of a procurement’s objectives in a way that delivers value to Canada.

The pricing objectives need to be agreed upon and clear to all stakeholders.

It is also important to stress that pricing will need to be reviewed, monitored and evaluated throughout the

life of the procurement. A pricing strategy established early in the acquisition lifecycle, for example, may not

over time operate as initially intended or it may not be effective or efficient as needed later on in the life of a

procurement. It is for these reasons, among others, that it is important for contracting officers to incorporate

the following five key pricing considerations into their ongoing management of a given procurement:

3.1 Managing Pricing Throughout the Acquisition Lifecycle: Monitor, Review and Evaluate

3.2 Engaging Expert Advice

3.3 Documenting and Justifying Key Pricing Decisions into the Contract

3.4 Developing a Validation Strategy

3.5 Capturing and Tracking Lessons Learned

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3.1 MANAGING PRICING THROUGHOUT THE ACQUISITION LIFECYCLE

Pricing should be managed throughout the acquisition lifecycle in order to ensure requirements are being

met as outlined in the contract and that objectives of both parties remain aligned with desired procurement

outcomes. Managing pricing through the life of a procurement serves to motivate contractors to fulfill

contractual requirements in a cost effective, timely and quality manner. An illustration of the acquisition

lifecycle is presented in Figure 3.1.a. below.

Figure 3.1.a: The Acquisition Lifecycle

The pricing strategy applied should be continually monitored and evaluated for compliance and continued fit

to the procurement objectives. Modifications in procurement objectives and priorities could require

modifications to the pricing strategy.

A number of risk factors can impact how often and which pricing decisions should be reviewed and revisited.

These include performance, market, financial and business risks. In addition, managing pricing throughout

the acquisition lifecycle becomes increasingly important when it comes to longer-term contracts because

there is a greater risk of variation of these factors. The lack of effective price management across the

acquisition lifecycle can have significant and undesirable consequences such as:

• overpayments;

• poor contractor relationships;

• increased risk of contractor insolvency; or

• failure to deliver.

For example, if a contract is to be amended or extended, the factors applied in the determination of the

original pricing strategy chosen may have changed and another pricing strategy may now be more

appropriate. A cost reimbursable basis of payment may have been selected initially for a contract due to the

number of unknowns in the requirement. If the requirement, however, becomes well known over time then

consideration could be given to introducing a fixed basis of payment and/or incentives. Additional information

and tools for managing pricing throughout an acquisition lifecycle can be found in the following discussion

papers:

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• Annex 5.2.2 - Discussion Paper: Measures to Manage Contractor Non-Compliance or

Unacceptable Behaviour

• Annex 5.2.4 - Discussion Paper: Managing Long-Term Contractual Relationships

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3.2 ENGAGING EXPERT ADVICE

The intention of the Guide is to assist contracting officers in applying their professional judgement to

procurement pricing. Pricing can be complex and may require the involvement of expert advice. For example,

expertise may be required to determine the

reasonability of the technical inputs included in

the pricing estimate, to conduct a benchmarking

exercise or to perform a should-cost analysis on

a new good or service.

Engaging Price Advisors

Contracting officers can draw upon the expertise

offered within PSPC by the Price Advisory Group

(PAG). The engagement of PSPC’s price advisors is highly recommended to support pricing decisions and

the development of pricing strategies early on in the acquisition lifecycle. The advice of a price advisor can

be acquired in accordance with both the Directive on the Use of Cost and Price Analysis Services and

the Guideline on the Use of Cost and Price Analysis Services .

Please note that it is mandatory to contact PAG for:

• any potential sole-source procurement with a total estimated value of $1,000,000 or more, including

applicable taxes, options and amendments;

• any competitive procurement with a total estimated value of $1,000,000 or more, including applicable

taxes and options, where only one compliant bid is received;

• any competitive procurement with a total estimated value of $1,000,000 or more, including applicable

taxes, with contract provisions for negotiated prices or where prices are likely to be negotiated as a

result of a contract amendment;

• any competitive procurement, with a total estimated value of $10,000,000 or more, including

applicable taxes, options and amendments.

As soon as it is known that any of the above conditions exist, PAG must be contacted to determine if any

further action is required early in acquisition lifecycle. PAG services that may be required:

• Before contract award to:

o assess the price proposal and costing rates negotiated for billing purposes.

o assess the proposed price or rate under the price/rate certification.

o assess the price support.

o provide advice on applying specific economic price adjustments.

• After contract award to:

o negotiate annual costing rates for billing purposes.

o determine reasonable and supportable pricing on add work requirements or change proposals.

Did You Know?

• Contracting officers can draw on expert advice

from the Price Advisory Group (PAG) within the

Procurement Support Services Sector.

• Please see Annex 3 for contact information.

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o determine if further work by government auditors is required where contract rates are subject

to negotiation or where contract costs rely on the contractor’s time recording system.

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3.3 DOCUMENTING AND JUSTIFYING KEY PRICING DECISIONS IN THE CONTRACT

Another key pricing consideration is documenting pricing decisions in the contract. It is essential to have a

transparent approach to documenting the pricing strategy, the pricing approach and the decisions with

respect to the pricing principles. It is also important to ensure that the documentation be thorough and

comprehensive enough to enable others to understand how the pricing strategy was intended to function.

This means maintaining a formal record of decision of the key components within the pricing strategy

including:

• the selection of basis of payment;

• incentives;

• profit levels,

• the validation strategy;

• limits and parameters,

• acceptance of costs not generally accepted; and

• any other deviations from current pricing guidance and the cost-benefit analysis carried out in the

decision making process.

The contracting officer must ensure to keep a record of all assumptions, rationales, agreements and

challenges related to the pricing of a contract.

Process Steps

The following documentation is required from the contracting officer:

I. Identify the pricing strategy used.

II. Explain the reasons for the pricing strategy.

• Contracting officers are responsible for determining fair and reasonable profit. Supporting

documents and any justifications (e.g., options analysis, profit calculations) that were used to

establish the pricing decision should be retained and documented in the procurement file, business

or other decision documents. This should be done for all contracts as well as contract amendments.

• This will support fairness and transparency and clearly document the intent and rationale for the

contracting officer’s pricing decisions. This supports sound stewardship, responsible contract

management and, ultimately, the long-term success of the contract. This will also provide

contracting officers who may be responsible for the contract in the future with access to

procurement files that provide a clear understanding of the reasons behind past contract pricing

decisions.

• Explain how the pricing was calculated or determined, if applicable.

In cases, however, were determining profit differs from the guidance provided in Section 5.2 (Profit Principles)

or where an alternative pricing strategy is applied Section 5.3 (Alternative Pricing Principles), contracting

officers will need to document and submit:

• an explanation of how the pricing is intended to work.

• an identification, description and estimate of expected costs and benefits of the pricing.

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• evidence or comparative information from other jurisdictions/sectors in support of the proposed

pricing practice, if available.

• an identification of any limits in the application of the pricing practice such as timeframes or

conditions that apply.

• a brief description, as applicable, on plans and approaches to:

o measure and track whether the contractor achieved the conditions in the pricing provisions.

o validate whether the contractor has achieved the conditions that activate the pricing

provisions, including gain-sharing and non-financial performance objectives.

o adjust or recalibrate contract pricing for multi-year contracts, including performance

objectives.

o review and assess the effectiveness of the pricing practice and make recommendations for

its use by others.

Incorporating Pricing into a Contract

Once the pricing is appropriately authorized through standard procurement approval process, contracting

officers will need to include all appropriate clauses for the basis of payment chosen and to ensure all aspects

of the price are clearly documented in the contract (e.g., in an Annex). A detailed breakdown of the cost,

profit and incentives should be included in the contract Basis of Payment section, where applicable.

Documentation on how the price will be administered throughout the lifecycle of the contract is also required,

including the validation strategy and pricing strategy review checkpoints. Price administration/management

will outline, for example, how often the price will be revisited, how the incentives are intended to work and

when they will be evaluated and awarded. This reduces the risk of future disputes arising due to vague terms

and conditions.

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3.4 DEVELOPING A VALIDATION STRATEGY

A validation strategy seeks to:

• manage risk in a contract;

• better understand the nature of the costs

being claimed;

• establish the credibility of the amounts

being charged; and

• validate the achievement of incentives.

It is important that the validation strategy be

established early on in the acquisition lifecycle and prior to both Request for Proposal or contract negotiation.

Please note, the Assurance Services Group is available to assist contracting officers in developing a

validation strategy.

The validation strategy should assess the risks in the contract pricing strategy and specific risks related to

the contractor to properly assess the areas within the contract that will require validation and when the

validation should be carried out. It will establish the level of assurance work that is required to perform the

validation. For example, higher dollar value, higher risk contracts may require the Assurance Services Group

to coordinate the validation work where as other areas of the strategy may be carried out by contracting

officers or through contractor attestations.

The timing of the validation strategy needs to be determined upfront because validation should be performed

at specific times based on the contract’s basis of payment and use of incentives. The timing of the validation

as well as who will carry out the validation requirements and how the results of the validation findings are

intended to be handled should all be laid out in the validation strategy. The strategy should be clearly

communicated to all parties, including the contractor and client department.

Pricing Approach Considerations

The validation requirements and timing will vary depending on the basis of payment and use of incentives.

Detailed considerations relating to validation strategies for different types of bases of payment are listed in

Table 3.4.a. below.

Did You Know?

• A validation strategy can be developed with

the use of the expertise from the Assurance

Services Group (ASG) within the

Procurement Support Services Sector.

• Please see Annex 3 for contact information.

21 | Page Public Services and Procurement Canada August 2023

Table 3.4.a.: Validation Strategy Considerations

Pricing

Approach

Validation Strategy

Considerations

Fixed Price

• In the case of a negotiated fixed price contract, considerable risk upfront can exist

when establishing the initial contract because it is very difficult to assess the

credibility of the costs and price proposed at the onset without validating. In light of

the fact the price is fixed for the life of the contract, validating pricing factors in

advance of signing a contract is imperative.

• A price/cost validation exercise should be completed prior to contract finalization for

any fixed price to ensure prices are appropriate, attributable and reasonable.

• Once the price is fixed and incorporated into the contract, it is very difficult to modify,

further highlighting the importance of validation upfront.

• Price validation methods differ depending on how the price of the contract was

determined:

o A competitive process with more than one compliant bidder. Multiple bids will

validate the fairness of the price.

Available market-based data to compare to the price, in the event there is only

one bid.

o Cost validation for a cost-base price build-up, typical for sole sourced contracts.

• In the event price cannot be validated through competition or the market, the price

is developed from a validated cost base with a profit calculation (See Section 5.2:

Profit Principles for more information).

• The level of validation required for a cost base is contingent on the level of

complexity. Contracting officers are encouraged to seek advice and expertise, as

required, from the PSSS.

Cost

Reimbursable

• In a cost reimbursable contract, price validation is required once costs have been

incurred to ensure claims are consistent with the terms and conditions of the

contract and that they are acceptable.

• In a cost reimbursable contract, it is equally important to develop a validation

strategy to ensure the costs claimed and accepted by Canada are in line with

Canada’s Contract Cost Principles SACC 1031-2 and Costing Standard (see Annex

2).

• It is also important to establish what costs are “acceptable” to Canada as early on

in a contract as possible.

• Agreeing with the contractor in advance of the acceptability of costs and accounting

practices with the Annex 2 (Costing Standard). This minimizes the risk of disputes

related to costing later in a contract.

22 | Page Public Services and Procurement Canada August 2023

• The validation strategy for a cost reimbursable contract should include an

assessment of acceptable costs in advance of the contract being signed or at the

time of the negotiations by using CAP Submission.

• A timely validation schedule can then be established to ensure the costs being

claimed are in line with those deemed acceptable at the outset of the contract. This

can be based on findings of a formal or informal audit. The audit provides the basis

for certification that the price is reasonable.

• More information on validation strategies can be found in Section 3.4 (Developing a

Validation Section)

Provisional

Pricing

• Provisional pricing is a basis of payment with a planned move from cost

reimbursable to fixed price, as the degree of certainty related to the contract

requirements increases.

• Validation is required in a provisional price contract, as the first portion of the

contract operates in a cost reimbursable environment. The validation strategy for

the cost reimbursable portion must include an assessment of acceptable costs

actually incurred.

• The validation strategy, timing and plan must be agreed upon in advance of the

contract commencing and must be well documented.

• The results of the cost validation exercise will be used to set the fixed price of the

contract moving forward.

Incentives

• Validation is also important to determine and measure incentives that are in place

in the contract.

• To ensure information tracking for incentives is credible (e.g., deliverables,

performance indicators, and costs), it is important to, first, ensure the contractor has

appropriate system controls (for example, accounting system and labour time

recording system audit).

• Determination of the sufficiency of controls should be included in the validation

strategy for the contract.

• The validation strategy must detail a schedule and plan for validating the

achievement of the incentives laid out in the contract.

Validation: Value Added Information

In addition to validating the actual costs incurred in a contract, the credibility of a contractor’s systems and

the achievement of incentives, there is considerable value in the information received from a validation activity

on the nature of the costs being incurred on a contract and profit being earned.

23 | Page Public Services and Procurement Canada August 2023

Validation can also be used to inform on the implementation of the pricing strategy, and to gain knowledge

on how the costing and pricing of a contract is actually working. This information helps with the decision

related to the pricing of amendments, follow-on contracts or changes required. The timely analysis of financial

information, costs and systems can help to better inform contracting officers and to support them in making

sound decisions.

In terms of contract pricing, the information provided through validation can be valuable for future pricing

decisions as well as serve as a conduit for sharing lessons learned on pricing moving forward and to help

identify opportunities for improvement.

Validation Tools: Should-Cost Analysis/Benchmarking

Should-cost analysis is a process for determining what a good or service might reasonably be expected to

cost based on a separate cost estimate and/or an objective assessment of the contractor’s operations to

identify and correct for any inefficiencies. If should-cost analysis/benchmarking is determined to be beneficial

and feasible (e.g., benefits outweigh the costs, availability of data and expertise), it could be used to assess

or establish a price.

24 | Page Public Services and Procurement Canada August 2023

3.5 CAPTURING AND TRACKING LESSONS LEARNED

Capturing and tracking lessons learned is vital to ensure policies, guidance, and training remain evergreen

and that contracting officers are continuously informed of opportunities and best practices on contract pricing.

Please Note

• When innovative pricing approaches and alternative pricing methods (in line with Section 5.3,

Alternative Pricing Strategies), the contracting officer should share with PSSS by email

(TPSGC.padgamtp-appbipm.PWGSC@tpsgc-pwgsc.gc.ca) details of the method applied.

Why is this important?

• This information will be used by PSSS to learn from the experiences of contracting officers and to

enhance consistency across procurements by updating this Guide.

• Lessons learned will be tracked and shared to facilitate stakeholder development and the

continuous improvement of the pricing guidance and associated strategies and processes.

25 | Page Public Services and Procurement Canada August 2023

4.0 PRICING APPROACH

The pricing approach is a key element in establishing a contract price. The pricing approach determines how

a contractor will be compensated for the provision of goods and services. This includes deciding the

appropriate basis of payment in combination with the use of incentives, where appropriate.

The goal of the pricing approach is to align contract pricing with the procurement’s primary goals and

objectives. The pricing approach includes:

• Determining the appropriate basis of payment, in combination with incentives (if appropriate);

• Determining profit levels;

• Selecting payment schedules and contract terms and conditions related to pricing;

• Driving the achievement of value in a procurement as defined by the buyer;

• Balancing the risks and uncertainties between Canada and the contractor; and

• Encouraging both efficient and economical performance within the contract.

Section 4.1 (Basis of Payment) and Section 4.4 (Incentives) are meant to help support contracting officers in

determining a pricing approach appropriate for a given procurement.

Section 4.5.1 provides Summary Tables of Basis of Payment Types and Section 4.5.2 provides Incentive

Types at the conclusion of the Pricing Approach section.

26 | Page Public Services and Procurement Canada August 2023

4.1 BASIS OF PAYMENT

What is a Basis of Payment?

A basis of payment is the base component of the pricing approach. It establishes the structure of the pricing

arrangement that can be stand-alone or be paired with incentives, where appropriate.

The basis of payment can and should be adapted according to the following:

• Degree and timing of the responsibility/risk assumed by the contractor for the costs of performance;

• Amount and nature of the profit offered to the contractor for achieving specified standards or goals;

• Amount and nature of the incentive offered to the contractor for exceeding specified standards or

goals.

Factors to Consider

Depending on the nature of the procurement, one or many types of bases of payment can be incorporated

into a contract in conjunction with a combination of incentives provided it is appropriate to achieve best value.

• In the case of provisional pricing,

which will be discussed later in this

document, a contract can switch from

one basis of payment to another after

set parameters are met.

• In other cases, a contract could have

multiple aspects with different levels

of certainty and risk, with each aspect

having its own basis of payment.

While the basis of payment options will be discussed in detail in Section 3.1 (Managing Pricing throughout

the Acquisition Lifecycle), selecting a basis of payment that is appropriate for a contract requires careful

consideration, measurement and assessment of the risk factors and uncertainties. It is also important to note

that the basis of payment option has an impact on the transfer of risk between Canada and the contractor.

Table 4.1.a. below provides the areas that need to be considered in determining a basis of payment.

Did You Know?

• A contract need not be confined to a single basis

of payment.

• Provided it is appropriate to achieve best value,

one or many types of bases of payment can be

incorporated into a contract and can even be used

in conjunction with a combination of incentives.

27 | Page Public Services and Procurement Canada August 2023

Table 4.1.a.: Consideration for Pricing Approach

The questions outlined below will help you determine which Pricing Approach is suitable for your procurement

and whether or not incentive options can apply.

Areas of

Consideration

Questions to Consider

Clarity of scope and

requirements

• Does the good or service have clearly established criteria?

• Is the good or service commercially available?

• Is this a complex procurement (refer to Supply Manual Annex 2.4:

Characteristics of Acquisitions Program Procurement Complexity Levels)

where the requirements are not well known?

• Are there uncertainties related to the development or implementation of the

good or service that could impact the achievement of contract requirements?

• Does the good or service being acquired have very specific requirements that

have not been done or tested before?

• Is the requirement of an urgent nature?

Market Forces

• What is the degree of market competition?

• Are costs subject to potential fluctuations in material availability and labour

costs?

Contract Duration

• Is the duration of the requirement/contract expected to be short-term?

• Is the requirement/contract delivered over a longer period of time?

• Is the contract for a short period of time with no possibility of extension?

• Is the initial contract for a short period of time but there is a possibility of

extensions?

Price Validation

• To what extent can price analysis provide for a reasonable pricing standard?

(e.g., availability of historical cost and pricing data)

• Is it possible to conduct a cost analysis including an assessment of the impact

of uncertainty and reasonable allocation of cost responsibility to the

contractor?

• Based on past experience with the contractor, has the contractor been able to

provide consistent and accurate cost estimates?

28 | Page Public Services and Procurement Canada August 2023

• What is the extent and availability of comparable market prices, benchmarks

and should-cost analysis?

• What are the impacts of concurrent contracts and their pricing arrangements?

Contractor

Readiness

• Is the contractor capable of performing the requirements of the contract? (e.g.,

skills, knowledge)

• Is the contractor financially stable and able to remain operational throughout

the duration of the contract?

• Is the contractor able to perform the requirements of the contract within

budget? (e.g., cost control/containment)

• Is the contractor’s accounting system able to support the timely development

of data related to costing and incentive targets in the manner outlined in the

proposed contract?

• Does the contractor plan to subcontract none, some or the bulk of the work

under the contract to another party?

Applicability of

Incentives

• Are there significant concerns related to cost controls?

• Is there measurable and justifiable value in rewarding performance superior

to that of the base standards established in the statement of requirements?

• Will the contractor achieve the target performance criteria required without an

incentive?

29 | Page Public Services and Procurement Canada August 2023

Basis of Payment Types

There are four primary bases of payment types:

• Fixed price;

• Fixed time/unit rate;

• Cost reimbursable; and

• Provisional price.

The Table 4.1.b. below provides a description of these basis of payment.

Table 4.1.b.: Basis of Payment Types

Section

Basis of Payment

Description

4.1.1

Fixed Price

Refer to Annex 1 for

further details on firm

price.

Sets a total fixed price for the delivery of a good or service for the

duration of a contract regardless of actual costs incurred. Options

include:

• Fixed Price Competitive: Price is established by market competition

with more than one bidder.

• Fixed Price Non-Competitive: Price is negotiated at the outset of the

contract or in an amendment to the contract.

• Fixed Price Subject to Economic Price Adjustment: Price includes

the ability to adjust for significant fluctuations of price outside of

Canada and the contractor’s control.

4.1.2

Fixed Time/Unit Rate

Fixed Time/Unit Rate: Calculates a set amount (which typically includes

direct costs, indirect costs (overhead charge) and profit), which is charged

based on a fixed rate and the actual hours worked/ actual volume of units

purchased.

• Fixed Time/Unit Rate subject to Economic Price Adjustment:

Price includes the ability to adjust for significant fluctuations of

price outside of Canada and the contractor’s control.

4.1.3

Cost Reimbursable

Reimburses a contractor for all acceptable contract costs incurred,

typically up to a set amount. Options include:

• No Fee: Allows for repayment of actual costs incurred only.

• Fixed Fee: Adds a specific profit amount to the costs incurred.

• Target Cost/ Incentive Fee: Provides for a sharing formula between

the contractor and Canada of cost savings achieved or costs

exceeding the target. A form of cost reimbursable contract with

greater cost controls.

• Fee Based on Actual Costs: Adds a variable amount of profit based

on the costs incurred.

30 | Page Public Services and Procurement Canada August 2023

4.1.4

Provisional Price

Provisional Price: Commences by using a cost-reimbursable basis of

payment with set parameters and then moves to a fixed price basis of

payment within the contract term, as a function of requirement and cost

certainty.

31 | Page Public Services and Procurement Canada August 2023

4.1.1 FIXED PRICE

Definition

Fixed price provides price certainty throughout the life of a contract. In a fixed price contract, the contractor

is paid a definite sum of money for carrying out the work regardless of the costs incurred, resulting in the

following factors:

• Risks related to cost fluctuations and resulting profits or losses are fully borne by the contractor.

• A higher profit rate is typically built into the price to compensate the contractor for taking on the risk

of fluctuating costs, as detailed in Section 4.4 (Incentives).

• Contractors are encouraged to control costs and maximize efficiency because all resulting savings

impact their profit levels. This can result in stronger performing contractors who are better able to

compete in the marketplace.

• There is generally a lower administrative burden in a fixed price contract over other bases of

payment. For example, while a contracting officer may want to validate estimated costs before

contract award, validation of actual costs is not required for a fixed price contract. See Standard

Acquisition Clauses and Conditions (SACC) Manual clause C8000C.

Factors to Consider

• A fixed price basis of payment is new in Canada (refer to Annex 1: Firm Price Basis of Payment

for details on the changes).

• A competitive fixed price is the optimal basis of payment for achieving value because it is based on

business profit motives. With multiple compliant bidders, the contracting officer is generally afforded

a high degree of comfort that the price being fixed is fair market value.

• It is important to note the difference between a fixed price and a firm price basis of payment for

non-competitive contracts:

o Price can only be fixed with strong certainty, assurance and validation of estimated

requirements, costs and profit.

o There is no Discretionary Audit clause in a fixed price contract, which means that once a contract

is signed, the contracting officer no longer has the ability to validate the costs and profit being

Please Note

• A fixed price basis of payment is a new basis of payment in Canada.

• See Annex 1 for further details on the firm price basis of payment.

 
32 | Page Public Services and Procurement Canada                       August 2023 
earned on a contract during the contract or at contract completion for the purposes of excess 
profit recovery. 
 
o Ensure as part of the validation strategy, that Canada retains its right to audit for information 
purposes (i.e. only related to potential future negotiations on interim or follow-on contracts). This 
should include the right to audit the underlying costs (including the cost of production) to produce 
the necessary level of price support needed to determine if the fixed price is fair and reasonable. 
General audit clauses/conditions (2010A, 2010B, 2010C, 2015A, 2029, 2030, 2035 and 2040) 
are a part of the general conditions template for low, medium and high complexity procurements.  
 
It is recommended that contracting officers use the “Audit” clauses from SACC Section 3 
General Conditions. For example, as appropriate, the “General Conditions – Higher Complexity 
– Goods SACC 2030, section 33”, “General Conditions – Higher Complexity – Services SACC 
2035, section 31” and “General Conditions – Research and Development 2040, section 42” 
should be used. The “Audit” clauses included in the General Conditions detail the contractor’s 
obligations related to audit (i.e. the contractor must retain evidence for all amounts claimed in a 
contract) and protects Canada’s right to audit (i.e. Canada’s right to audit all claimed amounts 
calculated in accordance with the Basis of Payment). 
 
o The longer the duration of a fixed price contract, the greater the risk that the cost base for pricing 
will not represent actual costs.   
 
When Should You Use the Fixed Price Basis of Payment? 
 
Due to the fact that a fixed price contract results in the price being set for the duration of the contract, it is 
important to consider this basis of payment when:  
 • The contracting officer has a significant level of assurance that the price being fixed is fair and will 
not result in unreasonable profits being paid by Canada. This assurance can be obtained through: 
 
o A competitive procurement with multiple compliant bidders, which allows the market to set 
the price. 
o Sufficient benchmarking and should-cost information to validate the price. 
o Available historical data on costing that is robust enough to be able to validate the price prior 
to setting the fixed price. With a follow on contract, for example, assurance services can be 
performed on the costs and profit of the previous contract to establish a fixed price in the 
follow on contract.  
 
• The requirements, scope of work and outputs to determine the level of effort are known, clearly 
defined and  are unlikely to change.  (e.g.,  where the  relevant technology, industry, platform,  or 
service is mature or proven). 
 
• The contract duration is short to medium-term to ensure that:  
 

33 | Page Public Services and Procurement Canada August 2023

o The price would not need to include additional profit premiums to account for long-term

requirements and cost uncertainties.

o The contracting officer has a reasonable level of assurance that the price will still be

reasonable and of value to Canada in the later years of the contract given the potential for

technology changes and process improvements.

• The schedule is relatively certain and considered achievable.

• It is appropriate for the contractor to bear the risk of cost uncertainty.

When Should You Not Use the Fixed Price Basis of Payment?

A fixed price basis of payment may not be appropriate for high risk procurements involving contracts with

highly uncertain or variable scopes (e.g., cutting edge, untested or developmental technology). Using a fixed

price basis of payment in these situations may result in:

• Contractors building a significant contingency (risk premium) into the contract price, which

ultimately results in a higher overall price that no longer provides value for money.

• Contractors struggling to perform the agreed work (for the fixed price).

o This may result in a need to renegotiate price, scope and/or schedule requirements, resulting

in the contract operating like a cost reimbursable contract, losing the benefits of a fixed price

contract, while the contractor is being paid higher profit premiums associated with fixed pricing.

o This may also result in placing at risk delivery of contracted outcomes and/or compromising

the capability (including safety and quality) as the contractor may look to ‘cut corners’ in an

attempt to minimize costs and preserve profits.

Example 4.1.1.a.: Profitability of a Fixed Price Contract

Canada negotiates a fixed price contract for $110,000 which is composed of $100,000 of validated cost

estimates plus a 10% profit, or $10,000. The profitability can be expressed by the line graph below.

34 | Page Public Services and Procurement Canada August 2023

Consider the following scenarios:

• If the contractor incurred costs of $110,000, which is equal to the fixed price, the contractor’s profit is nil.

In other words, the contract was not profitable for the contractor.

• If, however, the actual costs incurred by the contractor are $90,000, the contractor’s profit would be as

follows:

o Fixed price = $110,000

o Actual Contractor Costs = $90,000

o Profit = $20,000

In this case, due to cost efficiencies, the contractor’s profit is $10,000 ($20,000 - $10,000) more profitable

than originally negotiated.

• If the actual costs incurred by the contractor are $120,000, thereby exceeding the negotiated fixed price,

the contractor will be in a loss position, as follows:

o Fixed price = $110,000

o Actual Contractor Costs = $120,000

o Loss = $10,000

It is important to note that the profitability of a fixed price contract is not limited. In other words, the more cost

efficient a contractor is in performance of the work, the more profitable the contract is, and conversely, the

greater the amount by which the actual costs exceed the fixed price, the greater the loss the contractor incurs.

-40

-20

100

120

020 40 60 80 100 120 140

Profit

(in thousand of dollars)

Costs

(in thousand of dollars)

Fixed Price Contract

Cost = Fixed Price

110

Estimated Cost : $ 100,000

Profit (10%) 10,000

Fixed Price: $ 110,000

35 | Page Public Services and Procurement Canada August 2023

Process Steps

Process Overview

Document Decision to Use

Fixed Price Basis of

Payment

• Decision on which basis of payment would be most applicable for the

requirement should be documented in the procurement file.

Establish the Cost Base

• Applicability: See the Section 5.0.1 (Cost-Based Pricing Principles) on

circumstances when Cost- Based Pricing applies.

• To establish the cost base, follow Section 5.1 (Principles for Establishing

the Cost-Base).

• For non-competitive contracts, validation prior to contract award is

necessary to ensure that cost estimates are reasonable and that the

contractor’s financial systems, which support the estimates, are

sufficient and reliable.

Determine the Price

• Options to determine the price include the following:

o A competitive process with more than one compliant bidder;

o Available market-based data; or

o Costs plus profit (see Section 5.2 Profit Principles).

Validate the Price Prior to

Contract Award/Contract

Extension

Once the price is fixed and incorporated into the contract, it is very difficult

to modify, further highlighting the importance of validation prior to contract

award.

• In the case of a negotiated fixed price contract, validating the credibility

of the costs and price proposed is necessary to ensure the negotiated

price is fair and reasonable to Canada, particularly given the fact that

the price is fixed for the life of the contract.

• A price/cost validation exercise should be completed prior to contract

award or contract extension for any fixed price to ensure prices are

appropriate, attributable and reasonable.

• Price validation methods differ depending on how the price of the

contract was determined:

o Generally in a competitive process with more than one compliant

bidder, multiple bids will validate the fairness of the price.

o In a non-competitive or competitive process with only one compliant

bidder price validation might be based on available market-based

data to compare to the price; and/or cost validation; and a

reasonableness assessment of proposed profit. If the above

elements are lacking, then a fixed price basis of payment may not

be appropriate.

36 | Page Public Services and Procurement Canada August 2023

Process Steps

Process Overview

• The nature and level of validation required for a cost base is contingent

on the level of complexity of costing and dependency on the

contractor’s accounting systems. Contracting officers are encouraged

to seek advice and assistance, as required, from the Assurance

Services Group within the Procurement Support Services Sector.

• Options for Validation:

There are two different bases for prices that will affect how a contracting

officer approaches price validation for a procurement. They are:

1. Market based prices

• Competitive: The prices submitted by suppliers in response to a

competitive solicitation, where multiple bids are received, are

considered market based prices.

• Non-competitive (Negotiated): If the contract to be awarded

results from a non-competitive solicitation and there are similar

or comparable commercial goods or services available in the

market that match the requirement, the commercial price may

be suitable as a proxy of the market price, plus or minus any

adjustments to reflect any variations in the requirement.

• A price determined by the market for competitive contracts is the

preferred basis for fixed price contracts and should always be

used for requirements where there is a commercial/market price

available for setting a price or as a basis for price negotiation.

2. Cost-based prices

• Development of cost-based prices is based on estimated costs

to carry out the work. This cost base is established based on

the sum of reasonable estimates for the cost elements which

support the performance of the work.

• The underlying assumptions include:

o The contractor is competent and capable of performing

the work;

o Its business processes are up-to-date/cost-effective;

and

o The estimates of inputs required are reliable.

37 | Page Public Services and Procurement Canada August 2023

Process Steps

Process Overview

• Historical data from previous contracts may provide comfort that

estimates of inputs are reasonable and sufficient to establish a

cost base for pricing.

• Depending on the value and complexity of the requirement,

technical specialists with industry experience may be required

to establish a reliable estimate of inputs required to complete

the work.

• Guidance on the acceptability of the costs can be found in the

Standard Acquisition Clauses and Conditions Contract Cost

Principles (SACC 1031-2) and Section 5.1 (Principles for

Establishing the Cost-Base) of this Guide.

• Once the cost base has been established, a reasonable profit

may be negotiated and applied to the cost base. The profit

should be negotiated in accordance with Section 5.2 (Profit

Principles).

Incorporate Pricing into

the Contract

• It is important that the total fixed price and any supporting terms and

conditions are included in the contract to ensure that contract’s pricing is

clear to both parties.

Documentation,

Justification, Authorization

• Documentation of all decisions supporting validation, justification and

authorization of the price must be included in the procurement file.

38 | Page Public Services and Procurement Canada August 2023

4.1.2 FIXED TIME/UNIT RATE

Definition

This basis of payment provides the payment to the contractor for the actual hours worked or other units

procured in performance of the work. For example, time/units can represent labour or machine hours. The

amount paid for these hours or other units is calculated based on a predetermined fixed rate. A predetermined

fixed rate is typically composed of estimated direct costs, indirect costs (overhead charge) and profit. The

amount to be paid varies based on the increase and decrease in units. See SACC Manual clause C8001C.

When to Use

• When it is not possible to estimate in advance the level of effort and/or quantities required to perform

the contract, but it is possible to determine within reasonable limits the applicable direct and indirect

costs for each hour worked or other unit procured during the contract period.

• When there are provisions for adequate controls to ensure that the contractor is not using efficient

or wasteful methods.

Factors to Consider

• The contract profit on the contract will be impacted by any variances between the level of expected

volumes and the actual volumes procured. The overhead costs are either spread out over more or

less units than expected. Resulting in a higher or lower profit.

• All rate components need to be clearly documented. Consideration can be given to monitoring the

rate for reasonableness on an annual or other periodic basis to ensure ongoing value.

• The actual amount of hours worked or units procured in the performance of the work can be made

subject to government audit.

• Canada regularly negotiates rates with a limited number of major government suppliers. Please

contact the Procurement Support Services Sector (PSSS) for information on available rates, either

as negotiated by Canada or by Canada’s allies.

39 | Page Public Services and Procurement Canada August 2023

Process Steps

Process Overview

Document

Decision to Use

Fixed Time/Unit

Rate Basis of

Payment

• Once a decision has been made to use a fixed time/unit rate basis of payment,

document it in the procurement file.

Establish the Cost

Base

• Applicability: See the Section 5.0.1 (Cost-Based Pricing Principles) on

circumstances when Cost- Based Pricing applies.

• To establish the cost base, follow Section 5.1 (Principles for Establishing the

Cost-Base).

• For non-competitive contracts, price and technical validation prior to contract

award is necessary to ensure that cost estimates are reasonable and that the

contractor’s financial systems, which support the estimates, are sufficient and

reliable.

Determine the

Fixed Time/Unit

Rates)

• Options to determine the fixed time/unit rates include the following:

o A competitive process with more than one compliant bidder;

o Available market-based data; or

o Costs plus profit (see Section 5.2 Profit Principles).

• For non-competitive contracts, the fixed rate is often determined by negotiation

between the contractor and contracting officer with support from PSSS’s price

advisors.

Consider the Use

of Incentives

• Consider the use of incentives and other measures to align both parties’

objectives to achieve the best value for money.

• A cost-control incentive where possible would be beneficial.

• See Section 4.4 (Incentives) of the Guide

Incorporate

Pricing into the

Contract

• SACC Manual clause C8001C Fixed time/unit rate basis of payment incorporates

wording to include either a ceiling price or limitation of expenditure.

• Other SACC Manual time/unit rate basis of payment must be used with a ceiling

price (SACC Manual clause C1206C and C6000C), or without a ceiling price (in

which a limitation of expenditure clause, SACC Manual clause C6001C, must be

used). Refer to Section 4.3 Ceiling Price and Limitation of Expenditure.

40 | Page Public Services and Procurement Canada August 2023

Process Steps

Process Overview

Monitor, Review

and Evaluate

Pricing Strategy

• Monitor, review and evaluate the pricing strategy, as required, throughout the

contract. Take note of any issues with the contract and ensure early engagement

with PSSS to resolve any pricing matters.

Price Validation

• Validate the inputs (i.e. labour hours, machine hours, material, etc.).

• Audits or time verifications and rate certifications must be provided for in the

contracts.

• For more information on validation strategies see Section 3.4 (Developing a

Validation Strategy).

Document,

Justification,

Authorization

• As applicable throughout this process, ensure all decisions are appropriately

documented, justified, and authorized.

• For non-competitive contracts with negotiated rates, ensure a detailed

breakdown of the agreed to cost estimates is explicitly stated in the contract and

documented in the procurement file, as well direction on how the price will be

administered throughout the contract period.

41 | Page Public Services and Procurement Canada August 2023

4.1.3 COST REIMBURSABLE

A cost reimbursable basis of payment provides for the reimbursement to the contractor of allowable costs

incurred in performance of the work in the contract. Please refer to SACC 1031-2 and Annex 2 (Costing

Standard) for a description of allowable costs.

All cost reimbursable contracts must include SACC Manual clause C1004C indicating that Canada reserves

the right to recover amounts and make adjustments to amounts payable to the contractor where an

examination of the contractor’s records has identified amounts allocated to the contract that are not in

accordance with the contract terms.

Factors to Consider

As actual costs are reimbursed, the project budget could be exceeded if cost increases are greater than

estimated. This situation can be mitigated with the provision of price control mechanisms such as a ceiling

price or limitation of expenditure (Section 4.3 Ceiling Price and Limitation of Expenditure).

Different price control mechanisms are appropriate to different cost reimbursable options, as shown in the

following table:

Table 4.1.3.a.: Cost Reimbursable with Ceiling Price or Limitation of Expenditure

Cost Reimbursable Option

Ceiling

Price

Limitation of

Expenditure

No fee

Fixed fee

Target cost/ incentive fee - no maximum price

Target cost/ incentive fee - maximum price

Other examples of cost control useful for cost reimbursable basis of payment include:

• Implementing cost control incentives that can be used where possible to help encourage

contractors to control costs;

• Reimbursing only defined categories of acceptable costs, in line with SACC Manual 1031-2 and

Annex 2 (Costing Standard);

• Controlling the scope of work through specific tasking arrangements;

• Imposing limits on the recoverability of certain cost categories (e.g., direct R&D costs related to a

product will not exceed a set dollar value in a contract);

42 | Page Public Services and Procurement Canada August 2023

• Validating the actual costs incurred, to both control costs and meet requirements under

Section 34 of the Financial Administration Act (FAA) (when additional risk factors warrant the use

of a more formal validation strategy, contact the Procurement Support Services Sector, see Annex

3 for contact information); or

• Specifying the fixed time/unit rate for certain costs (e.g., fixed hourly rate for labour).

When Should You Consider a Cost Reimbursable Basis of Payment?

Cost reimbursable pricing is primarily used when there is uncertainty as to the scope and requirements of

the work. Cost reimbursable pricing is generally used in negotiated contracts. It may not provide much

encouragement for a contractor to limit costs unless paired with a cost control incentive.

Cost reimbursable pricing is best confined to contracts (or contract components) for which scope is uncertain.

As such, cost reimbursable pricing is most appropriate in the following types of situations:

• Research and development;

• Major system development;

• Prototype development and testing;

• Low rate initial production;

• Immature industry, platform, or service;

• Minimal competition; and/or

• Immature product/poorly defined support concept/understanding of requirements.

Cost reimbursable contracts should only be used when:

• A contractor’s accounting system is adequate for determining costs applicable to the contract.

• Adequate government resources are in place to manage a cost reimbursable contract, which

includes resources to review and validate costs claimed.

• Appropriate validation mechanisms exist during contract performance and after contract completion

to provide reasonable assurance that efficient methods and effective cost controls are used.

• It is not possible to reasonably estimate a price for the work that can be agreed upon by both parties

that would result in more equitable sharing of risks and responsibilities between Canada and the

contractor.

43 | Page Public Services and Procurement Canada August 2023

When Should You Not Consider a Cost Reimbursable Basis of Payment?

Cost reimbursable basis of payment should not be used if a commercial price is available.

Cost Reimbursable Options

There are four basic forms of the cost reimbursable basis of payment. Each starts with the defining feature

that the contractor is reimbursed for allowable costs incurred in performance of the work in the contract.

Cost reimbursable basis of payment can be used in conjunction with various incentives (see Section 4.4

Incentives) to ensure goals/objectives of both parties are aligned and value for money is achieved.

A combination of the types of various bases of payment can be used for different aspects of the procurement.

The four Cost Reimbursable basis of payment options are as follows:

1. Cost reimbursable with no fee

2. Cost reimbursable with a fixed fee

3. Cost reimbursable with target cost/

incentive fee

4. Cost reimbursable with fee based on

actual costs (not recommended for use)

Figure 4.1.3.a. below indicates the components of each option. The four options are further explained below.

Did you Know?

Cost reimbursable with target cost/ incentive fee

makes use of a sharing formula to control costs.

See Section 4.1.3.3

44 | Page Public Services and Procurement Canada August 2023

Figure 4.1.3.a.: Illustration of Cost Reimbursable Basis of Payment Types and their Components

45 | Page Public Services and Procurement Canada August 2023

4.1.3.1 COST REIMBURSABLE WITH NO FEE

Definition

• This basis of payment provides only for the reimbursement to the contractor of actual costs

incurred, as may be determined by government audit. Refer to SACC Manual clause C0201C.

• The contractor receives no fee.

When to Use

• Except for contracts covering the provision of assistance to a contractor, this basis of payment is

rarely used entirely on its own. Contractors cannot normally be expected to accept a contract that

provides no profit for the manufacture of goods or the provision of services.

• This basis of payment may be appropriate for contracts (or specific components of a contract) that

are exploratory in nature (i.e., research or development portion) or that involve not-for-profit

organizations.

• This basis of payment may be appropriate for specific types of costs within a contract (for example

travel and living expenses) for which a mark-up or profit is not appropriate related to that specific

procurement.

Factors to Consider

• This cost reimbursable option should include limitation of expenditure as a price control method since

a realistic statement of work cannot be submitted by the contractor, which prevents agreement

between the parties as to what constitutes the prescribed work and, therefore, negates using a ceiling

price.

Process Steps

Process Overview

Document

Decision to Use

Cost

Reimbursable

Basis of Payment

• Once a decision has been made to use a cost-reimbursable basis of payment,

document the type that is most appropriate for the requirement and why it was

chosen in the procurement file.

Establish the Cost

Base

• Only the establishment of the cost base will be required for this basis of payment.

• To establish the cost base, follow Section 5.1 (Principles for Establishing the

Cost-Base).

46 | Page Public Services and Procurement Canada August 2023

Process Steps

Process Overview

• Validation strategies prior to contract award are important to ensure proposed

costs are acceptable and that contractor’s accounting systems are sufficient and

reliable in capturing, measuring and reporting of contract costs.

Consider the Use

of Incentives

• Consider the use of incentives and other measures to align both parties’

objectives to achieve the best value for money.

• A cost-control incentive where possible would be beneficial.

• See Section 4.4 (Incentives) of the Guide.

Incorporate

Pricing into the

Contract

• In a contract or part of a contract with this basis of payment, which does not

include a ceiling price, SACC Manual clause C6001C - limitation of expenditure

must be included in the contract. Refer to Section 4.3 (Ceiling Price and Limitation

of Expenditure).

Monitor, Review

and Evaluate

Pricing Strategy

• Monitor, review and evaluate the pricing strategy, as required, throughout the

contract. Take note of any issues with the contract and ensure early engagement

with PSSS to resolve any pricing matters.

Price Validation

• Validate costs claimed by the contractor upon completion of the contract or

periodically, for example annually in the case of multi-year contracts.

• Validation can be conducted by performing verification procedures. These

procedures provide the basis for certification of pricing being in accordance with

the contract.

• More information on validation strategies, see Section 3.4 (Developing a

Validation Strategy).

Document,

Justification,

Authorization

• As applicable throughout this process, ensure all decisions are appropriately

documented, justified, and authorized.

• Ensure a detailed breakdown of the acceptable costs, given their nature and

amount, is explicitly included in the contract and documented in the procurement

file, as well direction on how the price will be administered throughout the contract

period.

47 | Page Public Services and Procurement Canada August 2023

4.1.3.2 COST REIMBURSABLE WITH A FIXED FEE

Definition

• This cost reimbursable basis of payment option provides payment to the contractor for the actual

amount of costs incurred in performing work and a fixed fee (expressed as a dollar amount) as agreed

to in the contract. The actual amount of costs incurred in the performance of the work may be subject

to government audit. While the fixed fee does not vary with actual costs incurred, it may be

renegotiated under certain circumstances. Refer to SACC Manual clause C0202C.

When to Use

• Use this basis of payment when circumstances do not permit the use of a fixed price basis of payment

and where the possible savings from the use of a cost reimbursable with target cost/ incentive fee

contract are likely to be offset by the complexities of contract administration resulting from its use.

• It is primarily used in research and advanced development or in projects where the required level of

effort is unknown.

Factors to Consider

• A possible benefit of this cost reimbursable option is that the contractor may be motivated to

decrease total cost to realize a higher rate of return (fee/cost).

• Another possible benefit is that the contractor may be motivated to finish the work as soon as

possible since the profit is fixed.

• Alternatively, under certain circumstances, a contractor may not be as motivated to control or reduce

costs because the fixed fee will be earned regardless of actual costs incurred and reimbursed.

Process Steps

Process Overview

Document

Decision to Use

Cost

Reimbursable

Basis of Payment

• Once a decision has been made to use a cost-reimbursable basis of payment, document

the type that is most appropriate for the requirement and why in the procurement file.

Establish the Cost

Base

• To establish the cost base, follow Section 5.1 (Principles for Establishing the Cost-

Base).

48 | Page Public Services and Procurement Canada August 2023

Process Steps

Process Overview

• Validation strategies prior to contract award are important to ensure proposed costs are

acceptable and that contractor’s accounting systems are sufficient and reliable in

capturing, measuring and reporting of contract costs.

Determine a

Fixed Fee Portion

• The amount of the fixed fee, based on an estimate of the costs to be incurred, should

be no greater than the appropriate amount of profit (Refer to Section 5.2 Profit

Principles).

• This fixed fee is typically based on a percentage of the estimated cost and does not

change once it has been accepted by both parties.

Consider the Use

of Incentives

• Consider the use of incentives and other measures to align both parties’ objectives to

achieve the best value for money.

• A cost control incentive where possible may be beneficial.

• See Section 4.4 (Incentives) of the Guide.

Incorporate

Pricing into the

Contract

• Cost-reimbursable with fixed fee basis of payment can be used with a ceiling price

(SACC Manual clause C6000C), or without a ceiling price (in which a limitation of

expenditure clause, SACC Manual clause C6001C, must be used) (Section 4.3 Ceiling

Price and Limitation of Expenditure).

Monitor, Review

and Evaluate

Pricing Strategy

• Monitor, review and evaluate the pricing strategy, as required, throughout the contract.

Take note of any issues with the contract and ensure early engagement with PSSS to

resolve any pricing matters.

Price Validation

• Validate costs claimed by the contractor upon completion of the contract or periodically,

for example annually in the case of multi-year contracts.

• For more information on validation strategies see Section 3.4 (Developing a Validation

Strategy).

Document,

Justification,

Authorization

• As applicable throughout this process, ensure all decisions are appropriately

documented, justified, and authorized.

• Ensure a detailed breakdown of the acceptable costs, given their nature and amount, is

explicitly included in the contract and documented in the procurement file, as well as

direction on how the price will be administered throughout the contract period.

49 | Page Public Services and Procurement Canada August 2023

4.1.3.3 COST REIMBURSABLE WITH TARGET COST/ INCENTIVE FEE

Cost reimbursable with a target cost/ incentive fee is a form of gain or pain sharing, where cost efficiencies

or losses are rewarded and shared through fee arrangements in which both the contractor and Canada share

the reward (risk) of meeting (or not meeting) contract performance criteria. This basis of payment provides

incentives for contractors to control costs.

Setting targets and percentages for gain/pain sharing formulas should involve determining the likelihood of

variations from the established target. Actual experience may indicate that the contractor’s underlying

business solution or Canada’s requirements have changed to the point where the sharing agreement and

the contract should be amended. See SACC Manual clauses C8002C, C8003C, C8004C, and C8005C.

For other incentives, see Section 4.4 (Incentives).

There are two primary types of target cost/incentive fee:

• target cost/ incentive fee with no maximum price; and

• target cost/ incentive fee with maximum price.

These two types of cost reimbursable with target cost/ incentive fee are described in more detail in Table

4.1.3.3.a. and Figure 4.1.3.3.a. below, and further in this section.

Table 4.1.3.3.a.: Target Cost Types

Target Cost Type

Description

Target Cost/ Incentive

Fee with No Maximum

Price

• Canada and the contractor share in cost savings or costs exceeding the

target in the performance of the contract.

• The contract uses a cost reimbursable basis of payment and there are no

limits to the losses or gains incurred.

• A sharing formula is predetermined at the outset of the contract to allocate

cost savings and costs in excess of pre-established target costs.

• The contractor has the ability to earn additional profit relative to the cost

savings, which places a higher degree of cost responsibility and cost

control on the contractor than that of a standard cost reimbursable

contract.

Target Cost/ Incentive

Fee with Maximum Price

• Canada and contractor share in cost savings or costs exceeding the

target in the performance of the contract up to the point of the maximum

price.

• The contract uses a cost reimbursable basis of payment up to the point

where the maximum price is reached, at which point, the contract closely

50 | Page Public Services and Procurement Canada August 2023

Target Cost Type

Description

resembles a fixed price contract, with the potential loss to Canada

capped, increasing the risk that is borne by the contractor.

• A sharing formula is predetermined at the outset of the contract to allocate

cost savings and costs exceeding pre-established target costs (up to the

maximum price).

• The contractor has the ability to earn additional profit relative to the cost

savings but takes on significantly more risk than a target cost/ incentive

fee with no maximum price because the contractor will not be paid any

more than the maximum price while retaining the obligation to complete

the work as specified in the contract.

51 | Page Public Services and Procurement Canada August 2023

Figure 4.1.3.3.a.: Target Cost/ Incentive Fee Types

The diagram below displays the difference in risk and reward sharing undertaken by Canada and the

contractor in a target cost/ incentive fee with no maximum price compared to that of a target cost/ incentive

fee with maximum price. The key difference between the two occurs at the point of the maximum price.

Target Cost/ Incentive Fee with No Maximum Price

When to Use

• When the actual costs and cost components (e.g., labour hours, labour mix, material requirements)

to be incurred in the performance of a contract cannot be accurately predicted and greater cost

control than that of a standard cost reimbursable contract is required.

• When it is too difficult to attract a contractor without having an over inflated fixed price to compensate

industry for the risks related to the uncertainties.

• When it is possible to establish an objective relationship between contractor profit and contract costs.

• When procuring non-commercial goods or services with unpredictable requirements such as new

products and research and development programs.

52 | Page Public Services and Procurement Canada August 2023

Factors to Consider

Risks

Benefits

• Developing estimates of target costs and all

related variations can be difficult and time

consuming.

• Adequate time for planning the project and

assessing the cost estimates is essential.

• With no cost limit, there is potential for costs to

exceed initial budgets which can result in the

need for additional funding.

• A misaligned gain/pain sharing ratio could

result in low effectiveness of the incentive

needed to achieve desired cost efficiencies.

• Performance objectives other than cost (e.g.,

related to quality or schedule) may be

compromised or overlooked particularly if the

focus is solely on cost.

• The contractor’s risk is lowered because a

portion or all (in a limited sharing arrangement)

costs are recovered.

• Contractors are incented to be efficient because

the more efficient they are, the greater their

profit.

53 | Page Public Services and Procurement Canada August 2023

Process Steps

Process Overview

Document

Decision to Use

Cost

Reimbursable

Basis of Payment

• Once a decision has been made to use a cost-reimbursable basis of payment,

document the type that is most appropriate for the requirement and why in the

procurement file.

Develop Target

Cost

• Establish a reasonable but challenging target cost that is achievable. There is no

purpose in setting target costs that the contractor cannot meet.

• A conservative estimate of target cost is preferable to an overly aggressive target

cost.

• Target costs should be established in line with Section 5.1 (Principles for

Establishing the Cost-Base).

• Validation strategies prior to contract award are important to ensure proposed

costs are acceptable and that contractor’s accounting systems are sufficient and

reliable in capturing, measuring and reporting of contract costs.

Develop Target

Profit

• Target profit (or target fee) should be developed using the approach detailed in

Section 5.2 (Profit Principles) using the target cost as the cost base.

• The contractor is rewarded a profit to control costs and, as a result, the target

profit is reflective of the level of cost responsibility assumed by the contractor.

• The target profit is the amount of profit payable without adjustment if the actual

costs incurred equal target cost.

Develop Sharing

Formula

• The sharing formula is used to calculate how savings and costs exceeding the

target will be shared between Canada and the contractor.

• The formula takes into account two scenarios:

o When the actual cost is less than the target cost.

o When the actual cost is greater than the target cost.

• A government share/contractor share ratio is established for each of these

scenarios. The ratios can be the same or can differ, depending upon the level of

risk acceptable by each party.

• The sharing formula subtracts the actual cost from the target cost and multiplies

this by the contractor’s share for the scenario that actually occurred. This is then

54 | Page Public Services and Procurement Canada August 2023

Process Steps

Process Overview

added to the actual cost and the target profit to arrive at a final price paid. (This

is demonstrated mathematically in examples later in this section.)

• In development of the sharing formula, it is important to consider all possible

variations, from the most optimistic to the most pessimistic, including any risk not

covered in the target cost and target profit, how aggressive the target cost is, and

potential changes through the acquisition lifecycle.

• For example:

o A more aggressive target cost may provide for a sharing ratio that heavily

rewards the contractor for costs less than target (20/80) but more equally

shares costs in excess of target (50/50) due to the higher likelihood of

exceeding the aggressive target.

o A target cost which is achievable and less aggressive, would result in a share

ratio that would more equally share costs less than target (60/40) with the

contractor taking on a larger portion of costs in excess of target (25/75).

• A Limited Sharing Arrangement can be used when there is a very high degree of

uncertainty in setting the target costs, as detailed in Example 4.1.3.3.b. below.

Maximum and Minimum Fees are used to limit the gains or costs exceeding the

target. Note that with these arrangements, the government assumes 100% of the

risk of costs exceeding the target at the minimum fee point.

Incorporate

Pricing into the

Contract

• Cost reimbursable with target cost/ incentive fee with no maximum price must

include a limitation of expenditure (SACC Manual clause C6001C). Refer to

Section 4.3 (Ceiling Price and Limitation of Expenditure).

Monitor, Review

and Evaluate

Pricing Strategy

• Monitor, review and evaluate the pricing strategy, as required, throughout the

contract. Take note of any issues with the contract and ensure early engagement

with PSSS to resolve any pricing matters.

Price Validation

• Validate costs claimed by the contractor upon completion of the contract or

periodically, for example annually in the case of multi-year contracts.

• For more information on validation strategies see Section 3.4 (Developing a

Validation Strategy).

Document,

Justification,

Authorization

• As applicable throughout this process, ensure all decisions are appropriately

documented, justified, and authorized.

• The target cost, target profit, sharing formula and validation plan must be

documented and incorporated in the contract.

55 | Page Public Services and Procurement Canada August 2023

Process Steps

Process Overview

• Ensure a detailed breakdown of the acceptable costs, given their nature and

amount, is explicitly included in the contract and documented in the procurement

file, as well as direction on how the price will be administered throughout the

contract period.

• See Section 3.3 (Documenting & Justifying Key Price Decisions) for further

details.

Examples

The impact of a target cost/ incentive fee with no maximum price may vary depending on how the incentive

is applied. Outlined below are three examples of different applications of this incentive and how contractors

may behave as a result.

The following factors apply to Examples 4.1.3.3.a., 4.1.3.3.b. and 4.1.3.3.c. below:

Target Cost

Estimated cost to perform the contract requirements is $100,000

Target Profit

10% of Costs is $10,000

Share Ratios

Vary with each example

Example 4.1.3.3.a.: Target Cost/ Incentive Fee with No Maximum Price Contract, Unlimited Sharing

Arrangement

In this example, a 60/40 ratio for costs less than target and 50/50 ratio for costs exceeding the target have

been established. The amount of profit that could be earned by the contractor is not limited in the case of

cost savings. Similarly, there are no limits to the cost that Canada and the contractor may share in the case

of costs exceeding the target, resulting in an unknown final price that could be higher than budgeted.

However, Canada only incurs 50% of costs exceeding the target and benefits in 60% of all cost savings.

56 | Page Public Services and Procurement Canada August 2023

-15

-10

-5

60 70 80 90 100 110 120 130 140 150

Profit

(in thousands of dollars)

Cost

(in thousands of dollars)

Target Cost No Maximum Price

Target

Cost

Target Profit

Target Cost: $100,000

Target Profit: $10,000

Target Price: $110,000

Share Ratio:

costs less than target: 60/40

costs more than target: 50/50

57 | Page Public Services and Procurement Canada August 2023

Example 4.1.3.3.a.: Target Cost/ Incentive Fee with No Maximum Price Contract, Unlimited Sharing

Arrangement (continued)

Target

Cost

Actual

Cost

Sharing Formula

[% * (Target Cost –

Actual Cost)]

Target

Profit

Contract Profit or

Loss

(Sharing Formula

+ Target Profit)

(Profit/Loss)/Actu

al Costs = %

Final Price

Paid

(Actual Cost

+ Contract

Profit or

Loss)

$100,000

$80,000

40% * ($100,000-

$80,000)

= $8,000

$10,000

$18,000

22.5%

$98,000

$100,000

$90,000

40% * ($100,000-

$90,000)

= $4,000

$10,000

$14,000

15.6%

$104,000

$100,000

($100,000-$100,000)

=$0

$10,000

10%

$110,000

$100,000

$110,000

50% * ($100,000-

$110,000)

= ($5,000)

$10,000

$5,000

4.55%

$115,000

$100,000

$120,000

50% * ($100,000-

$120,000)

= ($10,000)

$10,000

$120,000

$100,000

$140,000

$50% * ($100,000 -

$140,000)

= ($20,000)

$10,000

($10,000)

-7.1%

$130,000

58 | Page Public Services and Procurement Canada August 2023

Example 4.1.3.3.b.: Target Cost/ Incentive Fee with No Maximum Price but with Maximum and Minimum

Fees

In this example, there is a maximum limit imposed on the amount of profit that could be earned by the

contractor in the case of cost savings and a minimum amount of profit imposed in the case of costs exceeding

the target. No limits are applied on the amount of actual costs incurred.

In this case, the maximum limit of profit is set at $14,000 and the minimum limit is set at $5,000.

Using the same share ratios as indicated in Example 1, those limits would take effect once actual costs fall

below $90,000 or exceed $110,000. The share ratio only takes effect within this range of actual costs. If the

contractor’s actual costs were between $90,000 and the target cost of $100,000, then the contractor has to

share these cost savings with Canada in the 60/40 proportion. Similarly, if the actual costs were above the

target cost but below $110,000, then the costs exceeding the target are shared equally between the two

parties (50/50). If actual costs, however, are greater than $110,000 or lower than $90,000, the contractor is

eligible to receive either $5,000 or $14,000 of profit. This means that any costs exceeding the target or

savings greater than $10,000 belong to Canada.

70 80 90 100 110 120 130

Profit (in thousands of dollars)

Cost (in thousands of dollars)

Target Cost with No Maximum Price but with Maximum and Minimum Fees

Target

Cost

Target Profit

Target Cost: $100,000

Target Profit: $10,000

Target Price: $110,000

Min Fee: $5,000

Max Fee: $14,000

Share Ratio:

costs less than target: 60/40

costs more than target: 50/50

Range of Incentive

Effectiveness

Max Fee

100/0

Min Fee

100/0

59 | Page Public Services and Procurement Canada August 2023

Example 4.1.3.3.b.: Target Cost/ Incentive Fee with No Maximum Price but with Maximum and Minimum

Fees (continued)

Target

Cost

Actual

Cost

Sharing Formula

[% * (Target Cost – Actual

Cost)]

Target

Profit

Contract Profit or

Loss

(Sharing Formula

+ Target Profit)

(Profit/Loss)/Actual

Costs = %

Final Price

Paid

(Actual

Cost +

Contract

Profit or

Loss)

$100,000

$80,000

($100,000 - $80,000)

= $20,000 > Maximum Fee

$14,000

$10,00

$14,000

17.5%

$94,000

$100,000

$90,000

40% * ($100,000-$90,000)

=$4,000

$10,00

$14,000

15.6%

$104,000

$100,000

($100,000-$100,000)

=$0

$10,00

$10,000

10%

$110,000

$100,000

$110,000

50% * ($100,000-$110,000)

= ($5,000)

$10,00

$5,000

4.55%

$115,000

$100,000

$140,000

($100,000 - $140,000)

= ($40,000) < Minimum Fee

$5,000

$10,00

$5,000

3.6%

$145,000

Since there is a limit on the maximum and minimum profit, this incentive is effective only when the actual

costs incurred are not outside the cost range within which the profits that the contractor could earn vary. In

other words, the contractor may be willing to control the costs up to the point where possible profit stops

increasing with the increase of cost savings.

For Canada, this type of contract could be more costly than demonstrated in Example 4.1.3.3.a., as Canada

assumes 100% of risk of costs exceeding the target at the minimum fee point.

60 | Page Public Services and Procurement Canada August 2023

Example 4.1.3.3.c.: Target Cost/ Incentive Fee with No Maximum Price but with Changing Share Ratio

A final variation is where there are no maximum or minimum profits set, but instead, points at which the share

ratios may change.

In this example, the original share ratios are still reasonable when the actual cost is within a range of 10% of

the target cost, i.e., between $90,000 and $110,000. When actual costs fall below 10% of the target cost

(i.e., below $90,000) a different ratio, in this case 80/20, is triggered. Similarly, when actual costs rise above

10% of the target costs (i.e., above $110,000), a ratio of 20/80 will apply. The following graph illustrates the

described situation.

-10

-5

70 75 80 85 90 95 100 105 110 115 120 125 130

Profit

(in thousands of dollars)

Cost

(in thousands of dollars)

Target Cost no Max Price with Changing Share Ratio

Target

Cost

Target Profit

Target Cost: $100,000

Target Profit: $10,000

Target Price: $110,000

Share Ratio (costs within 10% *

Target Cost):

costs less than target: 60/40

costs more than target: 50/50

Share Ratio (costs differences

exceeding 10% * Target Cost):

costs less than target: 80/20

costs more than target: 20/80

61 | Page Public Services and Procurement Canada August 2023

Example 4.1.3.3.c.: Target Cost with No Maximum Price but with Changing Share Ratio (continued)

Target

Cost

Actual

Cost

Sharing Formula

[% * (Target Cost – Actual

Cost)]

Target

Profit

Contractor Profit or

Loss

(Sharing Formula +

Target Profit)

(Profit/Loss)/Actual

Costs = %

Final Price

Paid

(Actual Cost

+ Contract

Profit or

Loss)

$100,000

$80,000

($100,000 - $80,000) = $20,000;

• $10,000 < 10% (60/40)

• $10,000 > 10% (80/20)

(40% * $10,000) + (20% *

$10,000)

=$6,000

$10,000

$16,000

20%

$96,000

$100,000

$90,000

40% * ($100,000-$90,000) =

$4,000

$10,000

$14,000

15.6%

$104,000

$100,000

($100,000-$100,000) = $0

$10,000

10%

$110,000

$100,000

$110,000

50% * ($100,000-$110,000) =

($5,000)

$10,000

$5,000

4.55%

$115,000

$100,000

$140,000

($100,000 - $140,000) =

($40,000)

• ($10,000) < 10% (50/50)

• ($30,000 > 10% (20/80)

(50% * $10,000) + (80% *

$30,000)

= ($29,000)

$10,000

($19,000)

-13.6%

$121,000

The contractor is further incented to not exceed the cost above the certain percentage of the target cost in

this situation rather than in the situation outlined in Example 4.1.3.3.a. because the contractor bears a greater

percentage of costs if the variance is greater than the pre-established percentage of the target cost.

62 | Page Public Services and Procurement Canada August 2023

Target Cost/ Incentive Fee with Maximum Price

When to Use

• When it is possible to establish a firm target cost, target profit and sharing formula as well as be able

to establish a maximum price and cost sharing limit that sufficiently incents the contractor to assume

an appropriate share of the risk.

• When adequate requirements and cost information are available at the time the basis of payment is

being developed.

• When Canada would like to share expected efficiency savings in a contract.

• For a newer program, good or service, where there is a clear understanding of what Canada requires.

• When there are no significant unresolved technical process or design issues that will result in a

redesign of the requirements.

• When there are qualified contractors with the financial capacity to absorb any unforeseeable costs

exceeding the maximum price while still being able to deliver the product.

Factors to Consider

Risks

Benefits

• Significant risk is put on the contractor for

final delivery regardless of costs exceeding

the target. As a result, reasonable profit

sharing ratios must be established.

• Performance objectives other than cost (e.g.,

related to quality or schedule) may be

compromised or overlooked if the focus is

solely on cost.

• Canada is able to share in cost efficiencies.

• Canada limits the risk on costs exceeding the

target above the maximum price. After the

maximum price and cost sharing limit are

reached, the contractor bears the risk of any

additional costs.

63 | Page Public Services and Procurement Canada August 2023

Process Steps

Process Overview

Document

Decision to Use

Cost

Reimbursable

Basis of Payment

• Once a decision has been made to use a cost-reimbursable basis of payment,

document the type that is most appropriate for the requirement and why in the

procurement file.

Develop Target

Cost

• Establish a reasonable but challenging target cost. This means that it can be

attained by the contractor provided the contractor focuses on achieving

efficiencies. There is no purpose in setting target costs that the contractor cannot

meet.

• A conservative estimate of target cost is preferable to an aggressive target cost.

• Target costs should be established that are in line with Section 5.1 (Principles for

Establishing the Cost-Base).

• Validation strategies prior to contract award are important to ensure proposed

costs are acceptable and that contractor’s accounting systems are sufficient and

reliable in capturing, measuring and reporting of contract costs.

Develop Target

Profit

• Target profit (or target fee) should be developed using the weighted guidelines

approach as detailed in Section 5.2 (Profit Principles) using the target cost as the

cost base.

• The contractor is rewarded a profit to control costs and, as such, the target profit

is reflective of the level of cost responsibility assumed by the contractor.

• The target profit is the amount of profit payable without adjustment if the actual

costs incurred equal target cost.

Develop Sharing

Formula

• The sharing formula is used to calculate how savings and costs exceeding the

target will be shared between Canada and the contractor.

• The formula takes into account two scenarios:

o When the actual cost is less than the target cost.

o When the actual cost is greater than the target cost.

• A government share/contractor share ratio is established for each of these

scenarios. The ratios can be the same or can differ, depending upon the level of

risk agreed to be accepted by each party.

64 | Page Public Services and Procurement Canada August 2023

Process Steps

Process Overview

• The sharing formula subtracts the actual cost from the target cost and multiplies

this by the contractor’s share for the scenario that actually occurred. This is then

added to the actual cost and the target profit to arrive at a final price paid. (This

is demonstrated mathematically in examples later in this section.)

• In development of the sharing formula, it is important to consider all possible

variations, from the most optimistic to the most pessimistic, including any risk not

covered in the target cost and target profit, how aggressive the target cost is, and

potential changes through the acquisition lifecycle.

For example:

• A more aggressive target cost may provide for a sharing ratio that heavily rewards

the contractor for costs less than target (20/80) but more equally shares costs in

excess of target (50/50) due to the higher likelihood of exceeding the aggressive

target.

• A target cost which is achievable and less aggressive, would result in a share

ratio that would more equally share costs less than target (60/40) with the

contractor taking on a larger portion of costs in excess of target (25/75).

• A Limited Sharing Arrangement can be used when there is a very high degree of

uncertainty in setting the target costs, as detailed in Example 4.1.3.3.d. below.

Maximum and Minimum Fees are used to limit the gains or costs exceeding the

target. Note that with these arrangements, the government assumes 100% of the

risk of costs exceeding the target at the minimum fee point.

Develop

Maximum Price

• This is the maximum amount that Canada will pay on the contract.

• The maximum price represents the limit of Canada’s obligation to pay the

contractor for the work under the contract. This should be a realistic figure that is

not so high as to have no meaning.

• If the sharing arrangement is effective and the contractor is efficient in the

performance of the contract, the maximum price will not come into effect.

• The contract becomes a fixed price contract if the costs rise to the point where

the maximum price takes effect.

Incorporate

Pricing into the

Contract

• Cost reimbursable with target cost/incentive fee with maximum price basis of

payment must include a ceiling price clause (SACC Manual Clause C6000C).

Refer to Section 4.3 (Ceiling Price and Limitation of Expenditure).

65 | Page Public Services and Procurement Canada August 2023

Process Steps

Process Overview

Monitor, Review

and Evaluate

Pricing Strategy

• Monitor, review and evaluate the pricing strategy, as required, throughout the

contract. Take note of any issues with the contract and ensure early engagement

with PSSS to resolve any pricing matters.

Price Validation

• Validate costs claimed by the contractor upon completion of the contract or

periodically, for example annually in the case of multi-year contracts.

• For more information on validation strategies see Section 3.4 (Developing a

Validation Strategy).

Document,

Justification,

Authorization

• As applicable throughout this process, ensure all decisions are appropriately

documented, justified, and authorized.

• The target cost, target profit, sharing formula, maximum price and validation plan

must be documented and incorporated in the contract.

• Ensure a detailed breakdown of the acceptable costs, given their nature and

amount, is explicitly included in the contract and documented in the procurement

file, as well as direction on how the price will be administered throughout the

contract period.

• See Section 3.3 (Documenting & Justifying Key Price Decisions) for further

details.

66 | Page Public Services and Procurement Canada August 2023

Example 4.1.3.3.d.

The following example shows how the target cost with maximum price incentive functions.

Example Factors

Target Cost

Estimated cost to perform the contract requirements is $100,000

Target Profit

10% of target costs is $10,000

Maximum Price

$115,000

Share Ratios

Costs in excess of target to be shared 50/50

Costs less than target to be shared 60/40

This situation is illustrated on the following graph.

70 75 80 85 90 95 100 105 110 115 120

Profit

(in thousands of dollars)

Cost

(in thousands of dollars)

Target Cost with Maximum Price

Target

Cost

Target Profit

Target Cost: $100,000

Target Profit: $10,000

Target Price: $110,000

Max Price: $115,000

Share Ratio:

costs less than target: 60/40

costs more than target: 50/50

67 | Page Public Services and Procurement Canada August 2023

Example 4.1.3.3.d. (continued)

Target

Cost

Actual

Cost

Sharing

Formula

[% * (Target Cost –

Actual Cost)]

Resulting Price Before

Maximum Price

[%*(Target Costs –

Actual Costs)] + Actual

Costs + Target Profit

Final Price

Paid

Lesser of:

Resulting

Price or

Maximum

Price

($115,000)

Contractor Profit or

(Loss)

Final Price Paid –

Actual Costs

Profit/(Loss)/Actual

Costs = %

$100,000

$80,000

40% * (100,000-80,000)

=$8,000

8,000+80,000+10,000

=$98,000

$98,000

$18,000

22.5%

$100,000

$90,000

40% * (100,000-90,000)

=$4,000

4,000+90,000+10,000

=$104,000

$104,000

$14,000

15.6%

$100,000

(100,000-100,000) =$0

0+100,000+10,000

=$110,000

$110,000

$10,000

10%

$100,000

$110,000

50% * (100,000-110,000)

= ($5,000)

(5,000) +90,000+10,000

=$115,000

$115,000

$5,000

4.55%

$100,000

$111,000

50% * (100,000 - 111,000)

= ($5,500)

(5,500) +111,000+10,000

=$115,500

$115,000

$4,000

3.6%

$100,000

$112,000

50% * (100,000 - 112,000)

= ($6,000)

(6,000) +112,000+10,000

=$116,000

$115,000

$3,000

2.7%

$100,000

$140,000

50% * (100,000 - 140,000)

= ($20,000)

(20,000)

+140,000+10,000

=$130,000

$115,000

($25,000)

(-17.9%)

68 | Page Public Services and Procurement Canada August 2023

4.1.3.4 COST REIMBURSABLE WITH FEE BASED ON ACTUAL COSTS

Definition

Cost reimbursable with fee based on the actual costs provides only for the payment to the contractor of actual

costs incurred in the performance of the work in the contract plus the fixed percentage of those actual costs

as a fee. The actual costs incurred in performance of the work may be subject to government audit. The

amount paid is calculated based on actual costs incurred. Refer to SACC Manual clause C0205C.

When to Use

Use this basis of payment only when circumstances do not allow for the use of any other basis of payment.

Factors to Consider

• The application of this basis of payment results in higher profits being earned as costs increase,

resulting in no encouragement for cost control.

• Consider the applicability of Incentives, Section 4.4, before using this basis of payment.

• Ceiling prices are not applicable with this basis of payment.

Process Steps

Process Step

Process Overview

Document

Decision to Use

Cost

Reimbursable

Basis of Payment

• Once a decision has been made to use a cost reimbursable basis of payment,

document the type that is most appropriate for the requirement and why in the

procurement file.

Establish the Cost

Base

• To establish the cost base, follow Section 5.1 (Principles for Establishing the

Cost-Base)

• Validation strategies upfront are important to ensure costs agreed to should be

acceptable and that contractor’s accounting systems are reliable.

Please Note

This basis of payment is not recommended because it provides little or no control over contractor costs

and actually encourages contractors to increase costs as a way to increase profit.

69 | Page Public Services and Procurement Canada August 2023

Process Step

Process Overview

• For a competitive contract, the cost base may also be influenced by costs

included in initial bids, provided they meet the “Acceptable” cost criteria in

Canada’s Costing Standard.

Determine the

Fee

• For the fee portion of the basis of payment, establish the percentage that would

be applied to the actual costs incurred, as determined by Contract Cost Principles

1031-2 and/or Annex 2 (Costing Standard).

• For profit rate calculations follow Section 5.2 (Profit Principles).

Consider the Use

of Incentives

• Consider the use of incentives and other measures to align both parties’

objectives to achieve the best value for money.

• A cost control incentive where possible would be beneficial.

Incorporate

Pricing into the

Contract

• Ceiling prices are not applicable when this basis of payment is used.

• In a contract or part of a contract with this basis of payment, SACC Manual clause

C6001C - Limitation of expenditure must be included in the contract. Refer to

Section 4.3 (Ceiling Price and Limitation of Expenditure).

Monitor, Review

and Evaluate

Pricing Strategy

• Monitor, review and evaluate the pricing strategy, as required, throughout the

contract. Take note of any issues with the contract and ensure early engagement

with PSSS to resolve any pricing matters.

Price Validation

• Validate costs claimed by the contractor upon completion of the contract or

periodically, for example annually in the case of multi-year contracts.

• For more information on validation strategies see Section 3.4 (Developing a

Validation Strategy).

Document,

Justification,

Authorization

• As applicable throughout this process, ensure all decisions are appropriately

documented, justified, and authorized.

• Ensure a detailed breakdown of the acceptable costs, given the nature and

amount, is explicitly included in the contract and documented in the procurement

file, as well as direction on how the price will be administered throughout the

contract period.

70 | Page Public Services and Procurement Canada August 2023

Example 4.1.3.4.a.: Cost Reimbursable with Fee Based on Actual Costs

There is a research contract where the cost could not be reliably estimated prior to contract award. The profit

level, however, that could be earned by the contractor was negotiated as 5% of the actual costs incurred.

Having such an agreement in place, the contractor will be reimbursed for all allowable costs incurred plus

the 5% of these costs as a profit.

For example, if the contractor’s actual costs are $100,000, then the total payment to the contractor would be

$100,000 + 5% fee (or $5,000) for a total of $105,000. While the absolute amount of profit will vary with the

change in the actual cost, the profit percentage will always remain constant. The following chart graphically

shows the relationships between profit and the actual costs.

010 20 30 40 50 60 70 80 90 100 110 120 130

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

Profit

in thousands of $

Cost

in thousands of $

Profit

in % of actual costs

Cost Reimbursable with Fee Based on Actual Costs

Profit Percentage Line

71 | Page Public Services and Procurement Canada August 2023

4.1.4 PROVISIONAL PRICE BASIS OF PAYMENT

Definition

In a provisional price basis of payment, a contract begins with a cost reimbursable basis of payment when

the requirements and costs within the contract are uncertain or cannot be estimated, with a clearly defined

price ceiling or limitation of expenditure.

A provisional price basis of payment is used when there is a plan to move from a cost reimbursable basis of

payment to a fixed price basis of payment because there will be an increased certainty in terms of the contract

requirements over time, which therefore decreases the risks to Canada for the remainder of the contract.

Provisional pricing gives contracting officers the ability to reduce the risks to Canada when they are able to

better analyze and evaluate appropriate, attributable and reasonable costs.

Provisional price requires a milestone to be established that is relevant to the level of uncertainty for the

requirement. This milestone is typically tied to a certain percentage of work completed or achievement of

critical performance indicators within the contract when the costs are more certain and stable. This would

predefine when the cost reimbursable portion is complete, and the basis of payment can move to fixed price.

This must be clearly detailed in the contract.

The price validation is triggered when the contractor submits a declaration of the percentage of work

completed that corresponds to the milestone. This declaration must include a cost submission prepared by

the contractor (refer to SACC Manual clause C0300C). Costs must be validated before the basis of payment

is formally changed to a fixed price.

Contractors must cooperate in a timely manner

with auditors and provide all necessary

supporting evidence such as financial

information, as and when required by auditors.

The submission of all costs incurred must be

sufficient to disclose unit cost and cost trends for

the goods and/or services performed in relation

to the contract and inventories of both work in

progress and undelivered contract supplies on-

hand. Benchmarking by market data or historical

data on costs and profit calculation is also

included in the price validation process. The use

of expertise within PSSS to validate the price is

highly recommended.

When the milestone is attained and the costs become more certain and stable, Canada and the contractor

will negotiate a fixed price for the remainder of the contract based on the terms and conditions outlined in the

initial contract. An appropriate profit level will need to be included as part of this fixed price. When an

attributable, appropriate and reasonable fixed price has been agreed to by both parties, the original contract

will be formally amended and any changes to required clauses and terms will be made.

Important Reminder

• There is expert advice and support available

within the Procurement Support Services

Sector (PSSS) of PSPC to assist in validating

price.

• Price advisors and assurance advisors should

be consulted early in the process.

• Please see Annex 3 for contact information.

72 | Page Public Services and Procurement Canada August 2023

Figure 4.1.4.a. below is a visual representation of how these components work together in a Provisional Price

contract.

Figure 4.1.4.a.: How Provisional Price Works: A Visual Representation

When Should You Consider a Provisional Price Basis of Payment?

• Typically, provisional pricing is used in longer-term contracts (e.g., five (5) years or longer), where

it is not possible to fix the price due to uncertainty, or where there is an inability to set reasonable

estimates or targets on contract requirements and costs.

• Provisional pricing enables contracting officers to work towards the benefits of a fixed price, such

as cost efficiencies, transfer of risk to the contractor, and reduction of the administrative burden

that existed during the period where the contract had a cost reimbursable basis of payment. A cost-

benefit analysis could help to reveal the potential value in using provisional pricing.

When Should You Not Use Provisional Price?

• A provisional price basis of payment should not be used:

o Where there is a significant risk that Canada will not obtain the degree of collaboration and

cooperation from the supplier required for fulfilment of the contract terms unique to this basis of

payment. For example, when difficulties are experienced proposing or preparing to transition

the contract or during negotiations to transition the contract from cost reimbursable to fixed price

basis of payment.

73 | Page Public Services and Procurement Canada August 2023

o If the contract requirements and costs are stable or certain. In this situation, a fixed price basis

of payment is the more appropriate choice.

o In cases where the contract requirements and costs are likely to remain unstable or uncertain.

In this case, a cost reimbursable basis of payment is likely be the more appropriate option.

Factors to Consider

• Provisional pricing may increase administrative burden (time, resources and costs) due to the need

to assess, validate and fix the price part way through the contract. This is why it is important to

consider using cost-benefit analysis (e.g., option analysis) early in the procurement process to

ensure this basis of payment is the best fit for the requirement.

• The cost reimbursable portion of the contract comprises a similar risk exposure and resulting lower

profit premium because Canada bears the risk for cost variations. Similarly, the fixed price portion

of the contract has a similar risk exposure and resulting higher profit premiums as a fixed price

basis of payment due to the fact that the contractor bears the risk for cost variations. See Section

4.1 (Basis of Payment) for each basis of payment for further details.

• There is a risk for Canada that inefficient production practices from the cost reimbursable portion

of the contract could result if the contractor is not encouraged to control the costs. The contractor

may overstate costs to be able to establish the price at higher levels in later periods of the contract.

To help mitigate this risk, contracting officers should consider the use of cost incentives and ensure

that a price validation exercise is completed before fixing the price. For example, a price audit with

examination of actual costs and profit or benchmarking exercises, such as should-cost analysis,

could be performed.

Figure 4.1.4.b. below summarizes the key components of Provisional Price basis of payment.

74 | Page Public Services and Procurement Canada August 2023

Figure 4.1.4.b.: Provisional Price Basis of Payment: Process

Process Steps

Process Overview

Document

Decision to Use

Provisional

Pricing

• Since provisional pricing may create an increased administrative burden (time,

resources and costs) due to the need to firm up the price part way through the

contract, consider cost-benefit analysis in adopting this procurement strategy

early in the procurement process and document the decision accordingly in the

procurement file explaining how this basis of payment is the best fit for the

requirement.

Determine the

Initial Basis of

Payment to be

Used for the

Contract Price

• Determine the appropriate cost-reimbursable basis of payment that is to be used

for the initial portion of the contract corresponding to the contract’s milestones.

• Consider using the Cost Accounting Practices (CAP) Submission to develop a

common understanding with the contractor on the cost accounting practices

being applied in determining costs.

• Validation strategies prior to contract award are important to ensure proposed

costs are acceptable and that contractor’s accounting systems are sufficient and

reliable in capturing, measuring and reporting of contract costs.

• See Section 4.1.3 (Cost Reimbursable) for more information and detailed process

steps.

Initial Basis of Payment = Cost reimbursable

Maximum Price Ceiling

Milestone for Fixing Price - % of work complete

Cost Submission from Contractor

Fixed Price Recommendation from Price Validation

Price Negotiations and Amendment to Contract

75 | Page Public Services and Procurement Canada August 2023

Process Steps

Process Overview

Set the Price

Ceiling or

Limitation of

Expenditure

• Set a clear price ceiling or limitation of expenditure in the contract and monitor to

ensure it is adhered to. Refer to Section 4.3 (Ceiling Price and Limitation of

Expenditure).

Set an

Appropriate

Milestone that is

Relevant to the

Level of

Uncertainty for

the Requirement

• Milestone: Provisional pricing requires a milestone to be set in the contract to

determine when the cost reimbursable portion of the contract is complete and the

price for the remaining work is fixed. This is typically done based on a percentage

of completion of work or achievement of critical performance milestones within a

contract.

• Determine the percentage level for when the contractor will declare the cost

reimbursable portion of the work complete at which point a price validation is

required to determine the remaining work which will be performed on a fixed-price

basis.

• Document the milestone clearly in the contract and provide the justification for the

milestone in the procurement file.

• The following are suggested guidelines to follow when setting up this key

milestone in the contract:

o The milestone should generally be established at a point between 30%

to 70% of work completion.

o Decisions on the above percentage of work completion will depend on

the nature of the requirement.

o For example, where the nature of the requirement allows for costs to be

estimated early on the project timeline, a 30% work completed milestone

could be set as the point at which prices will be fixed. This may be typical

of new developmental contracts, where only 10% of the work will be

design and the next 20% represents production costs that are

predictable. In this example, the remaining costs can be easily estimated.

Negotiate

Transition from

Cost

Reimbursable to

Fixed Price

• Ensure the terms to negotiate the transition from the cost reimbursable portion

to the fixed price portion are incorporated in the original solicitation and contract.

• At a minimum, these terms should include:

o Responsibilities of Canada and the contractor – should address. cost

submission, price validation, and determining fixed price component;

o Timelines – for example a 60 day negotiation period; and

76 | Page Public Services and Procurement Canada August 2023

Process Steps

Process Overview

o Corrective measures.

Cost Submission

from the

Contractor

• This is a declaration made by the contractor that the cost-reimbursable portion

of the work has been completed and provides a cost submission prepared by

contractor relative to the remaining work on the contract that will be performed

on a fixed-price basis.

• Cost Submission:

o It is the contractor’s responsibility to declare when the milestone is

reached and then provide a cost submission.

o Contractors are required to cooperate fully and in a timely manner with

Canada by providing all necessary evidence as requested to support

the proposed costs needed to establish the fixed price portion of the

contract.

o Cost Submission:

• Breakdown of all costs incurred should be provided.

• The data must be sufficient to disclose unit cost and cost trends

for the goods and/or services performed in relation to the

contract, and inventories of work in progress and undelivered

contract supplies on hand (estimated to the extent necessary).

• The data must be accurate and reliable.

• Contracting officers should monitor the progress of the contract work to ensure

the contractor submits its declaration of percentage of work complete and a

cost submission in a timely manner.

• Provisional pricing is highly complex and involves professional judgment in

the cost acceptance and cost validation. Pricing depends on the contractor’s

accounting systems and internal controls. Contracting officers are encouraged

to seek Procurement Support Services Sector advice and assistance in both

determination of the price and obtaining assurances on the reliability and

accuracy of contractor invoices.

• Contracting officers should also anticipate when the cost reimbursable

milestone will be reached and communicate the expected timeline with the

Procurement Support Services Sector to enable PSSS to provide support in

77 | Page Public Services and Procurement Canada August 2023

Process Steps

Process Overview

the validation of costs and facilitate the timely completion of the exercise to fix

the price for the remainder of the contract, and limit delay in the continued

work under the contract.

Fixed Price

Recommendation

from Price

Validation

• Canada needs to validate the reasonableness of the contractor’s proposed costs

and profit.

• A price validation exercise will be conducted to determine a fair and reasonable

fixed price for the remainder of the contract.

• A price validation exercise usually involves a review of the actual costs incurred

to establish a basis from which a fixed price may be determined.

o It is recommended that Contracting officers seek assistance from the

Procurement Support Services Sector when conducting a price

validating exercise.

• Costs can also be validated through benchmarking (for example, comparison of

costs using market-data or historical data, etc.) if the information is available.

• An appropriate profit level will need to be negotiated as part of the fixed price.

o This would be calculated in accordance with Section 5.2 (Profit

Principles). Support for negotiating a fair and reasonable profit is

available from the Procurement Support Services Sector’s Price

Advisory Group.

• Cost information must be submitted by the contractor in a timely fashion and

Canada must, similarly, conduct its price validation exercise in a timely manner

so as to limit the delay to conversion of the basis of payment, and unnecessarily

impacting the progress of the work under the contract.

Price

Negotiations and

Use of Dispute

Resolution

Process, if

required

• Based on terms and conditions set out in the original contract, along with

recommendation on the fixed price from the price validation exercise, Canada

and the contractor will together negotiate a fixed price for the remainder of the

contract.

• In the event, the contractor and Canada are unable to come to an agreement on

a fixed price for the remainder of the contract:

• The dispute resolution process outlined in the contract may be invoked.

If agreement cannot be reached, then it may be necessary to

renegotiate the contract on a cost reimbursable basis of payment or

terminate, if the contractor’s proposed going forward is unaffordable.

78 | Page Public Services and Procurement Canada August 2023

Process Steps

Process Overview

• Contracting officers are recommended to consult with the Procurement Support

Services Sector in this situation.

Incorporate New

Pricing

Amendment to

Contract to

• After a fixed price is negotiated, the original contract will be formally amended to

convert its basis of payment to fixed price for the remainder of the contract period.

• The amendment must include an updated basis of payment clause, which

captures the cost reimbursable basis of payment for the initial portion of the

contract, which is now complete, and the fixed price basis of payment of the

remainder.

Monitor, Review

and Evaluate

Pricing Strategy

• Monitor, review and evaluate the pricing strategy, as required, throughout the

contract. Take note of any issues with the contract and ensure early engagement

with PSSS to resolve any pricing matters.

Price Validation

• Validate costs claimed by the contractor upon completion of the contract or

periodically, for example annually in the case of multi-year contracts.

• For more information on validation strategies see Section 3.4 (Developing a

Validation Strategy).

Document,

Justification,

Authorization

• As applicable throughout this process, ensure all decisions are appropriately

documented, justified, and authorized.

• For cost-reimbursable basis of payment, ensure a detailed breakdown of the

acceptable costs, given their nature and amount, is explicitly included in the

contract and documented in the procurement file, as well as direction on how the

price will be administered throughout the contract period.

• See Section 3.3 (Documenting & Justifying Key Price Decisions) for further

details.

Example 4.1.4.a.: Provisional Pricing

There is a requirement to build six ships for Canada but the cost per ship cannot be reasonably estimated at

the start of the contract. This being the case, the contractor is reluctant to commit to a fixed price. Provisional

pricing offers a means to transition a contract to a fixed price, once greater certainty exists. Initially, a cost

reimbursable basis of payment is used to establish the price.

It is believed that once two ships have been constructed, the contractor will be in a reasonable position to

estimate its costs for the remainder of the contract. As such, completion of the two ships represents a critical

performance milestone for the conversion of the basis of payment from cost reimbursable to fixed price.

79 | Page Public Services and Procurement Canada August 2023

Once the contractor has constructed the first two ships, the contractor advises Canada that this critical

performance milestone has been reached, and provides a cost submission, estimating the contractor’s cost

to construct the remaining four ships. The cost base is expected to benefit from the experience gained from

constructing the initial two, taking into account learning curve and production efficiencies. This cost

submission provides a basis for fixed pricing negotiations.

When the reasonableness of the estimated costs has been established, profit is negotiated, in accordance

with Section 5.2 (Profit Principles), and the total fixed price (cost plus profit) for the remaining four ships is

now established.

The contracting officer amends the contract to update the basis of payment.

80 | Page Public Services and Procurement Canada August 2023

4.2 ECONOMIC PRICE ADJUSTMENTS (EPAS) AND FOREIGN CURRENCY ADJUSTMENTS

(FCAS)

Definition

Economic price adjustments and foreign currency adjustments are tools in place to mitigate specific pricing

risks resulting from changing market conditions, where one or more elements of the cost of a good or service

may be subject to significant price fluctuations (i.e. increase and decrease) that are outside of Canada and

the contractor’s control (e.g., commodity prices, foreign exchange, and labour rate in collective bargaining

negotiations).

In these instances, neither Canada nor the contractor would have confidence in accepting a fixed price over

an extended period of time. As a result, the price is set or negotiated with a provision that allows for revisions

to the fixed base price upon the occurrence of certain contingencies.

• EPAs mitigate a significant risk posed by market fluctuations associated with a contractors’ input

costs related to a specific commodity (commodity risk).

• FCAs mitigate a significant risk posed by currency fluctuations related to a foreign-based source of

supply (foreign exchange risk).

When to use

• When it is not possible for Canada and the contractor to make a realistic estimate of future material,

labour or overhead costs, and the potential variations in these costs could be significant.

• In fixed price or fixed time/unit rate basis of payment in both competitive and non-competitive

situations. Adjustments to fixed prices or fixed time/unit prices in a contract will be allowed only if

provided for in the contract. Refer to various clauses for EPAs and FCAs in subsection 5-C of the

SACC Manual.

For example, when significant uncertainty exists in the market, such that:

• The contractor’s commodity pricing is highly volatile;

• Labour rates are a significant portion of the contract costs, and the contractor is in collective

bargaining negotiations; or

• A critical and designated source of supply for its input costs are exposed to foreign currency risk.

Economic price adjustments should not normally be included in contracts with delivery schedules of less than

12 months, or contracts valued under $100,000.

Factors to consider

• EPAs/FCAs can be applied in both competitive and non-competitive scenarios when warranted and

must be identified in all approval documents and the resulting contract.

• EPAs/FCAs provisions provide for both price increases and decreases to protect Canada and the

contractor from the effects of economic changes.

• Other considerations that could be made instead of or in addition to EPAs/FCAs for areas of

significant fluctuations, include:

81 | Page Public Services and Procurement Canada August 2023

o postpone the procurement;

o use available substitute products;

o provide advance information on requirements to potential contractors, to benefit from their

improved ability to control costs by forward planning, and to make full use of the commodity

futures markets in appropriate circumstances;

o reduce the period of term contracts or the quantities ordered on production contracts;

o increase production rates to compress the duration of contracts;

o reduce administrative time allowances in the procurement process (solicitation, award decision,

award of contract and authority to commence work), while adhering to required time frames

under Canada's trade agreements; and

o isolate the unstable element in pricing the work and providing for price adjustment, both upward

and downward, on it alone, in accordance with a reliable predetermined formula such as an

established economic index.

Process Steps

Process Overview

Determine

Whether a

Provision for an

EPA or FCA is

Required and

Document and

Justify the

Decision

• Supporting documentation to justify the use of this provision should be included

in the appropriate procurement file.

• When a competitive bidding process is used, the proposed EPA or FCA

provisions must be clearly outlined in the solicitation document. In all other

situations, EPA or FCA provisions must be agreed upon during negotiation of the

initial or base year contract price.

• The advice of a price advisor (from PSSS) is recommended in the development

of any significant or major economic price adjustment provisions, in accordance

with the Directive and Guideline on the Use of Cost and Price Analysis Services.

Establish the

Fixed Price/ Fixed

Time/Unit Rate

• See Section 4.1.1 (Fixed Price) or Section 4.1.2 (Fixed Time/Unit Rate) for more

information.

82 | Page Public Services and Procurement Canada August 2023

Process Steps

Process Overview

Establish How the

Contract Price will

be Adjusted

Upwards or

Downwards

• The price adjustment method used should be the simplest, most suitable

adjustment formula to provide the protection necessary to both parties with the

least administrative effort.

• Where a price adjustment is used, the awarded contract must include a term

specifying a ceiling price.

• The awarded contract must clearly identify the fixed price/rate (the base price),

the adjustment methodology or price index/exchange rate used (if applicable),

and the base period for which adjustments are to be made.

• A trigger point could be defined in the contract to establish when an EPA or

FCA is required (i.e., annual market change, raw material index +/- 3%)

• Adjustment provisions to prices for commercial goods and services:

o If the fixed price/rate includes a discount factor, from the initial or then

current established catalogue price, the same discount factor should

be applied to the adjusted price, unless otherwise stated in the contract.

o Statistics Canada publishes a variety of reports, providing changes in

price indices, material and labour costs. The Department of Labour

performs this function in the United States. Private sector surveys may

also be used. Numerous bank rates are also available for use with FCA

provisions.

• Adjustments to actual costs for labour or material:

o Ensure the contractor's accounting system permits timely compilation

of all necessary cost data relative to the EPA and/or FCA during

contract performance.

o The calculation of any adjustment formula should remain consistent

with the cost/price accounting treatment used to arrive at the base

price. This will ensure accuracy in measuring variation from the base

price.

o A company's union agreement with its employees may be considered

an acceptable economic labour rate index for that company, provided

that it reflects comparable labour rate movements within that industrial

sector.

83 | Page Public Services and Procurement Canada August 2023

Process Steps

Process Overview

Incorporate

Pricing into the

Contract

• The price adjustment formula must provide for both upward and downward

revision of the fixed base price and include a ceiling price or limitation of

expenditure. It must identify, if applicable, the economic wage or price index to

be used, the fixed base price element, and the base period for which adjustments

are to be made.

• The various economic price adjustment clauses are in subsection 5-C of the

SACC Manual.

Monitor, Review

and Evaluate

Pricing Strategy

• Monitor, review and evaluate the pricing strategy, as required, throughout the

contract. Take note of any issues with the contract and ensure early engagement

with PSSS to resolve any pricing matters.

Documentation,

Justification,

Authorization

• Ensure all decisions are properly documented, justified and authorized

throughout this process in the procurement file.

• See Section 3.3 (Documenting & Justifying Key Price Decisions) for further

details.

Example 4.2.a

There is a requirement for a contract for a production aircraft component which contains carbon steel.

Contract performance is expected to be for a period of five (5) years.

It was identified that 35% of the acquired part would be composed of carbon steel, the price of which may

fluctuate significantly over time. Therefore, it was agreed that an EPA clause would be included in the

contract in order to decrease the risk of cost uncertainty to the contractor or Canada. It was agreed to

adjust the price based on changes in the Global Carbon Steel Index (GCSI), which is considered to provide

the most accurate depiction of price changes of carbon steel.

The base point against which the changes would be compared was determined to be the GCSI figure for

the month when the contract commenced. The price would then be subject to adjustment at the end of the

each one-year period. Having the price set for each component item, the following EPA formula was

incorporated into the contract:

   

     󰇛  󰇜  

Where: B = GCSI for base period;

I = GCSI for the month preceding the month of reassessment of the price;

L = percentage of the price subject to adjustment;

P = base unit contract Price.

84 | Page Public Services and Procurement Canada August 2023

If:

• the base unit price for the procured part is $1,000;

• the GCSI for the base period is 142.1;

• the GCSI for the month preceding the month of reassessment of the price (one year after

signing the contract) is 168.7; and

• the percentage of the price subject to adjustment is 35% of the unit price,

Then:

•    

    󰇛  󰇜 



The calculated adjusted unit price of $1,065.52 will be used to price the contract for the next one-year

period.

85 | Page Public Services and Procurement Canada August 2023

4.3 CEILING PRICE AND LIMITATION OF EXPENDITURE

Contract budgets could be exceeded if actual costs or volumes are greater than estimated in a fixed time/unit

rate or cost reimbursable contract. This risk can be mitigated by the use of price control mechanisms such

as a ceiling price or limitation of expenditure.

• A ceiling price is used when the level of effort or quantity can be realistically estimated and there is

full agreement between the parties as to what constitutes the prescribed work. The contractor must

complete the prescribed work without additional payment, whether or not actual costs exceed the

ceiling price.

o During negotiations of a ceiling price, consider the uncertainties involved in contract

performance and the cost impact. Also, the ceiling should provide for assumption of a

proportion of the risk by the contractor.

o SACC Manual clause C6000C must be used in a ceiling price contract where it is necessary

to ensure the contractor does not make changes or carryout additional work without the prior

written approval of the contracting officer.

• A limitation of expenditure is the maximum amount of money a contractor may be paid for the

prescribed work. The limitation of expenditure is normally used when the level of effort cannot be

accurately estimated at the outset in cost-reimbursable and fixed time/unit rate type contracts.

“Expenditure” in this context, refers to payments made by Canada to the contractor. The clause

limits Canada’s total liability under a contract and establishes a notification and reporting

requirement on the part of the contractor. At the client’s request, the contracting officer will amend

the contract to increase the limitation of expenditure or request the contractor to complete the work

to the extent that the limitation of expenditure permits.

o SACC Manual clause C6001C provides for a limitation of expenditure which is a maximum

amount the contract may be paid for the prescribed work.

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4.4 INCENTIVES

What is an Incentive?

An incentive is the conscious use of rewards and recognition to encourage desired behaviour.

An incentive is a tool used in contracting to maximize value to both the Government of Canada and the

contractor by motivating and rewarding the achievement of Canada’s desired outcomes, when appropriate.

Incentives can be both short-term to achieve

specific goals or long-term to encourage the

sustainment of behaviours.

When appropriately structured, incentives can

allow Canada to focus the contractor on the

outcomes of critical importance to a procurement.

Incentives also allow Canada to share in cost

savings and risks while affording the contractor an

opportunity to earn more profit.

For additional information on the benefits of incentives, please refer to Annex 5.2.1 (Discussion Paper:

Contract Incentives to Encourage and Reward Enhanced Value to Canada).

When to Use

Incentives can be used:

• In both competitive and non-competitive procurements; and

• With all bases of payment types to reward superior contract performance which exceeds the base

standards established in the Statement of Requirement/Work and provides value to Canada.

When Not to Use

Incentives may not be appropriate or effective for all contracts, particularly when:

• The contractor will achieve the target performance criteria without an incentive.

• The contractor will not be motivated by the incentives to achieve the target performance criteria.

• There is minimal to no value to Canada for the contract to perform beyond the base standards

established in the statement of requirements.

Did You Know?

• Incentives can be used in both competitive

and non-competitive procurements.

• Incentives can also be used in with all bases

of payment types to reward superior contract

performance which exceeds the base

standards established in the statement of

requirement.

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Factors to Consider

• The performance objectives or outcomes associated with the incentive should be balanced and

aligned to the most important objectives of the procurement. Rewarding a contractor for simply

meeting the contract requirement should be avoided.

• Incentives should be challenging and add value to a procurement when achieved. It is important to

avoid incentives that are easily achieved and don’t add value to the procurement, but also to note

that when incentives are too challenging and difficult to achieve, a contractor may be discouraged to

invest the effort and cost required to achieve the performance.

• An assessment is needed to ensure the incentive(s) will, in fact, motivate a contractor to perform

(e.g., follow-on business, growth, maintaining or retaining a production capability, and positive past

performance information). This will vary by contractor based on many factors including but not limited

to basis of ownership, size, diversification, and organizational culture.

• Consideration should be given to whether or not the contractor has control over the achievement of

the incentives and whether the performance objectives can be measured and verified, which includes

ensuring that the contractor’s systems can adequately track the information required for

measurement.

• The benefits of the contract outcomes should exceed the combined cost of the incentives and cost

of their administration to all parties.

• The structure and administration of incentives should be as simple as possible. Simple, limited, high

level objective measurements are preferred over complex multi-variable algorithms. This includes

avoiding the use of too many incentives in a single contract. Too many incentives dilute the focus

and makes it more likely for the Government of Canada to pay for unintended outcomes. See the

section on Multiple Incentives and Competing Objectives below.

• If there are unstable market conditions and the procurement includes the use of an Economic Price

Adjustment (EPA) or Foreign Currency Adjustments (FCA), the EPA or FCA must be excluded from

determining the incentives. (See Section 4.2 Economic Price Adjustments and Foreign Currency

Adjustments for more information).

• The involvement and active communication with all stakeholders including program, technical,

acquisition, and price advisors in the incentive planning process is essential. In addition, modelling

of the impact and value of incentive programs from both the Government of Canada and the

Contractor perspectives is essential.

• Incentives may modify contractor behaviour. In order to ensure the behaviour modification is

planned and welcomed, it is imperative that the contract structure, including basis of payment,

88 | Page Public Services and Procurement Canada August 2023

statement of work, and performance management plans, be developed considering the perspective

of both the Government of Canada and the contractor. An incentive plan that is not informed by all

parties and perspectives can result in unintended consequences on a procurement.

Timing

Establishing incentives and how they will be applied, measured and tracked should be decided before a

contract is put into place and when the priorities and most important objectives of the procurement are

defined. It is important to stress, however, that planned incentives can be applied at multiple stages within a

procurement.

Non-Competitive Contracts: With respect to non-competitive contracts, incentives can be introduced during

negotiations of a contract price and applied anytime throughout the life of a contract.

Competitive Contracts: When it comes to competitive contracts, it is recommended that incentives be

introduced in the solicitation, as part of the resulting contract clauses. If there are uncertainties in terms of

the application of incentives, specific incentive parameters can be stated in the solicitation.

There will be times, however, particularly in contracts where the scope and performance of the goods and/or

service being contracted has too much uncertainty and will become clearer over time. In these situations, the

procurement team may have more information and, as a result, may be in a better position to apply incentives

appropriate for the contract. In these cases, the incentives to a contract may be in the best interest of all

parties. With respect to competitive contracts, negotiations would need to be undertaken within the

parameters established in the solicitation. Considerations should be given to the limitations established by

the various trade agreements.

Incentive Types

There are a number of incentive options available. The following is a list of incentives for which additional

guidance has been provided in the Guide. This is not to be considered an exhaustive list of incentives, but

rather a starting point from which to establish a base incentive. Table 4.4.a. below provides a brief description

of the following incentive types:

• Technical performance incentives;

• Schedule performance incentives;

• Awards fees; and

• Non-financial incentives.

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Table 4.4.a.: Incentive Types

Section of

Guide

Incentive

Type

Description

Objective

4.4.1

Technical

Performance

Incentives

The contractor is provided with the

opportunity to earn additional profit

upon achievement of one or more

technical performance goals.

• Superior technical

performance;

• Performance reliability;

• Improved service delivery;

and

• Increased availability.

4.4.2

Schedule

Performance

Incentives

The contractor is provided with the

opportunity to earn additional profit

upon achievement of one or more

targeted delivery dates.

• More timely delivery

4.4.3

Award fees

An award fee establishes a pool of

funds available to the contractor in the

event the contractor exceeds pre-

established performance elements.

Award fee arrangements are

appropriate when important elements of

performance cannot be objectively or

quantitatively measured.

• To achieve superior

performance in areas that

can only be measured

subjectively.

For example:

• Superior customer service;

• Management

responsiveness; and

• Quality assessments.

4.4.4

Non-

Financial

Incentives

The contractor is incented to achieve

superior performance to earn non-

monetary rewards that are not part of a

contractor’s pay.

• To exceed overall contract

performance objectives.

Multiple Incentives and Competing Objectives

It is possible to incent only one objective or multiple objectives in a single contract. While it can be

complex, effectively balancing incentives across multiple objectives can help avoid the unintended

consequence of sacrificing the performance of certain objectives. For example, a contractor may decide

90 | Page Public Services and Procurement Canada August 2023

to sacrifice the quality of a product if the only incentive in place in the contract is tied to product delivery

within a scheduled target date.

For multiple incentives to work as intended within a contract and to avoid competing objectives, it is

important to ensure that goals are not in conflict and that the different incentives are appropriately

balanced with consideration of the contract’s overarching priorities and objectives.

Examples of competing objectives:

• Cost versus Technical Performance

o It is likely that the cost to build and service a ship for achieving greater number of days at sea

is higher with each additional day at sea.

• Technical Performance versus Schedule

o It will likely take longer to build and test a missile that will travel farther and be more accurate.

• Schedule versus Cost

o In the ship building example, additional project work could result in overtime and higher labour

costs to meet delivery timelines.

o On the other hand, a ship builder incorporating new technology in production might be able to

deliver early and reduce overall project costs.

Selecting the Appropriate Incentive

To determine which incentive is best for a procurement it is important to start by assessing how the cost,

schedule and technical risks associated with the contract have been allocated in the basis of payment. This

would include consideration of the following two questions:

• How much risk and responsibility has already been assumed by the contractor for the cost of the

performance; and

• How much profit is already included in the contract to achieve the performance objectives?

The decision to use incentives and to determine which incentives to use requires professional judgement

by the contracting officer. There is no exact recipe on the necessary pricing elements for each

procurement. Instead, analysis, understanding and professional judgement are required.

See Section 4.5 (Pricing Approach Selection) for further considerations to considerations related to the choice

of Basis of Payment and Incentives.

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4.4.1 TECHNICAL PERFORMANCE INCENTIVES

Definition

Technical performance incentives include the technical goals that have to be achieved in performing the

contract and to bring value to Canada. These goals can be expressed in the form of technical criteria as well

as specifications and requirements. Incorporating technical performance incentives in a contract aims to

achieve and/or improve technical parameters related to the procurement that are of critical importance to

Canada. Upon achievement of one or more specified levels of technical performance, the contractor is

provided with the opportunity to earn additional profit.

When to Use

• When performance excellence and improvements would add value or are of critical importance to

the procurement and to Canada (e.g., quality and technical ingenuity).

• When it is possible to establish predetermined, objective and measurable incentive targets

applicable to technical performance.

• In all forms of pricing approaches ranging from fixed price to cost reimbursable.

• In combination with and in addition to other incentive plans related to cost, delivery and performance.

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Factors to Consider

Risks

Benefits

• Complicated to apply because it can be difficult

to establish an appropriate incentive formula

and to ensure it is fair with an optimal allocation

of risk and reward to incent the contractor to

deliver on performance objectives (e.g., cost

efficiency, technical sufficiency).

• Resources are required to monitor, manage

and evaluate.

• Can provide a practical way to motivate

excellence in contractor performance or to

meet technical performance criteria critical to

Canada.

• When established without a corresponding

cost control incentive or process, it can

potentially result in cost inefficiencies.

• It is effective only for incenting performance for

criteria that are objective. It should not be used

on performance criteria that require

professional judgement to assess actual

performance. See Section 4.4.3 (Award Fees)

for incentives related to subjective criteria.

Process Steps

Process Overview

Develop and

Define the

Performance

Criteria and

Parameters

• The selection of performance criteria and parameters relies heavily on contract

technical considerations.

• Selection of performance criteria and parameters are based on the technical

specifications in the procurement requirements and technical proposals of the

contractor.

• Choose the important elements of performance from which Canada would benefit

from improvements such as future cost savings related to production, operational

efficiencies and increased capabilities.

• The benefit to Canada of improving the minimum requirement must be clear and

definitive. There are no set rules for defining this benefit, and the criteria will vary

based on the procurement. They must be achievable at the minimum acceptable

level.

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Process Steps

Process Overview

Define the

Performance

Range and

Target

• Competitive Contracts: It is necessary to ensure that the performance levels are

formally accepted by the client and are reasonable for the potential suppliers.

• Non-Competitive Contracts: It is necessary to ensure that the performance levels

are formally accepted by both the client and the proposed contractor.

• Establish three targets:

• Standard Performance Target: Level of performance the contractor will likely

achieve with normal technical and management effort.

• Minimum Acceptable Performance: Level of minimum performance required

to meet the contractual performance obligation. This level must be

achievable and acceptable if only minimum performance levels are

achieved.

• Maximum Performance: Level of maximum performance that will add value

to the procurement. Above the maximum value, no further incentives are

required because it will no longer add value to Canada. This level should not

be set so high that a major technological breakthrough would be necessary

to achieve it.

Develop the

Incentive

Formula

There are many options available for Performance Incentive formulas. The following

are the two most commonly used formulas as shown in SACC Manual clause C8006C:

Variable Payment

• Rewards an increase on a pro rata basis for each level of improvement

above the standard performance target level up to the maximum

performance level.

• A pre-established formula determines the value to Canada of each

incremental increase/decrease in performance to the maximum and

minimum levels.

• A straight-line formula is the most standard method of applying this

incentive.

Target Incentive Fee

• Rewards a contractor a set fee for meeting specific performance targets.

• Performance targets that add value to Canada are clearly outlined in the

contract along with the corresponding fee percentage or dollar value.

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Process Steps

Process Overview

Establish

Methodology for

Validation of

Performance

• Define the validation process for the establishment of the levels to be achieved.

• Ensure all parties clearly understand and accept how performance will be

measured for the purpose of assessment.

• Validation programs and procedures should be well documented including details

such as timing, methods of testing, locations for testing, testing conditions,

number of tests and parties to observe testing.

Documentation,

Authorization

and

Incorporation

into Contract

• Performance levels, ranges and validation methods for determining whether or

not performance has been achieved must be documented in the contract.

• Ensure all parties clearly understand and accept the performance measurement

criteria.

• Clearly define the incentive targets and formulas along with the dollar or

percentage values to be awarded at each increment or target.

See Section 3.3 (Documenting & Justifying Key Price Decisions) for further

details.

Examples

The following examples are designed to show how to calculate the incentives.

Example 4.4.1.a.: Variable Payments Incentive

There is a contract for construction and ongoing cost of operations of a Canadian Coast Guard ship that

indicates that:

• The standard number of days required by the Canadian Coast Guard for the ship to be available to

be at sea is 150 days.

• The minimum acceptable period at sea is 140 days.

• The maximum period from which the Canadian Coast Guard could benefit from the ship being at sea

is 200 days.

• The base payment amount is $10,000,000.

• The available variable payments incentive amount is $500,000.

The difference between the maximum number of days at sea and the standard number of days is 50 (i.e. 200

less 150). Thus, the contractor has an opportunity to receive $10,000 more (i.e. $500,000 divided by 50

95 | Page Public Services and Procurement Canada August 2023

days) than the base pay of $10,000,000, for each additional day of being able to stay at sea above the target.

Similarly, the base pay could be reduced by the same amount for each day at sea below the target number

of days up to the point where the minimum requirements are reached.

Scenario 1

If the assessment of actual performance on the technical requirement shows that the coast guard ship could

be at sea for as many as 180 days, then the calculation of total contract price will be as follows:

• Base payment = $10,000,000;

• Variable amount (for each day of variance from the target period) = $10,000;

• Standard target period as per requirements = 150 days;

• Actual period for which the ship could stay at sea = 180 days;

• Payment adjustment = (180 days – 150 days) x $10,000 = $300,000; thus

• Total price = $10,000,000 + $300,000 = $10,300,000.

Example 4.4.1.a: Variable Payments Incentive (continued)

Scenario 2

If the assessment of actual performance on the technical requirement shows that the coast guard ship could

be at sea for no more than 145 days, then the calculation of total contract price will be as follows:

• Base payment = $10,000,000;

• Variable amount (for each day of variance from the target period) = $10,000;

• Standard target period as per requirements = 150 days;

• Actual period for which the ship could stay at sea = 145 days;

• Payment adjustment = (145 days – 150 days) x $10,000 = - $50,000; thus

• Total price = $10,000,000 - $50,000 = $9,950,000.

Example 4.4.1. b.: Target Performance Incentive

The same contract example presented above is used, but in this instance, target incentives have been

established for achievement of 180 days at sea valued at $150,000 and of 200 days at sea valued at

$300,000.

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Scenario 1: Contractor achieves 180 days

• Base payment = $10,000,000;

• Target incentive = $150,000; and

• Total price = $10,000,000 + $150,000 = $10,150,000.

Scenario 2: Contractor achieves 200 days

• Base payment = $10,000,000;

• Target incentive = $300,000; thus

• Total price = $10,000,000 + $300,000 = $10,300,000.

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4.4.2 SCHEDULE PERFORMANCE INCENTIVES

Definition

Schedule performance incentives involve rewarding the achievement of incentivised delivery timeline goals

set in the contract that are of critical value or provide additional value to Canada. The contractor is provided

with the opportunity to earn additional profit upon achievement of one or more targeted delivery dates.

When to Use

• When it is of critical importance to Canada to receive a good or service in a timely manner.

• When it is feasible to establish predetermined, objective and measurable incentive targets applicable

to delivery times.

• In all forms of pricing approaches ranging from fixed price to cost reimbursable.

• In combination with and in addition to other incentive plans related to cost, delivery and performance.

Factors to Consider

Risks

Benefits

• Canada’s action can both positively and

negatively impact contractor performance.

For example, a schedule performance

incentive could compromise the quality of

work.

• When established without a corresponding

cost control incentive or process, it can

potentially result in cost inefficiencies.

• Practical way to achieve required timelines.

• Practical way to ensure matters of an urgent

nature are delivered on time.

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Process Steps

Process Overview

Establish the

Schedule

Requirements

• The delivery requirement must be realistic and cannot be based on dates that are

impossible to achieve. At the same time, it must not be so easy that the contractor

could achieve the dates with minimal effort.

• Establish flexibility in the incentive with the use of minimum, maximum and target

dates, where possible.

Define the

Target Dates

and Date

Ranges

• Target dates are the delivery dates of critical importance to the performance of the

contract:

o One Target Date: The delivery incentive will provide a bonus payment simply

if the target date is met and no bonus payment if the date is not met.

o Target Date Range: The earlier the completion of performance the greater

value to Canada and the greater the incentive up to a maximum acceptable

delivery period.

Link Schedule

Requirements to

Performance

Requirements

• It must be clear that the delivery incentive is also contingent on the specifications

of the contract being met.

• If specifications are not met and further work is required to meet contract

specifications, the delivery time is measured to the point the work meets the

specifications.

Establish

Incentive

Formula

There are many options available for Schedule Incentive formulas. The following are

the two most commonly used formulas as shown in SACC Manual clause C8007C:

Variable Payment

• Rewards increase on a pro rata basis for each time period closer to the earliest

delivery date desired.

• If desired, penalties increase on a pro rata basis for each time period after the

standard delivery target up to the latest acceptable delivery date.

• Pre-established formula determines the value to Canada of each incremental

increase/decrease in schedule to the maximum and minimum dates.

• A straight-line formula is the most standard method of applying this incentive.

Target Incentive Fee

• Rewards a contractor a set fee for meeting a specific schedule target.

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Process Steps

Process Overview

• Schedule targets that add value to Canada are clearly defined in the contract

along with the corresponding fee percentage or dollar value.

Documentation,

Authorization

and

Incorporation

into Contract

• The dates or date range (earliest delivery date desired, standard delivery target,

and latest acceptable delivery date) must be clearly documented in the contract.

• The time intervals and formula over which the delivery incentive will be paid must

also be clearly documented and included in the contract.

• See Section 3.3 (Documenting & Justifying Key Price Decisions) for further details.

Examples

The following examples are designed to show how to calculate the incentives.

Example 4.4.2.a.: Variable Payment Incentive

• A contract has a base payment amount of $500,000.

• The target delivery time for the requirements was negotiated as 50 weeks, with the latest and

earliest acceptable completion dates being 55 and 40 weeks, respectively, from the outset of the

contract.

• A variable incentive (and penalty) was established at $5,000 per week for completion of the work

in advance (or behind) the target delivery time, up to a maximum incentive of $50,000. This

approach applies a straight line formula to the incentive, up to the established maximum.

Scenario 1

If the contractor delivered on the contract requirements in 43 weeks which is earlier than the target delivery

date by seven (7) weeks, then the calculation of total contract price would be as follows:

• Base payment = $500,000;

• Variable amount (for each week of variance from the target delivery date) = $5,000;

• Standard target period as per requirements = 50 weeks;

• Actual delivery period = 43 weeks;

• Payment adjustment = (50 weeks – 43 weeks) x $5,000 = $35,000; thus

100 | Page Public Services and Procurement Canada August 2023

• Total price = $500,000+ $35,000 = $535,000.

Scenario 2

If actual delivery on the contract requirements was in 54 weeks, which is later than the target delivery date

by four (4) weeks, then the calculation of total contract price would be as follows:

• Base payment = $ 500,000;

• Variable amount (for each week of variance from the target delivery date) = $5,000;

• Standard target period as per requirements = 50 weeks;

• Actual delivery period = 54 weeks;

• Payment adjustment = (50 weeks – 54 weeks) x $5,000 = -$20,000; thus

• Total price = $500,000 - $20,000 = $480,000.

Example 4.4.2.b.: Target Schedule Performance Incentive

• A contract has a based amount of $500,000.

• The target delivery time is 50 weeks, and will equate to a $50,000 incentive if met, for a total payment

amount of $550,000.

• If the delivery takes place after the target delivery date, the incentive of $50,000 is not paid, and the

maximum payable for the work, if and when complete, will be $500,000.

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4.4.3 AWARD FEES

Definition

Award fee incentives are used to motivate contractors to perform in areas critical to a procurement’s success

that are subject to judgment and qualitative measurement and evaluation. The award fee incentive is a pool

of funds, up to a maximum of which the contractor can earn, in addition to any profit or base-fee, upon an

evaluation of performance against pre-established criteria.

Figure 4.4.3.a.: Award Fees

When to Use

• When evaluating a performance that is subjective in nature and it is not feasible to determine

objective incentive targets applicable to cost, schedule or technical performance.

• When the contract amount, performance period, and expected benefits should warrant the cost of

the additional administrative and management effort of using award fees.

• When there is something to be gained by motivating excellence in performance including quality,

expediency, technical ingenuity and cost-effective management.

• In all forms of pricing approaches ranging from fixed price to cost reimbursable and in combination

with other incentives.

Profit

Cost

Max

Fee

Min

Fee

Target Cost

100/0

Share Line*

Base Fee or Profit

Award Fee Pool

*100 = Canada's share, 0 = contractor's share

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Factors to Consider

Risks

Benefits

• Significant administrative burden. Requires

resources to monitor, manage and evaluate.

• Challenging to align award fee earnings with

contract performance outcomes.

• Canada’s actions can both positively and

negatively impact contractor performance.

• Low qualitative ratings can potentially cause

tension with contractors.

• If multiple evaluation periods are in place

over the term of the contract, there is a risk

of disproportionate allocation of the total

award-fee pool over the evaluation periods.

A greater portion of award fees could be

earned in the early stages of the contract,

which could lower the contractor’s motivation

and lead to poor performance towards the

end of the contract.

• Awards fees can be a flexible way to motivate

excellence in contractor performance.

• Can motivate a contractor to concentrate

resources in areas critical to a program’s success.

• In a contract where cost control exists award fees

can focus the contractor’s efforts on qualitative

key performance areas.

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Process Steps

Process Overview

Prepare and

Document an

Award Fee Plan

• The award fee plan structures how the contractor’s performance will be

evaluated and is aligned with the government’s strategy, goals and objectives

for the procurement.

• Not all award fee contracts will be structured and administered in the same way.

• All details of an award fee plan must be documented and incorporated in the

procurement file.

• The plan must clearly communicate the key factors within an award fee

incentive, which includes the award fee amount and evaluation details such as

evaluation periods, teams, categories, criteria, ratings and process.

Develop the Award

Fee Amount

• The award fee must incorporate the following factors:

o Value to Canada for exceptional performance;

o Amount required to sufficiently motivate the contractor to achieve

exceptional performance; and

o Complexity of the work and the resources required for contract

performance.

• There are a number of different approaches to establish the award fee pool

such as a review of previous and current contracts for similar requirements,

awarding percentages based on risk and the importance of the established

evaluation criteria, the total value of the contract, and cash flow analysis.

• Award fees are earned by meeting predetermined evaluation criteria. The

contractor begins with 0% of the available award fee and must work up to the

evaluated fee.

Develop the

Evaluation Period

• The contract performance can be divided into evaluation periods when

required. It is possible to have one or multiple evaluation periods.

• Avoid evaluation periods that are too short in length, which can lead to

excessive administrative burden on the contract.

• Ensure that there is sufficient amount of the award fee available for payment at

contract completion to motivate contractor performance through to the end of

the contract.

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Process Steps

Process Overview

Establish the

Evaluation Team

• The number of members forming the evaluation team and their qualifications

will depend on the nature, dollar value and complexity of the acquisition.

• An appropriate balance between technical expertise and procurement expertise

should be considered.

• The evaluation team members must be familiar with the contract and the work

being performed, the evaluation categories, criteria and plan. The evaluation

team must also have the time available to commit to the evaluation in a timely

manner.

Develop the

Performance

Category

Basis of Payment

Standard

Rate

Available

Range

Fixed Price/Rate

Fixed Price

4 %

4 - 7 %

Fixed Price/Rate

Firm Price

4 %

4 - 7 %

Fixed Price/Rate

Fixed Time/Unit Rate: Ceiling Price *

1 %

1 – 4.5 %

Fixed Price/Rate

Fixed Time/Unit Rate: No Ceiling Price *

1 %

1 – 3.5 %

Cost Reimbursable

Cost Reimbursable: Target Cost /Incentive Fee

1 %

1 – 4.5 %

Cost Reimbursable

Cost Reimbursable: Fixed Fee with Ceiling Price

1 %

1 – 4.5 %

Cost Reimbursable

Cost Reimbursable: Fixed Fee No Ceiling Price

0 %

0 – 1 %

Cost Reimbursable

Cost Reimbursable: No Fee No Ceiling Price

0 %

* For Fixed Time/Unit Rate basis of payment, if rates are negotiated in arrears, refer to R4. Timing of

Negotiation.

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How to work within the Contractual Risk Profit Range?

Consider the Risk Factors

As detailed in Table 5.2.3.a above, the basis of payment for a contract determines the standard contractual

risk profit rate and the available range of profit. The level of contractual risk profit varies within the ranges

depending on the presence, likelihood, and impact of risk factors. The key risk factors to consider include:

• Accuracy of costing, and

• Technical and schedule risks

The key risk factors, sub-factors, and their impact are explained in Table 5.2.3.b below.

Key Questions to Ask

From there, Table 5.2.3.c: Key Questions to Ask, walks a contracting officer through a series of questions

related to the key risk factors to assess the presence, likelihood and impact of contractual risk in a contract.

Each procurement and program is unique, and the questions are designed to provide discussion points

among stakeholders regarding risk and to enhance each party’s understanding of contractual risk. The goal

of the assessment is to have an open conversation on the risks and which party is responsible to bear which

risks. It is important to ensure the assignment of risk is clear, transparent and well defined.

Assign the Contractual Risk Profit Rate

The profit rate is typically determined based on the presence and degree of risk factors in the contract.

Contracts with risk factors assessed as standard, will typically apply the standard rates defined in Table

5.2.3.a above. Elevated risks undertaken by a contractor should be appropriately rewarded with higher risk

premiums.

The Contractual Risk profit rate typically increases with either:

• The presence of a significant number of risk factors, or

• One or more risk factors that could significantly impact the contract’s risk.

A Standard Contractual risk is the lowest rate in the range. In rare circumstances, the Contractual Risk can

decrease below the standard rate or starting point in circumstances where the risk is negligible, non-existent,

or mitigations measures are in place to negate the impact entirely.

Key Contractual Risk Factors

The Contractual Risk Assessment Tool is a summary tool of the guidance provided in this section,

designed to support practitioners in the assessment of contractual risk in a procurement in order to establish

an appropriate contractual risk profit rate. The Tool can be found in Annex 6.3.

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Table 5.2.3.b: Explanation of Contractual Risk Factors

Main Risk

Category

Description

Impact

COST

Description: Risk of financial loss incurred by a contractor due to unplanned

increases in costs for a contract

Cost risk is assessed based on either the presence of a significant number of

risk factors that increase contractual risk or one or more risk factors that is

determined to have a significant impact on the contract’s risks.

R1. Well Established Scope, Requirements and Demand

Represents how clearly the

requirements, specifications, and needs

are defined.

Consideration is required for the

likelihood of unanticipated scope

changes or adjustments in

requirements, design, or needs over the

contract lifecycle.

Contracts with a well-defined scope and

operational requirements are

considered standard contractual risk.

Fixed Price/Rate Type

The possibility of fluctuations in the

scope, requirements and specifications

results in an increased risk of higher than

expected costs being incurred by a

contractor due to modifications in the

planned process, level of effort, volume

of inputs and expertise required.

Cost-Reimbursable Type

The risk of increases in costs due to

scope and requirement uncertainty is

taken on by the Government of Canada

in a Cost Reimbursable contract.

Minimal impact considerations for

contractor profit.

R2. Reliable Cost Estimates

A reliable cost estimate includes

credible, reliable, and accurate

underlying assumptions. A reliable cost

estimate typically requires a strong

forecast and cost estimate with

dependable sensitivity models, indices,

analysis, and a clear Statement of Work

(SOW) in place. Reliability can be

achieved with the availability of relevant

historical costing data for the work or

similar work.

Fixed Price/Rate Type

The risk of fluctuations in cost estimates

is a risk of financial loss to a contractor in

a Fixed Price/Rate contract. The more

reliable the cost estimate used to

determine the fixed price/rate, the lower

the contractual risk for the contract.

Cost-Reimbursable Type

The risk of fluctuations in costs due to

unreliable estimates results in an

increased risk of cost to the Government

of Canada in a Cost Reimbursable

contract. Minimal impact considerations

for contractor profit.

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Main Risk

Category

Description

Impact

R3. Potential Fluctuations from External Factors

Potential fluctuations refer to

unanticipated changes in market factors

that impact the cost estimates and

resulting contract price. These include

commodity prices, union labour

negotiations, foreign currency

fluctuations, etc. The fluctuations refer

to changes that cannot be reliably

estimated or forecasted due to a

dependency on external factors.

A contract that accounts for market

fluctuations through the use of an

Economic Price Adjustment (EPA) or

Foreign Currency Adjustment (FCA)

clause (Section 4.2) does not require a

change to the contractual risk factor.

The EPA/FCA clause provides

contractors with protection for

fluctuations outside their control.

Fixed Price/Rate Type

The possibility of fluctuations in costs

due to market uncertainties increases

the risk of financial loss to a contractor.

However, the inclusion of the EPA/FCA

clause minimizes the risk and no

resulting increase in contractual risk is

required. In the event there is a reliance

on market factors in the cost estimates

and the impact on price of market

fluctuations could be significant, and

there is no related EPA/FCA clause in

place, there would be an increase in risk

to the contractor that the costs would be

higher than planned, resulting in an

increase in the contractual risk factor.

Cost-Reimbursable Type

Minimal impact in a cost-reimbursable

contract as the risk of fluctuations in

costs is born by the Government of

Canada.

R4. Timing of Negotiations

The timing of price and fee negotiation

has an impact on the accuracy of the

costs and price estimated. Contract

prices determined before the contract

start date, and for Fixed Time/Unit Rate

contracts before the start of a contract

year, rely on estimates and

uncertainties, which results in a higher

level of risk.

Contract prices determined after a

contract has started and for Fixed

Time/Unit Rate contracts after the start

of a contract year, when a significant

portion of the work has been completed

to reasonably understand inputs and

related costs, have a lower level of risk.

Fixed Price/Rate Type

Standard risk conditions rely on a

contract being negotiated prior to the

commencement of a contract and for

Fixed Time/Unit Rate contracts before

the start of a contract year. The

contractual risk rate will decrease when

the prices and rates are negotiated after

a contract or contract year has started (in

arrears) and inputs and actual costs are

known. With this factor, a Fixed

Price/Rate contractual risk factor can go

below the normal range as the contract

price being negotiated is now actual

costs plus a fee, reducing the cost

uncertainty and risk to that of a cost-

reimbursable contract.

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Main Risk

Category

Description

Impact

If a substantial portion of the costs have

been incurred prior to the finalization of

contract prices or rates, the contracting

officer may assign a value as low as

zero percent, regardless of Basis of

Payment type.

For example, in a Fixed Time Rate

contract where costing rates are

negotiated annually in arrears, there will

typically be no cost risks, as the contract

would essentially be cost-reimbursable in

nature. The contractual risk portion of

profit should be decreased accordingly.

Regular assessments of contractual risk

factors should be conducted in line with

costing rate negotiations for Fixed Time

Rate contracts.

Cost-Reimbursable Type

Minimal impact in a cost-reimbursable

contract with regards to the

establishment of the ceiling price. The

contractual risk rate will decrease when

the prices and rates are negotiated after

a contract has started (in arrears) and

inputs and actual costs are known.

TECHNICAL &

SCHEDULE

Description: The risk that various contractual factors will impact a contractor’s

ability to successfully complete the technical aspects of the procurement as

scheduled according to the requirements in the contract.

Technical and Schedule risk is assessed based on either the presence of a

significant number of risk factors that increase contractual risk or one or more

risk factors that is determined to have a significant impact on the contract’s

risks.

R5. Technical Risk

Technical risk refers to the technical

skills, knowledge and/or innovation

required to meet procurement

objectives.

A contract that has a high level of

technical risk typically requires highly

skilled personnel, state of the art

machinery/leading edge technology,

and/or a high degree of development

and design.

Fixed Price/Rate and Cost Reimbursable

Type

A contract that with higher technical risk

typically results in a higher contractual

risk rating as there are more areas that

can impact the successful completion of

the contractual requirements.

Also, there can be the differentiation

between developmental vs. off-the-shelf.

Generally, off-the shelf would decrease

contractual risk as risks are lower for a

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Main Risk

Category

Description

Impact

Note: Lower technical risk areas are

typically sustainment or ancillary

services, such as maintenance and

support, spare parts or off the shelf

items procurement, IT services,

training, standard services, routine

support services and facilities support.

contractor for an established product line

where performance is known, and risks

of unknowns are lowered.

R6. Familiarity and Program (Products/Services/Processes/ Tasks) Maturity

Familiarity refers to a contractor’s past

experience with the same or similar

work and requirements being procured.

Program maturity refers to the level of

establishment of the

product/services/processes/tasks

involved in meeting the procurement

objectives.

Examples of less mature programs

include the following:

• Product lines would include

products that are developmental

that have a high degree of

uncertainty or risk because of the

untested nature of the technology

or the unproven, unique or

developmental nature of the

deliverable.

• Unproven processes or new

processes with minimal testing

Routine vs. non-routine tasks

(typically, the more routine a task,

the higher the degree of program

maturity)

Fixed Price/Rate and Cost Reimbursable

Type

Contractors that do not have experience

with same or similar work and do not

have a good understanding of the

process, resources and timelines

required to successfully meet

procurement requirements will

experience increased risk of

procurement failures, resulting in a

higher contractual risk rating.

A new program typically has an increase

in contractual risk, as the lack of program

experience could impact the successful

fulfillment of the procurement.

Note that the length of time for a

program to be considered mature will

vary depending on the industry (For

example: high-tech industry where

technology changes frequently vs. parts

manufacturing where technology does

not change frequently).

R7. Performance Specifications

Performance specifications refer to the

operational requirements of a product or

service, and the level of tolerances for

variances in the product or service

requirements.

Fixed Price/Rate and Cost Reimbursable

Type

Contractual risk increases for contracts

with demanding performance

specifications and low tolerances for

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Main Risk

Category

Description

Impact

This also includes timeline risks, which

is where there are tight restrictions

related to the delivery schedule and

timelines. Essential timelines and tight

timelines impose additional risk on

successful delivery of a contract. A

timeline is typically considered more

stringent and challenging when it is

significantly shorter from normal lead

times for the same or similar work.

For example: The acceptable range for

physical dimension for a manufactured

product as it can impact the reliability.

deviations for it. The contractor has

minimal room for error and a higher risk of

not being able to successfully deliver the

procurement on time.

R8. Contract Duration

This risk factor refers to the length of

the contract. Typically, the longer a

contract is, the riskier, due to the

greater amount of unknown factors in

the long-term.

1. The length of a contract can impact

the predictability of the scope,

requirements, inputs, and various costs

and overhead distribution rates. In

addition, typically, the longer a contract,

the predictability of the requirements,

factors and market conditions

decreases. For example, commodity

fluctuations, demand and supply,

inflation, etc.

2. The duration of a contract can also

impact the capacity to establish a

reasonable operational delivery

schedule and fair payment schedule. In

a longer term contract (5+ years) it is

difficult to establish a reasonable

operational delivery timeline. When the

final delivery schedule is changed or

modified, it can result in a loss of

revenue for a contractor, for example, if

they are forced to delay or cancel a

Fixed Price/Rate and Cost Reimbursable

Type

1. Generally, the longer the duration of a

contract, the greater the risk and

potential impact on the ability to

reasonably estimate requirements and

costs. This would be to a lesser degree

for Cost Reimbursable type contracts.

2. Typically, the longer the duration of a

contract, the higher the risk the

contractor will experience schedule

delays and resulting business loss, or

payment schedule changes and resulting

cash flow concerns.

3. Typically, the longer the duration of a

contract, the higher the risk is a

contractor will not successfully deliver

the contract.

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Main Risk

Category

Description

Impact

follow on contract due to required

adjustments to the delivery and

performance schedule.

The contract duration also impacts

ability to establish a fair and reasonable

payment schedule. This presents

further risk that the contractor will not

have sufficient payments and cash flow

to successfully meet contractual

obligations.

3. The duration of a contract can also

impact the ability of a contractor to

successfully complete a contract, due

to the heightened uncertainties in

timing, volumes, costs, resource

requirements and availability, supply

chain changes, parts obsolescence and

sourcing. Negative changes in a supply

chain, such as changes in suppliers

and parts obsolescence can negatively

impact a supplier’s ability to deliver a

contract.

Factors to Consider

It is important to consider the following factors in the determination of the contractual risk profit and the

contract price.

• Multiple Bases of Payment: Contracts with multiple bases of payments will be required to calculate

the contractual risk factor for each separate basis of payment. The remaining profit factors, General

Business Risk, Working Capital Employed and Fixed Capital Employed, are calculated separately

and are not impacted by the basis of payment. Contractual risk is the only factor requiring a

calculation per basis of payment. Refer to Example 5.2.3 d) below for an example of a contract with

multiple bases of payment. This methodology for multiple bases of payment also applies to

provisional price bases of payment.

• Task Authorizations and Requirement Add-Ons: Depending on the contract, separate contractual

risk assessments may also be required for task authorizations and/or add-ons to a contract that were

not competed. This methodology would be similar to that applied to multiple bases of payment.

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• Modifications to Basis of Payment and Risk Assignment: Once the contractual risk assessment

is complete, the resulting profit rate is reflective of the risk assumed and agreed to by each party. A

higher risk premium is awarded for taking on additional risk. In the event the risks are realized, for

example, cost increases, the rate in place has already compensated a contractor for the potential of

a cost increase. There is no further requirement to adjust the price. In the event, a contractor is no

longer able to bear the risk originally agreed upon, and a contract basis of payment is changed from

fixed price to cost reimbursable, it is important that the contractual risk profit rate also be adjusted,

to reflect the fact that the risk is now borne by the Government of Canada.

• Risk Mitigation: It is important to note that in the evaluation of contractual risk, the degree of risk

can be impacted by risk mitigation factors that are in place. For example, “pain sharing” agreements

can mitigate risk related to cost estimating as the contractor’s downside risk is limited as losses are

shared with the government. Another example is the “rolling wave” in a long-term contract, where

the contractor is only required to estimate costs in increments, mitigating the risk related to the

contract length. Another example is when a Fixed Price type contract has a provision to compensate

for design changes or additional work arising, mitigating risks related to uncertainties in scope,

requirements and demand.

• Warranty Risk: Warranty costs include those arising from fulfillment of any contractual obligation of

a contractor to provide services such as installation, training, correcting defects in the products,

replacing defective parts, and making refunds in the case of inadequate performance. This includes

assigning the contractor accountability for product warranty claims due to workmanship when

Canada is responsible for some levels of the maintenance activity.

Warranty risk is not considered a technical risk for the Contractual Risk factor as these costs are

typically accounted for in the Costing Standard. See Section 4.13 Provisions for Contingencies and

Warranty Costs of the Costing Standard for more detail.

• Contingencies: Contingency costs are considered non-applicable costs to the contract under SACC

1031-2. Risks related to any uncertainties in cost estimates are factored in the Contractual Risk profit

factor in R2. Reliable Cost Estimates.

Key Questions to Ask

The following key questions support a contracting officer in the assessment of the presence, likelihood and

impact of contractual risk in a contract.

Table 5.2.3.c: Key Questions to Ask in the Assessment of Contractual Risk

Risk Factor

Key Questions to Ask

R1. Well Established Scope,

Requirements and Demand

• Are the scope and requirements well defined?

• Is the likelihood of unanticipated changes to the operation

requirements and demand mid-low?

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Risk Factor

Key Questions to Ask

R2. Reliable Cost Estimates

• Is there an ability to develop strong forecasts and cost estimates?

• Is there a clear SOW in place as a base for the cost estimates?

• Are the underlying assumptions used to calculate the cost estimates

credible and accurate?

• Are dependable sensitivity models, indices and analysis in place to

accurately determine cost fluctuations?

• Is there reliable historical costing data for this work or similar work?

• Is the length of the contract short-medium in duration? If no, consider

the length of the contract and its impact on reliable cost estimates

(i.e. the predictability of requirements, inputs and resulting costs and

rates (labour, material and overhead distribution).

R3. Potential Fluctuations

from External Factors

• Are there potential market fluctuations that could significantly impact

the price (for example, commodity price, labour negotiations, foreign

currency)?

• If yes, is protection provided to the contractor for fluctuations outside

of the contractor’s control, such as Economic Price Adjustment

(EPA) / Foreign Currency Adjustment (FCA) clause?

R4. Timing of Negotiations

• Was the contract price, fee, and/or rates determined after the

contract start date and/or contract year (i.e. in arrears)?

• If yes, has a significant enough portion of the work been completed

that inputs and related costs are known? If yes, and contract is Fixed

Price/Rate type, consider a decrease in Contractual Risk from

standard levels.

R5. Technical Risk

• Are the contract requirements considered complex?

• Are highly skilled personnel or specific technical skills required?

• Is state of the art machinery or leading edge technology required?

• Is there a high degree of research, development and design

requirements?

• Is this considered developmental work (vs. off-the-shelf technology)

with significant risk related to customization?

• Is the contract for new product lines or non-routine tasks?

R6. Familiarity and Program

(Products/Services/Processes/

Tasks) Maturity

• Does the contractor have limited to no experience performing the

work or similar work for the government or another government

client?

• Is the program considered new (i.e. the product or service has not

been available in the market for a period of time)?

190 | Page Public Services and Procurement Canada August 2023

Risk Factor

Key Questions to Ask

R7. Performance

Specifications

• Are there high performance specifications and strict standards

required for successful delivery (for example, strict timelines, product

specifications or service standards)?

• Is there a very low tolerance for deviations in performance

specifications?

• Would a deviation in performance specification impact the success

of delivery?

• Are there exact specifications with zero tolerance for deviations in

place?

R8. Contract Duration

• Is the length of the contract medium to long term in duration?

• Does the length of the contract impact the ability to establish a

reasonable operational delivery schedule; and/or a fair payment

schedule?

• Is there a risk related to parts obsolescence that could significantly

impact the contract's successful delivery?

Examples

The following examples provide various scenarios that demonstrate how the contractual risk can be assessed

for a contract. The responses have been established by applying the questions within the Contractual Risk

Assessment Tool found in Annex 6.3.

Example 5.2.3 a)

Scenario:

• Negotiated Fixed Price 2-year contract for the acquisition of specialized protective equipment for

client department.

• Scope and requirements are clear and well known.

• Contractor has experience with similar work done in the past for other organizations and has

reasonable and accurate cost estimates.

• Negotiations for price and fee will be completed before the contract start date.

• Manufacturing of equipment requires skilled, unionized laborers. Collective bargaining is underway

and resulting new labour rates and escalation factors for the 2-year contract period are difficult to

estimate. Labour costs are significant, at 65% of the total estimated contract costs. Any fluctuations

in labour will result in significant fluctuation in costs for the contractor. Manufacturing of equipment

also requires special fibers and materials that are difficult to source with price fluctuations based on

market and demand. There is no Economic Price Adjustment (EPA) clause included in the contract.

• Incentives will not be used on the contract.

• The product is customized with specific performance specifications and requires state of the art

equipment to produce. Tolerances for deviations are lower than those typically required by

commercial customers. This product is similar to ones produced and sold to commercial customer

and general manufacturing process remains similar for customized versions for Canada.

191 | Page Public Services and Procurement Canada August 2023

• Due to the pressing operational needs of the client department for the protective equipment, Canada

is looking for very tight timelines for the production of the products on a regular basis over the 2-year

contract. Typically the contractor requires two months lead time to finish a pallet of product for a

commercial customer. Canada is looking for a one month lead time for the same quantity.

• No major subcontracting anticipated for the contract. Any subcontracting work that will be required

is typical for the industry.

Analysis and Solution:

Basis of Payment Type:

• Version A: Fixed Price

• Contractual risk profit range starting point: 4%

• 4% - 7% Range = up to 3% risk increase potential (1.5% Cost Risk + 1.5% Technical & Schedule

Risk)

Risk

Impact on

Procurement

Justification

R1. Well Established Scope,

Requirements and Demand

Standard

Scope and requirements are clear and well known.

R2. Reliable Cost Estimates

Standard

Contractor has past experience for reasonable and

accurate cost estimates.

R3. Potential Fluctuations

from External Factors

Significant

Significant fluctuations for skilled labours and direct

materials possible. Labour cost has significant impact

on total costs of contract. No EPA clause in contract.

R4. Timing of Negotiations

Standard

Negotiations will be completed before contract start

date.

Total Impact (Standard or

Above?)

+1.5%

R3 increases cost risk for the procurement and could

potentially have a significant impact on total costs.

Total cost risk impact = significant. Highest amount in

range awarded due to significant impact the risk factor

has on cost risk.

R5. Technical Risk

Moderate

Specialized product that requires “state of the art”

equipment to produce and highly skilled labour required.

R6. Familiarity and Program

(Products/Services/Processes/

Tasks) Maturity

Standard

Contractor is experienced with similar work.

Program is mature. Similar products for commercial

customers and similar process involved in

manufacturing.

R7. Performance

Specifications

Moderate

Low tolerance for performance deviations.

Tight timelines that are more stringent and challenging

compared to normal lead times. Technical and

Schedule risk increases.

R8. Contract Duration

Standard

2 year contract; no impact on the predictability of

requirements and costs.

Total Impact (Standard or

Above?)

+1.5%

R5 and R7 increase Technical and Schedule risk for the

procurement and have significant impact on contractual

risk. Total Technical and Schedule risk = significant.

192 | Page Public Services and Procurement Canada August 2023

Risk

Impact on

Procurement

Justification

Highest amount in range awarded due to a number of

moderate risk factors present.

Overall Impact on

Contractual Risk

+3%

Total Contractual Risk to be

Applied

Based on the above analysis, the contractual risk factor profit rate to award is determined to be 7%.

Example 5.2.3 b)

Scenario:

• Negotiated incentive based basis of payment: Cost Reimbursable with Target Cost, 6 year contract

for the development and maintenance of a fleet of specialized drones. For the Cost Reimbursable

with Target Cost basis of payment, the contractor and Canada have agreed upon contract

performance criteria where cost efficiencies or losses are rewarded and shared through the fee

arrangement in which both parties share the reward (risk) of meeting (or not meeting) them.

• Scope and requirements for the procurement are clear and well-established.

• Due to the developmental and specialized nature of the products being procured and uncertain

service level required to maintain the new product, cost estimates may not be very accurate or

dependable.

• Negotiations for price and fee are well on their way and will be completed before the contract start

date.

• Material and unionized specialized labour required is subject to great uncertainty based on market

conditions.

• The contractor is experienced with developing drones for other commercial and government

customers each with their own specific requirements in the past. The development process is similar

to a process for other drones developed by the contractor and is a proven process.

• Performance specifications required and tolerances for deviations is the same as other products the

contractor produces.

• Timelines and schedules for delivery and maintenance are similar to other products in the product

line of the contractor and maintenance schedule is estimated to be similar as well.

• No major subcontracting anticipated for the contract. Any subcontracting work that will be required

is typical for the industry.

Analysis and Solution:

Basis of Payment Type:

• Version B: Cost Reimbursable with Target Cost

• Contractual risk profit range starting point: 1%

• 1% - 4.5% Range = up to 3.5% risk increase potential (1.75% Cost Risk + 1.75% Technical &

Schedule Risk)

193 | Page Public Services and Procurement Canada August 2023

Risk

Impact on

Procurement

Justification

R1. Well Established Scope,

Requirements and Demand

Standard

Scope and operational requirements are clear and well

established.

R2. Reliable Cost Estimates

Moderate

Cost estimates are not very accurate or dependable.

Cost risk increases, slightly higher than standard risk.

R3. Potential Fluctuations

from External Factors

Standard

Although potential for fluctuations is high, minimal

impact due to cost-reimbursable type contract.

R4. Timing of Negotiations

Standard

Negotiations well on their way and will be completed

before contract start date. Minimal impact for a cost-

reimbursable contract.

Total Impact (Standard or

Above?)

+1%

R2 increases cost risk for the procurement and has a

slightly higher than standard impact on contractual risk.

Total cost risk impact = moderate, but with presence of

only one risk factor, only 1% extra is determined

applicable.

R5. Technical Risk

Moderate

Developmental nature of product and highly specialized

labour required increasing technical risk. Contract also

includes a maintenance portion which lowers technical

complexity risk. Overall slightly above standard risk.

R6. Familiarity and Program

(Products/Services/Processes/

Tasks) Maturity

Standard

Contractor is experienced with the development of

drones.

Similar product lines exist, and processes are proven.

R7. Performance

Specifications

Standard

Performance specifications and tolerances for

deviations are same as other products of contractor.

Timelines and schedules for delivery similar to other

products in product line.

R8. Contract Duration

Standard

6 year contract; minimal impact on the predictability of

requirements and costs.

Total Impact (Standard or

Above?)

+1%

Slight impact on Technical and Schedule risk from R5

= moderate, only 1% extra is deemed applicable.

Overall Impact on

Contractual Risk

+2%

Total Contractual Risk to be

Applied

Based on the above analysis, the contractual risk factor profit rate to award is determined to be 3%.

Example 5.2.3 c)

Scenario:

• Taking the same scenario as in Example 2, the following are the only factors that have changed:

194 | Page Public Services and Procurement Canada August 2023

o A “pain sharing” incentive is included in the contract. The government of Canada will share

any losses with the contractor, utilizing a 50/50 ratio.

Analysis and Solution:

Basis of Payment Type:

• Version B: Cost Reimbursable with Target Cost

• Contractual risk profit range starting point: 1%

• 1% - 4.5% Range = up to 3.5% risk increase potential (1.75% Cost Risk + 1.75% Technical &

Schedule Risk)

Risk

Impact on

Procurement

Justification

R1. Well Established Scope,

Requirements and Demand

Standard

Scope and operational requirements are clear

and well established.

R2. Reliable Cost Estimates

Moderate

Cost estimates are not very accurate or

dependable. Cost risk increases.

R3. Potential Fluctuations from

External Factors

Standard

Although potential for fluctuations is high,

minimal impact due to cost-reimbursable type

contract.

R4. Timing of Negotiations

Standard

Negotiations well on their way and will be

completed before contract start date. Minimal

impact for a cost-reimbursable contract.

Total Impact (Standard or Above?)

+1%

R2 increases cost risk for the procurement.

Total cost risk impact = moderate, only 1%

extra is deemed applicable.

R5. Technical Risk

Moderate

Developmental nature of product and highly

specialized labour required. Technical and

Schedule risk increases. Contract also

includes a maintenance portion which lowers

technical complexity risk. Overall slightly

above standard risk.

R6. Familiarity and Program

(Products/Services/Processes/ Tasks)

Maturity

Standard

Contractor is experienced with the

development of drones.

Similar product lines exist, and processes are

proven.

R7. Performance Specifications

Standard

Performance specifications and tolerances

for deviations are same as other products of

contractor.

Timelines and schedules for delivery similar

to other products in product line.

R8. Contract Duration

Standard

6 year contract; minimal impact on the

predictability of requirements and costs.

Total Impact (Standard or Above?)

+1%

Slight impact on Technical and Schedule risk

from R5 = moderate, only 1% extra is deemed

applicable.

195 | Page Public Services and Procurement Canada August 2023

Risk

Impact on

Procurement

Justification

Overall Impact on Contractual Risk

+2%

Total Contractual Risk to be Applied

NOTE: The contract includes a “pain sharing” incentive arrangement. The overall impact of the incentives on

the total contract price must be considered. Canada shares in any losses with the contractor if targets are

not met, the target profit that has been set in the contract considers this. Decisions on the target levels for

incentives should consider the overall profit rate (including the Contractual Risk profit factor). The Contractual

Risk profit for this example will still be 3% and the incentive amount may fluctuate over total contract price

according to the performance of the contractor. The contractor takes on the risk that targets may or may not

be met, depending on their performance and shares in the financial losses related to it with Canada.

Based on the above analysis, the contractual risk factor profit rate to award is determined to be 3%.

Example 5.2.3 d) - Multiple Bases of Payment

Scenario:

• Negotiated procurement for the development, production and maintenance of a fleet of specialized

drones.

• Multiple bases of payment:

o Cost Reimbursable: Fixed Fee No Ceiling Price (30% of the contract) - This is for the

maintenance portion of the fleet of specialized drones.

o Fixed Price (70% of the contract) - This is for the development and production of specialized

drones.

• Estimated total contract costs is $5.5 million.

• There are significant risks in many aspects of the contract, for this reason:

o It is determined that for the Cost Reimbursable portion of the contract, 1% contractual risk

profit factor is appropriate.

o It is determined that for the Fixed Price portion of the contract, 7% contractual risk profit

factor is appropriate.

Analysis and Solution:

Contractual Risk Profit Factor x Estimated Contract Costs = Total Contractual Risk Profit

Basis of Payment Type

Contractual Risk

Profit Factor

Estimated Contract

Costs

Total Contractual

Risk Profit

Cost Reimbursable: Fixed Fee

no Ceiling Price

30% x $5.5 million =

$1.65 million

$16,500

Fixed Price

70% x $5.5 million =

$3.85 million

$269,500

TOTAL

$286,000

Therefore, the total contractual risk profit estimated for this contract is $286,000.

196 | Page Public Services and Procurement Canada August 2023

5.3 ALTERNATIVE PRICING STRATEGIES

Alternatives to Cost-Based Pricing are ways to buy goods and services where the price does not rely on the

cost to the contractor of fulfilling the statement of requirements. There are some situations where alternatives

to Cost-Based Pricing might generate better value.

The Alternative Pricing Principles refer to the procedures and guidance in place for contracting authorities to

follow when a contract price is established applying an approach that does not fully incorporate the Cost-

Based Pricing Principles outlined in Section 5.0.1 Cost-Based Pricing Principles.

Alternatives to Cost-Based Pricing are not commonly applied and as such, guidance on specific alternatives

is not yet in place. Concepts and types of alternatives that could be considered are discussed further in Annex

5.4.1 (Discussion Paper Alternative Approaches to Cost-Based Pricing).

The Alternative Pricing Principles, detailed below, outline the process to follow to ensure the alternative

method is appropriately analyzed with consideration for the risks and the benefits, and to ensure that the

alternative approaches are shared for lessons learned and incorporation in future iterations of this Guide for

the benefit of the entire procurement community.

5.3.1 Objectives

The purpose of the Alternative Pricing Principles is to encourage contracting officers to broadly consider other

factors or alternative approaches in their pursuit of better value to Canada, in the development of contract

pricing.

For example, these could include:

• Access to better pricing via gainsharing or price reductions over time;

• Enhanced performance of government services to the public;

• Flexible contracting arrangements responsive to changing budgets and/or operational demand; or

• Improved contractor behavior or customer satisfaction for goods and services rendered.

5.3.2 When Alternative Pricing Principles Apply

When justification exists that an alternative pricing method might generate better value to Canada than the

application of the Cost-Based Pricing Principles (Section 5.0.1), the Alternative Pricing Principles are to be

applied in accordance with the Principles and Procedures outlined in Section 5.3.3 below.

The following requirements must be met in order to apply the Alternative Pricing Principles:

• The contract pricing is sanctioned by the delegated contracting authority

• Concurrence is obtained from the client

• The decision is documented as described in the procedures below

• The record of decision showing justification, client concurrence and the contracting authority’s

approval is shared with the Price Support Directorate (PSD).

197 | Page Public Services and Procurement Canada August 2023

5.3.3 Procedures for Application of Alternative Pricing Principles

Contracting Officers are responsible to justify and obtain approval for the use of the alternative pricing

methodology applied as opposed to the use of Cost-Based Pricing Principles in Section 5.0.1.

The Alternative Pricing Principles require a contracting officer to document the following in the Procurement

Plan, if applicable, a business case file or other decision document:

a) Identify the pricing practice proposed

b) Explain the reasons for the selection of proposed pricing practice, identify which Cost-Based Pricing

Principles were not used and why

c) Provide the evidence or comparative information from other jurisdictions/sectors in support of the

proposed pricing practice as a benchmarking, if available

d) Identify, describe and estimate expected costs and benefits of the chosen pricing practice to Canada

e) Explain how the pricing was determined, and provide a comparison to the profit and price

determination that would have been applied under Cost-Based Pricing Principles

f) Explain how the pricing is intended to work

g) Identify any applicable limits in the application of the pricing practices, such as timeframe or

conditions

h) Briefly discuss, as applicable, plans and approach to:

I. Validate contractor’s achievement of conditions that activate the pricing provisions, including

gain-sharing and non-financial performance objectives

II. Establish provisions for adjusting or recalibrating contract pricing, including performance

objectives for multi-year contracts

III. Review and assess the effectiveness of the pricing practice and make recommendations for

its use by others

It should also be noted that documentation must include evidence of program management (client)

acceptance/ concurrence with the contract pricing provisions.

Did You Know?

• Contracting officers should draw on expert advice from the: Price Advisory Group (PAG), within the

Procurement Support Services Sector (PSSS)

• Please see Annex 3 for contact information.

• Once the Alternative Pricing Method is approved by the delegated contracting authority, the contracting

officer should share with PSSS by email (TPSGC.padgamtp-appbipm.PWGSC@tpsgc-pwgsc.gc.ca) the

Alternative Pricing Principles that have been applied for lessons learned and incorporation into future

iterations of the Guide.

 
198 | Page Public Services and Procurement Canada                       August 2023 
6.0 ANNEXES  
ANNEX 1: Firm Price Basis of Payment 
 
ANNEX 2: Costing Standard 
 
ANNEX 3: Contact Information 
 
ANNEX 4: Process Steps for Cost Accounting Practices (CAP) Submission   
 
ANNEX 5: Discussion Papers 
 
ANNEX 6: Tools and Templates 
 
ANNEX 7: Glossary

199 | Page Public Services and Procurement Canada August 2023

ANNEX 1: Firm Price Basis of Payment

Comparison: Firm Price vs. Fixed Price Basis of Payment in a Non-Competitive Contract

Firm Price Basis of Payment in a Non-Competitive Contract

A firm price basis of payment provides for the establishment a price at the beginning of a contract based on

estimated costs and a negotiated profit, which for the most part, is not subject to adjustment unless through

the course of the contract, PSPC exercises its right to apply the discretionary audit clause. The discretionary

audit clause validates the actual costs incurred and profit earned in the contract and compares them to those

originally estimated in the establishment of the firm price. Resulting decreases in actual costs and related

excess profits realized by the contractor are then recovered by Canada.

Fixed Price in a Non-Competitive Contract

A fixed price basis of payment establishes a price in the same manner as a firm price contract, through the

development of a cost base and negotiation of a profit rate; however, a fixed price is not subject to any

adjustment. The contractor is paid a definite sum of money for carrying out the work regardless of the

actual costs incurred. A validated strategy is carried out before a contract is signed to ensure the

reasonableness and fairness of the price and, once the contract is signed, changes cannot be made to the

price.

Similarities

• Firm and fixed price contracts are used under similar circumstances, as detailed in the Fixed Price

(Section 4.1.1), when the contract scope and requirements are known and unlikely to change,

resulting in a realistic estimate of applicable costs, and the negotiation of a fair and reasonable profit.

• Firm and fixed prices in a non-competitive environment are built by estimating a cost-base and

negotiating a fair and reasonable profit, using Section 5.2 (Profit Principles).

• Both firm price and fixed contracts:

o place risk upon the contractor as they bear full responsibility for all costs and resulting losses;

o result in a high profit rate built into the prices as the risk is passed onto the contractor;

o provide incentive for the contractor to control costs and perform efficiently; and

o impose little administrative burden upon both contracting parties.

Please Note

• Firm Price basis of payment is no longer recommended for use.

• Refer to Section 4.1.1 (Fixed Price) for application of this option.

200 | Page Public Services and Procurement Canada August 2023

Differences

• It should be noted that the discretionary audit clause is not always applied in a firm price contract.

As a result, many firm price contracts result in similar application to that of a fixed contract. It is only

in the application of the audit clause that differences arise.

• A firm price may be subject to a discretionary audit and a resulting price adjustment in the event the

audit reveals excess profit (profit greater than that negotiated at the onset of the contract), where as

a fixed price remains the same throughout the contract regardless of fluctuations in costs and the

contractor bears all risks associated with those fluctuations.

• A discretionary audit clause may be included in a firm price contract, while there will be no

discretionary clause for the purposes of excess profit recoveries in a fixed price contract.

• A firm price essentially sets a maximum price limit that Canada will pay. In the event the contractor’s

actual costs incurred were much higher than estimated in the establishment of the contract price,

there is no resulting price increase. The contractor bears full risk related to cost increases and, as a

result, they are awarded a higher profit premium. In a fixed price contract, the contractor also bears

full risk related to cost increases but is able to retain all additional profits earned when costs are

under the original estimates.

Why is a Firm Price Basis of Payment Not Recommended for Use?

The firm price basis of payment is no longer recommended for use for the following reasons:

• Firm price removes all incentive for the contractor to improve their processes and to gain efficiencies

because Canada has the right to audit and recover the resulting overpayment.

• The discretionary audit clause may not be applied consistently and when it is applied, the audit and

resulting recovery appears punitive in nature.

• Firm price does not help build or maintain contractor relationships due to disputes over excess profit

recoveries and audit findings as well as the inconsistent application of the clause.

• Contractors are awarded a premium for Firm Price at the beginning of a contract. Then, throughout

the contract, if the scope and requirements are modified, the nature of the contract resembles that

of a cost reimbursable contract with Canada bearing the risks related to cost uncertainties and the

contractor earning a higher than necessary profit premium.

Application Differences between Firm and Fixed Price

For those contracts where the requirements, scope of work and outputs to determine the level of effort are

known and a validation strategy to determine the reasonableness and fairness of price can be conducted, a

fixed price basis of payment is recommended, in line with the criteria outlined in Section 4.1.1. The key

differences in application between fixed and firm price basis of payment are as follows:

• fixed price is set as a final price that is not subject to any adjustment throughout the lifecycle of the

contract if no amendment of the contract is needed.

• fixed price must be validated prior to contract initiation through available market-based data, a

validated cost base with a Section 5.2 profit calculation or should-cost analysis benchmarking.

• discretionary audit clauses will be replaced by a general audit clause.

• audits will not be conducted for the purpose of excess profit recoveries.

 
201 | Page Public Services and Procurement Canada                       August 2023 
Alternatives to Firm Price Basis of Payment 
 
In addition to applying a Fixed Price basis of payment, a Contracting Officer can consider other bases of 
payment that transfer risk to the contractor in a manner similar to that of a Firm Price contract, but that operate 
in fair and transparent manner. For example, Cost Reimbursable contracts with a Target Cost are a form of 
“gain or pain” sharing, where cost efficiencies or losses are rewarded and shared through fee arrangements 
in  which  both  the  contractor  and  Canada  share  the  reward  (risk)  of  meeting  (or  not  meeting)  contract 
performance criteria. The “gain or pain” sharing formula in this basis of payment acts as an incentive for the 
contractor to control their costs. See Section 4.1.3.3 for further details on the benefits and application details 
of Target Cost contracts.  
 
For contracts where scope and requirements may require modifications, a cost reimbursable type contract 
will be more appropriate for the cost uncertainty risks taken on by the contractor.  
 
Process Steps 
 
Although it is not recommended for use, a firm price basis of payment follows the same process steps as that 
of a fixed price which are detailed in Section 4.1.1 with the exception of the inclusion of the discretionary 
audit clause. The discretionary audit clause (SACC C0100C, C0101C or C0102C) must be incorporated in 
the contract when a firm price basis of payment is used.  
 
Please note: If a supportable commercial price is available, sufficient price support must be obtained 
and validated prior to accepting the commercial price. See Section 5.0.2 Commercial Pricing for 
more information.  
 
It is recommended that contracting officers ensure that the “Audit” clauses from the SACC Section 3 
General Conditions template (2010A, 2010B, 2010C, 2015A, 2029, 2030, 2035 and 2040) are used. 
For example, as appropriate, the “General Conditions – Higher Complexity – Goods SACC 2030, 
section  33”, “General  Conditions  –  Higher  Complexity  –  Services  SACC  2035,  section  31”  and 
“General Conditions – Research and Development 2040, section 42” are recommended. The “Audit” 
clauses included in the templates detail the contractor’s obligation related to audit (i.e. the contractor 
must retain evidence for all amounts claimed in a contract) and protects Canada’s right to audit (i.e. 
Canada’s right to audit all claimed amounts, calculated in accordance with the Basis of Payment).. 
 
 
 
 

 
202 | Page Public Services and Procurement Canada                       August 2023 
ANNEX 2: Costing Standard 
 
Table of Contents  
The Costing Standard……………….……………………………………………………………………………204 
Costing Standard Subsections…………………………………………………………………………………..213 
1) Asset-based Costs………………………………………………………………………………………213 
2) Employee-based Compensation Costs…………………………………………………………….....222 
3) Good/Service-based Costs……………………………………………………………………………..233 
4) Corporate/Various-based Costs………………………………………………………………………..237 
General Considerations for Costing …………………………………………………………………….………257 
Annex 2A: Costing Process………………………………………………………………………………..……..259 
Annex 2B: Contract Costing Rates………………………………………………………………………..……..260 
Annex 2C: Cost Management………………………………………………………………..………………..…266 
 
Costing Standard Subsections for the categorization of the specific costs by cost groups  
1) Asset-based Costs 
2) Employee-based 
Compensation 
Costs 
3) Good/Service-
based Costs 
4) Corporate/Various-
based Costs 
 
1.1 Amortization of 
Unrealized 
Appreciation of 
Assets 
 
1.2 Depreciation 
 
1.3 Excess 
Production 
Capacity 
 
1.4 Excess Facilities 
 
1.5 Impairment of 
Assets 
 
1.6 Leases 
 
1.7 Special 
Production 
Tooling and 
Special Test 
Equipment 
 
2.1 Dues and 
Membership 
 
2.2 Downtime 
 
2.3 Employee Benefits 
 
2.4 Executive and 
Employee 
Compensation  
 
2.5 Overtime Costs 
 
2.6 Pension Costs 
 
2.7 Pension Plan 
Refunds 
 
2.8 Severance 
Payments 
 
2.9 Training and Staff 
Development 
 
3.1 Bad Debts and 
Collection 
Charges 
 
3.2 Inventory Losses 
and 
Obsolescence 
 
3.3 Rework and 
Faulty 
Workmanship 
 
3.4 Surplus Materials 
Expense 
 
4.1 Allowance for 
Interest on Debt and 
Capital  
 
4.2 Extraordinary or 
Unusual Matters or 
Events 
 
4.3 Financial Related 
Expenses 
 
4.4 Fines and Penalties 
 
4.5 Fees for 
Professional Advice 
 
4.6 Goodwill 
 
4.7 Insurance 
 
4.8 Legal, Accounting 
and Consulting Fees 
in Connection with 

 
203 | Page Public Services and Procurement Canada                       August 2023 
1) Asset-based Costs 
2) Employee-based 
Compensation 
Costs 
3) Good/Service-
based Costs 
4) Corporate/Various-
based Costs 
 
1.8 Government 
Assistance 
Related to Fixed 
Assets, Research 
and Product 
Development 
 
2.10 Travel Costs and 
Living Expenses 
 
2.11 Department of 
National Defence 
(DND) Facility 
Costs 
 
2.12 Displacement/ 
Dislocation Pay 
Allowance  
Financial Re-
Organization, 
Security Issues, 
Capital Stock 
Issues, Obtaining of 
Patents and 
Licenses and 
Prosecution against 
the Crown 
 
4.9 Losses on 
Investment 
 
4.10 Losses on Other 
Contracts 
 
4.11 Patents and 
Licenses 
 
4.12 Prosecution of 
Claims against the 
Crown 
 
4.13 Provisions for 
Contingencies and 
Warranty Costs 
 
4.14 Refunds 
 
4.15 Research and 
Development 
 
4.16 Sales and Marketing 
Costs 
 
4.17 Taxes 
 
4.18 Joint Venture 
 
4.19 Transfer Pricing 
 

204 | Page Public Services and Procurement Canada August 2023

1) Asset-based Costs

2) Employee-based

Compensation

Costs

3) Good/Service-

based Costs

4) Corporate/Various-

based Costs

4.20 Head Office

Expense

4.21 Environmental Costs

4.22 Government

Supplied Materials

4.23 Donations

4.24 Strategic Innovation

Fund (SIF)

Repayment

The Costing Standard

The Costing Standard provides supplementary guidance that includes explanations of Canada’s expectations

and core costing principles to assist contracting officers in determining the acceptability of a cost and the

amount claimed. It builds upon the Contract Cost Principles, Standard Acquisition Clauses and Conditions

(SACC) Manual 1031-2, which provide a sound basis on which Canada can evaluate costs.

See Section 5.1 (Principles for Establishing the Cost-Base) for more guidance on the establishment of the

cost-base and Section 5.1.0 (Contract Cost Principles, SACC 1031-2) for more information on SACC 1031-

The Costing Standard is intended to:

• Enhance the clarity and understanding of acceptable costs, and

• Facilitate greater consistency in costing.

The Costing Standard emphasizes the core costing principles of attribution, appropriateness and

reasonableness to assist contracting officers in determining the acceptability of a cost and provides

examples, questions and measures for consideration to support costing decisions.

Detailed supplementary considerations for assessing the acceptability of specific costs are provided in the

sub-sections of this Annex, as well as additional guidance on the Costing Process (Annex 2A), Contract

Costing Rates (Annex 2B) and Cost Management (Annex 2C). In addition, costing Discussion Papers that

provide additional information and context are also available in Annex 5.

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Criteria for Assessing the Acceptability of a Contract Cost

To be acceptable, a contract cost must meet the criteria of:

• Attributable

• Appropriate; and

• Reasonable.

Attributable: A cost is attributable if it is incurred directly or indirectly for the fulfilment of the contract and it is

necessary to fulfil the requirements of that contract.

Appropriate: A cost is appropriate if it, by its character and nature, represents a cost that is expected to be

incurred in the conduct of delivering the contract.

Reasonable: A cost is reasonable if by its nature it does not exceed what might be expected to be incurred

in the normal delivery of the contract in question, whether under a competitive or non-competitive

procurement.

The criteria of Attributable and Appropriate should be used to determine if a cost should be accepted for a

contract, while the criterion of Reasonable should be used to determine what amount of an Attributable and

Appropriate cost should be accepted for a contract. If these criteria are met, it implies that accepting the cost

is of value to Canada. The following decision tree diagram illustrates this further.

Figure A2.a.: Contract Cost Acceptability Assessment Decision Tree

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In order to assess the criteria, professional judgement should be applied along with consultation from the

integrated procurement team (e.g., contracting officers, price advisors, auditors, client department members,

management, and others). Ultimately, the application of professional judgement should be guided by the

purpose and desired outcomes of the contract and the risk of the contract and respective costs.

Sub-Criteria: Attributable, Appropriate and Reasonable

The following tables provide sub-criteria, and corresponding example considerations, on how to assess

whether a cost is Attributable, Appropriate, and Reasonable. For a cost to be assessed as Attributable,

Appropriate, and Reasonable, “yes” must be answered for all respective sub-criteria. However, it should be

noted that the list of considerations to assess the respective sub-criterion are illustrative and accordingly may

not be applicable in each situation.

Is the Cost Attributable?

Sub-Criteria

Example Considerations to

Assess Sub-criteria

Is the cost not already

compensated in any way from

the contract or another

contract, whether past, existing

or proposed?

• Is the cost not already compensated through other means within the

contract (e.g., government grants)?

• Is the cost not already compensated through another contract?

• Is the cost (e.g. financing costs) not already compensated through

profit rate calculations (e.g., return on capital)?

Is there a sufficient level of

certainty for the occurrence of

the cost type?

• Have direct costs been tracked separately from indirect costs?

• Have the costs been recorded in the accounting system?

• Is there sufficient evidence that the cost has occurred or will occur?

• Is supporting information for the cost disclosed?

• If required, can the above information be verified by Canada?

Does the cost have a causal

relationship with or is otherwise

required/beneficial for the

performance of the contract?

• With respect to assessing the causal relationship of the cost,

consider the following:

o Does it contribute to the achievement of contract specific

activities or outcomes; and

o Could it have been avoided if not for the contract?

• In respect to assessing whether a cost is otherwise

required/beneficial, consider the following:

o Does it contribute to financial, schedule, and quality benefits for

the contract; and/or

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Is the Cost Attributable?

Sub-Criteria

Example Considerations to

Assess Sub-criteria

o Is it necessary and expected to be incurred for the performance

of the contract even though a causal relationship to the contract

cannot be shown (e.g., certain types of indirect general and

administrative costs)?

Is the Cost Appropriate?

Sub-Criteria

Example Considerations to

Assess Sub-criteria

Is the inclusion of the cost

congruent with applicable

government policies and

regulations?

• Is the inclusion of the cost congruent with policies and regulations

such as the Treasury Board Secretariat Directive on Travel, Income

Tax Act, provincial Employment Standards, PSPC code of conduct,

PSPC values and ethics, etc.?

Is the inclusion of the cost

consistent with comparator

information?

• Have the following sources of comparator information been

considered for the cost:

o internally available data for other contracts;

o accessible data for contracts from other government

procurement organizations (e.g., municipal,

provincial/territorial, and/or international);

o accessible documentation, including historical and forward-

looking financial reports, for the contractor;

o publically available financial reports from other companies in

the contractor’s industry;

o publically available financial reports from other companies in

the contractor’s geography; and/or

o other applicable sources of comparator information?

Does inclusion of the cost

provide the supplier with a

perceived unfair advantage

over others in the industry?

• Does the inclusion of the cost improve the competitive position (e.g.

by enabling reduced overhead costs) of the respective contractor

within its industry, and if so:

o Is the inclusion of the cost in the contract due to the contract’s

integration with other government mechanisms or programs

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Is the Cost Appropriate?

Sub-Criteria

Example Considerations to

Assess Sub-criteria

(e.g. Innovation, Science and Economic Development

Canada’s Industrial Technology Benefits Policy); and

o Would the reimbursement of the cost be viewed as a fair

subsidy to the contractor or the contractor’s region or industry?

Is the Cost Reasonable?

Sub-Criteria

Example Considerations to

Assess Sub-criteria

Is there a sufficient level of

evidence around the

measurement for the cost

amount?

• For actual costs:

o Has the cost amount been identified and recorded in the

contractor’s accounting system; and

o Can the contractor provide evidence to support costs such as

documentation and supporting calculations for the cost

amount?

• For cost estimates:

o Can the contractor provide empirical evidence for the amount

estimated for the cost (e.g., source of data, financial forecasts,

supporting calculations); and/or

o Has the contractor applied a rigorous cost estimating

methodology? (e.g., use of quality data, use of analogies,

parametric equations, build-ups, extrapolation from actuals)

o If required, can all of the above information be verified by

Canada?

Is the treatment of the cost

amount consistent with good

business practices and

congruent with contract

performance?

• Where applicable:

o Has the contractor used an acceptable measurement basis to

determine the cost amount?

o Has sound transfer pricing methodology been used to

determine transfer prices?

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Is the Cost Reasonable?

Sub-Criteria

Example Considerations to

Assess Sub-criteria

o Is the amount for the cost type congruent with applicable

policies and regulations (e.g., Treasury Board Secretariat

Directive on Travel, Income Tax Act, provincial Employment

Standards)

• Have the following sources of comparator information been

considered for the cost amount:

o internally available data for the contract in question (prior-

period and forecasted amounts);

o internally available data for other contracts;

o accessible data for contracts from other government

procurement organizations (e.g., municipal,

provincial/territorial, and/or international);

o accessible financial reports, historical and forward looking, for

the contractor;

o publically available financial reports from other companies in

the contractor’s industry;

o publically available financial reports from other companies in

the contractor’s geography;

o leading practices for managing the amount of the cost type;

and/or

o other applicable sources of comparator information?

• Have applicable credits (e.g., grants, subsidies, discounts,

allowances, rebates) been removed from the cost amount?

• Where measurable, does the amount of the cost provide value for

Canada and, where measurable, does the cost justify the benefits?

(e.g., research and development costs resulting in reduced

production costs)

Is there evidence that the cost

amount, to be allocated to

• Has the cost amount to be allocated to Canada been recovered:

o in past, existing, or proposed contracts?

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Is the Cost Reasonable?

Sub-Criteria

Example Considerations to

Assess Sub-criteria

Canada, has not already been

recovered?

o in profit rate or premium calculations?

• Has a direct (indirect) cost already been recovered as an indirect

(direct) cost?

Does the cost amount comply

with the terms and conditions

established in the contract, if

applicable?

• For established limits in the contract terms and conditions, does the

cost amount comply?

• Does the cost amount comply overall with any terms and conditions

(i.e. limits) set out in other contracts with the same contractor?

o For example, there may be a limit set in the contract terms for

the percentage of contractor indirect sales and marketing costs

that can be allocated to government contracts in relation to the

total cost of the government contracts (e.g., contractor indirect

sales and marketing costs can comprise up to X% of the total

cost of the contractor’s government contracts).

Has the cost amount been

allocated to the contract in

proportion to the benefits

received or expected to be

received by the contract?

• Has the cost amount been allocated fairly and accurately (i.e. direct

versus indirect cost) between the contract in question and other

existing government contracts and non-government business

activities in which the contractor may be engaged?

Assessment of Contract Cost Acceptability Using a Risk Guided Approach

To assist in assessing the acceptability of contract costs, a risk-guided approach should be applied. Applying

a risk-guided approach means that it is necessary to assess the:

• likelihood of incorrectly assessing the acceptability of a contract cost; and

• impact of the incorrect assessment of acceptability for a contract cost on the value to Canada

This approach is recommended because:

• contracts may vary based on the nature of the procured goods and services, the uncertainty of scope,

the level of strategic/reputational importance, the length of the contract, and the size of dollar value.

• costs may vary based on the nature of the cost, the uncertainty of occurrence of the cost, the level

of strategic/reputational importance, and the size of cost amount.

Correspondingly, the risk of incorrectly assessing the acceptability of a contract cost will vary depending on

the specific contract and specific cost in question.

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The table below identifies potential indicators for assessing likelihood and impact. Note that the list of

indicators is non-exhaustive and may differ depending on the type of cost-based payment.

Likelihood of Risk Occurring

Impact on the Value to Canada

• The nature of the procured goods and services

(e.g., routine versus new technology).

• The uncertainty of the scope of the contract (e.g.,

for cost-estimate types of bases of payment).

• The nature of the cost, including, but not limited

to, whether the:

o cost is classified as an indirect cost;

o cost is a derivative of transfer prices;

o cost amount has been measured using an

alternative measurement basis (e.g., fair

market value instead of opportunity cost);

and/or

o amount for the cost is an aggregate of

amounts for other cost (e.g., sales and

marketing costs may be comprised of

compensation costs, travel costs, and

others).

• Sufficiency of evidence required to support

acceptability for the cost, including, but not

limited to, whether certain evidence is:

o available (e.g. benchmark data); and/or

o measurable (e.g. benefits of cost type to

Canada).

• The reputational/strategic importance of the

contract

• The amount of the cost including the

proportional cost amount to the total contract

cost

• The reputational/strategic importance of cost,

including, but not limited to, whether:

o a high level of public scrutiny will occur

due to incorrect acceptance; and/or

o unfair subsidies will result from incorrect

acceptance.

The likelihood of the risk occurring, the impact on the value to Canada, and the overall risk level (which is an

aggregate of likelihood and impact) should be assessed using an appropriate mechanism (e.g. a rating scale).

The benefit of a risk-guided approach is that it will help Canada manage capacity, so that increased and

suitable effort (e.g. stakeholder consultations, due diligence, etc.) is allocated, to assess the higher risk

contract costs. Ultimately, a risk-guided approach will hasten the process of assessing contract cost

acceptability leading to more agile procurements.

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Assessing Contract Cost Acceptability During the Contract Lifecycle

The criteria of Attributable, Appropriate, and Reasonable can be used to assess the acceptability of contract

costs before contract initiation, during the contract period and after contract completion. These criteria can

be used as the basis to negotiate what costs would be appropriate for a contract, to provide limits for

determining a reasonable amount for a cost case and to assess if the reported contract costs are Attributable,

Appropriate and Reasonable.

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Costing Standard Subsections

Supplementary Considerations for Assessing the Acceptability of Specific Costs

Information for specific costs is presented as subsections in table format below.

• Description: This field identifies a description and/or examples of the respective cost.

• Supplementary Considerations: This field identifies supplementary considerations, for assessing

the acceptability of the specific cost in respect to the criteria of Attributable, Appropriate, and

Reasonable, that augments the guidance already provided in the Recommended Criteria for

Assessing the Acceptability of a Contract Cost section. This field also identifies discussion papers

or cost tables with related guidance which the practitioner can consult for further reference. This

field is not meant to include a complete list of all supplementary considerations, professional

judgement is required.

Please Note: When assessing the acceptability of a specific cost, it is important to consider that the respective

cost may be an aggregate of other costs (e.g. sales and marketing costs may be comprised of compensation

costs, travel costs, and others). Correspondingly multiple tables may need to be consulted to identify

supplementary considerations and examples for the cost being assessed.

1) Asset-Based Costs

1.1 Amortization of Unrealized Appreciation of Assets

Description: Amortization is the process of allocating the cost of an asset over a period of time. Unrealized

appreciation is an increase in the value of an asset that the owner does not receive because the asset has

not been sold.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Under SACC 1031-2, costs associated with the amortization of unrealized appreciation of assets are

considered non-applicable costs to the contract.

Amortization of unrealized appreciation of assets is currently under consideration.

Attributable

• No supplementary considerations noted.

Appropriate

• No supplementary considerations noted.

Reasonable

• No supplementary considerations noted.

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1.2 Depreciation

Description: Depreciation is the gradual exhaustion of the service capacity of fixed assets which is not

restored by maintenance practices. It is the consequence of such factors as use, obsolescence,

inadequacy, and decay.

"Capital Cost Allowance (CCA)” is an annual deduction (i.e. depreciation) used for income tax purposes

that can be claimed on fixed assets when determining taxable income.

“Fixed Assets” are long-term tangible assets that is not likely to be consumed or converted quickly into

cash (i.e. property, plant or equipment).

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Under SACC 1031-2, costs associated with the following are considered non-applicable costs to the

contract:

a. finance charges (please note all finance charges are considered non-applicable costs to a

contract)

h. amortization of unrealized appreciation of assets

i. depreciation of assets paid for by Canada

k. expenses and depreciation of excess facilities

Attributable

• No supplementary considerations noted.

Appropriate

• No supplementary considerations noted.

Reasonable

• The historical cost of an asset less related borrowing costs included in the cost of the asset should be

used to calculate depreciation costs.

• A contractor should apply its own accounting policies when valuing and recognizing assets on its

balance sheet, unless title is taken by Canada, or Canada pays for the asset under an Assistance

Program.

• Assets are generally depreciated over their useful life. In circumstances where an asset is acquired

for a specific contract only and has no useful purpose thereafter then, if agreed to in advance, the

asset may be fully depreciated over the life of the contract as an acceptable depreciation cost.

• The amount calculated using Capital Cost Allowance (CCA) rates should be no higher than the basic

CCA rates published by Canada Revenue Agency (CRA) for income tax purposes.

• Also, the use of accelerated CCA rates should not be considered reasonable, as it is not

permitted under General Condition SACC 1031-2. Contracting officers should consider the

risk associated with accelerated CCA rates, such that accelerated CCA rates assign a greater

215 | Page Public Services and Procurement Canada August 2023

cost to an individual period that may not reflect the use of the asset and may unfairly load

costs in a period and significantly impact individual contracts.

• There should be no recovery of depreciation costs where these costs have been recovered through

other means.

• Example: When a contractor receives a grant from Canada to buy a depreciable asset, the

amount of the grant should be subtracted from the asset’s historical cost.

• Unless the title is taken by Canada, any funding provided by Canada should be credited to the asset

(i.e. the funding amount should be deducted from the related purchase price of the assets, with any

depreciation or amortization calculated on the net amount). This includes direct and indirect benefits

such as the contribution for capital assistance. Investment Tax Credit should not be deducted from the

fixed asset cost.

• Note: leasehold improvement costs are similar in nature to capital additions and for depreciation

purposes should be amortized over the lesser of the expected useful life of the leasehold improvement

or the non-renewable term of the lease.

1.3 Excess Production Capacity

Description: Excess production capacity is the difference between the contractor’s supply of capacity and

demand for capacity. It is also known as ‘idle capacity or ‘capacity not used’.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

See Annex 5.3.5 (Discussion Paper – Production Capacity and Indirect Costs Allocation).

1.4 Excess Facilities

Description: Excess/idle facilities refers to all fixed assets in a contractor's books of account which are not

in use or for which no use is anticipated within a reasonable period. "Facilities" in this context means plant,

related land, equipment, or any other tangible capital asset, wherever located, and whether owned or

leased by the contractor.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Under SACC 1031-2, expenses and depreciation of excess facilities are considered non-applicable costs

to the contract.

Attributable

• Expenses associated with the maintenance and/or the amounts of depreciation attributable to Excess

Facilities are generally not attributable costs to government contracts.

• Expenses and/or depreciation of excess/idle facilities, as defined above, may be attributable when

they are required to achieve contract specific activities and outcomes.

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• For example: Canada requires access to contractor facilities and production capacity to be in a

state of readiness to respond to events such as health crises, war demands, and others. The costs

of idle facilities and excess capacity may be Attributable in this case.

• For example: Excess capacity may arise when Canada asks a contractor to build up its capacity

to support a large contracted project. The costs of idle facilities and excess capacity may be

Attributable in this case.

• Also, the expenses and/or depreciation of excess/idle facilities, which the government has ordered

retained for defence purpose, should be charged to a separate contract set up for that purpose.

• Idle facilities and excess production capacity costs should be verifiable. The contractor should be able

to provide supporting documentation and calculations if such information is requested.

Appropriate

Costs associated with facilities that are excess to the contractor’s current needs should be examined and

the following factors should be considered when doing this assessment:

a) Vacant, or largely vacant space;

b) Inactive or unused equipment;

c) Idle capacity required for stand-by purposes;

d) Indirect supporting staff no longer required either in full or part;

e) Other costs such as maintenance, repair, rent, property taxes, insurance, depreciation, etc.;

f) Management costs that should be reduced because of the reduction in active facilities.

Reasonable

• No supplementary considerations noted.

1.5 Impairment of Assets

Description: An asset impairment occurs when there is a sudden decrease in the market value of an asset

below its recorded cost (i.e. cost recorded on the contractor’s statement of financial position).

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Attributable

• The contractor should be able to provide evidence that asset impairment has occurred.

• Impairment of an asset caused by the production/service requirements of the contract may be

Attributable.

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• Example: The contractor is required to use its equipment above practical capacity for an extended

production period. As a result, the equipment experiences significant wear and tear and becomes

impaired. This impairment loss would presumably be Attributable.

• Impairment of an asset may be Attributable if the asset in question is acquired for a specific contract

and has no useful purpose thereafter.

• Example: The contractor is required to acquire a specific asset for a contract. Other than for the

contract in question, it is determined that the asset has limited commercial value. Due to contract

scope changes, the asset is no longer required. The contractor chooses to dispose of the asset,

due to its limited commercial value, and recognizes a corresponding impairment loss. This

impairment loss would presumably be Attributable.

• Impairment of an asset caused by contractor negligence would not be Attributable.

Appropriate

• No supplementary considerations noted.

Reasonable

• The contractor should provide evidence, such as documentation and supporting calculations, for the

impairment cost amount of the asset.

• Impairment costs, for assets, which are covered by insurance, should not be allocated to a contract.

1.6 Leases

Description: A lease may be categorized as an operating lease or a capital lease.

Lease: is the conveyance by a lessor to a lessee of the right to use a tangible asset usually for a specific

period of time in return for rent.

Operating Lease: the lessor does not transfer substantially all the benefits and risks associated with

ownership of the leased property. Lease payments are treated as an expense (i.e. monthly rent).

Capital Lease: transfers substantially all the benefits and risks associated with ownership of the leased

property from the lessor to the lessee. Typically, a lessee would record the underlying asset (property) as

though it owns/purchased the asset.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Attributable

• The contractor should be able to provide evidence of whether capital or operating lease costs have

occurred.

Appropriate

• No supplementary considerations noted.

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Reasonable

• To be considered reasonable any lease cost should be determined in accordance with the following.

• The type of lease must be correctly identified as either an operating lease or a capital lease based

on acceptable Canadian accounting standards; Canadian Generally Accepted Accounting

Principles (i.e. ASPE or IFRS). In the case of an operating lease, the actual rental cost paid is

considered to be a reasonable cost. In the case of a capital lease, the depreciation amount

calculated on the capitalized value of the asset in the lease over the lease term or economic life

of the asset, is considered to be a reasonable cost.

• For a capital lease, depreciation of the asset should be in line with ASPE or IFRS. The asset is

generally depreciated over the lesser of:

• the lease term

• the asset’s useful life

• For capital lease costs, consult the 1.2 Depreciation cost table. The same supplementary

considerations are generally applicable for capital lease costs. For operating lease costs, a

Reasonable amount could be informed by rental costs of comparable property, as well as property

market economic considerations, in the same geographic region.

1.7 Special Production Tooling and Special Test Equipment

Description: Special Production Tooling (SPT) are tools such as jigs, dies, fixtures, moulds, patterns,

taps, gauges and other like items, which are of such a specialized nature that, without substantial

modification or alteration, their use is peculiar to the production of supplies or the parts thereof, which are

required by Canada

Special Test Equipment (STE) is either single or multipurpose integrated test units engineered, designed,

fabricated or modified to meet the test requirements of the specifications peculiar to the end items of

equipment, which are required by Canada. Also included are associated computer software programs.

• "Special Test Equipment" does not include special production tooling; buildings and non-severable

structures (except foundations and similar improvements necessary for the installation of special test

equipment); and test equipment loaned from a client's inventory.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

• Since the cost of SPT or STE represents part of the cost of the end product being acquired by a

client, payment is made out of the client's funds appropriated for the purchase of that end product.

• SPT may be acquired on a price arrangement or basis of payment (i.e., fixed price or cost

reimbursable) that is separate from the one used to acquire the end product for which the tooling

is required.

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Attributable

• No supplementary considerations noted.

Appropriate

• Expenditures incurred by a contractor in connection with purchased SPT or STE (other than the

cost of such tooling or equipment) are usually recovered as preproduction expenses or factory

overhead.

• Administrative overhead is not accepted on STE.

• Purchased tooling should be included in the cost of sales base for the distribution of administrative

overhead.

Reasonableness

• When SPT is to be provided:

o a dollar limit is to be placed on the cost of the tooling with the provision that the cost is not

to exceed this limit until further authorization is obtained from Canada.

Profit Considerations

• No profit is allowed on Special Production Tooling (SPT) or Special Test Equipment (STE) which

is purchased by a contractor for use under a contract or purchased or otherwise acquired by its

subcontractors for use under approved subcontracts.

• When the production of the end product involves prior or concurrent expenditures for SPT or STE

under a separate agreement, or pursuant to a clause in a contract or subcontract, a profit of up to

5 percent may be allowed on all SPT fabricated in a plant owned or operated by a contractor.

o No profit is allowed on the cost of purchased equipment incorporated or built into the STE.

1.8 Government Assistance Related to Fixed Assets, Research and Product Development

Description: Government assistance is funding provided by the Government of Canada to the contractor

related to the costs of certain assets (i.e. fixed assets, research and product development).

"Company Funded Costs" are expenditures made from funds over which the enterprise has spending

power, and which were not provided to the company through the terms of a related agreement or

understanding.

Forms of funding include:

"Grant" is an unconditional payment made to a recipient, usually for a specific purpose, for

which the donor will not receive any royalties, goods, or services.

"Contribution" is a conditional transfer payment under an auditable agreement for which the

donor will not receive any royalties, goods, or services.

"Contribution Arrangement" is an undertaking between a donor department or agency and a

prospective recipient of a contribution, describing the obligations of each, and the terms and

conditions of payments and which contain conditions for royalties from resulting sales. The

arrangement may be as informal as an exchange of letters.

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Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Attributable

Company Funded Costs that may be considered attributable for contracts negotiated in accordance

with SACC 1031-2 are:

• Fixed Assets

o Government Assistance towards the acquisition of fixed assets should be deducted from the

fixed asset acquisition cost and the relevant depreciation calculated on the net asset amount.

Depreciation on the net amount may be included in the applicable overhead for cost recovery

on contracts.

• Research and Development

o Please note: Previously, the Supply Manual guidance states Investment Tax Credits (ITCs)

shall not be deducted from related research and development (R&D) expenditures when

determining the applicable costs, whereas it is proposed in the discussion paper for research

and development (R&D) expenditures to be reported net of applicable credits, which include

ITCs. ITCs and its application to related R&D expenditures when determining the applicable

costs is under review and consultation for the next iteration of the Guide.

o See Annex 5.3.6 Discussion Paper – Research and Development Costs for more information.

• Product Development

o Government Assistance, as well as third party funded assistance, towards a specific product

development should be netted against the relevant product development costs to arrive at the

portion to be recovered over the sale of that product or family of products.

Appropriate

• No supplementary considerations noted.

Reasonable

• No supplementary considerations noted.

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2) Employee-Based Compensation Costs

2.1 Dues and Membership

Description: Dues and memberships are regular fees often paid to an organization at regular intervals.

Professional designation annual membership dues would be one example.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Under SACC 1031-2, costs associated with dues and memberships other than regular trade and

professional associations are considered non-applicable costs to the contract.

Attributable

• Dues and membership, which are part of an employee’s standard remuneration package may be

considered Attributable as they reflect the necessary administrative costs of an employee performing

work on a contract.

• Other dues and membership may be Attributable if they have a causal relationship with the

performance of the contract.

• Example: Corporate membership fees of industry or trade associations may be Attributable in the

event the skill set is specifically required for the contract or membership fee is required to access

information required for the contract.

• The expenses associated with membership, either of the company as a whole or individual officers or

employees in associations whose prime purpose is to provide entertainment or recreation, are not an

acceptable cost to government contracts.

Appropriate

• No supplementary considerations noted.

Reasonable

• The cost amount for Attributable and Appropriate dues and memberships may be considered

Reasonable if the cost amount is comparable to industry benchmarks.

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2.2 Downtime

Description: Downtime is a form of excess capacity, except it applies to labour, instead of physical assets.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Attributable

• Generally not acceptable, unless downtime

• Is required to meet uncertain scope and demand,

• Is of a strategic nature that Canada has determined may be called upon to enable or support

urgent requirements, or

• Is caused by changes in government policy which could not have been predicted by the contractor.

Appropriate

• No supplementary considerations noted.

Reasonable

• No supplementary considerations noted.

2.3 Employee Benefits

Description: Employee benefits are various types of non-wage compensation provided to employees.

Examples include employee insurance, retirement benefits, tuition reimbursement, sick leave, vacation,

and others.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Attributable

• Employee benefits which are part of an employee’s standard remuneration package may be

considered Attributable as they reflect the necessary administrative costs of an employee performing

work on a contract.

Appropriate

• Attributable employee benefits may be considered Appropriate if the inclusion/occurrence of the cost

type is consistent with industry benchmarks.

Reasonable

• The cost amount for Attributable and Appropriate employee benefits may be considered Reasonable

if the cost amount is comparable to industry norms.

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2.4 Executive and Employee Compensation

Description: Executive and employee compensation section includes the following:

Executive Compensation: Includes the monetary and non-monetary benefits given to the senior

management of a company.

Profit Sharing & Bonus Payments (i.e. Incentive Remuneration Bonus Plans): Include payments made to

reward employee and executive performance. These payments may be based on the performance of the

individual and/or of the company (e.g. amount of profit earned, share price etc.).

Dividends: A distribution of a company’s earnings to the shareholders.

Stock Options and Stock Based Compensation: Compensation to employees based on the shares of a

company.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Under SACC 1031-2, the following are considered non-applicable costs to the contract:

l. Unreasonable compensation for officers and employees

s. compensation in the form of dividend payments or calculated based on dividend payments

t. compensation calculated, or valued, based on changes in the price of corporate securities, such as stock

options, stock appreciation rights, phantom stock plans or junior stock conversions; or any compensation

in the form of a payment made to an employee in lieu of an employee receiving or exercising a right, option,

or benefit.

Under Section 03 of Contract Cost Principles 1031-2, paragraph (b), fringe benefits can be included as

part of direct labour costs, as these costs can be a portion of gross wages or salaries which can be

identified and measured as having been incurred or to be incurred in the performance of the contract.

Under Section 04 of Contract Cost Principles 1031-2, paragraph 2. (c) indicates that fringe benefits (the

contractor's contribution only) can be included as indirect costs (overhead). A fringe benefit type that may

not be an overhead cost for 1031-2 purposes is amounts paid under Incentive Remuneration Profit Sharing

Plans. The reason these amounts are not considered costs is that normally these plans are considered as

a distribution of a portion of earnings to employees. Earnings that are profits or a distribution of retained

earnings are not costs. However, since the purpose of these plans is to remunerate employees, the

payments under these plans may be considered costs.

• For Incentive Remuneration Bonus Plans, the following criteria must be met in order for the costs

to be Appropriate:

• the plan includes a documented sharing arrangement, with all employees, and the

incentive amounts payable by the employer must be computed with reference to earned

profits;

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• the company pays employees directly or provides the funds for the employees plan to a

trustee in trust for the benefit of the employees who are members of the plan;

• the amount of cost will not exceed the amount of payment made to the employees or the

plan’s trustee;

• the cost is recognized only in the year the employee provides services to earn benefits

under the plan;

• the entire amount recognized as cost must be disbursed to employees in the fiscal year

when the benefits were earned or shortly after the end of the fiscal year (within a few

months, but well before the end of the fiscal year following the one for which plan benefits

were based);

• any funds payable by the trustee to the employer for over contributions or funds that the

plan may earn shall be used to reduce the current year costs unless these funds or over

contributions are paid directly by the employer to the employees within that current fiscal

year; or

• compensation to owners of closely held corporations, partners, sole proprietors, or

members of their immediate families should be in accordance with the personal services

rendered rather than a distribution of profits.

Refer to Annex 5.3.2 Discussion Paper: Executive Compensation and Bonus for detailed considerations

and examples of when executive compensation, profit sharing and bonus costs may be acceptable.

Appropriate and Attributable

• Compensation in the form of dividend payments or calculated based on dividend payments are

generally not appropriate or attributable, as they are a distribution of earnings to shareholders,

and not organization operating costs.

• Stock-Based compensation, calculated, or valued, based on changes in the price of corporate

securities are not considered attributable or appropriate. These involve the creation of a contingent

provision to retain and motivate employees, based on events which may or may not occur .Further,

compensation based on changes in securities price is not based on work actually performed.

Reasonable

• No supplementary considerations noted.

2.5 Overtime Costs

Description: Overtime is work performed by a contractor’s employee above the normal employee working

time standard. Standards will differ based on the relevant jurisdiction.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Attributable

• Overtime costs may be Attributable when it is specifically approved or requested by Canada. The

following are some examples of situations where overtime costs may be approved or requested.

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• When the client department requires the contractor’s resources to work above practical capacity in

order to adhere to an accelerated contract schedule.

• When the quicker completion of a contract activity, which requires overtime, may facilitate potential

financial, schedule, and quality benefits for the contract in question.

• Overtime costs are generally not Attributable when it is determined that the contractor has not been

efficient in completing contract activities (e.g. contractors spending significantly longer time on

completion of a contract task than average.

Appropriate

• No supplementary considerations noted.

Reasonable

• The calculation of overtime costs should align with jurisdictional labour regulations or relevant

collective bargaining or employee agreements.

• Limits on the amount of overtime costs could be established in the contract (i.e. a maximum

percentage of the total contract compensation costs).

2.6 Pension Costs

Description: A pension is any arrangement (contractual or otherwise) by which a program is established

to provide retirement income to contractor employees. Pensions may be in the form of a defined benefit

plan or a contribution plan.

"Actuarial Assumptions" are presumptions about future events that will affect pension costs and

obligations. These include theories concerning mortality, withdrawal, disability, retirement, changes in

compensation, interest on accrued pension benefits, investment earnings, and asset appreciation or

depreciation.

"Actuarial Cost Methods" are methods used to determine the cost of providing pension plan benefits

and to allocate that cost to specific time periods.

"Current Service Cost" is the cost of anticipated future retirement benefits accrued during any year

usually determined on an actuarial basis; it represents the aggregate estimated cost for one year's

service by each employee who is a member of the plan.

"Defined Benefit Pension Plan" specifies either the benefits to be received by employees after

retirement or the method for determining those benefits.

"Defined Contribution Pension Plan" is one in which the employer's contributions are fixed, usually as

a percentage of compensation, and allocated to specific individuals. The pension benefit for each

employee is the amount that can be provided at retirement based on the accumulated contributions made

on that individual's behalf and investment earnings on those contributions.

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"Experience Gain or Loss" is the measure of the difference between the expected and actual

experience of the plan.

"Past Service Cost" is the estimated cost of future retirement benefits accrued in the years prior to the

adoption of a pension plan; these costs are normally charged to operations over a reasonable number of

years.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Section 04(2)(c) of Contract Cost Principles 1031-2 states in part, that "indirect costs may include such

items as fringe benefits, (the contractor's contribution only)" in overhead pools. Pension benefits are a type

of fringe benefit.

Attributable

• Pension costs are part of an employee’s standard remuneration package; as such, the portion of

pension costs, borne by the contractor would be Attributable, since they reflect the necessary

administrative costs of an employee performing work on a contract.

• Losses associated with pension adjustments/revaluations would not be Attributable as they would be

unrelated to the performance of the contract.

Appropriate

• No supplementary considerations noted.

Reasonable

• The amount of time spent on the contract by the employee, in relation to the amount of time spent by

the employee employed at the contractor, should be assessed when allocating pension costs.

• Either Defined Contribution Pension Plans or Defined Benefit Pension Plans are acceptable in the

calculation of pension costs in accordance with Government Contract Cost Principles 1031-2.

• These costs should be reconcilable by the plan to the disclosure notes in accordance with the

relevant Canadian Generally Accepted Accounting Principles (i.e. ASPE or IFRS).

• Under Defined Contribution Pension Plans the employer's responsibility is simply to make a

contribution each year based on the formula established in the plan. The pension cost for a cost

accounting period will normally be the current and past service cost.

• Accounting for Defined Benefit Pension Plans is quite complex, because the benefits are defined

in terms of uncertain future variables, an appropriate funding pattern must be established to assure

that enough funds will be available at retirement to meet the benefits promised. The pension cost

for a cost accounting period will normally be the aggregate of current service, plus past service,

plus interest, minus expected return on plan assets, plus or minus experience gains/losses.

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2.7 Pension Plan Refunds

Description: A pension plan is any arrangement (contractual or otherwise) by which a program is

established to provide retirement income to employees.

On occasion, there exist credits due to refunds to contractors from companies handling their pension

plans. This situation could be as a result of large lay offs of employees, plan terminations and related

interest on funds invested. The accounting issue that arises from these terminations is whether a gain

should be recognized when these assets revert back to the company.

"Pension Plan Settlement” occurs when an employer legally discharges the obligation for accrued

pension benefits either by transferring assets directly to plan participants in exchange for their rights to

pension benefits or by purchasing annuity contracts in which a third party unconditionally undertakes to

pay all accrued pension benefits.

"Pension Plan Curtailment" occurs when the expected years of future service to be rendered by the

existing employee group is reduced significantly or when benefits will not be earned by employees for

some or all future periods.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Attributable

• The pension refund amounts to be deducted from overhead expenditures used to determine costing

rates should be the contractor's share of the expected pension credits.

Appropriate

• Upon a pension plan settlement or curtailment, the employer may have eliminated obligations with

respect to the plan, any gains or losses on the transaction, including any unauthorized amounts related

to previous plan amendments. Changes in assumption and experience gains and losses, should be

recognized immediately.

• On the other hand, if an employer settles only a part of the accrued pension benefits, a portion of any

gains or losses including any unamortized amounts should be recognized immediately.

Reasonable

• No supplementary considerations noted.

2.8 Severance Payments

Description: Severance payments are a cash settlement or paid leave granted to contractor employees

upon termination of employment for various reasons, or upon retirement. Remuneration for earned

vacation credits or compensation for unused sick leave credits is not considered as severance pay. Other

payments excluded from severance pay are return of contributions made to pension plans or retirement

savings programs.

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Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Attributable

• If the cause of termination that leads to the severance payment for the respective employee is linked

to poor contractor performance (non-compliance or unacceptable behaviour), then the corresponding

severance costs would presumably not be considered Attributable.

Appropriate

• No supplementary considerations noted.

Reasonable

• Severance payments could be calculated in accordance with:

• an employment contract, a collective agreement or enacted legislation;

• an established company policy; and/or

• based on the merits of a particular case.

• The amount of severance costs per employee should be comparable to industry benchmarks.

• The amount of time spent on the contract by the employee, in relation to the amount of time spent by

the employee employed at the contractor, should be assessed when determining an amount to allocate

for severance costs.

• Parameters limiting the cost amount of severance allocated to a contract could be established.

Contract duration is an example of a factor on which a parameter, limiting the amount of severance

costs, could be established (i.e. a positive correlation may exist between contract duration and

employee turnover frequency).

• In order for the severance payment to be deemed Reasonable any amount associated with the

following should not be included:

• profit sharing;

• commissions;

• patent or other rights.

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2.9 Training and Staff Development

Description: The objective of training and development is to improve an employee’s performance through

learning. As an example, training and development can consist of learning new knowledge, technical skills,

and/or soft skills.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Attributable

• Training and staff development which are part of an employee’s standard remuneration package may

be considered Attributable as they reflect the necessary administrative costs of an employee

performing work on a contract.

• Associated training and staff development costs would be Attributable when the contractor’s

employees are required to conduct online government training modules as a direct requirement of the

contract.

• Certain training and staff development activities may enable the contractor to deliver on the

performance of the contract in a more cost-effective, timely, and quality manner. Associated costs may

be Attributable to the contract.

Appropriate

• Attributable training and staff development activities, which are part of an employee’s standard

remuneration package, may be considered Appropriate if the inclusion/occurrence of the activities is

consistent with industry benchmarks.

Reasonable

• The cost amount for Attributable and Appropriate training and staff development activities, which are

part of an employee’s standard remuneration package, should be informed by industry benchmarks.

2.10 Travel Costs and Living Expenses

Description: Travel costs and living expenses are the costs for transportation, lodging, meals and incidental

expenses incurred by a contractor's personnel on official company business.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

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Attributable

• Typically, traveling and living expenses incurred by a contractor in the ordinary course of business are

to be treated as indirect costs chargeable to overhead (which is profit bearing).

• In order for travel costs to be acceptable as direct costs to a contract, the following conditions must be

met:

• such costs are directly attributable to the performance of the work under the contract;

• the practice of charging travel costs to a contract is consistently followed in the costing of both

government and non-government work; and

• all directly charged travel costs are eliminated from indirect costs allocated to government contracts.

Appropriate

• The practice of charging travel costs to a contract is consistently followed in the costing of both

government and non-government work.

Reasonable

• Costs for transportation may be based on mileage rates, actual costs incurred, or on a combination

thereof, provided the method used results in a reasonable charge.

• Costs for lodging, meals and incidental expenses may be based on per diem, actual expenses, or a

combination thereof, provided the method used results in a reasonable charge.

• The Treasury Board (TB) Travel Directive applies to travel expenses incurred on contracts with persons

outside the Public Service, when these expenses are a specific element of the contract. For more

details, consult the TB Travel Directive and Special Travel Authorities. The contracting officer may

accept the contractor's travel and living rates, if they are lower than the TB rates.

• Administrative overhead on travel and living expenses:

• Administrative overhead may be applied to direct travel and living expenses at either full rates,

where adequate support for the claimed general and administrative rate can be demonstrated, or

at a lower negotiated rate where such substantiation cannot be provided (apply SAAC Manual

clause C4000C).

• A contract may provide for direct travel and living expenses to be charged at cost with no allowance

for overhead or profit (apply SAAC Manual clause C4001C).

• Parameters limiting the cost amount of travel costs could be established (For example the amount of

the travel expense parameter could be established as a set percentage of the total contract cost.)

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2.11 Department of National Defence (DND) Facility Costs

Description: Department of National Defence (DND) service establishments may be able to provide

transportation, mess and lodging facilities to the contractor's employees performing work at or near these

establishments under mobile repair party and maintenance-type contracts. The commanding officer of the

DND establishment should, upon request, advise the contractor as to the availability of these facilities.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Attributable

• No supplementary considerations noted.

Appropriate

• No supplementary considerations noted.

Reasonable

• Any costs incurred by the contractor for the use of these facilities, plus any incidental expenses incurred,

should be considered reasonable and reimbursed under the contract, together with allowances for profit

and/or administrative overhead.

In order for the contractor to be reimbursed, contracting officers must include SACC C4004C in

the contract.

2.12 Displacement/Dislocation Pay Allowance

Description: A displacement/dislocation pay allowance is the reimbursement paid to employees who work

outside of their office for a short time (i.e. 6 months) and need to find temporary accommodations.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

For removal, living, car allowances and outside Canada expenses, consider the following:

Attributable

• Only one removal from and back to the original residence will be paid for each out-of-plant service

representative. Where removal expenses to the site of the work have been paid by the Canada on a

previous contract and the services are being extended for a further period, the contract amendment or

subsequent contract should only provide reimbursement for expenses incurred to move the

representative back to the original residence.

• Cases where the representative is required to go abroad must be dealt with individually and considered

on their merits.

Appropriate

• Removal expenses should not be paid on assignments of less than six months. For assignments

exceeding six months, any removal by an employee with dependents must be carried out during the

first 90 days, and for an employee without dependents during the first 60 days.

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• Reimbursement for living expenses for an employee with dependents on an assignment exceeding six

months should cease when the family is relocated (whether or not removal expenses have been paid)

to permanent quarters at the location of the work.

• Reimbursement for living expenses for an employee without dependents on an assignment exceeding

six months should cease when the employee's effects have been moved (whether or not removal

expenses have been paid) to the location of the work or in any event after the first 60 days of such

assignment.

Reasonable

• The displacement pay must be justifiable and/or is in accordance with the contractor’s established

practice.

• Reasonable car allowances in accordance with the contractor's practice may be paid for the use of

personally owned motorcars by the contractor's personnel for essential on-base traveling where local

Canada transportation is not available.

For additional information, see Annex 2B: Contract Costing Rates on out-of-plant service rates and mobile

repair party rates.

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3) Good/Service Based-Costs

3.1 Bad Debts and Collection Charges

Description: A bad debt is a contractor debt that cannot be recovered. Collection charges are the costs

associated with recovering a contractor debt.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Under SACC 1031-2, costs associated with the bad debts and collection charges are considered non-

applicable costs to the contract.

Since Canada as a debtor always pays its just debts, while it is only the commercial customers who have

bad debts on a contractor's books, the losses due to bad debts and the expenses of collection thereof are

not an acceptable cost to government contracts.

3.2 Inventory Losses and Obsolescence

Description: Obsolete inventory is a term that refers to contractor inventory that is at the end of its product

life cycle. This inventory has not been sold or used for a period of time and is not expected to be sold in

the future, resulting in losses for the contractor.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Attributable

• Inventory losses and obsolescence may be directly Attributable if it is due to contract production

requirements required by the client department.

• Example: The client department may have asked a contractor to produce a large inventory of

specific goods in the anticipation of requiring these goods for certain international crises; however,

these crises do not occur, and the contractor is left with obsolete goods that no longer have

commercial value. The resulting inventory losses and obsolescence would presumably be

Attributable in this case.

• In circumstances where stock losses or obsolescence costs do not directly apply to contracts, they

may still be Attributable. This will only apply when the contractor’s costing system is able to isolate

these stock losses as an indirect overhead.

• The contractor should demonstrate that the inventory losses and obsolescence were unavoidable.

• Inventory losses and obsolescence may be Attributable if the contractor can provide evidence and be

able to demonstrate that write-offs associated with inventory losses and obsolescence were not

because of poor storage, handling, or control.

Appropriate

• No supplementary considerations noted.

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Reasonable

• The amount for inventory losses and obsolescence should be the difference between the Net

Realizable Value of the inventory (i.e. value realized through ordinary sale of the inventory less selling

costs) and cost of the inventory in their accounting system.

3.3 Rework and Faulty Workmanship

Description: Rework is the contractor work required to correct a defective or non-conforming good or

service. Faulty workmanship is rework that occurs due to the contractor’s fault.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Attributable

• The costs of rework may be required for the performance of the contract; this recognizes that no

production or service process is likely to be completely effective and that attempts to achieve no rework

would be uneconomical for the contract.

• Contractors should have adequate quality control and monitoring systems in place to be able to identify

the level and the causes of rework, where material.

• The costs of faulty workmanship would not be Attributable where the fault has occurred due to poor

skills, training, systems or materials that the contractor has in place or has purchased.

• Costs associated with faulty workmanship may be Attributable where there is consensus that faulty

workmanship cannot be avoided because of the complexity or lack of maturity of the contract goods

or services.

Appropriate

• No supplementary considerations noted.

Reasonable

• Contracts, of a similar nature, could be referenced to inform what amount of rework and faulty

workmanship may be Appropriate for the contract in question.

• Consideration should be provided to whether rework and faulty workmanship costs are already

reflected in contract profit rate calculations, as a technical risk.

• The contractor should have plans in place to reduce rework costs through learning curve and efficiency

gains.

• Parameters limiting the amount of rework and faulty workmanship costs could be established.

• Example: The amount of the parameter could be established as a set percentage of the total

contract compensation costs.

In the event there is a warranty covering faulty workmanship, refer to warranty and contingencies section.

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3.4 Surplus Material Expense

Description: Surplus materials refers to excess or unused materials that remain after the contract has

been completed and/or are no longer required for the performance of the contract.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Attributable

• Surplus due to excess purchasing (i.e., a higher number of purchases than required by contract or

by normal business practices) by a contractor would not be considered Attributable.

• Costs of surplus materials, net of any credit received in the disposal or transfer of the surplus

material are Attributable in a production contract when the surplus is due to:

o normal accumulation of stores (i.e., the amount of inventory required by contract or by

normal business practices), during or on completion of a contract;

o major design changes or other major adjustments of a substantial nature not including

contract termination;

o minor design changes or other minor adjustments in the scope of the work provided the

contract does not specifically exclude such items.

Appropriate

• No supplementary considerations noted.

Reasonable

• Handling costs associated with the surplus materials are attributable in a contract whenever the

costs of surplus materials are acceptable.

• General and administrative overhead costs associated with acceptable surplus materials:

o Administrative overhead or material handling rate may be applied in a contract when the

surplus materials consist of work-in-process and finished goods resulting from design

changes and minor scope adjustments.

Other Considerations:

• Attributable and appropriate surplus costs may be considered separate in the determination and

assessment of incentive fees, targets for incentive contracts, and ceiling price for cost-reimbursable

contracts.

o For cost-reimbursable with fixed fee or cost reimbursable with incentive fee contracts, and

contracts containing a ceiling price, allowable costs of surplus materials will be treated as an

extra direct cost to the contract, outside the area of fixed fee, incentive fee or ceiling price

considerations. It may be necessary to renegotiate the principal terms of the contract.

o Where incentive fee contracts require negotiation of targets, the costs of surplus materials

should be included in the revision of a target only where other reasons make it essential to

re-open the calculation for the protection of either the contractor or Canada. Alternatively,

when a contract so provides, these costs may be paid for as an extra to the target or other

arrangements, e.g., at cost plus a fixed fee at whatever rate of profit is appropriate.

• Profit will be allowed on acceptable surplus material costs, except:

o in the case of surplus materials arising from the normal accumulation of stores, during or on

completion of a contract, profit will be allowed only if the inventories acquired for a contract

were financed by the contractor;

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o in the case of surplus materials arising from major design changes, or other major changes

of a substantial nature, profit will be allowed only if the inventories were either purchased by

the contractor or, if not purchased by the contractor, were manufactured by the contractor

and rendered surplus as the result of the changes.

o See Section 5.2 Profit Principles for further details on profit.

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4) Corporate-Based/Various Costs

4.1 Allowance for Interest on Debt and Capital

Description: Allowance for interest on Invested Capital, Bonds, Debentures, Bank or Other Loans with

Related Bond Discounts

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Under SACC 1031-2, costs associated with allowance for interest on invested capital, bonds, debentures,

bank or other loans with related bond discounts and finance charges are considered non-applicable costs

to the contract.

• This is because it is impossible to know how much of a contractor's capital should be properly provided

by equity capital and how much by borrowed capital. Since dividends (i.e. from equity capital) are a

distribution of profit and therefore not a cost, it would be unreasonable to allow interest on borrowed

capital as a cost.

Attributable

• Interest is not an Attributable as the cost-of-money (interest) is already compensated through return

on capital profit rate calculations.

• In addition, since interest on capital invested in a contractor's business is not considered a business

operating cost, neither is interest received by a contractor from funds invested outside of the business

considered a necessary credit against business operating costs.

Appropriate

• The method in which a contractor finances their operations is generally not Appropriate as it could

result in unfair treatment of contractors. For example, if interest were to be an acceptable cost, then a

contractor financed by bonds, debentures or long term loans could be in an advantageous position

compared to a contractor financed by the sale of equity. The government of Canada recognizes the

cost-of-money (interest) associated with capital employed, however financed, as a factor in the

calculation of profit.

Reasonable

• No supplementary considerations noted.

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4.2 Extraordinary or Unusual Matters or Events

Description: Such events are infrequent, atypical of normal business activities, and not primarily dependent

on decisions made by management. For example, a major earthquake in a region that does not experience

much seismic activity may be considered an extraordinary or unusual event, while a fire caused by

contractor negligence would not be considered an extraordinary or unusual event.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Attributable

• Costs of extraordinary or unusual matters/events, associated with assets that have a causal

relationship with, or are otherwise required/beneficial, for the performance of the contract, may be

Attributable.

Example: Natural disaster flooding occurs at the contractor’s office that destroys materials to be used

in creation of the good. The cost of replacing the materials may be Attributable.

• Extraordinary or unusual matters/events, which can be foreseen, would presumably not be Attributable

as it would be expected that the contractor would pursue preventative measures (e.g. purchase

insurance).

• The cost of extraordinary or unusual matters/events, which is covered by insurance, would presumably

not be Attributable.

Appropriate

• No supplementary considerations noted.

Reasonable

• There should be no recovery of costs associated with extraordinary or unusual matters/events when

these costs have been recovered through insurance proceeds.

• If recovery of costs is not covered through insurance, an independent valuation of the assets and costs

should be submitted by the Contractor.

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4.3 Financial Related Expenses

Description: Financial Expenses include the following:

• Financing Charges: Include costs associated with a contractor’s working and fixed capital.

• Financial Security Issue Costs: Include commissions paid, to investment banks, law firms, auditors,

regulators, for the issuance of contractor debt or equity.

• Financial Reorganization Costs: Costs associated with changing the capital structure, debt or equity,

of the contractor.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Under SACC 1031-2, financing charges are considered non-applicable costs to the contract.

Attributable

• Financing Charges, Financial Security Issue Costs and Financial Reorganization Costs would not be

Attributable since the cost is already compensated through return on capital profit rate calculations.

Appropriate

• No supplementary considerations noted.

Reasonable

• No supplementary considerations noted.

4.4 Fines and Penalties

Description: Penalties can be imposed by federal, provincial, municipal or other government authorities.

They may be issued to a contractor in the form of a fine.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Under SACC 1031-2, fines and penalties are considered non-applicable costs to the contract.

Attributable

• The amounts of fines and penalties imposed by federal, provincial or local authorities are not an

acceptable cost to government contracts, for to accept such amounts would be tantamount to the

government authority supporting financially the offense which gives rise to the imposition of a fine or

penalty.

Appropriate

• No supplementary considerations noted.

Reasonable

• No supplementary considerations noted.

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4.5 Fees for Professional Advice

Description: Fees related to professional advice that are associated with obtaining assistance by the

contractor. This includes professional advice on technical, administrative or accounting matters.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Under SACC 1031-2, fees, extraordinary or abnormal for professional advice in regard to technical,

administrative or accounting matters (unless approval from contracting officer is obtained) are considered

non-applicable costs to the contract.

Attributable

• Generally not attributable unless there is a causal relationship with the contract (i.e. professional

engineering consulting fees incurred for the benefit and a requirement specifically stated in the

contract) and approval is obtained from the contracting officer.

Appropriate

• No supplementary considerations noted.

Reasonable

• No supplementary considerations noted.

4.6 Goodwill

Description: Goodwill represents the value paid by a contractor on a business enterprise purchase in

excess of the fair value of the acquired firm's assets less the assumed liabilities. This amount is based on

the anticipated growth and earnings of the newly acquired company.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Attributable

• Business combinations, such as the acquisition of a company or a business, may result in the creation

of goodwill. The business combination would not have a causal relationship with, or otherwise

required/beneficial for, the performance of the contract and hence would presumably not be

Attributable.

• Any cost related to goodwill including amortization, expensing, write-off, or write-down of this intangible

asset called goodwill (however represented) is not acceptable.

Appropriate

• No supplementary considerations noted.

Reasonable

• No supplementary considerations noted.

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4.7 Insurance

Description: Insurance provides a contractor and its employee financial protection from potential and/or

uncertain losses.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Under SACC 1031-2, premiums for life insurance on the lives of officers and/or directors where

proceeds accrue to the Contractor is considered a non-applicable cost to the contract.

Attributable

• Proceeds from such life insurance need not be applied to reduce any cost to the contractor.

Premiums on this type of insurance are not acceptable in government contracts since Canada does

not derive any benefit therefrom.

• Insurance (e.g. medical), which is part of an employee’s standard remuneration package, may be

considered Attributable as they reflect the necessary administrative costs of an employee

performing work on a contract.

Other insurance types may be Attributable if they have causal relationship, or are otherwise,

required for the performance of the contract.

• Example: Insurance covering buildings, equipment, vehicles, and other assets used for the

contract in question may be Attributable.

Appropriate

• Attributable insurance types may be considered Appropriate if the inclusion/occurrence of the

insurance is consistent with industry and geography benchmarks.

• Insurance types used by the contractor to cover itself against its own performance in delivering the

contract in question would not be considered Appropriate.

• Example: This could include insurance against faulty workmanship, defective parts, breach of

contract, or loss or profit associated with poor performance.

Reasonable

• The cost amount for the premiums of Attributable and Appropriate insurance should be comparable

to industry/geography norms.

Insurance proceeds, related to acceptable insurance policy premiums, should be directly, or indirectly,

apportioned to contract(s), as a credit to corresponding costs (i.e. costs which the insurance policy

covered).

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4.8 Legal, Accounting and Consulting Fees in Connection with Financial Re -Organization, Security

Issues, Capital Stock Issues, Obtaining of Patents and Licenses and Prosecution Against the

Crown

Description: These include legal, accounting and consulting fees in connection with financial re-

organization, security issues, capital stock issues, obtaining of patents and licenses and prosecution

against the Crown.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Under SACC 1031-2, legal, accounting and consulting fees in connection with financial re-organization,

security issues, capital stock issues, and prosecution against the Crown are considered non-applicable

costs to the contract.

A distinction should be drawn between the occasional expenses in relation to the raising of capital referred

to here, which are not an acceptable cost, and the normal recurring expenses associated with the day-to-

day management and recording of capital transactions, which are an acceptable cost. The latter expenses

include those arising from the registry and transfer of share capital when they form part of the activity of

the company secretary, costs of share holders' meetings, normal proxy solicitations, reports to

shareholders, submission of required reports to government agencies, reasonable directors' fees and

incidental expenses of directors and for committee meetings.

Attributable

• No supplementary considerations noted.

Appropriate

• No supplementary considerations noted.

Reasonable

• No supplementary considerations noted.

4.9 Losses on Investment

Description: Losses on investments are losses incurred by the contractor due to its investments in equity

and/or debt.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Under SACC 1031-2, losses on investment are considered non-applicable costs to the contract.

Attributable

• Losses on investments would not have a causal relationship with, or otherwise required/beneficial for,

the performance of the contract and hence would presumably not be Attributable. It is the responsibility

of the contractor to manage investment decisions, and any losses would likely be independent of the

requirements of the contract.

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Appropriate

• No supplementary considerations noted.

Reasonable

• No supplementary considerations noted.

4.10 Losses on Other Contracts

Description: Losses on other contracts occurs when these contracts’ respective revenues are lower than

their respective costs.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Under SACC 1031-2, losses on other contracts are considered non-applicable costs to the contract.

Attributable

• Losses on other contracts would not have a causal relationship with, or otherwise required/beneficial

for, the performance of the contract in questions and hence would presumably not be Attributable.

• This principle also applies to application by a contractor of preferred overhead rates to certain

contracts. Where this occurs, the excess of actual overhead over the preferred overhead amount will

not be absorbed by government contracts.

Appropriate

• No supplementary considerations noted.

Reasonable

• No supplementary considerations noted.

4.11 Patents and Licenses

Description: Patents apply to newly developed technology as well as to improvements on products or

processes. Patents provide a time-limited, legally protected, exclusive right to make, use and sell an

invention. Licenses defines the terms under which an intangible property (e.g. intellectual property) is

licensed for use by one party (e.g. the contractor) to another party (e.g. Canada).

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Attributable

• Costs related to a patent/license (e.g. legal fees, consulting fees, etc.) that will subsequently be owned

by Canada may be Attributable if the patent/license can provide future value to Canada.

• Costs and professional fees for patents/licenses that will be maintained by the contractor or were

previously owned by the contractor prior to the commencement of the contract would not be

Attributable.

Appropriate

• No supplementary considerations noted.

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Reasonable

• No supplementary considerations noted.

4.12 Prosecution of Claims Against the Crown

Description: Examples of costs associated with prosecution of claims against the Crown would include

legal fees.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Under SACC 1031-2, costs associated with prosecution of claims against the Crown are considered non-

applicable costs to the contract.

Attributable

• Costs associated with prosecution of claims against the Crown would presumably not have a causal

relationship with, or otherwise required/beneficial for, the performance of the contract and hence would

presumably not be Attributable.

Appropriate

• No supplementary considerations noted.

Reasonable

• No supplementary considerations noted.

4.13 Provisions for Contingencies and Warranty Costs

Description: A contingency liability is a liability which could arise on the happening of some event which

may or may not occur.

Warranty costs include those arising from fulfillment of any contractual obligation of a contractor to provide

services such as installation, training, correcting defects in the products, replacing defective parts, and

making refunds in the case of inadequate performance.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Under SACC 1031-2, provisions for contingencies are considered non-applicable costs to the contract.

Attributable

• The initial provision or increase of funding for a contingent liability is considered to be a setting aside

of earned profits to meet possible liabilities against future profits and not a business operating cost

and therefore not an acceptable cost to government contracts.

• There is one exception to the above and that is in respect of the acceptability of costs for the provision

of warranties. A contractor may include as a cost a reasonable amount to be set aside as a provision

for the absorption of expenses associated with warranties given under the terms of the contract, upon

formal request by Canada.

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• With respect to warranties, ensure the costs are not already compensated in the technical risk

premium in the profit calculation.

Appropriate

• Contracts, of a similar nature, could be referenced to inform what type of warranty costs may be

Appropriate for the contract in question.

Reasonable

• In determining a Reasonable amount, the following factors should be taken into account:

• Amounts provided for warranty expenses should be separate for each distinctive product or family

of products;

• Amounts provided should reflect, where available, the previous performance of the product(s) in

regard to warranty, using an average of three to five years;

• Cost of any provision for warranty charged to a specific contract should reflect any difference in

the warranty period from that normally granted by a contractor on the product(s); and

• Costs should be net of any warranty contract sales to other customers.

4.14 Refunds

Description: Money received back pertaining to a cost incurred

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Attributable

• Refunds which are associated with a contract cost would be Attributable.

• Refunds should be traceable to the corresponding contract costs.

Appropriate

• No supplementary considerations noted.

Reasonable

• A refund should be applied as a credit to the contract cost with which it is associated.

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4.15 Research and Development

Description: There are two primary types of Research and Development costs, undertaken with the

expectation of generating future sales or reducing future costs.

1. General Research and Development: A planned investigation undertaken with the hope of gaining new

scientific or technical knowledge and understanding. Such investigation may or may not be directed

towards a specific practical aim or application.

2. Product Development and/or Improvement: A systematic program of work, going beyond basic and

applied research which is directed towards the creation of a new or improved product, system, component

or material, substantially in a marketable form, but excluding any manufacture beyond completion of the

new and improved product's prototype.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Under SACC 1031-2 Indirect Costs Section 04 (02) (h)

General research and development expenses as considered applicable by Canada may be included in

Indirect Costs (Overhead).

Under SACC 1031-2, Non-applicable Contract Costs, Section 7(m)

Product development or improvement expenses not associated with the product being acquired under the

contract are considered non-applicable costs to the contract.

General Research Phase

• Research phase is taken on with the prospect of gaining new knowledge and understanding. The

company is researching the unknown, and therefore, at this early stage, there is no future economic

benefit.

• The expenditure is treated as an expense as incurred and must be assessed through the Appropriate,

Attributable and Reasonable criteria accordingly.

Product Development Phase

• Development phase is the application of research findings/knowledge to a plan for the production or

creation of new or substantially improved materials, devices, products, processes, systems, or

services, before the start of commercial production or use.

• Should be assessed to determine if the cost meets the criteria Attributable, Appropriate and

Reasonable, as well as meeting the criteria of an intangible asset, such that the contractor can

demonstrate the existence of a market/value for the output of the development. See Annex 5.3.6

(Discussion Paper - Research and Development Costs).

Attributable

• No supplementary considerations noted.

Appropriate

• No supplementary considerations noted.

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Reasonable

• Development costs recorded as intangible assets are recovered directly through the costs of the

relevant products in line with the acceptable Canadian accounting standards; Canadian Generally

Accepted Accounting Principles (i.e. ASPE or IFRS) as they are sold provided:

• the total development costs applicable can be separately identified.

• the costs were not previously allocated to a government contract, directly or indirectly.

• The costs are prorated to specific product sales appropriately to all customers.

4.16 Sales and Marketing Costs

Description: Sales and Marketing costs are primarily incurred by contractors to generate future sales of

their goods or services. Examples of sales and marketing activities include selling, public relations,

advertising and entertainment.

"Bid and Proposal Expenses (i.e. bid and proposal development costs)" are the costs incurred in

preparing, submitting, and supporting bids and proposals, (whether or not solicited), on potential contracts,

including:

a. direct administrative effort, for the physical preparation of the technical proposal documents,

and also the technical and non-technical effort for the preparation and publication of cost data,

and other administrative data necessary to support the contractor's bids and proposals;

b. technical effort, incurred to specifically support a contractor's bid, or proposal, including the

system and concept formulation studies, and the development of engineering and production data;

and,

c. purchased services and supplies incurred to specifically support a bid or proposal.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Under SACC 1031-2, advertising, except reasonable advertising of an industrial or institutional character

placed in trade, technical or professional journals for the dissemination of information for the industry or

institution (7n) and entertainment expenses (7o) are considered non-applicable costs to the contract.

Refer to Annex 5.3.1 (Discussion Paper: Sales and Marketing Costs) for additional details and

considerations on when Sales and Marketing costs may be acceptable.

Attributable and Appropriate

• Entertainment expenses are not attributable or appropriate to Canada. This includes expenses for

amusement, diversion, social activities, and incidentals. In some circumstances, if it may be possible

to demonstrated that expenses associated with meetings and conferences, when called for the

dissemination of technical information or discussion of production problems and the like, are

acceptable. These expenses may include those for meals, transportation, rental of meeting places

and other incidentals provided they are reasonable.

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• Advertising that supports the publications of trade, technical or professional journals for the

dissemination of information for the industry may be considered acceptable in the event the

contractor's employees use the journals to enhance knowledge and skills that lead to increased

knowledge, efficiency and productivity benefits for the government contract, provided the Advertising:

• Is not display advertising, and is institutional or support advertising only

• Does not advertise a particular product or service of a contractor

• Is not a financial publication geared primarily to investors, versus industry or trade

• Advertising expenses associated with recruiting and employment opportunities may be considered

an acceptable cost, provided they are reasonable.

• Under paragraph 04 (02) (g) of SACC 1031-2, selling and marketing expenses which could be

considered to include, bid and proposal expenses, are listed as one of the items generally considered

to be indirect costs. There are some instances where bid and proposal expenses are directly charged

to the resulting contract as a consistent business practice by the contractor.

• Bid and proposal expenses may be considered Attributable as a direct charge to a contract when the

proposal contributes to the achievement of contract specific requirements and is required for

subsequent contract negotiations (i.e. to extend the length of the existing contract), provided that the

bid and proposal expenses are clearly denoted in the proposal and contract documents as forming

part of the agreed contract price.

Reasonable

• Sales and marketing costs must be allocated fairly between Canada and the contractor. Consideration

must also be given to ensure the benefits balance or outweigh the associated costs. Additional

allocation considerations include the following:

• selling and marketing expenses should be clearly identified by a contractor as distinct from other

indirect costs to the extent, where warranted, of creating a separate cost pool for these

expenses;

• where a contractor manufactures more than one particular product or provides more than one

particular service, the selling and marketing expenses specifically identifiable with each

particular product or service should be allocated directly thereto with any general expenses

being prorated equitably across all products or services; and

• a pro-rata share of the selling and marketing expenses allocated in accordance with the

particular products or services or family of products or services being acquired under the

contract included in the applicable overhead costs of the contract

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4.17 Taxes

Description: In Canada, taxes may be assessed at the federal, provincial/territorial, and municipal level.

Examples of tax types include income tax, consumer tax, property tax, and import/export tax.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Under SACC 1031-2, federal and provincial income taxes, excess profit taxes or surtaxes and/or special

expenses in connection with those taxes are considered non-applicable costs to the contract.

Attributable

• Tax accounting principles should be employed to determine the applicable tax types.

• Taxes, assessed on the inputs, which are causal with, or otherwise required/beneficial for, the

performance of the contract, cannot be avoided.

• Example: Types of inputs are raw materials, employees, and assets (e.g. factory). Respective taxes

of these inputs are sales tax, payroll tax, and property tax.

Appropriate

• Taxes assessed on income (e.g. income tax) and other taxes in connection with financing, refinancing

or re-organizing would not be an Appropriate cost.

• Note: Tax Refunds are under review for potential changes related to the applicability of such credits

against appropriate contract costs. Currently, guidance states that all tax refunds, federal or provincial,

are not required to be applied to reduce any related expenses. Consideration is being made to suggest

that refunds/credits relating to applicable costs, for example as detailed in the attributable tax costs

defined above, should be applied as a credit to the related appropriate contract cost. This remains a

proposed change for comment and feedback. Refer to 4.14 Refunds cost table for related guidance

on refunds.

Reasonable

• The amount paid by the contractor for Attributable and Appropriate taxes would be considered

Reasonable (in accordance with Canadian Tax Regulations).

4.18 Joint Venture

Description: "Joint Venture" is association of two or more parties who combine their money, property,

knowledge, expertise or other resources in a single joint business enterprise, sometimes referred as a

consortium, to bid together on a requirement.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Attributable

• Operational costs of a joint venture should be treated similarly as operational costs to any

contractor. As such these costs are Attributable to the extent that they are considered

reasonable and can be allocated to the contract based on SACC 1031-2 and Costing Standard

guidance.

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• When materials, supplies or services must be transferred to the joint venture under subcontracts

issued to a representative of the joint venture, the contracting officer should negotiate acceptable

subcontract costs with the representative in accordance with Non-Competitive Acquisitions of

Manufactured Products and Repair and Overhaul Services, from Agency and Resale Outlets in

Annex 10.3 of the Supply Manual.

• For non-competitive contracts intended to be awarded to a joint venture, special costs to the

joint venture arrangement alone, such as legal, accounting and consulting fees in connection

with the setting up of the joint venture, are generally not attributable costs.

Appropriate

• No supplementary considerations noted.

Reasonableness

• Joint venture costs should be assessed for reasonability in line with other standard contract costs.

• A bid price based on average rates from a joint venture is not considered reasonable. To be

considered reasonable, the total contract price should be based on the sum of the price of each

joint venture member’s workload that is priced separately using appropriate costing procedures.

4.19 Transfer Pricing

Description: Transfer pricing refers to the prices set for goods or services that are exchanged among

related parties (affiliated or entities under common control, joint control or significant influence). The

“Transfer Price” is the price at which a supplier sells its goods or services to a related party buyer.

“Intra-company transfer prices” refer to transfers between divisions of the same legal or corporate

entity.

“Inter-company transfer prices” refer to transfers between a company and its subsidiary or affiliate

enjoying separate legal status but otherwise under common ownership control.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Attributable

• No supplementary considerations noted.

Appropriate

• No supplementary considerations noted.

Reasonable

• Intra-company transfer prices must be charged under the contract at cost according to the Contract

Cost Principles 1031-2 without allowances for profit or an allocation of corporate general and

administrative expenses. These allowances must apply on the cost of the finished product sold to

Canada.

• Inter-company transfer prices charged under the contract must not be, whenever possible, greater

than those which approximate fair market value (i.e., market price).

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o Fair Market Value means the price that would be agreed to in an open and unrestricted market

between knowledgeable and willing parties dealing at arm's length who are fully informed and

not under any compulsion to transact.

o If the good or service has a going price at which significant quantities are known to sell in the

market in arm's length transactions, such a price will represent fair market value. Examples:

regulated prices, posted prices, catalogue prices and other prices actually available and given

in past transactions to arm's-length parties for the size, quality, timing and location of the

transaction, after all discounts have been considered.

o An inter-company transfer price representing fair market value will be used as "laid-down cost"

for that item for the purposes of computing mark-up, profit and contract price.

o Refer to Section 2.0 in the Guide for more information on Market Pricing.

• In situations where approximate fair market value cannot be determined, inter-company transfer prices

must be those that can be considered as reasonable under the circumstances if the parties to the

transaction had been dealing at arm's length.

If no price support exists for a fair market price, the transfer prices of the company are established

at cost calculated in accordance with Contract Cost Principles 1031-2 without allowance for profit

and without an allocation of corporate general and administrative expenses.

o For transfer prices where price support is provided:

▪ If the contractor can prove that the transfer price is at cost, then a reasonable profit

as set out in Section 5.2 Profit Principles must apply to the final product cost.

▪ If the contractor can provide satisfactory price support for a transfer price in excess

of cost, the profit element in such transfer price must be limited to a reasonable profit

as set out in Section 5.2 Profit Principles.

• Refer to Annex 5.3.4 Discussion Paper – Transfer Pricing for further support on the overall

considerations, documentation and assessing reasonability of transfer prices.

• Where necessary, common ownership control must be determined by reference to the latest issue of

appropriate trade surveys (e.g. Financial Post Survey of Industrials, Moody's Industrials, etc.), as

confirmed by means of a certification from the company as to ownership control (use SACC Manual

clause A9112C for this purpose).

o Ownership control is presumed in cases where at least 50 percent of the voting rights are

held by the affiliate.

o This clause is required to warrant that a contractor is not under common ownership control

of another division, parent company or affiliate supplying materials and/or services in

connection with the work under contract and gives Canada the right to terminate or readjust

the price to reflect level of profit payable under transfer pricing practices in the event of a

breach to this warranty.

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4.20 Head Office Expense

Description: "Head Office" is an office responsible for the policy direction and management of two or more,

but not necessarily all “segments” (i.e. branches, divisions, product departments, plants or other

subdivisions, etc.) of an organization. These segments report directly to a head office and are usually

identified with responsibility for profit and/or producing a product or service and is part of the same legal

entity.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Attributable

• For the allocation of any expenses to be attributable, generally company policies describing the

basis of allocation of these expenses in a Head Office/Segment relationship must exist. For

example, a company with two segments may have a company policy to split any head office

expenses (i.e. head office accounting and administrative expense) evenly between the two

segments.

Appropriate

• No supplementary considerations noted.

Reasonable

• Allocation based should be well documented and based on historical and present cost data with

considerations for future economic conditions. Allocations derived from an arbitrary forecasted

distribution base are not considered Reasonable.

• For the allocation of the expenses to be considered reasonable all, or any combination of the

following three methods should be used.

• Directly Chargeable – Expenses are identified as incurred specifically and totally for one

particular segment is included within the Head Office expense pool. Such expenses should be

allocated directly to the particular segment, to the extent practicable.

• Separately Allocated - Individual, or groups of expenses are allocated only to a limited group

of corporate segments. Such expenses are not typically incurred for specific segments but are

related to the segments by an objective and measurable relationship and subsequently are

allocated in costing pools based on this.

• Residual - These are the remaining expenses which are allocated to all, or most segments on

an overall basis. These expenses should be allocated to segments using a base or bases

which represent the total activity of the segments (see below). If the allocation amount were

material, utilizing all three methods of allocation may be necessary. In less significant

situations, a combination of the Directly Chargeable and the Residual methods might suffice.

In low-dollar value situations, the Residual method alone might be appropriate.

• There are many and varied bases which might be used to allocate residual

expenses. To be accepted and considered reasonable, the base(s) selected must

be representative and consistently applied to all segments of the organization. The

following are examples of bases for allocation which are often used, in each

segment of the organization:

o The number of personnel,

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o The dollar value of production,

o The cost of goods sold, or

o The total sales.

4.21 Environmental Costs

Description: "Environmental costs" are the costs incurred by an entity to prevent, abate, or remediate

damage to the environment or to deal with the conservation of renewable and non-renewable

resources.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Attributable

• The contractor should be able to provide evidence of

• Whether the environmental cost is required or planned to be incurred, and

• When the environmental cost relates to, either the current period or the future period.

Appropriate

• Environmental costs that are incurred for required and planned known environmental and

compliance activities would be appropriate. This may include:

• Known environmental and compliance costs

• Planned remediation costs, and

• Emerging legislative compliance requirement costs

Reasonableness

• The environmental costs incurred in the current operation period, for example, costs of disposal

of wastes, should be allocated to the current expenses in the contract.

• For environmental costs incurred in the current operation period for past operations (i.e. clean up

costs for activities that occurred previously), material amounts should be deferred and amortized

over a reasonable number of future periods (i.e. expected contract life).

• The environmental costs incurred in the current period for future operations, for example,

depreciable equipment purchased to control hazardous emissions, should be amortized over the

periods for which benefits are expected from the costs incurred.

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4.22 Government Supplied Materials

Description: "Government-Supplied Materials" (GSM) are material supplied to a contractor by a

government department or agency on a “free-issue” basis for incorporation into the end product. GSM

are also commonly referred as Government Furnished (GF) or Contract Issue (CI) materials.

“Government Furnished (GF) materials” are materials supplied by Canada to be used in the production

process. (See Subsection 1.7 Special Production Tooling and Special Test Equipment for cost and

profit considerations.)

“Contract Issue (CI) materials” are materials issued by Canada free of charge to the supplier, or the

supplier’s representative, while being and remaining the property of Canada.

"Accountable Advance Spares" are non-catalogued materiel owned by the government and

manufactured or purchased by contractors in accordance with agreements between contractors and

the government. Accountable Advance Spares are used in the repair and overhaul of government

equipment.

"Laid-Down Cost" is the cost incurred by a contractor to acquire a specific product. This includes the

invoice price (less trade discounts) charged to the contractor plus any applicable charges for

transportation, exchange, custom duties, and brokerage charges, but excludes sales taxes (i.e. Goods

and Services Tax and Harmonized Sales Tax).

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Attributable

• Material handling costs related to the storing and transferring out of storage are Attributable and

allocated to the GSM, GF or CI materials when they are embodied (i.e. when they are used in a

contract). For example, in a repair and overhaul contract, Canada provides various special parts

and material handling costs related to these parts are allocated to the GSM, GF or CI materials

when these parts are used by the contractor in the repair.

• General and Administrative (G&A) overhead expenses and material handling costs that are

applicable should be allocated as a cost associated with the embodiment of government supplied

material in the year when the materials are embodied. When transfers of GSM, GF or CI materials,

for example from accountable advance spares inventory, are made to Canada for asset disposal,

the general and administrative overhead expenses and material handling costs that are applicable

are allocated at the time of transfer.

Appropriate

• No supplementary considerations noted.

Reasonableness

• When the contractor stores GSM, GF or CI materials for Canada, the cost of the items being stored

would normally include the laid-down cost of the purchased GSM, GF or CI materials; or the

applicable direct material, direct labour, factory overhead and G&A applicable to the manufacturing

operation of the manufactured GSM, GF or CI materials.

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Profit Considerations

• The costs of GSM, GF and CI materials must not be included in the direct materials. No profit is

allowed on these materials.

o However, direct labour and overhead costs associated with the acquisition, stocking and

handling of GSM, GF and CI materials and AA spares embodied may be included under

the appropriate cost element for profit purposes.

4.23 Donations

Description: A donation is a gift (i.e. money or goods) for which no consideration is given in return.

Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Under SACC 1031-2 Section 07 (p), donations except those to charities registered under the Income Tax

Act are considered non-applicable costs to the contract.

Attributable

• Donations, except those to political parties, are an acceptable cost provided they comply with the

Income Tax regulations and are taken into overhead in the period they are paid rather than

pledged.

Appropriate

• No supplementary considerations noted.

Reasonableness

• No supplementary considerations noted.

4.24 Strategic Innovation Fund (SIF) Repayment

Description: “Strategic Innovation Fund (SIF)” provides major investments in innovative projects that

will help grow Canada’s economy for the well-being of all Canadians. SIF funding is project-based, with a

portion of eligible supported project costs (expenditures) being reimbursed. The various programs

administered by Innovation, Science and Economic Development Canada (ISED) are subject to specific

terms and conditions. SIF also incorporates several legacy programs according to the terms agreed on

with each recipient, including Automotive Innovation Fund (AIF), Automotive Supplier Innovation Program

(ASIP), Strategic Aerospace and Defence Initiative (SADI), Technology Demonstration Program (TDP),

and Technology Partnership Canada (TPC). See Program Guide: Strategic Innovation Fund for more

information.

“Contribution” is a conditional transfer payment under an auditable agreement for which the donor will

not receive any royalties, goods, or services.

“Royalties” are usage-based payments made by one party (the licensee) to another (the licensor) for

ongoing use of an asset, for example an intellectual property right.

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Supplementary Considerations for the Criteria of Attributable, Appropriate, and Reasonable

Attributable

• SIF contribution amounts are repayable by default. They are structured to ensure fairness between

recipients and are determined individually on a case-by-case basis.

• Non-repayable contributions will only be considered for certain projects where the risk

assessment, as verified during due diligence, confirms that there will be significant benefits for

Canadians.

Appropriate

• The contribution amount and the terms of repayment will be determined after a due diligence

assessment of the full application. They are based on the overall project benefits and risks.

Reasonable

o The amount of the recovery shall be determined by the original SIF agreement. For

contributions that are product specific, a product development recovery rate will be

established. For non-product specific agreements, the recovery will be made through a

General and Administrative Overhead and shall be recovered over a reasonable amount of

time.

o The recovery amount allowed on contracts shall be limited to the original SIF contribution per

the agreement. For rate negotiation purposes, the amount in excess of the original contribution

shall be considered a separate element outside the rate negotiations and will not be an

allowable contract cost.

▪ Note: SADI funding conditional repayment is based on a royalty applied to the

company’s gross business revenues, or in some circumstances, those of relevant

business unit or division. Royalty rates are set such that companies owe the amount

distributed if revenues remain flat over the entire 15-year repayment period. Royalty

payments are waived in years of negative revenue growth. Royalty rates increase in

years of strong revenue growth. Maximum repayable amounts are determined by

Industrial Technologies Office (ITO) based on a risk assessment.

257 | Page Public Services and Procurement Canada August 2023

General Considerations for Costing

Principles-Based Guidance for Determining Contract Costs

Rules-based standards state explicit requirements that must be followed without deviation, while principles-

based standards permit the exercise of professional judgment to fit the circumstances, providing flexibility to

promote creativity and innovation in the procurement of goods and services.

Costing in Canada is a principles-based approach for assessing the acceptability for contract costs. The

overarching principle is contracting for value to Canada. The application of the criteria between contracts

should be consistent, but the outcomes, in terms of contract cost acceptability, may differ depending on the

complexity of the contracts in question. A principles-based approach to determining contract costs requires

professional judgement. For further guidance on the merits of principles-based guidance, refer to Annex

5.1.2 (Discussion Paper: Rules-Based vs. Principles-Based Standards).

Financial and Cost Accounting Work Together to Determine Contract Costs

Financial accounting is used to report the expenses and revenues, assets and liabilities, and cash flow

position of an enterprise to external users, typically on a quarterly and annual basis. For example, Canada

reports its public financial statements using financial accounting.

Cost accounting is used internally to report costs for decision-making purposes for various cost objects (e.g.,

goods and services, departments, programs, contracts etc.). For example, in Canada, cost accounting is

used to inform cost-benefit, capital investment, cost-recovery and other decisions.

Both financial accounting and cost accounting principles should be used to determine the cost base to price

a contract. Financial accounting can be used to generate the initial source of cost information for a contract,

while cost accounting can be used to allocate/adjust this cost to derive the cost basis of a contract.

For further guidance on how financial and cost accounting work together to determine contract costs, refer

to Annex 5.1.1 (Discussion Paper: Financial Accounting vs. Cost Accounting).

Reporting Costs on an Accrual Basis Instead of a Cash Basis

Accrual accounting records events in the period in which they are incurred (incurred cost) whereas cash

accounting records the events only when cash is received/paid. Under the accrual method, the matching

principle is followed to recognize revenues in the same period as the expenses that were incurred to earn

those revenues. With the cash method, only the receipt or payment of cash triggers the recognition of a

transaction which can create timing differences when these transactions are recorded compared to the

accrual method, i.e., expenses may be recorded in an earlier period than when revenues are recorded due

to the difference in timing of the actual payment of expenses and receipt of revenues.

Accrual accounting should be used as the basis for measuring cost when establishing non-competitive

government contracts. The accrual method for measuring cost estimates and actual costs would generally

be appropriate for most cost types where the amount can be estimated and there is a sufficient level of

certainty of occurrence.

258 | Page Public Services and Procurement Canada August 2023

The cash method may provide better value to Canada for cost types where the amount cannot be accurately

estimated and/or there is insufficient level of evidence for occurrence. The cash method is rarely used.

For further guidance on the applicability of accrual versus cash accounting on contract costs, refer to Annex

5.1.3 (Discussion Paper: Accrual vs. Cash Based Accounting).

259 | Page Public Services and Procurement Canada August 2023

ANNEX 2A: COSTING PROCESS

The activities, steps, and outputs involved in using the Costing Standard to assess the acceptability of

contract costs are depicted in the diagram below.

Figure A2.A.1.: Costing Standard Process

All key decisions should be documented with reasoning and consideration should be made to include

important elements in the contract terms and conditions.

260 | Page Public Services and Procurement Canada August 2023

ANNEX 2B: CONTRACT COSTING RATES

Contract Cost Principles 1031-2 and Annex 2 Costing Standard provide detailed guidance on the

determination of acceptable costs, including indirect costs.

"Indirect Costs” are costs that cannot be directly identified or measured as applicable in the performance of

one contract. Instead, indirect costs may apply to multiple contracts and customers. These are costs which

have been incurred in the performance of the contract for the operation of the contractor's business in general

but cannot be identified and measured as directly applicable to the performance of the contract.

Indirect costs are typically allocated to a contract by applying contract costing rates as detailed below.

Contract Costing Rates

Definition

A contract costing rate, can be an indirect or direct rate with no inclusion of a profit component. It is the

most common method of allocating fairly and conveniently a contractor’s costs to a contract.

How do they work?

The diagram below illustrates the process of establishing costing rates.

Figure A2.B.1. Process of Establishing Costing Rates

Total Contractor Indirect Costs

Pool 1: Facilities OHD

Machine Hours

Rate = $/Hour

Pool 2: G&A Costs

Total Costs

Rate = %

Pool 3: Engineering

OHD

Direct Engineer

Labour Hours

Rate = $/Hour

1. Establish Cost Pool / Group

2. Determine the Allocation

Factor

Group

3. Establish Costing Rates

Process

261 | Page Public Services and Procurement Canada August 2023

1. Establish Indirect Cost Pools / Groups

To inform the fair allocation of indirect costs through costing rates, indirect costs should be grouped

together logically into groups, also known as pools. Cost pools are commonly used for the allocation of

overhead costs. The costs within indirect cost pools should be similar enough in their relationship to

each other that the allocation of the total costs in the pool provides a result which would be similar to

that achieved if each cost within that pool were separately distributed, and also be grouped in a simple,

clear, consistent manner.

Indirect cost pools/groups often reflect an organization’s business or operational lines. Some common

examples of cost pools could be general and administrative (G&A) costs, manufacturing overhead,

material handling overhead, engineering overhead, etc.

2. Determine the Allocation Factor

Once the indirect cost pools/groups are established, the total costs are allocated to a contract using a

cost allocation factor. The allocation factor for an indirect cost pool/group should reflect the causal

relationship of the pooled costs to the contracts to which these costs are distributed. Examples of

allocation factors include labour hours, machines hours, square footage, etc.

3. Establish the Costing Rates

The costing rates are calculated by dividing the contractor’s total annual costs in a costing pool/group

by the annual volume/dollar value of the allocation factor.

The rates are calculated annually and are typically based on the previous year’s actual costs and

volumes with forecasts or estimates for any predicted increases or decreases.

When would you use Contract Costing Rates?

Contract costing rates are required to facilitate contract costing and are applied in the many costing activities

within the contract, including the following:

• To negotiate a contract price

• To determine hourly costing rates for invoicing

• To determine the contract costs

Types of Costing Rates:

There are many different types of costing rates that can be applied in a contract, including those we have

already discussed above, related to the allocation of overheads and general and administrative costs.

Other types of rates may require additional considerations to those noted above. These special rates may

not be appliable to all the contracts and should be determined on a case-by-case basis. Contracting officers

are responsible for negotiating fair and reasonable rates which would normally be based on a fixed time/unit

rate, i.e., percentage or dollar amount - hourly, per diem, monthly, etc. and shown as a separate line item in

the basis of payment to differentiate them from the general overhead rates.

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These include:

• Take-Out Rates

• Out-of-Plant Service Rates

• Mobile Repair Party Rates

• Material Handling Rates

• Purchased Labour Rates

Take-Out Rates

Definition

A take-out rate is the negotiated rate applied to the recovery of overhead costs on goods and services which

do not form the major portion of the company's business but are in themselves significant relative to a

government contract. The resulting rate, in most cases, should be somewhat less than that which applies to

other work processed through the company's facilities.

When should you use Take-Out Rates?

Take-out rates may be established to apportion overhead expenses on a reasonable and justifiable basis on

goods and services which requires less overhead effort than the company's regular activity.

Potential applicable areas for negotiated take-out rates include subcontracts, drop shipments, mobile repair

parties (see the sub-section of Mobile Repair Party Rates), and other specialized applications such as for

travel and living that are charged directly to a contract.

The task of identifying where and when a take-out rate is applicable is left to the discretion of the negotiators,

who are in the best position to establish the need, based on the information available at the time.

The purpose of a take-out rate is to allocate overhead costs to a contract. Other overhead recovery rates

must not include any of the costs of any contracts that are subject to take out rates. This means that take out

rates that are established without taking into account the full costs of specific situations may result in

unrecovered overhead as this overhead cannot be recovered on other contracts. As an example; this situation

can arise if a contract is established using a take out rate that is set to limit the total price of the contract and

the rate is not sufficient to allow full cost recovery.

Out-of-Plant Service Rates

Definition

Out-of-plant service rates are typically used to allocate the indirect costs of services that occur offsite and

out-of-plant and often is shared among multiple locations. Out-of-plant services include field services

representatives, out-of-plant technical services and mobile repair parties away from the contractor’s plant.

Due to the fact that the above services are not fulfilled in contractor’s facilities, separate cost grouping for

costs allocation to offsite locations may be necessary to permit equitable distribution of costs on the basis of

the benefits accruing to the cost objectives.

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When should you use Out-of-Plant Service Rates?

Out-of-plant service rates are applicable when services are not carried out on the primary business site.

Typically, full plant overhead should not be applied to out-of-plant charge-out rates, unless the out-of-plant

technical services are relatively minor, which is defined as less than 10 percent of the contactor’s total

business (volume /direct labor) in any one year. For example, a shipbuilding company will send field service

representatives for an annual maintenance to service the government’s ships for 2 weeks. As these services

only account for 8% of the company’s total business volume in a year, the out-of-plant rates could be

calculated, and the resulting rates should be less than the full recovery rates.

Mobile Repair Party Rates

Definition

A mobile repair party is an individual, or group of individuals, performing work away from the contractor’s

plant, generally at the client’s location. A mobile repair party rate is calculated to allocate the indirect costs

related to the mobile repair party work for the government contract.

Repair work is normally carried out in a contractor's facility but, on occasion, to meet the requirements of a

customer department, the contract specifies the repair work is required to be performed at other locations.

The full overhead costs may not be applicable to the mobile repair party costs. Mobile repair party rates are

applied in these cases to fairly allocate applicable indirect costs to the mobile repair party work.

When should you use Mobile Repair Party Rates?

The overhead rate on mobile repair party work is typically at the full plant rate. This is because the mobile

repair party work may only be a part of the out-of-plant services. However, under the following three

circumstances, negotiation of mobile party repair rates may be required to reflect the reduced costs applicable

for the mobile repair party work.

a. Where the estimated hours to be expended for mobile repair party work exceed 5% of the estimated

total direct labour hours for both commercial and defence repair and overhaul work during the

contract period, or

b. Where the estimated hours to be expended for mobile repair party work are less than 5%, but the

contracting officer considers that a significant number of direct labour employees are hired for mobile

repair party work only; or

c. Where the contractor maintains adequate cost records to permit the calculation and negotiation of a

separate mobile repair party rate.

264 | Page Public Services and Procurement Canada August 2023

Material Handling Rates

Definition

A material handling rate is an overhead rate established to allocate indirect costs associated with handling

materials. The material handling pool may include costs for purchasing, receiving, incoming inspection,

storing, inventorying, packaging, and shipping materials. It is important that material handing costs clearly

exclude costs relevant to the labour-hour rates such as direct labour costs and fringe labour costs.

When should you use Material Handling Rates?

The material handling rates are typically used by manufacturing companies when material handling is a

crucial component of their production or business operation. When materials for resale as well as materials

for overhaul or manufacturing are handled, the development of a material handling rate becomes necessary.

One common base for allocation of material handling costs is the cost of material used. If free issue materials

(materials that are free of charge, for example, materials suppled by the Government or by a Government

agency) are handled along with purchased materials, a handling rate can be developed if the free issue

materials can be valued. If it is not possible to set a reasonable value on the free issue materials, then a

basis for allocation other than material cost would have to be used. In this case, it may be possible to have

a record of the number of parts handled to serve as a base for distribution of material handling costs.

However, the full material handling rate would no longer be appropriate if

• High-cost units are mixed with lost cost units,

• Trading operations are conducted along with overhaul and manufacture, or

• Higher costs than normal are incurred in handling materials used in specific contracts because of

special requirements of customers.

In the above situations, cost support should be obtained for the material handling costs breakdown to

determine the accurate costs and allocation base over the cost of material or over the number of parts

handled.

Purchased Labour Rates

Definition

Purchased labour costs are costs incurred by a contractor/entity for temporary personnel procured from the

outside for skills such as engineers, technical writers, technicians, or craftsmen.

Contractors' cost accounting method for purchased labour and overhead allocation varies depending on the

circumstances under which purchased labour costs are incurred. For example, some contractors classify

purchased labour as direct labour costs when the work is performed in the contractor's facilities under their

supervision and otherwise meets the definition of direct labour costs under the Contract Cost

Principles SACC 1031-2. Other contractors may classify purchased labour as subcontract costs.

265 | Page Public Services and Procurement Canada August 2023

When should you use Purchased Labour Rates?

When treating purchased labour as direct costs, the contractors may use either the purchased labour rate

or average labour rate incurred by their own employees for comparable work. However, differences

between the average labour rate incurred by the contractor's own employees and purchased labour prices

are treated as overhead costs and are allocated accordingly.

The allocation of these purchased labour costs should be based on the causal or beneficial relationship to

the cost drivers (i.e. certain indirect expenses) and the allocation method must be consistent with the

contractor’s disclosed cost accounting practices.

The accounting treatment for purchased labour must be evaluated on a case-by-case basis with

consideration given to the materiality of costs involved and the overall effect of the accounting treatment on

final cost objectives such as ascertainment of cost and proper presentation of cost data for measuring cost

efficiency. Acceptance or rejection of the contractor's treatment of purchased labour must be based on:

a. the causal and beneficial relationship of indirect expenses and purchased labour, and

b. the nature of the employer/consultant relationship.

The preferred cost accounting method for purchased labour is to have a separate direct cost for this activity

with an appropriate allocation of applicable overhead. Other methods are acceptable providing the

accounting method is considered reasonable and justifiable and meets the relevant Contract Cost

Principles SACC 1031-2.

Did you know the risks of applying multiple rates in a contract?

• The costing rates applicable, costing pools and allocation factors are contract specific and will vary from one

contract to another.

• Special attention is required when applying two or more types of costing rates in one or more contracts with a

contractor to avoid Canada double paying for indirect costs in multiple costing pools.

• Guidance and cost interpretation from the Price Advisory Group (PAG) of the Procurement Support Services

Sector (PSSS) is recommended. Please see Annex 3 for contact information.

266 | Page Public Services and Procurement Canada August 2023

ANNEX 2C: COST MANAGEMENT

Cost Support and Validation

Cost management is a continuous process of estimating, allocating, controlling, proving and validating

contact costs. This section focuses on the aspects of cost support and validation strategies in cost

management.

Cost Support

Cost support is the method of showing how the claimed costs related to a contract are identified and assigned

in order to establish the cost base or a costing rate.

Breakdown of Expenses

A breakdown of expenses is required by a contracting officer and a price advisor to evaluate the direct costs,

indirect costs and costing pools. There may be situations where an invoice or claim has a total combined

dollar value for a group of expenses, for which further detail is required on cost classifications. In these cases,

it is appropriate to request financial statements from the contractor, such as an income statement, a

statement of expenses or a trial balance or general ledger that will contain details of the expense/costing

accounts.

Proof of Costs Incurred

Proof to validate the price being submitted by the contractor would be required at the beginning of a contract,

in line with SACC clause C0008T, which is to be included in bid solicitations for all non-competitive bids. Also

reviews and approvals of various cost claims throughout the management of the contract is required.

Support for costs that can be requested include but is not limited to:

• copies of invoices

• copies of receipts

• copies of cheques

• proof of banking transaction via financial bank/credit card statements, etc.

• payroll registers for salary evidence

• time sheet logs

Depending on the cost and magnitude of the amount (i.e., single large dollar amount vs. pool/group of costs),

different supporting documents can be used. For example, supporting documentation for direct costs such

as salaries and wages can be found in a breakdown of expenses from the organization such as in an income

statement or supported through copies of employee pay stubs, time sheets or other verifiable logs, through

a payroll/project/labour time recording system. In addition, copies of legal agreements/contracts with prices

clearly stated could also be useful supporting documentation for cost acceptance.

Supporting documentation provided should include enough detail for the contracting officer to determine what

the cost/expense incurred is for, the amount paid, the date of purchase and who was paid (i.e., supplier

name).

267 | Page Public Services and Procurement Canada August 2023

When scrutinizing supporting documentation for costs incurred such as invoices, there may be costs that are

not related to the procurement/project or do not meet the Attributable, Appropriate, and Reasonableness

criteria. These costs should be excluded from the contract costs.

Validation Strategy

Validation is the act of checking or proving the validity and accuracy of something. In terms of cost validation,

it refers to a systematic process of verifying the actual costs incurred in a contract, the credibility of

contractor’s systems and the achievement of incentives.

Why is validation strategy needed?

Developing a validation strategy is an important part of costing and contract management. It seeks to:

• manage risk in a contract;

• better understand the nature of the costs being claimed;

• establish the credibility of the amounts being charged; and

• validate the achievement of incentives

What is included in a validation strategy?

It is important that the validation strategy be established early on in the acquisition lifecycle and prior to both

the Request for Proposal and contract negotiation.

The validation strategy should assess the risks in the contract pricing strategy and specific risks related to

the contractor to properly assess:

• the areas within the contract that will require validation, and

• when the validation should be carried out

What should be validated?

The strategy will establish the level of assurance work that is required to perform the validation. For example,

higher dollar value or higher risk contracts may require the Assurance Services Group to coordinate the

validation work whereas other areas of the strategy may be carried out by contracting officers, through

requests for support as outlined in the sub-session of Cost Support.

Areas that may require validation include:

• the accuracy of cost estimates or costs being claimed;

• the actual levels of profit being earned;

• the ability of a contractor’s system to appropriately track costs; and

• information related to the achievement of contract incentives.

The Assurance Services Group (ASG) within the Procurement Support Services Sector (PSSS) is available

to assist contracting officers in developing a validation strategy. Please see Annex 3 for contact information.

268 | Page Public Services and Procurement Canada August 2023

SACC Contract Clauses

In order for validation to be carried out for a contract, appropriate clauses must be included in the contract

terms and conditions. The key audit and validation related clauses are listed in the following table:

Category

SACC Clauses

Description

General Audit Clauses

• 2010A 17

• 2010B 16

• 2010C 14

• 2015A 17

• 2029 13

To audit the amount claimed for low dollar value

and medium complexity authorized users, goods,

professional services, and services respectively

• 2030 33

• 2035 31

• 2040 42

To audit, inspect and examine the accounts and

records of the contractors of high complexity

contracts and Research and Development

contracts

Auditing Clause

C1004C

To provide additional details concerning the effects

of audit findings and adjust allowable contract

amounts and payments.

Mandatory

Discretionary Audit

Clauses

(For Firm Price Basis

of Payment – all non-

competitive contracts

valued over $50,000)

C0100C

To validate the lowest price or rate charged by

anyone else, including the contractor’s most

favored customer through a price certification for

commercial goods and services.

Please note: If a supportable commercial price is

available, sufficient price support must be obtained

and validated prior to accepting the commercial

price. See Section 5.0.2 Commercial Pricing for

more information.

C0101C

To validate the actual profit earned on a contract

for non-commercial goods and services

Cost Reimbursable

Contracts

C0300C

To support information available for audit that

requires a detailed cost submission of all cost

elements signed and certified by the contractor

when costs will be computed in accordance with

Contract Cost Principles 1031-2

C0307C

To support information available for auditing

contracts for repair and overhaul services

Fixed Time Rate

Contracts

C0710C

To provide for the verification of time charged and

the contractor’s time recording system

269 | Page Public Services and Procurement Canada August 2023

Contracting officers must refer to the SACC Manual for other related audit clauses to ensure terms and

conditions are appropriately included in the contract for proper validation of the costs claimed by the

contractor.

Service Contacts

The profit for all services not established by price competition, except repair and overhaul, are negotiated

on the basis of the prevailing rates for the type of work required and recognizing the circumstances of

each contract. Considerations may be given to the following areas:

Areas of Consideration

Description

Requirements of the task

An assessment of skill level, expertise necessary, or complexity

of the task requirements

Bidder qualifications

Prices will vary in terms of factors like the calibre of proposed

personnel, knowledge or expertise, previous experience,

personnel utilization rate, use of facilities, or the area of

specialization

Market conditions

• A determination as to whether there is a commercial or going

rate (the average or usual price that is charged) for a particular

expertise or service capability in private industry should be

made.

• If these rates cannot be determined, the profit scales

recommended by provincial professional associations may be

used as a reference point from which the reasonableness of

a negotiated rate can be compared

Costing/pricing practices

The costing structures of individuals, bidders and universities are

different and will vary significantly. Some costs that would

otherwise be charged separately are sometimes charged to

overhead, thus increasing the total rate but may not necessarily

increase the total contract price.

The profit of the service contracts includes only those elements of cost properly associated with the actual

time expended on the work. These are the direct labour costs and their fair share of overheads, general

and administrative expenses and profit. Other direct costs such as charges for publication of reports,

special computer or test services, travel and living, should normally be shown separately. Each case is

required to be taken on its own merits to arrive at an assessment of which amounts are reasonable

charges, either as a profit element, or as a separately charged item.

In all contracts for services with a cost reimbursable or fixed time rate basis of payment, the rates of

payment should be specified for the entire period required for performance of the contract, including all

phases and specified option periods. When this is not possible, payments for each year or phase are

based on a pre-agreed rate or formula that is to be specified in the contract.

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ANNEX 3: CONTACT INFORMATION

Organization

Organization Description

Contact Information

Pricing and

Professional

Accounting Practices

Group (PPAPG)

The Pricing and Professional

Accounting Practices Group

(PPAPG) is responsible for:

1. administering the Cost

Accounting Practices

(CAP) Submission

program and

2. provides guidance, tools

and support to pricing.

1. TPSGC.PADeclarationdesPCA-

APCAPSubmission.PWGSC@tpsgc-

pwgsc.gc.ca

2. tpsgc.padgamtp-appbipm.pwgsc@tpsgc-

pwgsc.gc.ca

Price Advisory Group

(PAG)

The Price Advisory Group

(PAG) is responsible for direct

support in the negotiation of

interim rates or cost-base for

pricing and advice to

contracting officers on basis of

payment.

TPSGC.PASoutiendesprix-

APPriceSupport.PWGSC@tpsgc-pwgsc.gc.ca

Assurance Services

Group (ASG)

The Assurance Services

Group (ASG) provides contract

related assurance and advisory

services on credibility, integrity,

and reliability of financial and

non-financial information used

to support contractor claims.

tpsgc.padgagsc-APPBASG.pwgsc@tpsgc-

pwgsc.gc.ca

271 | Page Public Services and Procurement Canada August 2023

ANNEX 4: PROCESS STEPS FOR COST ACCOUNTING PRACTICES (CAP) SUBMISSION

Process Steps

Process Description

Initiate The Process

• The contracting officer identified in the solicitation document initiates the CAP

Submission process.

Provide and

Complete Template

• The contractor will be provided with a template for the Cost Accounting Practices

(CAP) Submission by the Procurement Support Services Sector.

• Contractors can complete and submit the CAP Submission tool to the point of

contact identified in the solicitation document.

• Any questions about this document should also be directed to the point of

contact identified in the solicitation document.

Review of the CAP

Submission

• The Procurement Support Services Sector will review the CAP Submission.

Requests for clarification or additional information from the Contractor may be

made.

• Review of CAP Submission: Items are assessed to determine whether or not

they are in accordance with SACC 1031-2.

Documentation and

Contract

Amendment

• The contracting officer will incorporate the CAP Submission in the contract by

way of a certification by the contractor.

• The original CAP Submission will be retained by the Procurement Support

Services Sector and a copy distributed to the client department and contracting

officer.

Refer to the Section 5.1.2 (Cost Accounting Practices Submission) for additional information.

272 | Page Public Services and Procurement Canada August 2023

ANNEX 5: DISCUSSION PAPERS

ANNEX 5.1 BACKGROUND: CONTRACT PRICING IN CANADA

These discussion papers provide general considerations for contract costing and pricing in Canada. They

provide further guidance on various topics to support contracting officers’ understanding of how contract

pricing works in Canada.

ANNEX 5.1.1 DISCUSSION PAPER - FINANCIAL ACCOUNTING VS. COST ACCOUNTING

Financial Accounting versus Cost Accounting for Reporting Contract Costs

Context

This discussion paper provides guidance to contracting officers in the negotiation of non-competitive

contracts or contracts where price negotiations with the successful bidder are required following a

competitive process.

This discussion paper is intended to help inform contracting officers, to prepare for contract negotiations

and manage the contract through its lifecycle. Based on the scale and complexity of the acquisition, this

requires considerable support from the contracting team, which may include price advisors, client

department representatives and other subject matter experts. This discussion paper is not intended to be

a procedural document.

Why This Matters?

Financial accounting and cost accounting can be used to determine the cost base to price a contract.

When contractors rely primarily on financial accounting, without proper consideration of cost accounting,

to report contract costs, the reported costs may not be attributable, appropriate, and reasonable. As such,

clear direction around the application of both financial and cost accounting is required to help ensure that

reported contract costs meet these criteria and ultimately optimize value to Canada.

Recommendation

Both financial accounting and cost accounting principles should be used to determine the cost base to

price a contract. Financial accounting can be used to generate the initial source of cost information for a

contract, while cost accounting can be used to adjust this cost information and derive the cost basis of a

contract.

This initial source of cost information can be relied on more heavily when the cost-based payment for the

contract, or components or phases of the contract, is determined by actual costs. When the basis of

payment is determined by cost estimates, the initial source of cost information may provide a historical

basis to estimate costs; however, additional data

will be required to develop a sound cost estimate.

Discussion on the additional data required to develop a cost estimate is out of scope.

273 | Page Public Services and Procurement Canada August 2023

Ultimately, the application of both financial and cost accounting will help ensure that the costs included in

a contract are attributable, appropriate, and reasonable.

Analysis

This section first describes the purpose and key principles of financial and cost accounting as it pertains

to cost reporting, identifies the similarities between them, and explains their differences. Second, it

describes how financial and cost accounting work together to determine the cost basis of a contract. Last,

it identifies potential challenges that contractors may experience in determining the cost basis of a

contract.

A. Cost and Financial Accounting as it pertains to Cost Reporting

Purpose and Key Principles of Financial Accounting

Financial accounting is used to report the expenses and revenues, assets and liabilities, and cash flow

position of an enterprise to external users, typically on a quarterly and annual basis. For example, the

Government of Canada reports its public financial statements using financial accounting.

In financial accounting, a cost might be in the form of an expense or an asset. Generally, a cost is an

expense (e.g., depreciation), if it relates to the revenue incurred by an enterprise during a specified period,

and an asset (e.g., equipment cost) if it provides future economic benefit to the enterprise.

Financial accounting is governed by a set of authoritative publically available principles.

From a cost

reporting perspective, these principles:

1 identify conditions under which a cost type

should be recognized (e.g., reporting expenses in the

same period the corresponding revenues are incurred);

2 identify the conditions and options for measuring the amount of a cost type (measuring an asset at

historical cost vs. fair market value); and

3 identify that supporting information for the cost type and amount should be disclosed such that the

level of detail and understandability is balanced with the cost of producing the supporting information

(e.g., supporting calculations and assumptions for fair market value measurement of an asset).

Purpose and Key Principles of Cost Accounting

Cost accounting is used internally to report costs for decision-making purposes for various cost objects

(e.g., goods and services, departments, programs, contracts etc.). For example, in the Government of

Canada, cost accounting is used to inform cost-benefit, capital investment, cost-recovery and other

decisions.

In cost accounting, costs must be allocated to cost objects as either direct or indirect costs. In alignment

with the Treasury Board Secretariat (TBS) Guidelines on Costing, costs are considered direct, when they

are incurred solely to support one cost object

, and indirect, when they are incurred to support more than

CPA Canada Handbook, International Financial Reporting Standards, 2018 Edition, 2017.

Examples of cost types include depreciation, research and development, executive compensation, and others.

Guidelines on Costing. Treasury Board Secretariat, January 2016, https://www.tbs-sct.gc.ca/pol/doc-eng.aspx?id=30375, Accessed 1 March 2018.

274 | Page Public Services and Procurement Canada August 2023

one cost object. Indirect costs may be allocated to cost objects using cost pools, groupings of

homogeneous or like cost types (e.g., employee-based costs).

The TBS Guidelines on Costing identifies six principles for costing

1 costing requires stakeholder consultation and judgement;

2 costing must be done for a specific purpose (different purposes require different information);

3 costing should be done consistently for costing exercises that have the same purpose so that the

resulting information will be comparable;

4 costs can be affected by changes in the level of activity of a cost object in three main ways:

• costs can change in proportion to changes in the level of activity of a cost object;

• costs can remain constant regardless of changes in the level of activity of a cost object; and

• costs can remain constant with a particular range of activity but when change when the level of

activity of a cost object passes a specific amount.

5 data used in a costing exercise must of high quality and must be reasonable, consistent, defensible,

reconcilable and current; and

6 the benefits of cost information (i.e., level of detail, timeliness, accuracy, and complexity) must be

balanced against the cost of producing it.

Similarities and Differences between Financial Accounting and Cost Accounting

The principles identified for financial accounting and cost accounting are not mutually exclusive. For

example, even though the cost accounting principle of stakeholder consultation and judgement is not

authoritatively identified as a financial accounting principle, it is required for financial accounting.

The key similarities between financial and cost accounting, pertaining to cost reporting, are identified

below:

• professional judgment and stakeholder consultation are required to determine costs;

• cost types (e.g., deprecation, research and development, executive compensation) and amounts

need to be recorded and tracked using a reliable accounting system;

• information, supporting costs, should be of high quality and balanced against the costs of

producing the information; and

• consistent accounting methods should be used for costing exercises that have the same purpose.

The key differences between financial and cost accounting, pertaining to cost reporting, are identified

below.

• Financial accounting principles provide authoritative standards for identifying conditions, under

which a cost type should be recognized, and for identifying conditions and options for measuring

the amount of a cost type. Cost accounting does not provide the same degree of authoritative

standards.

• Financial accounting is used to reports costs of one final cost object (the enterprise) for the same

purpose(s), while cost accounting can be used to report costs for several cost objects for different

purposes.

IBID

TBS uses the term costing instead of cost accounting in its guide.

275 | Page Public Services and Procurement Canada August 2023

• Financial accounting generally only needs to track data to report on amounts for cost types. For

cost accounting, additional, or less, financial data or non-financial data (e.g., about the activity

that drives a cost) may need to be tracked depending on the purpose of the respective costing

exercise and/or in order to allocate costs to cost objects.

• Compared to financial accounting, cost accounting requires an increased understanding of how

the cost will change in relation to changes in the level of activity of the cost object; this is of

particular importance for allocating indirect costs to cost objects and for developing cost

estimates.

• Financial accounting generally requires reports only at the end of a reporting period, while cost

accounting may require reports at any time and with any degree of frequency depending on user

needs.

Key Takeaways for Financial Accounting and Cost Accounting

Based on the identified similarities and differences between financial and cost accounting, two key

takeaways have been identified.

• Cost accounting routinely relies on the cost information produced by financial accounting.

Financial accounting provides authoritative standards for generating an initial source of cost

information (e.g., cost types and amounts). Cost accounting may further transform this cost

information, depending on the purpose of the costing exercise, through:

• the collection of additional financial or non-financial data requirements;

• the application of a different cost measurement basis;

• the classification of costs as direct or indirect,

• the pooling of homogeneous costs;

• the allocation of costs to cost objects; and/or

• the development of cost estimates.

• Cost accounting can be time consuming and difficult. Producing accurate and complete

reports based on cost accounting can be time-consuming and difficult due to:

• the additional data required, particularly for allocating costs and developing cost estimates;

and/or

• the misalignment of timings with financial accounting reporting dates, particularly for reporting

actual contract costs.

The first takeaway is elaborated on in the next section and the second takeaway is explained in the

Contractor Challenges for Producing Contract Cost Reports section of the discussion paper.

B. How Financial and Cost Accounting Work Together to Determine Contract Costs

In order to depict how financial and cost accounting work together to determine contract costs, the purpose

of contract costing must be discussed.

The purpose of contract costing is to determine what costs, types and amounts, should be acceptable for

contracts, or components or phases of contracts, for which the basis of payment is cost-based (i.e.,

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determined by actual costs, cost estimates, or a combination thereof), so that the best value is provided

to Canada

Value to Canada, from a contract costing perspective, can be determined by a contract cost’s alignment

to three criteria.

• Is the cost type attributable to the contract, including whether the cost type has a causal

relationship with, or otherwise required/beneficial for, the performance of the contract?

• Is the cost type appropriate for the contract, including whether the inclusion of the cost type in

the contract is fair and equitable?

• Is the amount of the cost type for the contract reasonable, including whether the amount is

consistent with good business practices, congruent with contract performance, and fairly

allocated?

Note that the criteria of attributable and appropriate are used to determine if a cost type should be accepted

for a contract, while the criterion of reasonable is used to determine what amount of an attributable and

appropriate cost type should be accepted for a contract. If these criteria are met, it implies that accepting

the cost is of value to Canada. These criteria, as they apply to contract costs, are explained in further

detail in the Costing Standard.

The application of both financial and cost accounting ultimately ensure that the costs included in a contract

are attributable, appropriate, and reasonable. Financial accounting can be used to generate the initial

source of cost information for a contract, while cost accounting can be used to adjust this cost information

and derive the cost basis of a contract. The below diagram depicts how these two accounting types work

in tandem to determine a contract cost that provides value to Canada.

Canada is representative of The Government, including the customer(s), the industry including the contractor, and the Canadian taxpayers.

277 | Page Public Services and Procurement Canada August 2023

Exhibit A5.1.1.a. Financial and Cost Accounting Work Together to provide Value to Canada

Note that the above diagram does not explain every step and detail involved in the application of financial

and cost accounting for determining contract costs. Furthermore, it does not detail all of the sub-criteria

and considerations that should be met to achieve a contract cost that is attributable, appropriate, and

reasonable. As previously stated, these criteria are explained in further detail in the Costing Standard.

The intent of the diagram is to depict that financial accounting can provide an initial source of authoritative

information for determining contract costs. This initial source of cost information can be relied on more

heavily when the basis of payment for the contract, or components or phases of the contract, is determined

by actual costs. When the basis of payment is determined by cost estimates, the initial source of cost

278 | Page Public Services and Procurement Canada August 2023

information may provide a historical basis to estimate costs; however, additional data

will be required to

develop a sound cost estimate.

Current Guidance for the Use of Financial and Cost Accounting for Contract Costing in Canada and

Comparators

Canada

: Current guidance implies that the use of cost accounting is required to determine the cost basis

of a contract. No explicit guidance is provided for the role of financial accounting.

Australia

: Current guidance states that a contractor’s contract cost report should not focus on

compliance to the financial accounting system, but rather to the criteria identified in the guidance for

assessing allowable contract costs. The guidance implies that cost accounting is required to determine

the cost basis of a contract. However, no explicit guidance is provided on how financial and cost

accounting can work together to determine the cost basis of a contract.

United Kingdom

: Current guidance states that although contractors may adopt a variety of accounting

policies and make judgements in the preparation of financial statements for statutory reporting purposes,

the application of these policies will not necessarily result in the correct treatment of costs for contracts.

The guidance implies that cost accounting, and not financial accounting, should be used as the primary

lens to determine the cost basis of a contract. However, no explicit guidance is provided on how these two

types of accounting can work together to determine the cost basis of a contract.

United States

: Current guidance is aligned with the Government’s Cost Accounting Standards. No

explicit guidance is provided for the role of financial accounting.

In summary, the recommendations in this Discussion Paper do not contradict benchmark guidance. Costs

produced by financial accounting provide just the initial source of cost information for deriving the cost

basis of a contract. In order to derive the cost basis of a contract, which meets the criteria of attributable,

appropriate, and reasonable, cost accounting must be used.

C. Contractor Challenges for Producing Contract Cost Reports

As previously identified, producing accurate and complete reports based on cost accounting can be time-

consuming and difficult due to the below reasons:

• the additional data required, particularly for allocating costs and developing cost estimates;

and/or

• the misalignment of timings with financial accounting reporting dates, particularly for reporting

actual contract costs.

These challenges, and potential mitigation strategies, are elaborated on further below.

Discussion on the additional data required to develop a cost estimate is out of scope.

Contract Cost Principles. SACC Manual, Public Service Procurement Canada, 16 July 2012, https://buyandsell.gc.ca/policy-and-guidelines/supply-

manual/annex/10/5/13, Accessed 29 October 2017.

Australian Government-Department of Defence-Capability Acquisition and Sustainment Group, Capability Acquisition & Sustainment Group Cost

Principles, October 2017.

Single Source Regulations Office, Single source cost standards-Statutory guidance on Allowable Costs, February 2018.

United States General Services Administration Federal Government, Federal Acquisition Regulations, 17 August 2007.

279 | Page Public Services and Procurement Canada August 2023

The additional data required, particularly for allocating costs and developing cost estimates.

Tracking and collecting certain cost data, which can be both financial and non-financial in nature, may be

time consuming, costly, and even infeasible. For example, estimating multiple years’ worth of accurate

cost activity information (e.g., forecasted time spent by employees on a contract) to allocate costs (e.g.,

employee benefits) can be time-consuming and potential infeasible depending on the complexity and

uncertainty of the scope of the contract. These challenges may be even more applicable for small and

medium-sized enterprises (e.g., start-up companies) since these suppliers may not have sufficient

accounting capabilities to sufficiently collect and track the data required to estimate and/or allocate

contract costs.

To mitigate the above challenge, the cost-based payment type used for the contract, or portions or phases

of the contract, could provide consideration to the contractor’s ability to collect and track the supporting

data required to determine the cost basis of the contract. For example, depending on the nature of the

data requirements, certain portions or phases of a contract could have bases of payment which are

informed by actual costs instead of cost estimates.

The misalignment of timings with financial accounting reporting dates, particularly for reporting

actual contract costs. The schedule for providing contract cost reports to the Government may not align

with the schedule for releasing financial accounting reports. Depending on the type of accounting system

being used by a contractor, certain costs may only be reconciled at financial accounting reporting dates;

as such, contract cost reports may not be 100% accurate and complete.

To mitigate the above challenge, the Government and contractor could, at the outset of the contract,

mutually determine a schedule for cost reporting over the contract’s duration, such that the contractor is

able to report accurate and complete costs.

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ANNEX 5.1.2 DISCUSSION PAPER - RULES-BASED VS. PRINCIPLES-BASED STANDARDS

Rules-Based Versus Principles-Based Standards

Context

This discussion paper provides guidance to contracting officers in the negotiation of non-competitive

contracts. It is one of a suite of documents (e.g. other discussion papers, the Costing Standard, etc.)

developed to support PSPC’s review of Canada’s pricing framework. Together, these documents provide

recommendations for updated guidance, with respect to pricing for non-competitive contracts, including

mechanisms to help address the challenges with Canada’s current Cost and Profit Policy.

This discussion paper is intended to help inform contracting officers, to prepare for contract negotiations

and manage the contract through its lifecycle. Based on the scale and complexity of the acquisition, this

requires considerable support from the contracting team, which may include price advisors, client

department representatives and other subject matter experts. This discussion paper is not intended to be

a procedural document.

This guidance paper considers the merits of rules versus principles-based standards that may be

considered for PSPC’s revision of Canada’s pricing framework that is intended to provide guidance for

contracting officers when negotiating a contract that includes a good understanding of contractor costs to

help inform and negotiate the price of a non-competitive contract.

The overarching principle is contracting for value to Canada. The underlying principles for determining if

contract costs are of value to Canada, are the criteria of Attributable, Appropriate, and Reasonable. The

application of the criteria between contracts should be consistent, but the outcomes, in terms of contract

cost acceptability, may differ depending on the complexity of the contracts in question.

A principles-based approach to determining contract costs requires professional judgement. As such,

education and training is required to minimize different interpretations of the criteria of Attributable,

Appropriate, and Reasonable.

Research completed to understand approaches in the UK, USA and Australia noted that no jurisdiction

follows a completely principle or a rules-based approach, rather each follow a hybrid approach with more

reliance on one approach. Current PSPC guidance includes principles as well as rules and also places an

emphasis on cost and profit, whereas the revised guidance is intended to both consider the current

approach as well as emphasize price and value.

Includes 1031-2 (“Contract Cost Principles”) of the Standard Acquisition Clauses and Conditions and Chapter 10 (“Cost and Profit”) of the Supply Manual

281 | Page Public Services and Procurement Canada August 2023

Some of the trade-offs between a rules and principles based approach include the following:

Advantages

Disadvantages

Rules

• Consistency of application

• Less professional judgement required

with focus on step-by-step process to

apply rules

• Training to rules simpler (e.g.,

classroom, online)

• Little room to exercise professional

judgement

• Many rules required that envisage a

multitude of possible scenarios that

must be maintained over time

• Rules can still be subject to

interpretation

Principles

• Ability to exercise professional

judgement

• Provides flexibility in negotiating

contracts

• Focus on maximizing value to Canada

• Differing interpretation may lead to

inconsistent approaches in negotiating

contracts and unintended outcomes

after contracts are negotiated

• Training to principles not as simple,

requires learning and development

over time combining formal (e.g.,

classroom, online and informal training

(e.g., mentoring)

Why This Matters?

The application of either rules-based or principles-based approach can impact which costs are allowable,

and the level of judgement required to apply principles, within a contract for goods and/or services. By

better understanding the merits and limitations of both methods, as well as their implications to inform the

understanding of costs from which to negotiate the price of a contract; contracting officers can incorporate

the most appropriate approaches and judgements to deliver maximum value for Canadians. As a result,

these standards can assist in establishing a more consistent practice across government with regards to

the acceptance of allowable cost types.

Recommendation

The recommendation for Canada is to implement a principles-based approach with recommendations,

where applicable, for expected practice and examples of appropriate deviations provided based on sound

principles. The three key principles to be followed are Attributable, Appropriate and Reasonable.

Contracting officers should consider these three principles when considering the costs put forward by

contractors to inform the negotiation of price. This approach will assist in achieving improved consistency

of practice with principles-based standards that encourage flexibility and innovation to support maximizing

the value for Canadians derived from non-competitive contracts. For example, the use of historical cost is

recommended (the recommendation based on the cost principle), but the use of replacement cost or

opportunity cost may be appropriate in certain instances (buy and sell principle of best value). With

recommendations and principles that emphasize the benefits for all parties involved, the contract becomes

a vehicle to promote clarity and fairness that go beyond agreement on the specific costs to be allowed.

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Analysis

A. Rules-Based versus Principles-Based Standards

Rules-based standards state explicit requirements that must be followed without deviation, while

principles-based standards permit the exercise of professional judgment to fit the circumstances, providing

flexibility to promote creativity and innovation in the procurement of goods and services.

Although rules-based standards allow for consistency and comparability, there is considerable effort

required to provide a list of rules that envision all possible scenarios when negotiating a non-competitive

contract. Under a principles-based approach, the use of professional judgment informed by principles

enables adaptability to a changing environment and the unique circumstances for a particular goods or

services procurement resulting in benefits to all stakeholders involved. Consistency needs to be

demonstrated within an acceptable range, requiring documentation of alternatives analysis and

decision/approval. Principles inherently allow for experimentation; contractors must be afforded similar

treatment and public disclosure required to inform the marketplace and account to Parliament for due

exercise of professional judgment.

The current approach for Canada includes a combination of principles and rules. Principles noted in

Canada’s current contract costing guidance, for example, include general principle and reasonable cost.

• General Principle - “The total cost of the Contract must be the sum of the applicable direct and

indirect costs which are or must be reasonably and properly incurred and/or allocated, in the

performance of the Contract, less any applicable credits. These costs must be determined in

accordance with the Contractor's cost accounting practices as accepted by Canada and applied

consistently over time.”

• Reasonable cost – “A cost is reasonable if the nature and amount do not exceed what would be

incurred by an ordinary prudent person in the conduct of a competitive business.”

Rules noted in Canada’s current contract costing guidance include a list of costs that are non-applicable

to a contract (e.g., losses on investments or other contracts, fines and penalties, and entertainment

expenses).

B. Preferences in Other Jurisdictions

In the United States, rules-based standards have been promulgated based on principles and are more

typically applied in accounting and procurement through the use of US GAAP accounting standards and

the Federal Acquisition Regulation. This approach is generally favored in more litigious environments, as

deviations from the rules are more easily enforced. In the UK and Australia however, principles-based

standards have been developed with accompanying guidance that provide interpretations that can be

viewed to some extent as rules. With regards to procurement and generating contracts, additional

emphasis is applied to innovation and value for money, as the establishment of general principles enables

creativity and develops a better working relationship with third party contractors on future engagements.

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C. Implications

In the context of negotiating contracts, the implications for the use of rules-based versus principles-based

accounting standards depend on the expectations and outcomes to be achieved from the contract. For

example, if a contract is negotiated based on a set of rules to determine what costs are allowable and if

the contractor is expecting to follow routine processes for standard work that need to be followed, and

require minimal innovation, then a rules-based approach may be appropriate because of its ability to

generate consistency of practice and its ease in implementation and managing over the life of the contract.

It also facilitates subsequent compliance audits that Canada may conduct.

Conversely, if a contract is being established for a new, complex good/service, the application of general

principles may be more appropriate to negotiate a cost-based contract. This would enable more innovation

and creative approaches to the procurement to achieve Canada’s objectives, outcomes and maximize

value. It can also result in more effective relationships and collaboration with contractors to develop

innovative approaches to delivering the goods or services required. Particularly for large and complex

non-competitive contracts (often in Defence), the objective is to obtain maximum value for Canadians.

Within a confined, rules-based contract, there is little room for deviation from the standard. If Canada’s

strategic objectives and outcomes for a procurement require a solution that is not a readily available good

or service, the contracting officer, the customer and the contractor must jointly negotiate a contract that

reflects the nature of the solution being sought as well as the distribution of risks and benefits.

Under a principles-based approach, the stakeholders are not as confined to specific requirements and

may need to develop a contract that may require a stage-gate process. The assessment of costs that are

acceptable under the contract should be straight forward, as long as the costs, which are included under

either a rules or principles-based contract, are clearly described in the contract. For large complex

procurements, which may require a stage-gate process, this will require contract amendments to provide

clarity on the type and amount of cost to be included as each gate is achieved. Ultimately, this will help to

achieve better outcomes for Canada’s revised pricing framework.

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ANNEX 5.1.3 DISCUSSION PAPER - ACCRUAL VS. CASH BASED ACCOUNTING

Accrual versus Cash Based Accounting

Context

This discussion paper provides guidance to contracting officers in the negotiation of non-competitive

contracts or contracts where price negotiations with the successful bidder are required following a

competitive process.

This discussion paper is intended to help inform contracting officers, to prepare for contract negotiations

and manage the contract through its lifecycle. Based on the scale and complexity of the acquisition, this

requires considerable support from the contracting team, which may include price advisors, client

department representatives and other subject matter experts. This discussion paper is not intended to be

a procedural document.

Why This Matters?

Misunderstandings between the concepts and application of accrual and cash-based accounting can have

a negative impact on understanding and determining contract costs. As a result, users should be aware

of the key differences between the two methods and instances and the potential impact of each in

establishing and managing a contract. This knowledge will support more consistent understanding and

basis to estimate contract costs in support of further value to Canada.

Recommendation

The recommended approach for Canada is to follow accrual accounting as the basis for measuring cost

when establishing non-competitive government contracts. The accrual method for measuring cost

estimates and actual costs would generally be appropriate for most cost types where the amount can be

estimated and there is a sufficient level of certainty of occurrence. For example, the amount of direct

labour costs to be included in a contract can be based on the estimates calculated by the contractor as

part of their accounting records that typically follow accrual method as labour payments are accrued as of

period end and paid shortly thereafter.

The cash method may provide better value to Canada for cost types where the amount cannot be

accurately estimated and/or there is insufficient level of evidence for occurrence. The use of the cash

method would likely be unusual and used rarely. In the event that the cash method is selected the amount

of the cost would only be known with certainty at the time of payment. Examples include, but are not

limited to, warranty or severance payments. In these examples, the contracting officer may choose to

include terms and conditions in the contract that state that while the cost may be acceptable (if it meets

all of the other acceptability criteria) the amount will be determined in the future when the warranty costs

or severance payments are actually disbursed.

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The following decision tree illustrates the recommendation.

Exhibit A5.1.3.a. – Accrual vs Cash Method

Analysis

A. Accrual versus Cash Accounting

Accrual accounting records events in the period in which they are incurred (incurred cost) whereas cash

accounting records the events only when cash is received/paid. Under the accrual method, the matching

principle is followed to recognize revenues in the same period as the expenses that were incurred to earn

those revenues. With the cash method, only the receipt or payment of cash triggers the recognition of a

transaction which can create timing differences when these transactions are recorded compared to the

accrual method, i.e., expenses may be recorded in an earlier period than when revenues are recorded

due to the difference in timing of the actual payment of expenses and receipt of revenues.

It is important to recognize that all Canadian government departments and agencies follow accrual

accounting as required for financial reporting purposes (i.e., Public Accounts). This is consistent with other

governments used as comparators, including the United States, United Kingdom, and Australia.

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B. Application to Government Contracts

Cash and accrual accounting have pros and cons to consider. The following summary is based on an

Australian Government website and has been edited to be more relevant to the context of this discussion

paper.

Cash accounting:

• is a simple system that keeps track of a contractor’s cash flow;

• is generally suited to smaller contractors that mostly handle transactions in cash;

• presents a picture of how much money the contractor has on hand and in its’ bank accounts; and

• does not capture money that is owed from, or to, others.

Accrual accounting:

• is more complicated than cash accounting;

• is better suited to contractors that don't get paid for some period of time after provision of goods

or services;

• is a system that accounts and reports a truer financial position at a point in time, as it captures

money that is owed from, and to others; and

• is helpful when dealing with many contracts and large dollar amounts.

Most if not all contractors in Canada and abroad use accrual accounting. Similarly federal government

departments and agencies in Canada and similar organizations in other countries follow accrual

accounting to present a more accurate financial position at any point in time.

Cash vs. Accrual Accounting, Australia Government – Department of Industry, Innovation and Science, May 2016.

287 | Page Public Services and Procurement Canada August 2023

ANNEX 5.2 PERFORMANCE MANAGEMENT DISCUSSION PAPERS

These discussion papers are intended to provide additional guidance and support to contracting officers

in understanding tools and options available for performance management.

ANNEX 5.2.1 DISCUSSION PAPER - CONTRACT INCENTIVES TO ENCOURAGE AND

REWARD ENHANCED VALUE TO CANADA

Contract Incentives to Encourage and Reward Enhanced Value to Canada

Context

This discussion paper provides guidance to contracting officers in the negotiation of non-competitive

contracts or contracts where price negotiations with the successful bidder are required following a

competitive process.

This discussion paper is intended to help inform contracting officers, to prepare for contract negotiations

and manage the contract through its lifecycle. Based on the scale and complexity of the acquisition, this

requires considerable support from the contracting team, which may include price advisors, client

department representatives and other subject matter experts. This discussion paper is not intended to be

a procedural document.

This paper explores the following topics:

• considerations for the use, design, and administration of contract incentives;

• potential financial incentives, including respective benefits, drawbacks, and considerations; and

• potential non-financial incentives, including respective benefits, drawbacks, and considerations.

Incentive work in tandem with the various contract management measures, which are described

respectively in Annex 5.2.2 (Discussion Paper - Measures to Manage Contractor Non-Compliance or

Unacceptable Behaviour)

It is important to remember that incentives do not replace sound price setting and relationship

management practices, which are described respectively in Annex 5.4.1 (Discussion Paper: Alternative

Approaches to Cost-Based Pricing) and in Annex 5.2.4 (Discussion Paper: Managing Long-Term

Contractual Relationships).

Why This Matters?

Incentives can encourage and reward superior contractor performance which exceeds the base goods

and services established in the statement of requirements. Incentives are the backbone of performance-

based contracting, as the contractor is rewarded based on the achievement of certain performance

objectives that, in theory, are linked to contract outcomes. These performance objectives are generally

above and beyond the minimum criteria established in the contract statement of work. Indicators used to

evaluate performance objectives may include technical (e.g., quality, safety, innovation), schedule, cost

and other measures. Incentives can be of a financial or non-financial nature. The intent is to design

288 | Page Public Services and Procurement Canada August 2023

incentive mechanisms that motivate the contractor and enhance value to Canada, supplementing the

incentive inherently provided by the underlying basis of payment.

However, in a contract, the linkages between incentives, performance objectives, and contract outcomes

are not always effective and verifiable for the following reasons:

• the use of incentives may not always be appropriate or effective;

• designing and administering appropriate and effective incentives, including corresponding

performance objectives, can be complex; and

• there are several different types of financial and non-financial incentives (each with their own

respective benefits, drawbacks, and considerations) that can be used in a contract.

When incentives are inappropriately selected, designed, and administered, the result can have unintended

consequences and ultimately lead to suboptimal contractor performance. As such, clear guidance

regarding the use of incentives is required to help ensure appropriate incentives are structured and

administered to provide value to Canada.

Recommendation

Incentives should be used to reward superior contract performance which exceeds the base standards

established in the statement of requirements. The use of incentives may not be appropriate or effective

for all contracts, particularly when:

• the contractor is already receiving a fair profit on the contract;

• the contractor will achieve the target performance criteria without an incentive;

• the contractor will not be motivated, by the incentive(s), to achieve the target performance

criteria; or

• there is no, or minimal, value to Canada for performance beyond the base standards

established in the statement of requirements.

When the use of incentives is determined to be appropriate, they should be designed and administered

such that:

• the corresponding performance objectives are balanced and linked to contract outcomes;

• the contractor has control over the performance objectives to which the incentives are linked;

• the achievement of the performance objectives can be measured and verified;

• the process by which the incentive is awarded, and the incentive amount, are reasonable, and

align with government policy and regulations; and

• the benefits of the contract outcomes exceed the combined cost of the incentives and the cost

of administering the incentives.

A combination of financial and non-financial incentives can be used in the same contract to complement

each other. Ultimately, selection of the ‘right’ incentive(s) can drive cost-effective, high-quality, and timely

outcomes in performance-based contracts.

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Analysis

A. Considerations for the Use, Design, and Administration of Contract Incentives

Assessing the Appropriateness and Effectiveness of Including Incentives in a Contract

Table A5.2.1.a. briefly describes the factors that should be assessed when determining the

appropriateness and effectiveness of using incentives in a contract.

Table A5.2.1.a.

Factors

Example Criteria to Assess (Not Exhaustive)

Is the contractor already

receiving a fair profit on the

contract?

If the contractor is earning a profit premium as a component of the

profit, how would the profit premium interact with any other incentive

provisions within the contract?

Refer to Section 5.2 (Profit Principles) for further guidance on profit

determination.

Will the contractor achieve

the target performance

criteria without an

incentive?

Has the contractor typically adhered to, or exceeded, performance

criteria in past contracts?

Is the contractor well known for its expertise and performance in

respect to the contracted activities?

Is the nature of the contract routine or complex (e.g., is the good or

service being procured a commodity or a custom requirement or new

technology)?

Will the contractor be

motivated by the

incentive(s) to achieve the

target performance

criteria?

Does the incentive align with the contractor’s strategic goals?

Is the potential impact of the incentive significant enough to motivate

the contractor?

Is there value to Canada

for contractor performance

beyond the minimum

performance criteria?

Will the client department, and/or the Government, benefit from

contractor performance above the base standards established in the

statement of requirements?

The benefits, drawbacks, and considerations of using specific types of financial and non-financial

incentives in a contract are discussed later in this discussion paper.

Considerations for Designing and Administering Contract Incentives

Incentives should be designed and administered such that:

• the corresponding performance objectives are balanced and aligned to contract outcomes;

• the contractor has control over the performance objectives to which the incentives are linked;

• the achievement of the performance objectives can be measured and verified;

• the process by which the incentive is awarded, and the incentive amount, are reasonable, and

align with government policy and regulations; and

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• the benefits of the contract outcomes exceed the combined cost of the incentives and the cost of

administering the incentives.

Designing Aligned and Balanced Performance Objectives

Below are some key considerations for designing balanced performance objectives that are aligned to

contract outcomes.

• All contract outcomes should be traceable to users’ needs and aligned with the client department’s

strategic objectives (e.g., enhancing preparedness in defence, reducing the total cost of

ownership).

• All performance objectives should be fully integrated and aligned to motivate contractor

performance of all contract outcomes, avoiding opportunities for the contractor to ‘game the

system’ by focusing on select key performance indicators at the expense of others. For example,

the contractor may compromise a technical indicator, such as quality or safety, in order to achieve

a higher assessed score for schedule and cost indicators. Specific suggestions for mitigating this

include:

• making incentive payments conditional upon the achievement of minimum performance

thresholds across all assessed performance indicators;

• appropriately weight the performance indicators to signal the relative importance of each

indicator; and

• evaluating performance based on the achievement of performance objectives that integrate

cost, technical, and schedule indicators.

• Importantly, the performance objectives, and respective target criteria, should encourage

innovation in service delivery and promote a culture of continuous improvement and must not

compromise safety or undermine critical safety processes.

• For long-term, multi-milestone contracts, consideration should be provided for designing and

integrating incentive linked performance objectives, at various contract milestones, based on

factors such as but not limited to:

• the history of contractor performance at prior contract milestones; or

• technological advances in the contractor’s industry (i.e., advances can create new norms

for cost, schedule, and/or technical contract performance).

• The total number of performance indicators should be manageable (a suitable number would be

between three and five key performance indicators).

Designing Attainable Performance Objectives

Below are some key considerations for designing attainable performance objectives.

• The contractor, and to the extent possible its sub-contractors, should have control overachieving

the target criteria for the performance objectives. Clauses should be included in the contract that

provide flexibility for the amendment of the performance objectives and criteria, in the event that

the client department and/or the Government require changes (e.g., to align with a new policy or

a shift in scope).

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• If the scope of the contract, including outcomes, is initially uncertain, incentives and corresponding

performance objectives can be integrated into the contract (via a contract amendment) in later

phases of the contract as the scope becomes more defined.

Designing Measurable and Verifiable Performance Objectives

Below are some key considerations for designing measurable and verifiable performance objectives.

• Performance objectives may be measured by quantitative or qualitative indicators. When

qualitative indicators are used, they should be expressed in clear and descriptive terms, along

with clear expectations on how and who will perform the assessments.

• Establishing accurate target performance criteria for performance objectives can be challenging.

For example, establishing an accurate target cost or schedule in non-competitive contracts may

be difficult if there is limited comparable market data. The challenge is further compounded when

the nature of the contracted activities is complex and atypical. Accordingly, sound methodology,

with appropriate expert advice (i.e., the client department, price advisors, etc.), should be used to

develop and validate contract target cost (and schedule) estimates.

• Verification of the contractor completion of performance objectives, which are linked to incentives,

is required as per Section 34 of the Financial Administration Act. To ensure verifiability of

performance objectives, both the contractor and client department should have sound data

measurement capabilities including, but not limited to, the below.

• all data sources/systems should be readily identified (e.g., Accounting Systems or Labour

Time Recording Systems);

• all data elements, required for the indicator to be measured, should be readily available;

and

• data stewardship should be a part of the contractor’s and client department’s operational

culture, and well documented processes should be in place to continuously measure and

maintain data quality.

Ensuring Fairness in the Incentive Design and Administrative Process

Below are some key considerations in ensuring fairness in the incentive design and administrative

process.

• The magnitude of the incentive reward should be reasonable and clearly understood and

agreed upon by both the Government and the contractor.

• The incentive evaluation process should be understood and agreed upon by both the

Government and the contractor.

• The incentive evaluation process should be free from bias and duplicable.

• Details about the incentive design and administrative process, including linked performance

objectives, indicators, and criteria, should be clearly documented in the contract terms and

conditions. Related dispute resolution terms should also be included in the contract.

Detailed considerations for ensuring fairness in the incentive design and administrative process are

discussed in Financial Incentives and Non-Financial Incentives sections.

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Assessing the Costs and Expected Benefits of Incentives

Administering contracts containing incentives may be costly and/or infeasible from both the perspective

of the Government and the contractor. Certain incentives

may require increased governance and

oversight from the Government. Furthermore, as described previously, the contractor and the Government

require sound data measurement capabilities to monitor and verify contract performance. All of this may

be both difficult and costly.

As such, incentives should be designed so that the anticipated benefits to contract performance outweigh

the costs of administration and the anticipated reward. To better understand, and accordingly realize, the

benefits of different incentives, the Government should at a central level:

• monitor the effectiveness of the incentives;

• review performance objectives, indicators, and criteria regularly for relevance;

• capture lessons learned; and

• maintain a repository of lessons learned that is available for access to all contracting officers.

Benchmarks – Guidance, for Incentive Use, Design, and Administration, in Comparator

Jurisdictions.

From a benchmark perspective, the above recommendations generally align with guidance provided by

comparable jurisdictions such as Australia

, the United States (U.S.)

, and the United Kingdom

(U.K)

However, there is one notable difference from guidance provided by the U.S. Federal Acquisition

Regulations (FAR). This difference is in respect to guidance for contracts with multiple incentive

arrangements. Specifically, since outstanding results may not be attainable for each of the incentive areas,

all multiple incentive contracts must include a cost incentive, or constraint, which operates to preclude

rewarding a contractor for superior technical performance or schedule results when the cost of those

results outweighs their value to the Government.

Such guidance for contracts with multiple incentive arrangements is not recommended for Canada moving

forward, as it is too prescriptive and increases the complexity of monitoring and evaluating incentives.

B. Financial Contractor Incentives

Financial incentives make use of a monetary reward in order to encourage a contractor to achieve specific

performance objectives. This section describes three types of financial incentives:

1 technical performance incentives;

2 schedule performance incentives; and

3 award fees.

Examples of such incentives include award fees or award terms. These incentives are discussed later in this discussion paper.

Factsheet 002 - Performance Measures. Australian Government, Department of Defence, Capability Acquisition and Sustainment Group, PBC Centre of

Excellence. 2016.

United States General Services Administration Federal Government, Federal Acquisition Regulations, 17 August 2007, Accessed 14 August 2017.

Guidance on the Baseline Profit Rate and its Adjustment. SSRO, 15 March 2017.

293 | Page Public Services and Procurement Canada August 2023

These incentives can be applied on contracts where the underlying basis of payment is cost-based. They

are used widely within Canada, the United Kingdom, the United States, and Australia in both competitive

and non-competitive contracts.

Technical Performance Incentive

Performance is assessed and an adjustment made to the base payment which is calculated using a

variable scale. The adjustment is generally calculated against discretely measurable performance

objectives. As an example, a technical performance indicator in an aircraft contract could be the speed of

the aircraft, in kilometers/hour. A technical performance incentive could be that for every kilometers/hour

above (below) the target speed, the contractor would receive a financial reward (penalty). Below is an

illustrative example showing how the payment adjustment would be calculated.

Example A5.2.1.a.

Consider the below example, to better understand the concepts of technical performance incentive

calculation.

A. Contractor’s base payment

$100,000

B. Variable amount (for every 100 km variance from target speed)

$1,000

C. Target speed as per the statement of requirements

5000 km/hr

D. Actual speed for aircraft supplied by contractor

6000 km/hr

E. Payment adjustment (= (D-C)/100 x b or (6000 – 5000)/100 x $1,000)

$10,000

F. Total payment (=A +E or $100,000 + $10,000)

$110,000

Schedule Performance Incentive

Performance is rewarded, based on the achievement of contract performance objectives, through

advanced or more frequent payments. Note that the total price of the contract remains the same. An

example of an ‘incentivized’ contract payment schedule is depicted below.

Example A5.2.1.b.

Original Contract

Payment Schedule

‘Incentivized’ Contract

Payment Schedule

Cumulative Increase in

Contractor Cash Flow

Payment 1

$50,000

$100,000

$50,000

Payment 2

$50,000

$300,000

Payment 3

$200,000

$300,000

$400,000

Payment 4

$200,000

$100,000

$300,000*

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Payment 5

$200,000

$100,000

$200,000

Payment 6

$300,000

$100,000

Total

Contract

Payment

$1,000,000

* = ($100,000 + $300,000 + $300,000 + $100,000) – ($200,000 + $50,000 + $50,000 +$200,000)

Award Fees Incentives

Performance is assessed and an additional payment made based on the achievement of specific contract

performance objectives. An award fee is generally only paid if the contractor exceeds pre-established

performance criteria. Award fees may be based on qualitative evaluations, conducted during and/or after

the work is complete. Award fees are frequently used to incentivize performance for project objectives that

cannot be measured quantitatively (e.g., the quality of a consultant report). Below is an illustrative example

showing how the award fee would be calculated.

Example A5.2.1.c.

Consider the below example, to better understand the concepts of award feed calculation (basis of

payment is fixed price)

A. Fixed price

$10M

B. Maximum award fee

$1M

C. Actual award fee (based on Canada’s assessment of the

contractor’s performance against the pre-established performance

indicators)

80%

D. Award fee (= b x c or $1M x 80%)

$0.8M

E. Final contract price (= a + d or $10M + $0.8M)

$10.8M

Table A5.2.1.b. - Benefits and Drawbacks

Benefits

Drawbacks

Technical

Performance

Incentive

• Effective for incentivizing

performance for project

objectives that can be objectively

measured.

• Appropriate when it would not be

effective for the Government to

share the risk and reward

associated with achieving a

performance objective (e.g.,

when the Government receives

• May not be effective for

incentivizing performance for

objectives that require

professional judgement in order

to assess whether the

performance objective has been

met.

• The formula established for

variable payments may not be

fair and can result in a

295 | Page Public Services and Procurement Canada August 2023

Benefits

Drawbacks

substantive benefit from the

enhanced performance and the

contractor took on virtually all

risks to achieve the required

outcome).

suboptimal allocation of risk and

reward to incentivize the

contractor to deliver on

performance objectives (e.g.,

cost efficiency, technical

sufficiency).

Schedule

Performance

incentive

• The contract payment schedule

can be a powerful determinant of

contractor profitability.20

Advanced or more frequent

payments increase the working

capital of the contractor and

correspondingly reduce the

contractor’s debt and costs of

financing.

• Effective for incentivizing

performance from small and

medium-sized contractors who

may not have ready access to

capital.

• May not always be applicable,

as this incentive type is subject

to restrictive Treasury Board

guidelines regarding advanced

payments.21

• A contractor, who has been paid

a substantial amount of the

contract price before the end of

the contract, may not be as

motivated to complete the

remaining contract work or to

provide quality work.

Award fees

• Effective for incentivizing

performance for objectives that

are more subjective requiring

professional judgement to

assess.

• May not be effective if the

evaluation process is not

understood and agreed upon by

both the Government and the

contractor.

• May not be effective if the

evaluation process does not

facilitate a verifiable and

structured evaluation (i.e., the

assessment is not duplicable

and free from bias).

Arnold, Scot A. Defense Department Profit and Contract Finance Policies and Their Effects on Contract and Contractor Performance. Institute for

Defense Analyses, 2009.

Advanced Payments. Supply Manual, Public Service Procurement Canada, 6 June 2015.

296 | Page Public Services and Procurement Canada August 2023

Overarching Considerations for Financial Incentives

Reasonability of Incentive Amount

One consideration for financial incentives is how to assess whether the incentive amount is reasonable.

To determine if an incentive amount is reasonable, considerations such as, but not limited to, the below

can be assessed.

• How much value (e.g., quality, timely, and cost-effective outcomes) above the baseline

requirements specified in the statement of work is being generated for the client department?

• What is the difficulty of achieving the respective performance criteria?

• What incentive amounts have been established on contracts of a comparable nature and scale?

If an incentive type with an offsetting disincentive is being used, the amounts of these offsets should be

reasonable.

Impact on Contractor Profitability

Another consideration for financial incentives is that the incremental impact on the contractor’s profitability

may sometimes not be significant enough to motivate the contractor to achieve the required performance

objectives that the incentives are linked to.

This concern could arise with the following circumstances.

• Regulation may inappropriately constrain the parameter of financial incentives. For example, in

the United Kingdom, the Single Source Regulations Office identifies that incentive adjustments

must not exceed 2% of the price of the respective contract.

Alternatively, a price ceiling for a

contract may be established.

• The achievement of the conditional performance objectives requires disproportionate additional

resources from the contractor. For example, for a contract, where firm price is the basis of

payment, the contractor may assess that to achieve the performance required for the respective

incentive, it would have to incur more costs than the amount of the incentive.

In these situations, the contractor may not be incentivized and instead redirect effort to supporting more

profitable pursuits and or growth initiatives.

C. Non-financial Contract Incentives

Although non-financial contract incentives do not directly impact the profitability of a contractor, they can

contribute substantially to future contractor profitability. As such, they may be an effective supplement, or

alternative, to direct financial incentives. This section describes three types of non-financial incentives:

1 reputation enhancing measures;

2 contract award terms; and

3 contractor employee motivation.

J. Leotta. Different Incentives in Government Contracting, ICEAA, June 2015.

Guidance on the Baseline Profit Rate and its Adjustment. SSRO, 15 March 2017.

297 | Page Public Services and Procurement Canada August 2023

These incentives can be applied with any basis of payment or pricing methods. The first two types of non-

financial incentives are used, within Canada, the United Kingdom, the United States, and Australia, in both

competitive and non-competitive acquisitions.

Reputation Enhancing Measures

Description of Reputation Enhancing Measures

Reputation enhancing measures formally or informally recognize a contractor for strong performance.

Some examples of reputation enhancing measures are:

• testimonials regarding the contractor’s work and the resulting impact on the client department;

• contractor performance recognition programs (e.g., Boeing has an awards program for its

suppliers)

;

• formal performance evaluations (e.g., evaluations forms; or a strategic supplier performance

management program which the United Kingdom uses)

; or

• media coverage that highlights and acknowledges the contractor’s contribution to a successful

outcome.

Benefits of Reputation Enhancing Measures

Benefits, specific to the contractor, include:

• an increased chance of winning future contracts, competitive or non-competitive, particularly

when the potential customer assesses past contractor performance when awarding a contract;

• a potential positive impact on share price for publically traded contractors, when testimonials or

good news stories are made public; and

• a sense of fulfilment, felt by the contractor and its employees, for recognition of a job well done.

Benefits, specific to the Government, include the following:

• Some reputation enhancing measures, such as a contractor performance award program, may

also facilitate indirect competition to perform among contractors, even if the contractors’

respective contracts are of a non-competitive nature.

• Informal reputation enhancing measures (e.g., testimonials, press coverage) can be a low-cost

approach to incentivizing performance.

Key Consideration for Reputation Enhancing Measures

A key consideration for the use of reputation enhancing measures, particularly with those of a more

informal nature, is that the way in which they are ‘administered’ may be perceived as a conflict of interest,

particularly if it appears that the Government is favouring or promoting certain contractors based on the

frequency and/or nature of testimonials or media coverage.

Supplier Recognition. Boeinghttps://www.boeingsuppliers.com/awards.html. Accessed October 26, 2017.

Managing Government Suppliers. United Kingdom - National Audit Office. November 2013.

298 | Page Public Services and Procurement Canada August 2023

As such, public statements regarding contractors need to comply with all applicable guidance regarding

communications. Essentially, it is important not to present a general endorsement of the contractor, but to

instead speak to the specific work performed and corresponding outcomes achieved by the contractor.

Contract Award Terms

Description of Contract Award Terms

Contract award terms are granted to a contractor if it achieves the agreed upon performance objectives.

Contract award terms extend the length of an existing contract for an additional period of time and are a

contractual obligation of the Government if the contractor fulfills the agreed upon performance objectives.

For example, in Australia supplemental award terms are granted for certain performance-based contracts,

conditional on the achievement of cost objectives such as a reduction in the government’s total cost of

ownership.

The use of an award terms as an incentive differs from the more commonly used general option provision

within a contract. When the award term is incorporated as an incentive, the contract must be extended if

the contractor achieves the conditional performance objectives. In contrast for more traditional option

terms, the Government has discretion as to whether it extends the contract regardless of the contractor’s

performance.

When establishing contracts with award term incentives, the contracting officer should consider including

clauses that allow it to opt out of a contract extension (i.e., not grant an award term) for appropriate reasons

other than insufficient performance. Appropriate reasons could include, but are not limited, to the following:

• the Government no longer requires the respective goods or services; and

• the Government does not have funds available for the award term period.

Benefits of Contract Award Terms

Arguably, granting supplement contract award terms to incentivize contractor performance could be more

effective than financial incentives, because the potential financial benefits for the contractor could be much

higher.

Moreover, award terms may also build an effective long-term relationship between the Government and

a contractor who is performing well. The establishment of a long-term relationship can yield several

benefits which are discussed in Annex 5.2.4 (Discussion Paper - Managing Long-Term Contractual

Relationships).

Ultimately, the use of award terms may be appropriate when acquiring goods and services in capital

intense industries with long development cycles or requiring specialized skills and knowledge.

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Drawbacks of Using Contract Award Terms

Award Terms Can Inhibit Competition

One drawback associated with using an award term as an incentive is that it inhibits bid competition (i.e.,

other qualified suppliers do not have the opportunity to bid on the respective contract), thereby potentially

reducing the value to Canada in the long run by diminishing the potential for a robust competitive market

of suppliers.

Additionally, from an integrity perspective, in a non-competitive environment, the respective contractor

would, in substance, be awarded the same work package more than once without having to successfully

compete in multiple procurements. This risk is especially material when the contract is lengthy, thus

providing a greater chance for shifts in the respective industry competitive landscape.

As such to mitigate the above drawbacks, research should be conducted, from both market research and

a regulatory standpoint, to ensure that inclusion of an award term incentive is appropriate and provides

value to Canada. Research could consider the following factors for the respective contract type, scope,

and industry:

• What competition regulations (e.g., from the Competition Bureau) exist?

• Are there established limits for the length of a contract?

• What is the long-term forecast of qualified suppliers?

Funding may not be Available to Support Award Terms

Another risk with this incentive approach is that the client department’s budgetary outlook may not align

with the funding required to support the award term(s) for the contract in question. This risk is particularly

material for high-dollar value contracts associated with high dollar value complex projects.

Therefore, for contracts of this nature, it is critical that control measures are in place at both the inception

of the contract and during contract management:

• At contract inception, the availability of future funding, for the client department, should be

confirmed and approved through sound costing, budgeting, and investment management

processes.

• During contract management, periodic assessments of the contractor performance should be

conducted to assess the probability of the extension of any contract award terms (e.g., periodic

cost reviews if the performance objective is to reduce the Government’s total cost of ownership).

Ultimately, the results of these periodic assessments should be used to inform budget planning

decisions.

Potentially Less Effective when the Contractor holds a Monopoly Position

An additional risk associated with this incentive approach is that a contractor may not be motivated to

achieve the conditional performance objectives of the award terms, for example when the contractor

perceives itself as the only supplier with the capability to provide the required goods or services.

Collaborating with the contractor to develop reasonable contract performance objectives, which are

aligned to both parties’ strategic goals, could help mitigate this risk. When this is not sufficient or practical,

300 | Page Public Services and Procurement Canada August 2023

to mitigate the ‘monopoly position’ of the contractor, the contract in question could be scrutinized to

determine what portions of the contract can and cannot feasibly be performed by other suppliers.

Facilitating Contractor Employee Motivation

The incentives discussed thus far have been designed to reward contractor performance from a corporate

lens (e.g., profits, cash flow, contractor reputation, and future business). However, a motivated and

engaged, and ultimately high-performing team of contractor employees, can also be key to achieving

contract performance. Although the Government cannot directly motivate the contractor’s workforce to

achieve contract performance through monetary compensation, it can facilitate employee performance in

various ways.

Linking Employee Bonuses to Contract Key Performance Indicators

Canada’s current Cost and Profit Policy indicates that performance incentive pay is allowable if it is a

reasonable cost.

From a benchmark perspective, contract costing guidance from Australia, the United

Kingdom, and the United States indicate that compensation costs, including bonuses, are allowable if they

are reasonable.

272829

In Australia, employee bonus pools are an allowable contract cost if the bonus is

due to achievement of key performance indicators set out in the contract, and if the bonus amount is

reasonable. Ultimately the inclusion of employee-linked incentives in a contract could help motivate and

retain talented contractor employees, and, correspondingly, provide increased value to Canada due to

improved quality and commitment to the contract from the contractor workforce.

This recommendation aligns to the guidance provided in the Costing Standard and in Annex 5.3.2

(Discussion Paper - Executive Compensation and Bonus). The latter document provides further

discussion on when employee compensation costs, such as bonuses, may be acceptable for a contract.

Intrinsic Motivation

Intrinsic motivation for contractor employees can be created through team bonding between the

Government and the contractor personnel. For example, joint team-building events that encourage

collaboration and empower employees by driving engagement and self-worth. Arguably, intrinsic

motivation of contractor employees could be one of the most effective incentives for encouraging contract

performance, notwithstanding the difficulties inherent in measuring its impact.

It should be noted that the application of this ‘incentive’ is not within the direct means of the contracting

officer, but rather the client department project team. Please refer to Annex 5.2.2 (Discussion Paper -

Measures to Manage Contractor Non-Compliance or Unacceptable Behaviour), and Annex 5.2.4

(Discussion Paper - Managing Long-Term Contractual Relationships) for further guidance on the

importance of contract relationship management.

Annex 5.3.2 (Discussion Paper - Executive Compensation and Bonus).

Single Source Regulations Office, Single source cost standards-Statutory guidance on Allowable Costs, July 2016.

Australian Government-Department of Defence-Capability Acquisition and Sustainment Group, Capability Acquisition & Sustainment Group Cost

Principles, September 2015.

United States General Services Administration Federal Government, Federal Acquisition Regulations, August 17, 2007.

301 | Page Public Services and Procurement Canada August 2023

ANNEX 5.2.2 DISCUSSION PAPER - MEASURES TO MANAGE CONTRACTOR NON-

COMPLIANCE OR UNACCEPTABLE BEHAVIOUR

Measures To Manage Contractor Non-Compliance or Unacceptable Behaviour

Context

This discussion paper provides guidance to contracting officers in the negotiation of non-competitive

contracts or contracts where price negotiations with the successful bidder are required following a

competitive process.

This discussion paper is intended to help inform contracting officers, to prepare for contract negotiations

and manage the contract through its lifecycle. Based on the scale and complexity of the acquisition, this

requires considerable support from the contracting team, which may include price advisors, client

department representatives and other subject matter experts. This discussion paper is not intended to be

a procedural document.

There are various measures to help ensure contractual outcomes meet the client department’s objectives

and ultimately provide value to Canada. These include the appropriate use of traditional contractual

'carrots and sticks', as well as softer measures to help ensure the contract works for both parties. The use

of contract incentives to encourage contract performance are discussed in Annex 5.2.1 (Discussion Paper

- Contract Incentives to Encourage and Reward Enhanced Value to Canada), while the use of softer

measures, which focuses on managing long-term contractual relationships to help develop a performance

culture, are described more fully in Annex 5.2.4 (Discussion Paper - Managing Long-Term Contractual

Relationships). This discussion paper focuses specifically on measures to manage contractor non-

compliance or unacceptable behaviour, which need to be administered with appropriate regard for the

impact they may have on the overall contractual relationship.

Why This Matters?

Contractor non-performance is a potential issue that can undermine achievement of the client

department’s objectives and erode value to Canada. Contractor non-performance can be a result of non-

compliance to the provisions of the contract, unacceptable behaviour or both. Contractor non-compliance

occurs when a contractor fails to fulfill the performance requirements and/or other terms and conditions

established in the contract, whereas unacceptable behaviour occurs when the contractor, or its

employees, engage in unethical, offensive, uncooperative, dishonest, or other inappropriate behaviour(s).

A range of contract management measures can be established to:

• mitigate the risk of non-performance;

• identify and assess the extent of non-performance; and

• rectify or reduce the impact of non-performance.

Such measures help ensure the contractor is motivated to fulfill contract requirements in a cost effective,

timely, and quality manner.

However, some contract management measures are not always effective or feasible in some situations.

Furthermore, when contract management measures are inappropriately designed or administered, the

result can have unintended consequences and ultimately create a vicious cycle of poor contract

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performance. Clear guidance regarding the use of contract management measures is offered herein to

help ensure preventative, detective and corrective measures are structured and administered to help

optimize value to Canada.

Recommendation

A combination of preventative, detective, and corrective measures should be employed to manage non-

compliance or unacceptable behaviour by the contractor. Specifically:

• preventative measures should be employed to mitigate the risk of non-performance;

• detective measures should be used to identify and assess the extent of any non-performance;

and

• corrective contract management measures should be employed to reduce the impact to the

client department of any contractor non-compliance or unacceptable behaviour, and to correct

the contractor’s performance.

Contract management measures should be designed such that:

• the definition of contract non-performance is based on:

• contract terms and conditions (e.g., statement of work);

• established project management standards; and

• for performance-based contracts, performance criteria for measurable/verifiable,

controllable, and balanced performance objectives.

• the administration of preventative and detective measures reflect the value and complexity of

the contract and is linked to contractor past performance;

• collegial, more informal, tactics, followed by quality control and performance management

remedies, are established as the preferred corrective measures to rectify contractor non-

performance;

• the administration of disincentives uses a tiered approach, based on pre-established criteria,

ideally in accordance with a formal contractor non-compliance point scheme;

• the process by which disincentives are administered, and their severity, are reasonable and

align with applicable Government policy and regulations; and

• the anticipated benefits, in respect to improved client department outcomes, exceed the costs of

administering contract management measures.

• To promote fairness, transparency and consistency, contract management measures (and the

methods for administering them) need to be incorporated within the contract so there are no

surprises for the Government or the contractor and both parties cooperate if these measures

have to be applied in the future.

• Designing and administering appropriate contract management measures requires upfront effort

to define the criteria that will be used to assess non-performance, to structure the associated

contract terms and conditions, and to monitor the contractor’s performance throughout the

resulting contract.

• Note that a combination of financial and non-financial contract management measures can be

used, in the same contract, to complement each other. Ultimately, selection of the ‘right’

measures is key to discouraging non-performance, and, where necessary, aligning contract

performance, to achieve cost-effective, high-quality, and timely outcomes.

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Analysis

A. Preventative Contract Management Measures

This section describes how a robust contract performance and project management framework can be

employed as a preventative measure to discourage contractor non-compliance or unacceptable

behaviour. It then discusses the merits of using performance securities, as a more assertive preventative

measure, to deter non-compliance.

Contract Performance Management

In the long run, sustainable contract performance requires the contractor to establish appropriate systems,

to support compliance with the contract requirements, and to embrace an appropriate service-focused

culture. Accordingly, an important measure to encourage contractor compliance is to establish reasonable

performance criteria that reflect measurable, controllable (by the contractor), relevant, and balanced

performance objectives.

An example of a performance objective would be to maximize the level of availability for aircraft. The

related performance criteria would indicate the absolute, minimum, and target performance thresholds for

the percentage of time that aircraft are available. A description of these three performance thresholds is

provided below.

• Target performance thresholds are performance criteria for which the contractor is typically

rewarded if they are achieved, but generally not penalized if they are not. They are of particular

importance for contract performance incentives.

• Minimum performance thresholds set the base level or minimum standard of a contract

performance indicator to be achieved. There may be disincentives for not achieving the minimum

performance threshold.

• Absolute performance thresholds indicate the performance criteria at which the achievement

of a performance objective is deemed a failure. There may be more onerous disincentives for not

achieving an absolute performance threshold.

These performance thresholds are also depicted in the exhibit below.

Note that in practice, establishing effective performance objectives, which the contractor is motivated to

achieve, is challenging. Ideally, when performance objectives are designed and administered effectively,

the contractor is motivated to achieve the rewards associated with the target performance criteria, and the

risk of contractor non-compliance is reduced substantially.

304 | Page Public Services and Procurement Canada August 2023

For further discussion on performance-based contracting concepts, please refer to Annex 5.2.1

(Discussion Paper - Contract Incentives to Encourage and Reward Enhanced Value to Canada).

Contract Project Management

A robust project management framework is an important preventative measure to help manage contractor

performance. It reinforces contract expectations, at all levels, regarding what is to be delivered, who is

responsible for delivering it, when and how it should be delivered, the acceptance criteria, and for how

much. Ideally, the project management framework comprises of up-to-date project documentation

including, but not limited to:

• a project charter, which incorporates shared objectives;

• a detailed work plan and budget;

• a project code of ethics, which is governed by the PSPC Code of Conduct for Procurement

(signed by the contractor and the Government);

• project roles and responsibilities (for both the contractor and the Government);

• project status reporting and meeting requirements;

• quality control and deliverables approval process;

• project risk management protocols;

• contract management procedures; and

• conflict and dispute resolution procedures, including escalation clauses.

When project management approaches incorporate the above project documentation, align with a formal

framework, and are embraced and followed by both the contractor and client department, they can be a

critical enabler for achieving contract performance.

Two important project management components – the quality control process and conflict and dispute

resolution procedures – are briefly elaborated on below.

Quality Control Process

As a preventative measure, the quality control process could include a provision for routine quality audits.

Where applicable, the provision should indicate that a contractor’s International Organization for

Standardization (ISO)

certifications may be impacted if the quality audits detect significant contract

quality compliance issues.

Conflict and Dispute Resolution Procedures

Clearly documented conflict and dispute resolution procedures, in the contract, can serve as an effective

preventative measure to deter contract non-compliance. For example, there are escalating conflict and

dispute resolution procedures beginning with escalation to senior management, followed by a dispute

resolution board and culminating with a formal arbitration. Conflict and dispute resolution procedures, such

The ISO is an international standard-setting body, composed of representatives from various national standard organizations, which promotes worldwide

proprietary, industrial, and commercial standards.

305 | Page Public Services and Procurement Canada August 2023

as arbitration, can be costly for both the contractor and the Government and therefore encourage the

parties to solve potential performance compliance issues before reaching this level.

Performance Securities

Another more assertive preventative measure to help manage contractor performance is to require

performance securities from the contractor at the outset of the contract, or construction phase, to secure

due and proper performance of the contract. Performance securities are used within Canada, the United

Kingdom, the United States, and Australia in both competitive and non-competitive contracts. This section

describes three forms of performance securities:

1 security deposits;

2 performance bonds; and

3 a guarantee of performance.

These securities can be applied on contracts regardless of the basis of payment.

Security Deposits

The contractor provides a deposit to the Government. If the required performance is achieved, the deposit

is returned to the contractor. If the contractor fails to perform, the deposit is forfeit. Examples of security

deposits include a standby letter of credit or certified check.

Performance Bonds

A guarantee is obtained from a third party (e.g., a bank or insurance company) by the contractor. If the

contractor fails to perform, the third party compensates the Government for losses attributed to contractor

non-compliance and arranges to complete the contractor’s obligations in accordance with the contract

terms and conditions.

Guarantee of Performance

A guarantee is provided by the contractor’s parent company, or affiliate, to secure performance of the

contract. If the contractor fails to perform, the guarantor is held accountable.

Benefits and Drawbacks of each Form of Performance Security

The benefits and drawbacks of each form of performance security are summarized in Exhibit A5.2.2.a.

Next Generation Performance-Based Support Contracts – Achieving the Outcomes that Defence Requires. Australia - Department of Defense, 5 Feb.

2010.

306 | Page Public Services and Procurement Canada August 2023

Exhibit A5.2.2.a. – Performance security benefits and drawbacks

Benefits

Drawbacks

Security

deposit

• The contractor is motivated to

perform, as it puts its own financial

collateral at risk.

• Relatively simple to administer since

only two parties are involved.

• May not be viable for a contractor,

from a cash flow perspective, when

its primary cash flow source is the

contract in question. This is quite

likely to be an issue for some small

and medium enterprises.

• Does not secure performance of the

contract if the contractor defaults.

Performance

bond

• Secures performance of the contract

if the contractor defaults.

• A viable approach for a contractor

who does not have a strong cash

flow position (because the contractor

is responsible only for financing the

performance bond).

• May not be viable for a non-

competitive contract because a

guarantor may not have the

capability to complete the

requirements of the guaranteed

contract if the original contractor

defaults.

• Performance bonds are a relatively

high-cost form of security, and these

costs will be reflected in the

contractor’s price.

• More difficult to administer since

more than two parties are involved.

Guarantee of

performance

• Helps secure performance of the

contract if the contractor defaults.

• The contractor is more motivated to

perform, as its parent company or

affiliate is also accountable and has

a vested interest in the performance

of the contract.

• More viable form of security, than

other forms, for a non-competitive

contract, assuming there is a parent

company or affiliate with additional

resources (this assumes that a

parent company or affiliate has the

capability to deliver on the

requirements of the non-competitive

contact).

• Infeasible if the contractor does not

have a parent company or affiliate.

• The contractor’s parent company or

affiliate may not be willing to expose

itself to such a financial risk, unless it

receives a higher profit premium on

the price of the guaranteed contract.

• Similar performance issues may

arise with a related party performing

the work.

• More difficult to administer since

more than two parties are involved.

307 | Page Public Services and Procurement Canada August 2023

Considerations for the Use of Performance Securities

As per Exhibit A5.2.2.a. which summarizes benefits and drawbacks, performance securities can be costly,

from both the contractor’s and the Government’s perspective. In determining whether to make use of a

performance security, contracting officers should consider the following factors.

• The dollar value of the contract and the financial capacity of the contractor.

• The complexity of the work; are the requirements of a routine nature?

• The feasibility of securing a performance bond and the anticipated cost.

• The feasibility of securing a guarantee of performance and the strength of the financial capacity

of the guarantor.

• The experience of the contractor as it pertains to the scope and requirements of the contract; has

the contractor completed similar work for past customers?

• The contractor’s past performance; has the contractor formerly received poor performance

evaluations from the Government or other customers?

• The alignment with applicable Government policies and regulations; does the administration of

the performance security align with financial, legal and/or contracting policies?

• Do the anticipated benefits, in respect to improved client department outcomes, exceed the costs

of administering the performance security?

Chapter 4.50 Financial Security of the Supply Manual provides guidance for the administration of

performance securities. The above discussion on performance securities is meant to supplement this

guidance.

B. Detective Contract Management Measures

A robust project management framework establishes appropriate monitoring and oversight for the contract

to help identify contractor non-compliance and assess the extent and impact on the desired contract

outcomes. This section describes two detective measures:

1 earned value management; and

2 quality assurance requirements.

Earned Value Management

Description of Earned Value Management

Earned value management is used to measure project performance and progress in a pre-agreed and

objective manner.

It is an effective tool for monitoring and projecting costs, in relation to a project’s

schedule and performance accomplishment, and can help detect and anticipate performance compliance

issues and risks. Earned value management can be applied on contracts where the underlying payment

is based on cost estimates – the budget of a contract must be pre-established –, which is not the case for

contracts where the underlying payment is based on actual costs.

Coker, Ryan L. and Peeler, David L. EVM and Contracting: A Take on Effective Affordability Issues, ICEAA World, Issue #2, 2017.

308 | Page Public Services and Procurement Canada August 2023

Example A5.2.2.a.

Consider the below example, to better understand the calculation of earned value management.

A contractor is engaged in a year long contract and is required to produce 10 widgets in the first month at

$1,000 each. At the end of the month, the contractor has spent $9,000 but has only produced 8 widgets.

Using the above information, the contractor’s:

• planned valued (budgeted cost of work scheduled) is $10,000 (= $1,000 x 10);

• earned value (budgeted cost of work performed) is $8,000 (= $1,000 x 8);

• actual cost of work performed is $9,000;

• schedule variance (earned value minus planned value) is -$2,000 (= $8,000 - $10,000); and

• cost variance (earned value minus actual cost) is -$1,000 (= $9,000 - $10,000).

Based on these earned value management calculations, the contractor is exceeding the production budget

and is behind the production schedule for the month. Correspondingly, the contractor’s ‘performance’ for

the first month indicates that there is a risk that budget and schedule compliance may be issues for the

remainder of the contract duration.

When to Use Earned Value Management

Currently, the Supply Manual and the Standard Acquisition Clauses and Conditions do not provide explicit

guidance on when and how to apply earned value management on contracts within Canada.

The contracting officer should consider the merits of using earned value management based on the value,

risk, and duration of a contract. The higher the value, risk, and duration of a contract, the more appropriate

it may be to apply earned value management. Note that the effectiveness of earned value management

can be compromised if the initial cost estimate is weak.

This guidance generally aligns with guidance provided by Australia and the United Kingdom.

3334

The

United States is more prescriptive in that it requires earned value management to be incorporated into the

project management framework for any contracts with a value over $20 million.

Quality Assurance Requirements

Description of Quality Assurance Requirements

Quality assurance checks confirm that the performance of contract work and deliverables meet agreed

upon criteria. Responsibility for quality assurance checks can lie with the contractor, the Government, or

both.

Australian Government-Department of Defence-Capability Acquisition and Sustainment Group, Earned Value Management.

Ministry of Defence, Acquisition System Guidance, Commercial Toolkit, Earned Value Management, December 2017.

Coker, Ryan L. and Peeler, David L. EVM and Contracting: A Take on Effective Affordability Issues, ICEAA World, Issue #2, 2017.

309 | Page Public Services and Procurement Canada August 2023

From the contractor’s perspective, this may include, but is not limited to, maintaining substantiating

evidence that the goods or services conform to contract quality requirements. From the Government’s

perspective, this may include, but is not limited to, performing quality assurance reviews at various phases

of the contract, as may be necessary, to determine whether the goods or services conform to the

statement of requirements. Alternately, a third-party could be contracted to perform an independent

assessment of contract performance quality. Overall, routine quality assurance inspections can be an

effective control mechanism to detect and anticipate performance compliance issues and risks.

How to Administer Quality Assurance Requirements

For the administration of quality assurance requirements, contracting officers should consult the guidance

currently provided by PSPC in Subsection 5.D - Delivery, Inspection and Acceptance from the Standard

Acquisition and Clauses Conditions Manual.

Overarching Considerations for the Use of Detective Contract Management Measures

Assessing the Cost and Expected Benefits of Earned Value Management and Quality Assurance

A consideration in determining how to incorporate earned value management and quality assurance into

the project management framework is that the value of these tools may be diminished by the costs

associated with their implementation and administration.

Accordingly, in assessing whether to incorporate earned value management and quality assurance

contract management measures, the contracting officer should consider:

• the past performance and relevant experience of the contractor;

• the dollar value and complexity of the contract;

• the anticipated cost to administer these provisions; and

• applicable Government policies and regulations.

What to Consider when Non-Compliance is Detected

When non-compliance is detected, a root cause analysis should be conducted to determine whether non-

compliance was within or outside of the collective control of the contracting parties. The results of the root

cause

analysis should determine the type and severity of corrective measure to apply. Moreover, a

formal non-compliance point scheme, aligned with the terms and conditions of the contract, could be used

to track and assess contract performance compliance issues. The use of a non-compliance point scheme

is discussed in more detail in the following section.

C. Corrective Contract Management Measures

Corrective contract management measures should be employed to reduce the impact to the client

department of any contractor non-compliance or unacceptable behaviour, and to ultimately correct

contract performance. This section briefly describes several potential corrective measures, ranging from

collegial, more informal, tactics to quality control and performance management remedies, and to more

onerous, financial and non-financial disincentives to rectify contractor non-performance.

A root cause analysis is a method of problem solving used for identifying the primary causes of performance compliance issues.

310 | Page Public Services and Procurement Canada August 2023

Note that guidance already exists for the administration of corrective measures in the following PSPC

policy documents:

• Vendor Performance Corrective Measure Policy contained within the Standard Acquisition and

Clauses Conditions Manual; and

• Chapter 8 – Contract Management from the Supply Manual.

The below discussion on the administration of corrective measures is meant to supplement this guidance.

Collegial Tactics

Description of Collegial Tactics

Examples of informal tactics include, but are not limited to, meetings or email communications and team-

building workshops between contractor and Government personnel to resolve compliance or behavioural

issues. These tactics are most effective when they are implemented in a non-confrontational manner,

where communications are direct and supported by evidence or examples of the observed non-

performance.

When to Use Collegial Tactics

Collegial, more informal, tactics are often a more effective method of addressing non-performance than

the enactment of more formal, or contractually established measures, particularly when non-performance

is infrequent, and the impact is not severe. Where possible, such tactics should be incorporated in the

contract as the first measure for correcting non-performance.

Quality Control and Performance Management Remedies

When more formal corrective measures are needed to address contractor non-performance, quality

control and performance management remedies may be appropriate. The application of quality control

and performance management remedies should be aligned to the project management standards

established in the contract.

Description of Quality Control Remedies

Quality control involves monitoring specific contractor results to determine whether they comply with

relevant quality standards and identifying ways to eliminate the cause(s) of unsatisfactory performance,

resolve any issues that arise, and help mitigate risks associated with the solution.

When to Use Quality Control Remedies

Exhibit A5.2.2.b. provides examples of quality control remedies and when they may be appropriate.

311 | Page Public Services and Procurement Canada August 2023

Exhibit A5.2.2.b. – Quality control remedies to consider

Nature of Non-

performance

Description of Consequence

Potential Quality Control

Remedies

Individual or

isolated case

An individual team member produces

a deliverable with an error in content,

consistency, correctness or

compliance

• Rework the deliverable

• Review applicable standard

and/or guidelines

Insufficient

comprehension

leading to

recurring

defects

Team members are unable to

effectively apply a specific project

standard or guideline to the

production of deliverables

• Additional training for the delivery

team

• Clarify tasks

• Clarify standards and/or

guidelines which are ambiguous

Inadequate

project

standards or

guidelines

Team members are unable to

effectively apply a specific standard

or guideline to the production of

deliverables

• Revise portions of

methodologies, standards and/or

guidelines which prove to be

inappropriate for the work being

performed

Quality control remedies can be administered by the client department or the contracting officer. For the

administration of quality control remedies, the guidance currently provided by PSPC, in Subsection 5.D -

Delivery, Inspection and Acceptance from the Standard Acquisition and Clauses Conditions Manual,

should also be consulted.

Description of Performance Management Remedies

This section describes performance management remedies that may help to correct unacceptable

behaviour.

Performance management remedies may include the following steps:

• problem identification and analysis;

• a constructive discussion of problem behaviours;

• anticipation of the likely reaction and an appropriate response to the actual reaction to the

discussion;

• formal documentation of the discussion; and

• follow-up.

The above components can be formally administered using a performance improvement plan. A

description, and the benefits and risks, of a performance improvement plan are discussed next.

Managing Difficult Employees and Disruptive Behavior, Society for Human Resource Management, 4 November 2015.

312 | Page Public Services and Procurement Canada August 2023

Description of a Performance Improvement Plan

A performance improvement plan is a formal, structured, and specific action plan which outlines contractor

performance compliance and behaviour issue(s) and the steps that will be taken to improve performance.

Typically, the plan is developed by the contractor and approved by the client department in consultation

with the contracting officer.

Performance improvement plans should build upon consideration of the following factors:

• Are the contract performance criteria and/or scope reasonable? Contracts can be complex, and

the scope of work can be unclear or evolving. Accordingly, performance criteria, and/or objectives,

may have to be revised.

• What are the root causes of the performance compliance issues, and is the Government able to

support the contractor in rectifying them? For example, the root cause could be a shortfall in the

contractor’s cash flow position. In some situations, the Government may wish to adjust the

contract payment schedule to mitigate the contractor’s cash flow problem, while still meeting with

the requirements of the Financial Administration Act.

• Are personnel from both the contractor and the Government side exhibiting unacceptable

behaviour? For example, if the respective personnel are forming a hostile relationship, the project

steering committee could assess the feasibility of redeploying these personnel, so they do not

have to interact with each other.

The Merits of a Performance Improvement Plan

Establishing and implementing a contractor performance improvement plan can be an effective tool for

administering both quality control and performance management remedies. Performance improvement

plans allow the contractor to take ownership of their performance and demonstrate their commitment to

improve and correct contract compliance and behaviour issues. Furthermore, by formally providing an

opportunity for the contractor to improve its performance, the Government’s risk of litigation is decreased

if the performance does not improve, and more onerous measures are required.

Considerations for the Use of a Performance Improvement Plan

Two important considerations for the use of a performance improvement plan are that:

• structuring and administering a performance improvement plan requires time and resources from

both the contractor and the Government; and

• the relationship between the contractor and the Government may become antagonistic, especially

when the contractor interprets the performance improvement plan as a first step toward the

inevitable application of more onerous measures.

Accordingly, the intent and structure of a performance improvement plan, including the conditions under

which one would be required, should be agreed upon by both parties, at the outset of the contract, and

formally documented in the project charter.

313 | Page Public Services and Procurement Canada August 2023

Financial and Non-Financial Disincentives

This section first outlines a proposed framework for a non-compliance point scheme. Second, it discusses

the effectiveness of the application of pre-established financial disincentives in correcting contractor non-

compliance. Third, it discusses the effectiveness of non-financial disincentives. Last, it briefly discusses

reputational disincentives, including the broader impact they can have on a contractor’s future

marketability.

Non-compliance Point Schemes

Disincentives should be negotiated upfront and included in the contract terms and conditions. The

application of pre-established contract disincentives should be guided by a formal contractor non-

compliance point scheme, which aligns with the terms and conditions of the contract.

A non-compliance point scheme can be used to track and assess areas of non-compliance. The scheme

should consider the following:

• what performance indicator to assess in order to achieve the required performance objectives

(e.g., cost, asset availability, schedule);

• the level of contract non-compliance for a performance indicator (e.g., as based on target,

minimum, or absolute performance criteria);

• any performance trends for the assessed indicator (e.g., has performance been improving,

deteriorating, or stagnant);

• the nature of the root cause, and whether it was within or outside of the contractor’s control;

• potential impact on contract outcomes; and

• overall contractor non-compliance rating.

The pre-established criteria for applying disincentives should be based on the above factors. Criteria

should generally be structured so that disincentives are applied using a tiered approach (i.e., where

feasible, less onerous measures are applied first when non-performance is detected and escalate to more

onerous measure with repeated and/or increasingly serious non-performance is detected). Formal

documentation of the details described in the non-compliance point-scheme provides auditable evidence

in the case that a lawsuit is issued against the Government.

Financial Disincentives

Financial disincentives make use of a monetary adjustment to reprimand the contractor for non-

compliance. Financial disincentives are used, within Canada, the United Kingdom, the United States, and

Australia, in both competitive and non-competitive contracts. This section discusses four types of financial

disincentives:

1 at-risk amounts;

2 gain/pain sharing incentives;

3 holdbacks; and

4 liquidated damages.

Next Generation Performance-Based Support Contracts – Achieving the Outcomes that Defence Requires. Australia - Department of Defense, 5 Feb.

2010.

314 | Page Public Services and Procurement Canada August 2023

These financial disincentives can be applied for all types of bases of payment or pricing methods.

At-Risk Amounts

Performance is linked to a portion of the contractor’s ‘normal’ payment. For example, a technical

performance indicator could be the percentage level of availability for aircraft. For every percentage below

the target (or minimum) availability performance threshold, the contractor’s ‘normal’ payment would be

reduced by a variable amount. An example for illustrative purposes solely is provided below.

Example A5.2.2.b.

Consider the below example, to better understand the calculation of at-risk amounts.

A. Contractor’s normal payment for the month

$100,000

B. At-risk amount (payment deduction for each % point below

minimum performance threshold)

$1,000

C. Minimum availability performance threshold

80%

D. Achieved availability for the month

75%

E. Payment adjustment (= (D-C) x B or (75 – 80) x $1,000)

-$5,000

F. Total payment (= A + E or $100,000 - $5,000)

$95,000

In alignment with Annex 5.2.1 (Discussion Paper - Contract Incentives to Encourage and Reward

Enhanced Value to Canada) at-risk amounts may also be referred to as variable payments.

Gain/Pain Sharing Incentives

Performance is penalized (rewarded) through fee arrangements whereby both the contractor and the client

department share the risk (reward) of not meeting (meeting) contract performance criteria. Typically, a

pre-agreed formula is used as the basis to share losses (gains), as a result of the negative (positive)

variances, between the Government and the contractor. For illustrative purposes solely, an example

based on target cost criteria is provided below.

Example A5.2.2.c.

Consider the below example, to better understand the concepts of gain/pain share incentive calculation

where the basis of payment cost reimbursable.

A. Target contract cost

$10M

B. Contractor share of gains/losses

20%

C. Government share of gains/losses

80%

315 | Page Public Services and Procurement Canada August 2023

D. Final contract cost

$11M

E. Contract price ceiling

$12M

F. Non-adjusted contract fee

$1M

G. Adjusted fee: (= B x [A – D] + G or 20% x [$10M - $11M] +$1M)

$0.8M

H. Final contact price (= D + G or $11M + $0.8M)

$11.8M

Holdbacks

Payment amounts, associated with a particular milestone or delivery date, are withheld until the required

performance is achieved. Note that a holdback may also be used as a preventative measure in some

industries and situations, such as for example in construction contracting.

Liquidated damages

The Government payment is reduced based on a pre-estimated loss, or rate of loss, associated with the

contract’s non-performance, without being required to prove actual damages. Note that these liquidated

damages would not be triggered until all pre-established cure provisions are exhausted. For more

information see, Annex 5.2.3 - Liquidated damages.

Example A5.2.2.d.

For example, in an international border crossing such as a bridge or tunnel, liquidated damages associated

with unscheduled lane closure to affect emergency repairs might be as follows:

Occurrence of

unscheduled lane

closure

Time

Liquidated Damages

($ per hour per lane)

Peak business periods

Monday to Friday 7 am to 6 pm

$1,000

Off peak hours

weekdays and weekends 6 pm to 7 am

$500

Special periods

Identified dates (e.g., holidays)

$2,500

Benefits and Drawbacks of each Financial Disincentive Type

The benefits and drawbacks of each financial disincentive type are summarized in the exhibit below.

316 | Page Public Services and Procurement Canada August 2023

Exhibit A5.2.2.c. – Financial disincentive benefits and drawbacks

Financial

Disincentive

Benefits

Drawbacks

At-risk

amounts

• Provides contractor motivation to

correct performance, when there is a

paired positive incentive (i.e.,

variable payment) reward for

exceeding the target performance

criteria. Note that at-risk amounts,

and the paired incentive rewards, if

applicable, would be assessed at

each payment period.

• If the at-risk amount is small, this

disincentive may not be the most

effective measure to rectify

contractor performance.

Gain/pain

sharing

incentives

• Assuming gain/pain sharing

incentives are applied at various

milestones during the contract, and

not just at the end of the contract, the

Government and contractor may be

encouraged to work together, to

correct performance, and avoid

sharing a financial loss at a future

contract milestone date.

• May incentivize contractor

performance when performance does

not meet target criteria, but still

complies with minimum or absolute

criteria (i.e., it would be more feasible

for the contractor to improve its

performance and potentially realize

an incentive reward).

• Sharing ratio of losses (gains) could

be misaligned and discourage the

contractor from improving

performance.

• Losses from not meeting

performance criteria are shared by

the Government.

• While gain sharing is effective, loss

sharing can be a significant

distraction as parties seek to

minimize loss and apportion blame.

Collegiate behaviours, if they existed,

could collapse.

Holdbacks

• Provides the Government with

means to rectify contract non-

performance.

• May further disrupt contract

performance, if the contractor’s cash

flow situation is a critical success

factor for achieving contract

performance; this risk may be

particularly material if the contractor

is a small or medium enterprise or if

the contract in question is the primary

cash flow source for the contractor.

317 | Page Public Services and Procurement Canada August 2023

Considerations for the Use of Financial Disincentives

One overarching consideration for the application of financial disincentives is that, while necessary,

financial sanctions can exacerbate the underperformance because the contractor is less likely to invest in

restorative measures.

Additionally, the impact on contractor’s profitability may sometimes not be significant enough to motivate

the contractor to correct its performance. This consideration, which was also identified for incentives in

Annex 5.2.1 (Discussion Paper - Contract Incentives to Encourage and Reward Enhanced Value to

Canada), becomes particularly material when:

• a contract price floor constrains the parameter (e.g., the dollar amount) of financial

disincentives; or

• correction of performance requires disproportionate additional resources from the contractor.

In these situations, the contractor may not be incentivized to correct/improve performance and may

instead redirect effort to supporting more profitable customers and or growth initiatives.

Scope-based Non-financial Disincentives

The application of scope-based disincentives, as informed by contractually pre-established criteria, may

be appropriate and effective in instances where financial disincentives were not successful, are not

feasible, or need to be supplemented. Scope-based non-financial disincentives are used, within Canada,

the United Kingdom, the United States, and Australia, in both competitive and non-competitive contracts.

The section describes four types of scope-based disincentives:

1 warranties;

2 step in rights;

3 repatriation of services; and

4 termination.

These disincentive types can be applied for all types of bases of payment or pricing methods.

Warranties

The contractor is requested to provide an assertion as to the sufficient performance of different aspects

of a contract, including general warranties, fitness for purpose warranties, latent defects, and technical

data warranties. Where performance is not sufficient, corrective measures to fix the identified deficiencies

are usually included.

Step in Rights

The government can step in and have the services performed by itself or another party, with the costs of

this work being at the expense of the contractor.

Next Generation Performance-Based Support Contracts – Achieving the Outcomes that Defence Requires. Australia - Department of Defense, 5 Feb.

2010.

318 | Page Public Services and Procurement Canada August 2023

Repatriation of Services

Services can be removed from the contract by the government and allocated back to the government,

which can be used to reduce the scope of a contract.

Termination

Termination provides the ability to end the contract, in whole or in part, in response to default (including

poor performance) by the contractor. In the case of a service contract another variation would be to reduce

the tenure or scope of the contract.

Benefits and Drawbacks of each Scope-based Non-financial Disincentive Type

The benefits and drawbacks for each scope-based disincentive type are summarized in the exhibit below.

Exhibit A5.2.2.d. – Scope-based disincentives, benefits and drawbacks

Scope-based

Disincentives

Benefits

Drawbacks

Warranties

• Simplest scope-based disincentive

to administer, as contractor is held

accountable to rectify performance

compliance issues.

• Effective, when the contractor has

the capability, to rectify performance

compliance issues.

• Not an appropriate disincentive to

rectify non-compliance for cost or

schedule performance.

• Not an appropriate disincentive

when contractor does not have the

capability to rectify performance

compliance issues.

• The contractor may incorporate the

costs of warranty (in excess of a

reasonable warranty allowance) into

the price of the contract.

Step in rights

• The contractor is held accountable

for its performance compliance

issues, as it is responsible for paying

for the costs of the remainder of

contract work being performed by

another party.

• May be effective, when the

contractor does not have the

capability, to rectify performance

compliance issues.

• May be appropriate when contractor

non-compliance is assessed as

significant.

• May be appropriate when the

Government has found a qualified

• May not be viable for a non-

competitive contract, because the

Government or another party may

not have the capability to complete

the requirements of the contract.

• Difficult to administer due to

contractual amendment

requirements and the challenges of

employing another party to perform

the work.

• Taxpayers may lose faith in the

integrity and effectiveness of the

acquisition system in respect to the

quality, timeliness, and cost-

effectiveness of service delivery.

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Scope-based

Disincentives

Benefits

Drawbacks

supplier to replace the current

contractor.

Repatriation

of services

• May be appropriate, when the

contractor does not have the

capability, to rectify performance

compliance issues.

• May be appropriate when the

contract in question can be

scrutinized to determine what

portions of the contract can and

cannot feasibly be performed by the

government.

• May not be viable for a non-

competitive contract, in such that the

Government or another party may

not have the capability to complete

the ‘repatriated’ requirements of the

contract.

• Even when the repatriation of

services is feasible, there is the risk

that contract performance will further

deteriorate, especially if the

contractor and the added party are

required to collaborate but have

formed a hostile relationship.

• Difficult to administer due to

contractual amendment

requirements and due to the

integration of another party to

perform contract work.

Termination

• May be effective, when the

contractor does not have the

capability, to rectify performance

compliance issues.

• May be appropriate when contractor

non-performance is assessed as

significant.

• May be appropriate when the

Government has found a qualified

supplier to replace the current

contractor.

• May not be viable for a non-

competitive contract, in such that the

Government or another party may

not have the capability to complete

the requirements of the contract.

• Does not secure performance of the

contract for the Government.

• The termination process can be

costly and lengthy.

• Taxpayers may lose faith in the

integrity and effectiveness of the

acquisition system in respect to the

quality, timeliness, and cost-

effectiveness of service delivery.

Considerations for the Use of Scope-based Non-financial Disincentives

The most significant consideration for scope-based disincentives, as they apply to non-competitive

contracts, is that their application may not be effective, or feasible, when the Government is unable to find

a qualified supplier to replace the non-compliant contractor. One reason for this could be due to the non-

compliant contractor owning background intellectual property that is critical for the accomplishment of

performance requirements. In order to mitigate this, the Government could consider the following:

320 | Page Public Services and Procurement Canada August 2023

• assessing the feasibility of holding background intellectual property in escrow at the outset of

the contract; and

• including conditional performance terms in the contract that allow the Government to provide the

intellectual property to another supplier to complete contract requirements if the contractor is

non-compliant with performance requirements.

Reputational Disincentives

Description of Reputational Disincentives

Another disincentive type to consider employing is reputational disincentives. Reputational disincentives

could be administered formally or indirectly.

• formal means of administration could include evaluation forms or a supplier performance

management program; and

• an indirect means of administration could be through media coverage that highlights the reasons

for failure of a contracted project.

Reputational disincentives could penalize the contractor in a broader context through the following ways.

• The contractor could have a decreased chance of winning future contracts, competitive or non-

competitive, particularly when the potential customer assesses past contractor performance when

awarding a contract.

• There could be a potential negative impact on the share price for publically traded contractors, as

a result of adverse media coverage.

How should Reputation Disincentives be Used?

Specifically, Canada should assess the merits of establishing a strategic supplier management program

similar to the one existing in the United Kingdom. As part of this program, the Cabinet Office collects

information on each contract with strategic suppliers every six months.

The Office also gathers ad hoc

intelligence from departments each month. Each of the strategic suppliers is assigned an overall

performance rating of red, amber, or green. Ratings are based on operational delivery, but also other

factors including the savings they have made and their level of engagement with government’s wider

commercial agenda. There is also a ‘high risk’ rating, based on poor performance or financial risk, which

entails a formal process of designation and an improvement plan. Ultimately, the establishment of a

strategic supplier management program will enable the Government to conduct a thorough pre-

qualification of potential suppliers, and correspondingly use this assessment to develop an appropriate

contracting strategy, for the client department project requirements.

The recommended approach to reputation disincentives differs from Australia, with this jurisdiction using

a more aggressive approach. The Australian Department of Defence uses a public 'name and shame'

approach on large projects where contractors have not performed, and there appears to be a reluctance

on the part of the company to invest in a remedy for the situation. A 'Projects of Concern' list is publicly

reported by the Minister and discussed at publicized Senate hearings.

Managing Government Suppliers. United Kingdom - National Audit Office. November 2013.

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Considerations for the Use of Reputational Disincentives

Key considerations for the use of reputational measures include that their use could result in:

• exposure to litigation, for defamation or for future lost profits, from the contractor; or

• a more hostile relationship during the remaining tenure of the contract.

As such, public statements regarding contractors need to comply with all applicable guidance regarding

communications.

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ANNEX 5.2.3 DISCUSSION PAPER - LIQUIDATED DAMAGES

What are Liquidated Damages and Liquidated Damages Clause?

Liquidated damages are a specific sum of money expressly stipulated by the parties in a contract as the

amount of damages to be recovered by either party for a breach of the agreement by the other. It must be

a genuine pre-estimate of the loss that will be caused to one party if another party breaks the contract. It

constitutes the amount, no more and no less, that the plaintiff is entitled to recover in the event of breach

without being required to prove actual damages. (See Supply Manual Glossary Liquidated Damages)

Liquidated damages clause is the provision made for Canada to recover the pre-estimated loss or rate

of loss that would result from a delivery default or breach of the contract, without being required to prove

actual damages.

Why are Liquidated Damages Provisions Needed?

There is a risk to Canada that it would suffer actual damages as a result of contractor’s breach of the

obligations as outlined in the predetermined performance specifications in the contract and such damages

are likely to be extremely difficult to quantify. Therefore, liquidated damages are used to protect Canada

from its downside loss if the contractor cannot fulfill the contract and to compensate Canada for probable

damages.

The contacting officers should take prompt actions such as terminating the contract and repurchasing to

prevent excessive loss to defaulting contractors and to protect the interests of Canada.

When to Apply

Contracting officers are required to consider the potential impact on pricing, competition, and contract

administration before using a liquidated damages clause in solicitations and contracts for supplies,

services, research and development, and construction.

Use liquidated damages clauses only when:

• The time of delivery or timely performance is so important that Canada may reasonably expect to

suffer damage if the delivery or performance is delinquent; and

• The extent or amount of such damage would be difficult or impossible to estimate accurately or

prove.

When the inclusion of a liquidated damages clause is appropriate, the SACC Manual clause D0024C must

be incorporated in the contract.

Rate of Assessment of Liquidated Damages

Care should be taken to ensure that the rate of assessment of liquidated damages is reasonable. The

probable damages should be estimated by reference to the individual circumstances of the particular

procurement. The contract should specify the ceilings for collection of liquidated damages. Such ceilings

or maximums can be stated in either of the following two ways:

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• By specifying a fixed amount payable upon delinquency. This method should be used when it is

intended that the contract will be terminated immediately when delinquency occurs and the goods

or services “reprocured” elsewhere. The cost of “reprocurement” must be included in the overall

fixed amount; or

• By specifying a rate of assessment of damages. This rate per calendar day of delay must not

exceed a stated percent of the contract price. This method should be used when, upon default

occurring, it is intended to serve notice of default requiring the contractor to remedy the default

within a stated period of time. The cost of “reprocurement” must be excluded in computing

liquidated damages, since this item will be claimable separately in the event that the contract is

terminated, and the goods or services procured elsewhere.

To ensure uniformity of application, the amount or overall ceiling should not exceed 10 percent of the

contract price. Ceiling prices in excess of 10 percent may be used when justified by the individual

circumstances of the particular acquisition, subject to the approval of the contract approval authority.

For additional information, see Annex 5.2.2 Discussion Paper – Measures to Manage Contractor Non-

Compliance or Unacceptable Behaviour.

Did You Know?

• Liquidated damages are not punitive but are used to compensate Canada for probable damages.

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ANNEX 5.2.4 DISCUSSION PAPER - MANAGING LONG-TERM CONTRACTUAL

RELATIONSHIPS

Managing Long-Term Contractual Relationships

Context

This discussion paper provides guidance to contracting officers in the negotiation of non-competitive

contracts or contracts where price negotiations with the successful bidder are required following a competitive

process.

This discussion paper is intended to help inform contracting officers, to prepare for contract negotiations and

manage the contract through its lifecycle. Based on the scale and complexity of the acquisition, this requires

considerable support from the contracting team, which may include price advisors, client department

representatives and other subject matter experts. This discussion paper is not intended to be a procedural

document.

Why This Matters?

Long-term contracts can optimize value to Canada by, for example, by:

• enhancing price certainty;

• fostering industry confidence to invest;

• aligning service requirements to the underlying asset life; and

• sustaining a strategic national industry.

At the same time, long-term contracts can amplify the risk of underperformance and overpayment when such

contracts are poorly managed or fail to incorporate appropriate incentives and flexibility to address change.

The effectiveness of long-term contracts is often affected by inadequate contract management, misaligned

incentives and poor relationships between the parties.

Poor long-term contractual relationships could be a consequence of government policies and a lack of

awareness. Challenges can arise when long-term contracts are not sufficiently structured to respond to

inevitable changes in an appropriate and timely manner. Changes may be precipitated by a diverse range of

forces, such as evolving performance requirements, technological advancements, shifts in the contractor’s

cost structure, and external factors that require ad hoc negotiations. The Government’s ability to identify and

implement effective contract amendments requires consistent contract oversight and good relationships

between the parties.

In addition to the issues associated with inadequate contract management and misaligned commercial

relationships, other potential risks, to both parties in a long-term contract, may arise from the high

dependency on a single contractor or customer. For the contractor, these risks may include the opportunity

cost to earn more income with another customer and the potential to become less competitive due to shielding

from market forces. For the Government, these risks may include increased exposure to the risk of contractor

default due to insolvency or failure to deliver—these risks could be exacerbated by the lack of alternative

contractors when the contract expires and needs to be renewed (i.e., an ongoing supply contract as opposed

to a contract for a project).

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Although long-term contractual relationships offer benefits, benefits can only be realized when good contract

management practices are implemented, commercial interests are aligned between the parties and risks are

identified and mitigated.

Recommendation

In order to enhance the value that long-term contracts provide to Canada, contracting officers should assess

when to establish long-term contracts and what provisions will help to position the parties for long-term

success. In particular, contracting officers should incorporate a proactive management approach because it

can be a key success factor to ensure that long-term contracts optimize value to Canada. For example:

• Proactive contract management can help to ensure both parties fully meet their obligations as

effectively and efficiently as possible. It can help ensure that the parties identify and resolve any

issues or concerns in a timely manner which is consistent with the contract terms and conditions.

• Proactive contract management can enable ongoing assessment of the contractor’s performance

and whether the desired outcomes are being met; or whether Canada’s requirements could be better

served by going out to the market (which requires monitoring of the market, including prices, labour

trends and innovations).

• As part of a proactive contract management approach, more emphasis should be placed on

relationship management, rather than focusing solely on the transactional nature of the contract.

Strong collaborative relationships can play an important role in helping the parties respond to change,

which is an inevitable factor in any long-term contract. Guidance to proactively develop and maintain

effective long-term contractual relationships could build upon the guiding principles of ISO 44001—

an international standard for developing a platform to facilitate effective business relationship

management.

• A proactive contract management approach should incorporate provisions to manage and promote

consistency in the event of turnover in contractor personnel and contract management officers, such

as the documentation of intent and agreements. These provisions should help to ensure that the

succeeding contract management officers can enforce the agreements of their predecessors,

perform the Government’s responsibilities in a consistent manner (e.g., timely review of contractor

reports and requests), and are not exploited by the contractor.

These guiding principles for long-term contractual relationships could be applied for performance-based

contracts, which typically span a longer time horizon.

It is important that both the Government and the contractor build capability and capacity to properly manage

contracts. For example, the effectiveness of long-term contracts can be undermined by failure to provide

timely communication, the unavailability and/or frequent turnover of contract management personnel, and a

singular focus on the transactional aspect of the contract

. Leading contract management practices highlight

the need for both parties to work collaboratively to respond to inevitable changes in a long-term contract.

As opposed to the establishment of a platform to work collaboratively to resolve issues and concerns.

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Analysis

A. What are the potential benefits of long-term contracts?

Benefits of long-term contracts

Good long-term contractual relationships can build mutual trust and provide benefits for all parties involved,

including:

• assuring the supply of goods and services over a longer term without the costs and risks associated

with frequent acquisitions;

• creating opportunities for improved contractor performance due, in part, to the long-term commitment

to the contractor

;

• encouraging a lifecycle approach to the development of major equipment and infrastructure projects;

• facilitating long-term efficiencies in the client department, the contractor and the supply chain;

• enabling the contractor (and its supply chain) to obtain more favourable financing as it can borrow

against the “collateral” of a long-term contract, which may then reduce the overall price to the

Government;

• enabling long-term capacity and resource planning, while also potentially yielding economic

development benefits (e.g., workforce training and development of intellectual property to support

market expansion); and

• preparing Canada for unforeseen external factors (e.g., unexpected substantial changes in the

relevant market) through collaboration with the contractor.

These benefits are particularly attractive when procuring goods and services in capital-intensive industries,

such as construction and telecommunication, with long product development cycles or industries requiring

specialized skills and knowledge.

Examples from comparator jurisdictions

The United Kingdom’s use of long-term contracts, by way of multi-year performance-based contracts, have

been helpful to reduce costs because contractors are better able to stabilize their supply chains and to obtain

better prices from the supplier base.

Similarly, the Australia Department of Defence has noted that the use of long-term contracts for major surface

ship repair and maintenance have helped to deliver greater efficiencies and savings — stemming from the

contractor’s ability to progressively adopt lessons learned from prior activities as part of the continuous

improvement program.

An extended time period can incentivize the contractor to invest in research and development of new technology, methodologies, assets and employees to

drive innovation and continuous improvement thereby improving quality and capability.

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B. What are the potential risks of long-term contractual relationships?

Long-term contractual relationships can expose both parties to substantial risk, including:

• from the Government’s perspective, reducing the overall size and competitiveness of the market in

relatively shallow supply markets;

• from the Government’s perspective, encouraging and/or facilitating monopolistic behaviour by the

contractor, including uncompetitive pricing or variable quality;

• from the Government’s perspective, increasing the Government’s exposure to the risks of contractor

insolvency and the contractor’s failure to perform because of an overreliance on a single supplier;

• from the Government’s perspective, decreasing value to Canada over the term of the contract due

to external factors, such as the emergence of more cost-effective solutions or falling market pricings;

and

• from the contractor’s perspective, potentially reducing the contractor’s ability to compete in the

market, increasing the contractor’s exposure to the risk of contract termination, and reducing the

contractor’s ability to negotiate terms that are favourable or acceptable to the contractor because of

an overreliance on a single customer.

Failure to establish a proactive and collaborative working relationship between the parties can potentially

amplify the risks inherent in a long-term contract. For example, a 2014 UK National Audit Office report noted

that the lack of a strategic approach to managing contractual relationships inhibited parties from collaborating

effectively to address problems and improve service.

To mitigate long-term contracting risks, substantial planning is required to structure and implement effective

contractual terms and conditions. Generally, a multi-functional team is required. The team might include the

client department, and subject matter experts with knowledge, skills and experience to help ensure an

effective framework for contract management is established within the contract. In many instances, support

from internal subject matter experts and external advisors can be a key success factor.

C. How can contractual terms and conditions help in the management of long-term contracts?

As demonstrated in Exhibit A5.2.4.a., various standard contract terms and conditions can help to position a

long-term contractual relationship for success.

Exhibit A5.2.4.a. -Considerations of contract terms and condition

Contract term and

condition

Considerations

Appropriate definition

of requirements

• By incorporating performance-based requirements and referencing

appropriate external standards (e.g., standards by the International

Organization for Standardization), expectations can be set at the onset of

the contractual relationship. Additionally, external standards are updated

from time to time and can help ensure the good or service is consistent

with evolving industry requirements.

• Prescriptive requirements increase the need for change orders (and

hence cost) in order to accommodate minor shifts in operations or external

conditions. Where possible, performance requirements should be used

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Contract term and

condition

Considerations

(and should describe in sufficient detail to avoid ambiguity which could

become the subject of dispute).

• Overly prescriptive requirements can limit the potential for contractor

innovation, thereby compromising the potential for cost reductions, quality

improvements, and overall optimization of the value to Canada.

Provisions to

discourage, and

mitigate the impact of,

poor performance by

the contractor

• Performance based disincentives can be important tools to reduce

payment to the contractor when it fails to deliver in accordance with the

requirements (e.g., missed milestone dates or for failure to maintain an

asset in accordance with pre-established availability requirements).

• Additional provisions that may be incorporated to address chronic under-

performance include increased reporting and monitoring requirements.

For example, the contractor may be required to develop and implement a

remediation plan, which is then approved and tracked by the Government

(typically by the contracting officer or an independent third party).

Provisions to

encourage, and share

the benefits of

exemplary

performance by the

contractor

• Performance-based incentives can be important tools to increase

payment to the contractor if it exceeds the base pre-established

performance requirements. Refer to Annex 5.2.1 (Discussion Paper -

Contract Incentives to Encourage and Reward Enhanced Value to

Canada) which discusses contract incentives to encourage and reward

enhanced value to Canada.

• Rolling contract extensions 43 (with strong off ramps for performance

failures) can be a powerful incentive for the contractor to perform.

Provisions for

extensions of the

contract to incentivize

investment and

innovation by the

contractor

• Provisions for extensions can help Canada to take advantage of, for

example, lower supply costs or technological innovations that could

improve outcomes or drive efficiencies.

• Provisions for extensions can also be helpful in instances when the life

expectancy of a project is uncertain.

• Implement a partnering approach with industry by way of long-term

availability-based contracts with options or series of long-term extensions

to manage relationships with contractors44.

Payment mechanisms

to specially address

financial risk

associated with long-

term contracts

• While the initial contract term may transfer most (if not all) cost risk to the

contractor, gain/pain sharing mechanisms in the later years, or any

optional term(s), can help incentivize collaboration and reward contractor

innovation.

• Economic price adjustment clauses transfer risk from the contractor to the

Government.

Pre-established

contract amendment

procedures

• Pre-established procedures can help identify and affirm the need for

change, assess the impact of potential solutions and expedite amendment

approvals to the contract in order to address unforeseen circumstances

Rolling contract extensions are a series of extension options that are held by the Government.

As seen in the UK Ministry of Defence. Examples include the Sea King Integrated Operational Support (SKIOS), Integrated Merlin Operational Support

(IMOS), Availability Transformation Tornado Aircraft and Multi-Role Hydrographic and Oceanographic Survey Vessels contracts.

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Contract term and

condition

Considerations

Step-in rights for the

Government to

address the risk of

contractor insolvency

or when the Contractor

(repeatedly) fails to

meet the performance

requirements as

established in the

contract

• Through step-in rights, the Government can step in and have the services

performed by itself or another party, with the costs of this work being at

the expense of the contractor. Refer to Annex 5.2.2 (Discussion Paper -

Measures to Manage Contractor Non-Compliance or Unacceptable

Behaviour) which describes measures to manage a contractor’s non-

compliance or unacceptable behaviour.

Provisions to ensure

Canada’s right to

contract with alternate

suppliers or to self-

perform some or all of

the work at specific

times

• These provisions would generally be applied for well-defined discrete

scopes of work or specific time periods in the contract, or if the contractor

(repeatedly) fails to meet the performance requirements established in the

contract.

• Such provisions should, for example, ensure Canada’s access to

background intellectual property and ownership of foreground intellectual

property.

Provisions to allow for

termination of the

contract for

convenience

• Provisions such as termination based on mutual consent can help Canada

to take advantage of, for example, fundamental shifts in the market or in

requirements.

Holdbacks

• Holdbacks provide the Government with means to rectify contract non-

performance.

• Such provisions may further disrupt contract performance, if the

contractor’s cash flow is compromised. This risk may be particularly

material if the contractor is a small or medium enterprise or if the contract

in question is the primary cash flow source for the contractor.

D. What are the leading practices for managing long-term contracts?

Guiding principles

Guiding principles for the effective management of long-term contractual relationships have been common

across comparator jurisdictions and are also observed in some PSPC contracts. These guiding principles

are:

• Leadership framework. Successful long-term contractual relationships require a supportive

management framework that is flexible and able to respond to changes in priorities. For example,

many long-term relationships in high-value complex acquisitions are overseen by a board comprised

of five to seven senior government and contractor executives who meet on a regular basis to review

performance against pre-established performance standards, consider issues and propose

resolution.

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The adoption of a consistent strategic relationship management approach, ideally beginning in early

contracting phases, should be incorporated in the contract management framework. For example,

as new contract managers are brought in, the parties would develop a transition plan to help ensure

new personnel understand the background of the relationship between the Government and

contractor and are able to fulfill their responsibilities in a consistent and timely manner.

• Clear contract ownership and governance. The relationship with a contractor begins with the

alignment of contracts with appropriate contract ownership and governance provisions (e.g., rights

to change contract requirements and to direct the contractor) to enable ongoing coordination

between the parties, regular feedback on performance, and timely resolution of disputes in a mutually

beneficial manner.

Given the division of responsibility for contract management between PSPC and the end user,

effective collaboration between the contracting authority’s representative and the end user’s

technical representative is a key ingredient for ensuring effective contract management. Depending

upon the scope and complexity of the goods and services being procured, additional parties may be

required to adequately support the long-term relationship. This may include various disciplines,

including for example commercial, financial, legal and policy specialists as well as technical subject

matter experts. All such individuals would participate as part of a multi-disciplinary team, with clear

definition of their roles and responsibilities for overseeing the contract, managing relationships and

authorizing change.

A relational charter, or the inclusion of relational terms in a project charter, would be helpful to outline

roles, responsibilities and expectations under a selected contract ownership and governance

structure.

• Performance management and communication. A performance management framework, and a

corresponding feedback and communication mechanism, would be established, ideally before

contract initiation.

A framework for the establishment, tracking and reporting of key performance indicators, in

conjunction with provisions, to appropriately redress concerns and reward successes is important:

incentive structures should be calibrated and administered, and contractors should be measured

against clear, objective and meaningful metrics. (Possible examples of performance measures

include quality checks, service standards, and price and cost comparisons.) These key performance

measures would be reviewed, and updated for new requirements if applicable, at least annually.

Regular feedback (likely on a weekly or monthly basis) would be provided to the contractor, and

where applicable, they would require the contractor to develop an improvement plan to redress the

noted deficiencies.

Government and contractor employees would be encouraged to communicate problems as soon as

possible. A leading practice is to put an expiry date on problems (claims). If a contractor or the

Government does not raise an issue within a pre-established time of its occurrence, then the relevant

party forfeits the right to raise the matter at a later date. At the same time, Government and contractor

331 | Page Public Services and Procurement Canada August 2023

employees should be mindful that the escalation of issues to management and external parties

should be carefully considered to avoid the perception of political gamesmanship.

Some agencies (e.g., Infrastructure Ontario and the Australian Department of Defence) are

establishing grades for contractors. If the contractor’s performance falls below a pre-established

standard, the contractor would be penalized in the evaluation of future bids for a period of time. Refer

to Annex 5.2.2 (Discussion Paper - Measures to Manage Contractor Non-Compliance or

Unacceptable Behaviour) for further details regarding grading contractor performance.

• Risk management. Clear risk allocation and management help avoid misunderstanding and

miscommunication regarding responsibilities and improve the potential for collaboration between the

Government and the contractor. All identified risks should be assigned to the appropriate owners and

be documented and monitored in a risk register

. Contingency plans should be prepared and

monitored. The contract manager should report critical risks to the joint leadership team (e.g.,

governance board) on a regular basis (typically monthly although more frequent review may be

warranted in some circumstances).

• Information management. A single contract management information system that combines

acquisition and finance requirements would mitigate issues from the distribution of contract

information across disparate systems (e.g., paper-based filing, electronic filing and e-mails) and

organizations.

Sharing reliable information between the Government and contractor is particularly important in

alliance contracts and public-private partnerships (e.g., operational and financial information) when

the contract includes gain/pain sharing mechanisms.

• Financial management. The payment mechanism and supporting processes should be defined,

documented and understood by all parties. The contractor’s business and financial performance

should be periodically reviewed to ensure that financial remedies (e.g., warranties, indemnities,

insurance and security) continue to be feasible. Payments, including for performance, should be

completed without unnecessary delays. The relationship between payments and performance should

be clearly established in the contract. Non-compliance or underperformance should invoke liquidated

damage and other consequences as necessary.

• Co-location of Government and contractor teams. Co-locating Government and contractor

personnel could foster collaboration and relationships—a practice that is currently used in Canada

for large procurements. In the United States, the Government had on-site management

representation at contractor plants for the US Fleet Ballistic Missile System contract. This was viewed

to be one of the contributing factors to the success of the program. Co-location is also common in

alliance contracts and public-private partnerships. If co-location is not possible, regularly scheduled

visits between Government and contractor teams could be a good alternative. Frequency of visits

would depend upon the duration, complexity, and risk profile of the project.

A risk register is a component of a risk management plan—identifying and describing risks with respect to probability, impact, allocation of ownership and

treatment approach.

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ISO 44001: Collaborative Business Relationship Management Systems

ISO 44001 is an international standard, recently published by the International Organization for

Standardization, for developing a common enabling platform to develop and sustain positive outcomes in

complex business relationships. The standard provides guidance on the effective identification, development

and management of collaborative business relationships within or between organizations.

Many consider the ISO 44001 standard as a framework of leading practices for long-term contractual

relationships.

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ANNEX 5.3 COSTING DISCUSSION PAPERS

These discussion papers are intended to support cost interpretation and provide additional guidance for

cost acceptability decisions to support contracting officers’ understanding of the complex areas in preparing

for contract negotiations and in managing a contract through its lifecycle.

ANNEX 5.3.1 DISCUSSION PAPER - SALES AND MARKETING

Sales and Marketing

Context

This discussion paper provides guidance to contracting officers in the negotiation of non-competitive

contracts or contracts where price negotiations with the successful bidder are required following a competitive

process.

This discussion paper is intended to help inform contracting officers, to prepare for contract negotiations and

manage the contract through its lifecycle. Based on the scale and complexity of the acquisition, this requires

considerable support from the contracting team, which may include price advisors, client department

representatives and other subject matter experts. This discussion paper is not intended to be a procedural

document.

Why This Matters?

Sales and marketing costs are primarily incurred by contractors to generate future sales of their goods or

services. Assessing if sales and marketing costs are acceptable for a Government contract is difficult

because:

• there are many types of sales and marketing activities;

• the benefits of sales and marketing costs for a contract are not always evident/measurable;

• the inclusion of sales and marketing costs may be perceived as a conflict of interest in the

relationship, between the Government and the contractor;

• the inclusion of sales and marketing costs in a contract may be viewed as an unfair subsidy; and

• there are many factors to consider when determining the amount of sales and marketing costs to

include in a contract.

Clear guidance is required to help ensure that sales and marketing costs are only included in the contract

cost base if they are Attributable, Appropriate, and Reasonable.

Recommendation

In alignment with the contract cost Acceptability criteria outlined in the Costing Standard, sales and marketing

costs should be accepted for a contract when the costs are Attributable, Appropriate, and Reasonable.

When assessing the criterion of Attributable, below are some key factors to consider.

• Are the sales and marketing costs supportable and verifiable?

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• Generally, not attributable unless the sales and marketing costs contribute to the achievement of:

• contract specific requirements;

• strategic contract outcomes; or

• financial benefits for the contracts that the Government has with the respective contractor?

When assessing the criterion of Appropriate, below are some key factors to consider.

• Are the respective sales and marketing activities ethical based on applicable Government policies

and regulations?

• Are the nature of the sales and marketing costs consistent with available sources of comparator

information?

• Is the reimbursement of the sales and marketing costs, as it pertains to the impact on fairness and

equity for other suppliers, acceptable?

When assessing the criterion of Reasonable, below are some key factors to consider.

• Does the cost amount justify the expected return on benefits for the Government?

• Is the cost amount consistent with available sources of comparator information?

• Is the cost amount net of applicable credits?

• Does the cost amount comply with any parameters that may have been pre-authorized in the

contract?

• Has the cost amount been allocated fairly between the Government and the contractor with

consideration for the benefits associated with the costs?

The above factors are presented in the logical order that contracting officers will need to follow when

assessing the acceptability of sales and marketing costs. It should be noted that the identified factors for

assessing the criteria of Attributable, Appropriate, and Reasonable are not exhaustive. As such, the identified

factors should be consulted alongside the applicable sections of the Costing Standard.

Analysis

A. Types of Sales and Marketing Activities

For this discussion paper, the scope of sales and marketing primarily relates to the following activities:

Selling. Selling is a generic term encompassing all efforts to market the contractor’s goods or services.

Selling includes advertising, corporate image enhancement, bid and proposal efforts, marketing planning,

and direct selling.

Advertising. Advertising means the use of media to promote the sale of goods or services. Advertising media

include but are not limited to conventions, exhibits, free goods, samples, magazines, newspapers, trade

papers, direct mail, dealer cards, window displays, outdoor advertising, radio, television, and the Internet. A

relevant example is a trade exhibition, which is an exhibition organized so that companies in a specific

industry can showcase and demonstrate their latest goods and services.

Public Relations. Public relations means all functions and activities dedicated to maintaining, protecting,

and enhancing the image of a concern or its goods or maintaining or promoting reciprocal understanding and

favourable relations with the public at large, or any segment of the public. The term public relations includes

activities associated with areas such as advertising, customer relations, etc.

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Entertainment. Entertainment includes amusement, diversions, social activities, tickets to show or sports

events, meals, lodging, rentals, transportation and gratuities. It also includes membership in social, dining,

or country clubs or other organizations having similar purposes.

B. Assessing the Acceptability of Sales and Marketing Costs

Overarching Considerations for Assessing the Acceptability of Sales and Marketing Costs

It should be noted that sales and marketing costs may be an aggregate of other costs (e.g., compensation

costs, travel costs, etc.). Therefore, when assessing the acceptability of sales and marketing costs, the

criteria of Attributable, Appropriate, and Reasonable should also be assessed for the respective aggregate

costs. Applicable discussion papers and cost specific considerations from the Costing Standard should be

consulted as required.

Assessing the Attributable Criterion

Sales and marketing costs are generally not attributable unless the costs:

• are supportable and verifiable; and

• contribute to the achievement of contract specific requirements;

• strategic contract outcomes; or

• financial benefits for the contracts that the Government has with the respective contractor.

Supportable and Verifiable

Sales and marketing costs should be readily identifiable based on contract cost reports produced by the

contractor.

The contract cost reports should:

• disclose the nature and purpose of the sales and marketing costs;

• identify direct sales and marketing costs; and

• identify indirect sales and marketing costs.

Disclosed information should include the type of sales and marketing activities, the sales and marketing cost

breakdown (e.g., compensation costs, travel costs, etc.), and how the costs contribute to the achievement of

benefits for the contract.

Achievement of Contract Specific Requirements

There are situations in which advertising, public relations, and bid/proposal development costs can contribute

to the achievement of contract specific requirements. Brief examples of when these types of sales and

marketing costs may be Attributable are provided below.

Advertising Costs. The client department may require service (i.e., maintenance) support under a contract,

where it expects the contractor to be the conduit between potential maintainers and the customer. To fulfil

the maintenance component of the contract, the contractor may need to incur advertising costs to solicit

services from maintenance sub-contractors.

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Public Relations Costs. The client department may require the contractor to communicate with the public

or media about specific issues related to the contract in question. Logically, the contractor would incur public

relations costs to conduct the required communication activities.

Bid/Proposal Development Costs. Bid/proposal development costs may be incurred by the contractor

during the course of a non-competitive contract when the Government requires the contractor to submit a

proposal, with technical and cost information, to extend the length of the existing contract (i.e., through the

activation of an option term).

Achievement of Strategic Contract Outcomes

In alignment with the Treasury Board Secretariat Contracting Policy

, contracts may be structured with due

consideration of strategic outcomes that:

• support long-term industrial and regional development and other appropriate national objectives,

including aboriginal economic development; and

• comply with the government's obligations under the North American Free Trade Agreement, the

World Trade Organization – Agreement on Government Procurement and the Agreement on Internal

Trade.

In exceptional circumstances, sales and marketing costs may be Attributable when the respective contract

includes such outcomes.

In order for these strategic sales and marketing costs to be considered for acceptance, the following

conditions should be in place:

• A cost benefit providing details on the expected costs in comparison to details on the expected

benefits to be realized within the contract. The strategic benefit should be clear, as should the cost

of the strategic benefit, with an explanation as to why it is attributable to the contract. All details

should be supportable, verifiable and well documented.

• A timeline for the realization of the strategic benefit to Canada, as well as detailed parameters on

when the achievement of these benefits will be verified. This would include established checkpoints

to validate whether or not the benefits are being achieved. In the event the strategic benefits are not

occurring, the parameters and contract should outline that the sales and marketing costs will no

longer be accepted or will require adjustment.

• The acceptance of the sales and marketing costs, the parameters and the timelines all require

documentation in the contract or the Cost Accounting Practices (CAP) Submission.

Achievement of Financial Benefits for the Contracts that the Government has with the Respective Contractor

In exceptional circumstances, sales and marketing activities could allow contractors to expand their customer

base and correspondingly increase their production volume. Increased production volume can potentially

lead to reduced costs being allocated to each good produced by the contractor. Resultantly, this could create

potential cost savings for the Government across the contract(s) it has with the respective contractor.

Contracting Policy. Government of Canada, Treasury Board Secretariat of Canada. October 2013. https://www.tbs-sct.gc.ca/pol/doc-eng.aspx?id=14494.

Accessed 1 March 2018.

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Consider the following example:

A supplier has been contracted by the Government to produce goods. During the course of the contract, the

Government and contractor have determined that sales and marketing costs may be Attributable because

the successful sales of these goods to other customers could provide financial benefits to the contracts that

the Government has (or will have) with the respective contractor. Essentially, the contractor would experience

increased production volume, and potentially increased production efficiency, thereby reducing its total cost

incurred per good.

In order for these costs to be considered for acceptance, the following conditions should be in place:

• The contractor would have to provide a cost benefit analysis to support the claim that the marketing

costs were of benefit to Canada. This would include details of the expected costs required to obtain

the additional customer with a comparison to the calculation of the expected decrease in production

costs to be realized in the contract with Canada. This evidence should be supportable, verifiable

and well documented.

• A timeline for the realization of the cost savings benefit to Canada, as well as detailed parameters

on when the savings will be verified. This would include established checkpoints to validate whether

or not the cost savings are being achieved. In the event the savings are not occurring, the

parameters and contract should outline that the sales and marketing costs will no longer be

accepted or will require adjustment.

• The acceptance of the sales and marketing costs, the parameters and the timelines all require

documentation in the contract or the Cost Accounting Practices (CAP) Submission.

Assessing the Appropriate Criterion

Sales and marketing costs may be Appropriate for a contract when:

• the respective sales and marketing activities are ethical based on applicable Government policies

and regulations;

• the nature of the costs is consistent with comparator information; and

• the reimbursement of the costs, as it pertains to the impact on fairness for other suppliers, is

acceptable.

Ethical Considerations based on Applicable Government Policies and Regulations

Sales and marketing costs would not be Appropriate if the incurrence of such costs is unethical based on

applicable Government policies and regulations. One important Government policy to consider here is the

Values and Ethics Code for the Public Sector

. Based on this policy, the key factor to consider is whether

the nature of the sales and marketing costs maintain the perception of independence, in the relationship,

between the Government and the contractor, and are not perceived as a conflict of interest. The perception

of independence should be assessed from the lens of the Canadian taxpayer.

Value and Ethics Code for the Public Sector. Government of Canada, Treasury Board Secretariat of Canada. December 2011. http://www.tbs-

sct.gc.ca/pol/doc-eng.aspx?id=25049. Accessed 1 March 2018.

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As an example, entertainment costs, such as costs associated with attending a sporting event, would be

perceived as a conflict of interest in the relationship, between the Government and the contractor, and would

correspondingly not be considered Appropriate or Acceptable.

Consistency of the Nature of Sales and Marketing Costs with Comparator Information

The nature of sales and marketing costs should be consistent with comparator information, if available.

Sources of comparator information include but are not limited to:

• internally available data for other contracts;

• accessible data for contracts from other government procurement organizations;

• accessible documentation, including historical and forward-looking financial reports, for the

contractor;

• publically available financial reports for other companies in the contractor’s industry; or

• publically available financial reports for other companies in the contractor’s geography.

Consider the below scenario for illustrative purposes only.

In the Assessing the Attributable Criterion section of the Analysis, it was assessed that the incurrence of

advertising costs, to solicit services from maintenance sub-contractors, may be Attributable.

Also, as per the Different Types of Sales and Marketing Activities section of the Analysis, forms of advertising

may include but are not limited to conventions, exhibits, free goods, samples, magazines, newspapers, trade

papers, direct mail, dealer cards, window displays, outdoor advertising, radio, television, and the Internet.

Assume it is assessed that radio or television forms of advertising would not typically be used to solicit

services from maintenance sub-contractors. Furthermore, assume it is assessed that online advertising is

the typical channel for soliciting services from maintenance sub-contractors.

For the above scenario, logically, the sales and marketing costs related to radio or television advertising

would not be Appropriate, whereas online advertising costs could be Appropriate.

Impact on Fairness for other Suppliers

Consideration should be provided to whether the inclusion of sales and marketing costs for a contract would

improve the competitive position (i.e., through increased customer revenues and decreased production costs)

of the respective contractor within its region or industry. This may occur when the intent of the sales and

marketing costs is to decrease the production costs of the contracted goods by increasing the customer base

and correspondingly production volume of the contractor. For such a circumstance, the contracting officer

should, with proper consultation

, assess the following.

• Is the inclusion of the sales and marketing costs in the contract due to the contract’s integration with

other Government of Canada mechanisms or programs (i.e., for the purpose of achieving strategic

outcomes)?

The contracting officer may be required to consult internal or external expertise.

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• Would the inclusion of the sales and marketing costs be viewed as a fair subsidy to the contractor or

the contractor’s region or industry

Clear documentation of the cost savings or strategic benefit to Canada, as well as the plan for validation and

monitoring of this benefit, in the CAP Submission or the Contract is required to demonstrate the fairness of

the decision.

Assessing the Reasonable Criterion

When assessing what constitutes a Reasonable amount for Attributable and Appropriate sales and marketing

costs, factors including, but not limited to the below should be considered.

• Does the cost amount justify the expected return on benefits for the Government?

• Is the cost amount consistent with comparator information?

• Is the cost amount net of applicable credits?

• Does the cost amount comply with any limits that may have been pre-authorized in the contract?

• Has the cost amount been allocated fairly between the Government and the contractor with

consideration for the benefits associated with the costs?

Comparing the Cost Amount to Expected Return on Benefits

It should be clearly demonstrated that the amount of sales and marketing costs incurred by the contractor

justifies the expected return on benefits for the Government. Benefits for the Government can be of either a

quantitative nature (e.g., production cost savings) or qualitative nature (e.g., achievement of strategic policy

outcomes).

When the primary intent of the sales and marketing costs is to reduce production costs for the contracts that

the Government has with the respective contractor, the contractor should demonstrate that the production

cost savings for these contracts is at least equivalent to the respective sales and marketing costs that have

been incurred. This cost benefit analysis and the agreed parameters of the agreement, including validation

and time periods should be documented and noted in the contract or CAP Submission, as detailed above in

the Assessing the Attributable Criterion section.

When the incurrence of sales and marketing costs are linked to the achievement of strategic outcomes, a

cost-benefit analysis could be or could have been conducted in order to determine the level of costs to the

Government that would justify the achievement of the respective benefits.

This cost benefit analysis and

the agreed parameters of the agreement, including validation and time periods should be documented and

noted in the contract or CAP Submission.

Consistency of the Amount of Sales and Marketing Costs with Comparator Information

The amount for and sales and marketing costs should be consistent with available comparator information.

Potential sources of comparator information are identified in the Assessing the Appropriate Criterion section

of the Analysis.

The perception of an unfair subsidy could result in a legal challenge and/or harm to Canada’s reputation internationally.

This is particularly important when assessing benefits of a qualitative nature.

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For example, the amount for and sales commissions should be informed by industry sales commission rates.

Adjusting the Cost Amount for Applicable Credits

The amount for Attributable and Appropriate sales and marketing costs should be reported net of applicable

credits. Applicable credits may include Government funding, such as grants or subsidies, the contractor is

receiving to conduct sales and marketing activities to achieve strategic Government outcomes. The nature

and amount of any related funding or credits should be disclosed by contractors and the sales and marketing

costs should be adjusted accordingly.

Compliance of Cost Amount with Pre-Authorized Contract Parameters

A contract may contain limits for the amount of sales and marketing costs that can be reimbursed to the

respective contractor. The inclusion of limits may be of more relevance when the contractor has multiple

active contracts with the Government.

For example, there may be a limit for the percentage of contractor indirect sales and marketing costs that

can be allocated to Government contracts in relation to the total cost of the Government contracts (i.e.,

contractor indirect sales and marketing costs can comprise up to X% of the total cost of the contractor’s

Government contracts).

These limits should be documented in the contract or CAP Submission.

Fairly Allocating Sales and Marketing Costs

Allocation to Contracts

To enable a reasonable and justifiable share of selling and marketing expenses to be charged against PSPC

contracts, the following practice should generally be adopted:

a. Selling and marketing expenses should be clearly identified by a contractor as distinct from other

indirect costs to the extent, where warranted, of creating a separate cost pool for these expenses;

b. Where a contractor manufactures more than one particular product or provides more than one particular

service, the selling and marketing expenses specifically identifiable with each particular product or service

should be allocated directly thereto with any general expenses being prorated equitably across all

products or services; and

c. A pro-rata share of the selling and marketing expenses allocated in accordance with b) above to the

particular products or services or family of products or services being acquired under the PSPC contract

included in the applicable overhead costs of the contract.

One specific consideration for the fair allocation of sales and marketing costs is that these costs can provide

future benefits to both the Government and the contractor. As previously identified, the benefits for the

Government can be of either a quantitative or qualitative nature.

When the primary intent of sales and marketing costs is to reduce contractor production costs, the

Government will potentially benefit from reduced contract costs and the contractor will potentially benefit from

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increased sales and reduced costs. As such, the sales and marketing costs could be allocated between the

contractor’s Government contract(s) and non-Government business activities in proportion to amount of

financial benefits that are expected to be realized by the contractor and the Government’s contract(s).

Furthermore, costs could also be allocated over the period of time that would be expected for the benefits to

be realized.

When the incurrence of sales and marketing costs are linked to the achievement of strategic outcomes, the

results of a cost-benefit analysis would inform the fair allocation of these costs between the contractor’s

Government contract(s) and non-Government business activities.

The ratio of the contractor’s Government revenues to its total revenues can help inform a fair allocation.

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ANNEX 5.3.2 DISCUSSION PAPER - EXECUTIVE COMPENSATION AND BONUS

Executive Compensation and Bonus

Context

This discussion paper provides guidance to contracting officers in the negotiation of non-competitive

contracts or contracts where price negotiations with the successful bidder are required following a competitive

process.

This discussion paper is intended to help inform contracting officers, to prepare for contract negotiations and

manage the contract through its lifecycle. Based on the scale and complexity of the acquisition, this requires

considerable support from the contracting team, which may include price advisors, client department

representatives and other subject matter experts. This discussion paper is not intended to be a procedural

document.

Why This Matters?

As the types and dollar amounts of executive and employee compensation and bonus vary widely among

contractors and if contracts do not explicitly outline which executive compensation and bonus costs are

allowable and at what amount, there is a risk that Canada will overpay for the goods and services obtained.

Additionally, while some of these costs may be clearly identified as direct, they are typically included as

indirect costs and can represent a high proportion of these costs. With a more robust consideration and

treatment of executive compensation and bonus costs, resulting contracts will have further clarity of the

acceptability of these costs to help ensure value for Canada.

Clear guidance is required to help ensure that executive compensation and bonus costs are only included in

the contract cost base if they are Attributable, Appropriate, and Reasonable.

The current approach in Canada, as stated in the Contract Cost Principles is guided by the General Principle

1031-2 01. “The total cost of the Contract must be the sum of the applicable direct and indirect costs which

are or must be reasonably and properly incurred and/or allocated, in the performance of the Contract, less

any applicable credits. These costs must be determined in accordance with the Contractor's cost accounting

practices as accepted by Canada and applied consistently over time.”

Section 1031-2 07 states “unreasonable compensation for officers and employees” are considered non-

applicable costs to the contract. As a result, the current approach requires the contracting officer to determine

the reasonability of executive compensation and bonuses.

Recommendation

In alignment with the contract cost Acceptability criteria outlined in the Costing Standard, executive

compensation and bonus costs should be accepted for a contract when the costs are Attributable,

Appropriate, and Reasonable.

When assessing the criterion of Attributable, some key factors that should be considered include:

• Are the executive compensation or bonus costs supportable and verifiable?

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• Are the executive compensation or bonus costs required/beneficial for the performance of the

contract?

When assessing the criterion of Appropriate, some key factors that should be considered include:

• Are the costs in accordance with the contractor’s internal compensation policy which are applied

when establishing contracts in the regular course of business?

• Is the inclusion of the executive compensation or bonus consistent with benchmark and/or industry

norms?

• Is the bonus in line with specific guidance Incentive Remuneration Bonus plans?

When assessing the criterion of Reasonable, some key factors that should be considered include:

• What proportion does executive compensation or bonus represent? E.g., proportion of total cost of

contract, total executive compensation paid by contractor, total or bonus paid by the contractor. Is

this proportion consistent with benchmarks and/or industry norms?

It should be noted that the above factors for assessing the criteria of Attributable, Appropriate, and

Reasonable are not exhaustive. The above factors should be consulted alongside the applicable sections of

the Costing Standard.

• Has the cost amount been allocated fairly between the Government and the contractor with

consideration for the benefits associated with the costs?

The above factors are presented in the logical order that contracting officers will need to follow when

assessing the acceptability of executive compensation and bonus costs. It should be noted that the identified

factors for assessing the criteria of Attributable, Appropriate, and Reasonable are not exhaustive. As such,

the identified factors should be consulted alongside the applicable sections of the Costing Standard.

Analysis

A. Executive Compensation and Bonus

Executive compensation includes monetary benefits which are given to the senior management of a company

and form the base pay of the executive, including:

• Salary: reflects the extent of experience and sustained level of performance for a job or position

• Benefit: deals with the provision of time off with pay, employee services, health care services,

allowable insurance protection and retirement incentives

• Performance Incentives: rewards the extent of accomplishment agreement targets.

• Perquisites: a special right or privilege enjoyed as a result of one's position, such as housing loans;

these are in addition to benefits offered to other employees.

Bonus payments are payments made to reward performance. These payments may be based on the

performance of the individual and/or of the company (e.g., amount of profit earned, share price etc.).

An additional consideration when assessing executive compensation, and bonus costs for a contract is talent

management. By incorporating executive and employee rewards, such as, bonuses into allowable costs

within the terms and conditions of the contract, contractors may be better positioned to further compensate

its employees to attract and retain top talent that may also provide value to Canada if the executive

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compensation were driven by achieving efficiencies and reducing overall costs of delivering the goods or

services.

For purposes of this discussion paper, consideration is given to help contracting officers determine the extent

to which the following cost types (and related amounts) should be included in a contract:

• executive compensation base pay; and

• bonus payments

Please note profit sharing is a system in which employees and executives receive a direct share of the profits.

A redistribution of profit is not a cost and as such is generally not acceptable as a contract cost.

B. Assessment

Overarching Considerations for Assessing the Acceptability of Executive Compensation and Bonus Costs

It should be noted that executive compensation and bonus costs may be an aggregate of other costs (e.g.,

sales and marketing costs, travel costs, etc.). Therefore, when assessing the acceptability of executive

compensation and bonus costs, the criteria of Attributable, Appropriate, and Reasonable should also be

assessed for the respective aggregate costs. Applicable discussion papers and cost specific considerations

from the Costing Standard should be consulted as required.

The contracting officer needs to exercise professional judgement in assessing the extent to which executive

compensation and bonus is Attributable, Appropriate, and Reasonable and may need to engage additional

support as needed from price advisors and possibly other subject matter experts.

Assessing the Attributable Criterion

Executive compensation and bonus costs may be Attributable when the costs:

• are supportable and verifiable; and

• are required for the performance of the contract.

Supportable and Verifiable

Executive compensation and bonus costs should be readily identifiable based on supported and verifiable

evidence that may include contract cost reports or similar information produced by the contractor.

The information from the contractor should:

• describe the nature and purpose of the executive compensation and bonus costs;

• identify direct executive compensation and bonus costs; and

• identify indirect executive compensation and bonus costs.

Disclosed information should include the type of executive input, i.e., direct or indirect, to the contract delivery,

the executive compensation cost breakdown (e.g., base pay, bonus pay, etc.).

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Required for Performance of the Contract

The question whether executive compensation costs are required for the performance of the contract and if

they are direct or indirect cost must be addressed. Direct involvement of executive would result in their

compensation being directly attributed to the contract. If executive involvement is not direct, executive

compensation may be included in indirect costs or overhead. The extent to which executive compensation is

included in indirect costs or overhead and allocated to the contract should be assessed by the contracting

officer with support as needed from the contracting team (e.g., price advisor, or other subject matter

specialist).

As noted in the supportable and verifiable criteria, disclosed information should demonstrate how the

executive compensation and bonus costs contribute to the achievement of the contract either directly or

indirectly.

Assessing the Appropriate Criterion

Executive compensation and bonus costs may be Appropriate for a contract when the costs:

• are in accordance with the contractor’s internal compensation policy which are applied when

establishing contracts in the regular course of business; and

• are consistent with benchmarks or industry norms.

• are in line with specific guidance of Incentive Remuneration Bonus plans (see below)

Regular Course of Business

To assess the extent to which contractors include executive compensation and bonus in their regular course

of business, the contracting officer should verify the contractor’s current policy, as well as the timing of the

policy, to ensure it was in place well in advance of contract negotiations to mitigate the risk of contractor

policy manipulation.

For example, the company’s general salary policy should be reviewed to ascertain the compensation is

uniformly paid according to the set criteria.

If the contracting officer can align the needs for the contract with the compensation costs that the contractor

typically provides, they could be considered an appropriate cost to Canada. It is expected that all other

contracts engaged in by the contractor would also follow similar compensation terms for executives as they

have been established through the regular course of business. Additional data may be available to the

contracting officer to demonstrate Canada’s experience with the contractor that may help determine the

extent to which these costs are typically included or not.

Benchmarks and/or Industry Norms

Benchmarks or industry norms can provide useful comparators by which a contracting officer and team can

assess the appropriateness of executive compensation and bonus costs. Data can be obtained from a variety

of sources including Statistics Canada, third party data providers and current and past contracts negotiated

by Canada. Contract officers and team should consider where the best sources of information can be

obtained from to assess the appropriateness of the executive compensation and bonus costs proposed by

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the contractor. It is also important to note that regional norms for compensation may differ even in the same

industry which can affect comparability of data (i.e., significant difference in what an executive is paid in

Toronto vs. Edmonton in the same industry).

Incentive Remuneration Bonus Plans

Incentive remuneration bonus plans are designed to link the performance of employees to the achievement

or organization objective.

See Annex 2, sub-section 2.4 for specific criteria that must be met in order for the costs to be Appropriate.

Assessing the Reasonable Criterion

Proportion

The reasonability of the executive compensation and bonus can be assessed based on the proportion of cost

represented compared to the total cost of the contract. In order to refine the determination of reasonable

proportions when assigning executive compensation and bonus costs to the contract, it may be beneficial for

Canada to apply a specific percentage depending on the type of good or service. For example, for a complex

project, based on Canada’s experience and supported by data from other PSPC contracts, it may be

appropriate that the maximum executive compensation and bonus costs represent x% of the total project

costs. Therefore, executive compensation and bonus costs exceeding any established threshold would not

be considered reasonable.

The use of percentages allows for adaptability with the size and requirements of the project. The use of

comparator data is a key element of Canada’s pricing framework and should include information from the

contracts negotiated by Canada. This will provide a source of useful benchmarks for the contracting team to

use.

Additional considerations for determining the reasonability of executive compensation include:

• compensation paid to executives in similar positions, compared to related executive pay scales

surveys;

• the executive’s previous experience, experience in other positions within the company and similar

appointments in other companies;

• comparison of the compensation paid for the nature and scope of the work, or service, as defined

in the contract of service and/or the position description;

• the size and complexity and the corporate management structure;

• the company’s general salary policy should be reviewed to ascertain the compensation is uniformly

paid, according to set criteria;

• in the case of smaller contractors with a limited number of officers, the amount of compensation

paid to executives in the previous year should be reviewed, as a substantial increase over the prior

year tends to indicate compensation may be excessive, further investigation should be made to

determine whether the executives’ salaries are for services rendered, rather than a re-distribution

of the business’s profits;

• the compensation paid to executives through related party transactions.

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ANNEX 5.3.3 DISCUSSION PAPER – ASSET VALUATION

Asset Valuation

Context

Asset valuation is the process of determining the value of a company’s assets, such as buildings, equipment,

brands, goodwill, etc.

This guidance on asset valuation is intended to provide contracting officers with additional information that

may help in understanding the complexities related to asset valuation when working with price advisors or

other specialists engaged to support them in preparing for contract negotiations and in managing a contract

through its lifecycle. Based on the scale and complexity of the acquisition, this requires considerable support

from the contracting team, which may include price advisors, client department representatives and other

subject matter experts.

For contracts where pricing is based on costs, the value attributed to the contractor’s assets has a direct

impact on the calculation of the contractor’s cost (i.e. historical cost or fair market value) and any resulting

profit calculation where asset depreciation expense is a component that is considered. There is a risk that

Canada may not award an appropriate level of profit if the cost of the asset is not representative of its value,

and if the resulting depreciation expense is not accurate.

Recommendation

It is recommended that historical cost be used for establishing the asset cost basis from which to negotiate

the price of a contract.

Use of a Cost Accounting Practices (CAP) Submission should be considered by contracting officers and/or

price advisors to identify and establish an agreement with the contractor on the accounting methods to be

used to recognize costs. A copy of the CAP Submission can be obtained at the following address:

https://gcdocs.gc.ca/tpsgc-pwgsc/llisapi.dll?func=ll&objaction=overview&objid=157226238

In the exceptional case, where fair market value might be used as the basis of valuing a contractor’s assets,

a reliable measurement needs to be established and documented to achieve best value for Canada. For

example, in exceptional situations where it may be in Canada’s best interest to consider compensating a

contractor for a fully depreciated asset (I.e. a contractor may be able to receive a significant amount of

revenue from the sale or lease of the asset which is fully depreciated. However this fully depreciated asset

is required to fulfill contract requirements but is not compensated for it’s use as a cost in a contract, as it is

fully depreciated) using fair market valuation (i.e. replacement cost) to motivate the contractor to retain the

asset for ongoing government contracts, may be considered. The fair market value (replacement cost) must

be demonstrated through supportable and verifiable evidence, and the related cost of the asset would be

included in the cost base of the contract. The contractor would calculate depreciation based on replacement

cost using methods consistent with those required for calculating depreciation using historical cost.

348 | Page Public Services and Procurement Canada August 2023

Definitions and Considerations

While many asset valuation methods exist, there are three different asset bases that are commonly used to

determine the cost of an asset: historical cost, replacement cost, and opportunity cost. In order to efficiently

determine the acceptability of the contractor’s method for asset valuation, the contractor should provide

Canada access to supporting information for purposes of assessing the contractor’s approach. For example,

by including access to the appropriate information in the terms and conditions of the bid solicitation. This will

permit the parties to have open and honest discussions regarding cost and risk trade-offs and efficiencies

before finalizing the contract.

Historical Cost (Recommended)

Historical cost represents the actual cash outlay that was made for a particular good or service net of any

rebates and including any costs to delivery, install, etc. This information can generally be found in the financial

statements of contractors that follow Generally Accepted Accounting Principles (GAAP – IFRS/ASPE).

Typically historical cost is used as the basis for establishing contract cost due to its inherent reliability.

Amounts are based on past transactions that can be verified and are generally viewed as a reasonable

indicator of future costs. In addition to its inherent reliability, historical cost also helps ensure that Canada will

not pay more for the use of the asset than the contractor originally paid.

Understanding how the historical cost of the asset was established and whether the depreciation is

attributable, appropriate and reasonable can be complex and may require the use of expert analysis.

Contracting officers may want to consult with price advisors or other experts for this analysis. Examples of

issues to consider include foreign exchange and taxes:

• Foreign exchange that has been hedged by the contractor should follow accounting standards IFRS

for public companies or ASPE 3856

for private companies. Gains or losses resulting from

foreign exchange hedging that are related to the contract may correspondingly be deducted or added

to the cost base. The contracting officer should consult with other members of the procurement team

to determine if foreign exchange amounts should be included in the cost base or not.

• Tax implications associated with assets owned by the contractor include provincial tax amounts that

may or may not be attributable or appropriate to include in the cost base. The contracting officer

should consult with other members of the procurement team to determine if tax amounts should be

included in the cost base or not.

Replacement cost and opportunity cost should only be considered for asset valuation when a supplier would

not be compensated fairly under a historical cost basis. Use of these alternatives should only occur when

they can be supported by a strong business case.

Where circumstances appear to support the use of alternatives other than historical cost, Canada should

also consider an outright purchase of the asset or direct compensation for opportunity cost exposures,

associated with the asset and removing this component from the price negotiations related to the larger

IFRS 9 – Financial Instruments, https://www.iasplus.com/en/standards/ifrs/ifrs9

ASPE Section 3856 - Financial instruments, https://www.iasplus.com/en-ca/standards/part-ii-aspe/broad-topics/section-3856-financial-instruments

349 | Page Public Services and Procurement Canada August 2023

contract. This approach is similar to commodity or contract treatment recommended to address market

uncertainty and commodity and foreign exchange risks.

Replacement Cost

Replacement cost is a method to determine fair market value and represents the cost required to duplicate

a particular good or service under current market conditions. Replacement costs can show the changing

market dynamics and better reflect current market cost of goods, labour, overhead, etc. and may, in rare

instances, be a reasonable value to be included in the cost basis on which to negotiate the price of a contract.

When replacement cost is used as the basis of valuing a contractor’s assets, the cost needs to be assessed

against the overall value to Canada including economic, social, security, and other factors.

Measurement is a key risk of using replacement cost. It is less verifiable than historical cost and relies on

either comparable, relevant market value transactions of similar assets (i.e. in comparable condition), , or on

the expertise of a professional valuator. It is important to consider the basis on which the replacement cost

is determined and to ensure that any payments made for Canada’s use of contractor assets above the

historical cost are appropriate and required to maximize value for Canadians.

Where judgment is involved in determining asset values, care needs to be exercised, including the following

considerations:

• If experts are involved, assurances are required that they are independent and no conflict of interests

exists in their relationship with the contractor,

• Experts are duly accredited and in good professional standing.

• If benchmarks such as property values are used, they should match the asset and approximate the

asset’s location. For example:

o Matching – The asset is valued as though it is newly constructed, when the asset is not new;

o Location – Use of out-of-market proxies, while similar facilities are selected, with rents

referenced are as found in downtown Toronto, but the asset’s location is Pickering.

It is important to consider whether the original cost of the asset was paid for by the government previously

as this may impact the contract to be negotiated for subsequent goods or services to Canada.

Opportunity Cost

Opportunity cost occurs when the contractor has alternative uses for the asset for which the market might

pay a significant premium. As a result of the significant difference between the current value of the asset and

its historical cost, the contractor may be faced with a large opportunity cost if the contractor is to continue

using the asset to deliver a contract for the government and forego the sale of it.

Opportunity cost is not generally recommended as a basis for asset valuation because it can be extremely

subjective. The process involves identifying appropriate alternative uses for an asset and requires

calculations of the expected value of future transactions. Verification for these factors may, in many cases,

not be possible because reliable sources of supporting data may not exist.

350 | Page Public Services and Procurement Canada August 2023

A contractor taking the position that a business opportunity exists that would generate greater profit than the

contract with Canada would not necessarily be considered as relevant given that the contractor has already

chosen to forego that opportunity by entering into a contracting process with Canada. Negotiating a cost

basis for contract pricing based on assertions by a contractor that they ‘could but won’t’ engage in a more

profitable business alternative would likely lead to a less than desirable result for Canada.

Appendix A

Current Asset Valuation Guidance in Comparator Jurisdictions

The United Kingdom Single Source Regulations Office (SSRO) uses a principle based framework and allows

practitioners to exercise professional judgment in determining whether a particular cost basis is appropriate.

As a result, there is not clear direction provided on what cost basis should be used to determine the price of

the goods or services procured. The guidance specifically allows costs to be charged to the public sector

procurement authority if they are deemed to be appropriate, attributable, and reasonable by the reviewing

practitioner.

The costs should also be supported by adequate and sufficient evidence, assigned to contracts

only once, and are recorded and reflected in the books of account.

Re-evaluations of assets are permissible

but have to be agreed by the Secretary of State if they are to be Allowable.

The United States principles are more prescriptive, but do not specifically identify which cost basis is

appropriate. Under the Unites States Federal Acquisition Regulation, costs are allowable only when they are

reasonable, allocable, in accordance with standards promulgated by the Cost Accounting Standards Board

or generally accepted accounting principles, and the terms of the contract.

Article 31.202-2 (c) specifically

states that when “contractor accounting practices are inconsistent with this subpart 31.2, costs resulting from

such inconsistent practices in excess of the amount that would have resulted from using practices consistent

with this subpart are unallowable”.

Most specifically this would include replacement and opportunity costs

not being allowable consistent with the United Kingdom. Therefore, historical costs would be deemed to be

appropriate cost basis under the United States guidance as well.

Australia’s Department of Defence Capability Acquisition and Sustainment Group is very similar to the United

Kingdom in that it is principles based and allows for judgment to be exercised. It does not specifically identify

what cost basis should be used, but again suggests that the contractor’s accounting system for identifying

the contract cost should be “based on sound accounting principles, appropriate for the purpose of the

contract, and internal control practices, consistently applied”.

Therefore, similar to the guidance identified

above from the United Kingdom and United States, a contractor’s use of cost basis depends on what is

specifically authorized in Australian Government-Department of Defence-Capability Acquisition and

Sustainment Group, Capability Acquisition & Sustainment Group Cost Principles accounting standards. As

Single Source Regulations Office, Single source cost standards-Statutory guidance on Allowable Costs, July 2016,

https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/609688/Allowable_Costs_guidance_1_July_2016_-

_Final_WEB2.pdf>, accessed August 14, 2017.

Ibid.

United States General Services Administration Federal Government, Federal Acquisition Regulations, August 17, 2007,

https://www.acquisition.gov/sites/default/files/current/far/pdf/FAR.pdf, accessed August 14, 2017.

Ibid.

Australian Government-Department of Defence-Capability Acquisition and Sustainment Group, Capability Acquisition & Sustainment Group Cost Principles,

September 2015, http://www.defence.gov.au/casg/Multimedia/CASG_Cost_Principles_(Sep_2015)-9-4057.pdf>, accessed August 14, 2017. CAGS Revised to

v2.0 October 2017 http://www.defence.gov.au/casg/Multimedia/CASG_Cost_Principles-9-8642.pdf. Accessed March 24, 2018

351 | Page Public Services and Procurement Canada August 2023

identified above, the historical basis of cost recognition is supported by the International Financial Reporting

Standards (IFRS), and the replacement cost and opportunity cost basis of valuation are not permitted.

352 | Page Public Services and Procurement Canada August 2023

ANNEX 5.3.4 DISCUSSION PAPER – TRANSFER PRICING

Context

In line with guidance provided in the Costing Standard, Sub-Section 4.19, this discussion paper on transfer

pricing is intended to help inform contracting officers, to prepare for contract negotiations and manage the

contract through its lifecycle. Based on the scale and complexity of the acquisition, this may require

considerable support from the contracting team, which could include price advisors, client department

representatives and other subject matter experts.

Transfer pricing refers to the prices set for goods or services that are exchanged among related parties

(affiliated or entities under common control, joint control or significant influence). The “Transfer Price” is the

price at which a supplier sells its goods or services to a related party buyer.

This document provides information to help contracting officers identify whether the final cost of a procured

good or service is valued fairly in situations where the goods or services may have been exchanged through

several transactions among related parties, and to help mitigate the risk of profit overpayment by Canada.

Transfer pricing policies and practices are typically used to determine the price of a good or service

transferred between related parties (entities under common control, joint control or significant influence). The

appropriateness of transfer pricing practices should also be extended to consortium or subcontractor

arrangements where significant influence over pricing may exist between the parties, even if the entities

involved would not otherwise be considered as related.

For government contracts, the final costs of a procured good or service may be a derivative of transfer prices,

particularly when the procured good or service has progressed through a supply chain involving multiple

related parties.

A simplified example of a transfer pricing arrangement for a contractor selling equipment to the Government

is depicted below. The example, including amounts and transfer price and contract price calculations, are for

illustrative purposes only.

353 | Page Public Services and Procurement Canada August 2023

Exhibit A5.3–4.a. - Example of a Transfer Pricing Arrangement

Related Party 1 – Raw

Material Supplier (e.g.

unprocessed minerals,

refined metals, etc.)

Cost Incurred: $110M

Transfer Price: $120M

Related Party 2 –

Manufacturer (e.g.

processed and semi-

finished materials, etc.)

Price Paid for Raw Materials: $120M

Additional Cost Incurred: $200M

Total Cost Incurred: $320M

Transfer Price: $380M

Prime Contractor –

Original Equipment

Manufacturer (e.g. aircraft,

tanks, etc.)

Price Paid for Processed Metals: $380M

Additional Cost Incurred: $420M

Total Cost Incurred: $800M

Final Contract Price: $900M

Value Added

The following table further illustrates how to calculate the reasonable profit for the above scenario:

When costs and profits are considered from the perspective of only the Prime Contractor, it may

appear that the total cost and profit incurred for the equipment are $800M and $100M

respectively. However, when costs and profits are considered from the perspective of the entire

supply chain, the total cumulative cost and profit incurred are in substance actually $730M and

$170M, respectively. $70M

of profit has already been incurred due to the transfer price

amounts established by Related Party 1 and Related Party 2.

In reality, the above supply chain for the purchased equipment could be much more complex and might

involve several additional parties (internal divisions or subcontractors). When the supply chain of a procured

good or service is complex, there is risk that the final costs, and correspondingly the final price, of the

$70M = [$120M-$110M]+[$380M-$320M] or $10M+$60M

Related Party

Transactions

Cost

Additional cost

(by each related

party)

Total

cost

Profit

Transfer price

Profit

additional

cost only

A+B

A+B*(1+C)

B*C

Related party 1

N/A

110

9.09%

120

Related party 2

120

200

320

30%

380

Prime

contractor

380

420

800

23.81

900

100

Totals

730

900

170

354 | Page Public Services and Procurement Canada August 2023

procured good or service could be unreasonable if the transfer price charged at a particular stage of the

supply chain does not align with the value added to the procured good or service.

Recommendation

• The transfer prices used to derive the final costs

of a purchased good or service should be

reasonable.

• To be reasonable, transfer price amounts should align with the value

added to the procured good

or service by the respective related parties. In alignment with the Organization for Economic Co-

operation and Development (OECD) Transfer Pricing Guidelines for Multinational Enterprises and

Tax Administrations 2017

, the amount of value added by a related party to the procured good or

service, should be assessed based on the related party’s functions performed, assets employed,

and risks assumed in respect to the good or service.

• Furthermore, contracting officers should assess the total cumulative profit incurred during the

supply chain (i.e., between related parties) of a procured good or service to determine if the

respective final cost is reasonable.

• The use of a Cost Accounting Practices Submission to identify and establish an agreement with the

contractor on accounting methods to be used for transfer pricing should be considered in

consultation with the Procurement Support Services Sector.

The proposed recommendation aligns with one of the objectives of the OECD's Base Erosion and Profit

Shifting (BEPS) project, and transfer pricing legislation

that CRA adopts, which is to develop transfer pricing

guidelines that align transfer pricing outcomes with value creation.

The intention of these recommendations

is to align to objectives and processes already adopted by an organization to meet other financial reporting

requirements.

Application

Assessing if Transfer Prices are Reasonable

Importance of the Procured Good/Service Value Chain When Assessing Reasonability

Application of the above Recommendations requires that transactions occur under arm’s length terms and

conditions. The arm’s length principle is designed to prevent income shifting. This differs from the concept of

The contracting officer must ensure that these costs first meet the criteria of Attributable and Appropriate.

Value added should be considered from the perspective of value provided to Canada.

Organization for Economic Co-operation and Development, OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017, July

2017, http://www.keepeek.com/Digital-Asset-Management/oecd/taxation/oecd-transfer-pricing-guidelines-for-multinational-enterprises-and-tax-administrations-

2017_tpg-2017-en#.WZ2Y8cLfOUk#page36, Accessed 23 August 2017.

Transfer Pricing, Government of Canada, https://www.canada.ca/en/revenue-agency/services/tax/international-non-residents/information-been-moved/transfer-

pricing.html

Base Erosion and Profit Shifting. OECD. October 2017. https://www.oecd.org/ctp/transfer-pricing/Compilation-revised-guidance-profit-splits-2017.pdf.

Accessed 1 March 2018.

355 | Page Public Services and Procurement Canada August 2023

fair market value, which is intended to convey the value of assets and liabilities based on a hypothetical

market.

In order to assess if transfer price(s) are reasonable, the procurement team will need to understand the value

chain, the set of activities that generate value for the procured good or service, and how each related party

contributes to this value. In accordance with OECD guidelines, value can be based on the significance of:

• The functions performed by the related party (e.g., manufacturing, research and development,

administration, sales and distribution, etc.);

• The assets employed by the related party (production equipment & machinery, patents, office

equipment, etc.); and

• The risks assumed by the related party (credit risk, market risk, product/service liability risk,

technology risk, etc.).

Based on the above factors, if it is determined that the related party does not contribute significant value to

the procured good or service, it would be expected the transfer price established by the related party is not

much higher than the total cost incurred by that related party.

For example, for the purchased equipment, as per Exhibit 1 in the Context section, it is reasonable to assume

that the transfer price profit percentage (in relation to total cost incurred) charged by the raw material supplier

(i.e., Related Party 1) would be less than the profit percentage charged by the manufacturer (i.e., Related

Party 2).

Consideration should be given for including documentary support for transfer pricing as part of the contractual

requirements. For example, the documentary support required by the Canada Revenue Agency (CRA)

and

identified in subsection 247(4) of the Income Tax Act includes:

• The terms and conditions of the transaction and their relationship, if any, to the terms and conditions

of each other transaction entered into between the participants in the transaction

• The identity of the participants in the transaction and their relationship to each other at the time the

transaction was entered into

• The functions performed, the property used or contributed, and the risks assumed, in respect of the

transaction, by the participants in the transaction

• The data and methods considered, and the analysis performed to determine the transfer prices or

the allocation of profits or losses or contributions to costs, as the case may be, in respect of the

transaction and

https://www.canada.ca/en/revenue-agency/services/tax/international-non-residents/information-been-moved/transfer-

pricing/09.html#ContemporaneousDocumentationUnderSubsection2474

356 | Page Public Services and Procurement Canada August 2023

• The assumptions, strategies and policies, if any, that influenced the determination of the transfer

prices or the allocation of profits or losses or contributions to costs, as the case may be, in respect

of the transaction

Monitoring Cumulative Profit to Assess Reasonability

Contracting officers should assess and analyze the total cumulative profit incurred throughout the supply

chain (i.e., between all related parties) of a procured good or service using the profit percentage to determine

if the respective final cost is reasonable. This profit percentage should be calculated before a contract profit

rate is applied to the final cost. For example, as per Exhibit A5.3.4.a. in the Context section, the profit

percentage incorporated in the final cost would be equal to 9.6% (Profit [$70M] / Cost [$730M]).

Considerations for assessing whether this profit percentage is reasonable include:

• Monitoring if there are any material variations in the respective profit percentage for the good or

service provided during the period of the contract; and/or

• Comparing the profit percentage for the supply chain (i.e., between related parties) of the good or

service to available and relevant benchmark information (e.g., industry, similar contracts, etc.)

• Contracting officers should consider this profit percentage when determining the appropriate

contract profit rate to apply to the final cost.

To monitor the total cumulative profit incurred during the supply chain of a procured good or service, open

access to certain company documentation is required. Examples of documentation to consider for review are

described further in the Information to Review when Assessing the Reasonability section.

Risks to Consider when Assessing Reasonability

When assessing if transfer prices are reasonable, the procurement team should be aware of the below risks:

• Intra-company transfer prices may include a profit component by a division to assess divisional

performance. There is a risk that transfer prices may be inflated when the performance objectives of

a division do not align with the performance objectives of the whole organization (e.g., a division is

evaluated based only on its own profits). Ensure that any intra-company profits included do not result

in an overstatement of costs beyond what would be reasonable in an arms-length transaction.

• Inter-company transfer prices may be manipulated for tax avoidance purposes or to artificially

inflate prices and resulting profits. For example, if a contractor has a subsidiary in a low tax rate

country, there exists the risk that the subsidiary will charge an inflated transfer price to the

contractor for tax avoidance purposes. It should be noted that there are tax regulations in place to

mitigate this from occurring.

357 | Page Public Services and Procurement Canada August 2023

Information to Review when Assessing the Reasonability

In assessing if the final costs of a procured good or service, which are a derivative of transfer prices, are

reasonable, the following information should be considered for review.

Information to Review

Considerations

• Contractor’s policy and documentation

on inter-company and intra-company

transactions and transfer prices.

• Consistency of the company’s stated policies and

financial records used for other purposes (e.g.,

audited financial statements).

• Contractor, and related party, contracts

and invoices for similar goods or

services provided to other customers

(both government and non-government).

• The transfer prices charged in a sample

of other contracts (e.g., with value chain

activities of a similar nature).

• Consistency in the application of the proposed

transfer pricing method with the price charged to

other customers, with appropriate consideration of

any differences in the requirements or risk

associated with the contracts.

• Supporting documentation showing

build-up of price and underlying costs.

• Confirmation that the proposed transfer price has

been calculated in accordance with the contractor’s

transfer pricing policy

• Confirmation that the related parties’ costs are in

compliance with Canada’s Cost and Profit Policy

• Tax returns filed with the tax

administration containing transfer prices

• Conformation that the transfer price for tax purposes

is aligned with the Organization for Economic Co-

operation and Development (OECD) or Canada

Revenue Agency (CRA) Transfer Pricing Guidelines

Note that open access to company documentation is required to determine if transfer prices are reasonable.

Appendix A

Current Transfer Pricing Guidance in Comparator Jurisdictions

Australia: Transfer pricing must comply with applicable tax rules. All documentation held by the contractor

for tax regulation purposes must be made available to the Government for review should the documentation

be requested.

United States: The transfer price shall be the cost incurred with allowances being made for price when it is

an established practice of the transferring organization, and the contracting office has not determined the

price to be unreasonable.

Australian Government-Department of Defence-Capability Acquisition and Sustainment Group, Capability Acquisition & Sustainment Group Cost Principles,

October 2017, http://www.defence.gov.au/casg/Multimedia/CASG_Cost_Principles-9-8642.pdf , Accessed 1 March 2018.

United States General Services Administration Federal Government, Federal Acquisition Regulations, 17 August 2007,

https://www.acquisition.gov/sites/default/files/current/far/pdf/FAR.pdf , Accessed 23 August 2017.

358 | Page Public Services and Procurement Canada August 2023

United Kingdom: The Single Source Regulations Office (SSRO) does not provide explicit guidance on

transfer pricing. However, it’s Guidance on the Baseline Profit Rate and its Adjustment contains a profit on

cost once adjustment (POCO) clause.

The adjustment ensures that if a party to a qualifying defence

contract enters into a single source subcontract with another group member, and this group subcontract is

necessary to enable the performance of the qualifying defence contract, then profit arises only once in relation

to allowable costs included in the group subcontract price.

Guidance on the Baseline Profit Rate and its Adjustment. SSRO, 15 March 2017,

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/599881/SSRO_Guidance_on_the_baseline_profit_rate_and_its_adjustment_2017-

18.pdf . Accessed October 26, 2017.

359 | Page Public Services and Procurement Canada August 2023

ANNEX 5.3.5 DISCUSSION PAPER – PRODUCTION CAPACITY AND INDIRECT COSTS

ALLOCATION

Context

This guidance is intended to provide contracting officers with additional information that may help in

understanding the complexities related to the methods available for the allocation of indirect costs when

working with price advisors or other specialists engaged to support them in preparing for contract negotiations

and in managing a contract through its lifecycle.

This discussion paper is not intended to be a procedural document. Based on the scale and complexity of

the acquisition, considerable support might be required from the contracting team, which may include price

advisors, client department representatives and other subject matter experts. Contracting officers are

encouraged to consult with the Procurement Support Services Sector (PSSS).

Definitions

Production capacity (“capacity”) represents the volume of activity (e.g. labour hours, machine hours) a

contractor’s resources (e.g. labour, equipment, etc.) can sustain in order to produce goods over a specified

time period.

These resources will generally have indirect costs, such as, but not limited to, salaries (i.e. for labour) or

depreciation (i.e. for equipment), associated with them. These associated indirect costs can be allocated to

a contract, if they meet the prerequisite conditions of being attributable, appropriate, and reasonable

, using

either an estimated indirect cost rate or the actual indirect costs incurred. Estimated indirect cost rates are

determined by dividing the estimated total indirect costs associated with the respective resources by the

capacity of those resources.

In a production (“manufacturing”) setting, there are four main capacity basis types that can be used to allocate

indirect costs.

1 Theoretical capacity: the maximum volume of activity that can be attained by a contractor’s

resources (e.g. labour, equipment, etc.), over a specified time period, that does not allow for any

normal idle time (e.g. maintenance on equipment, employee vacations, etc.).

2 Practical capacity: the maximum volume of activity that can realistically be attained and sustained

by a contractor’s resources that allows for normal idle time (theoretical capacity minus normal idle

time).

3 Normal capacity: the forecasted volume of activity expected to be achieved by a contractor’s

resources, to satisfy average customer demand for contractor goods, over a number of periods (e.g.

3-5 years) under normal circumstances, taking into account seasonal, cyclical, and trend factors.

Further clarification on the prerequisite conditions of the attributable, appropriate, and reasonable criteria is provided in the Allocating Direct and Indirect Costs

section of the Costing Standard.

Brierley, John A, et al. Reasons for Adopting Different Capacity Levels in the Denominator of Overhead Rates. 2006, https://cmaaustralia.edu.au/wp-

content/uploads/2021/10/JAMAR8-Reasons_for_Adopting-Different-Final.pdf. Accessed Sept. 2017.

360 | Page Public Services and Procurement Canada August 2023

4 Budgeted capacity: the anticipated volume of activity expected to be achieved by a contractor’s

resources, to satisfy customer demand for contractor goods, for the upcoming period (e.g. upcoming

year).

The first two types are measures of supply of capacity, while the last two types are measures of demand for

capacity. Refer to Appendix A. Measuring Capacity for details on how to measure the amount of supply and

demand for capacity of a contractor.

Excess capacity can be defined as the supply of capacity minus actual capacity utilized by the contractor to

fulfil demand.

Recommendation

In establishing overhead rates or burden for the purposes of contract pricing, practical capacity of a

contractor’s resources should be used as the base for allocating indirect costs because it provides the most

accurate representation of the cost of capacity used.

1. For contracts using a cost reimbursable basis of payment, contract pricing can be established using

allocable estimated or actual indirect costs;

• Where contract pricing is based on the allocation of actual indirect costs, the process for

establishing any preliminary overhead rates and adjusting these rates for actual indirect costs

must be defined in the contract terms.

• Where contract pricing is based on the allocation of estimated indirect costs, the estimated

overhead rates and, if applicable, any process for amending overhead rates on a periodic basis,

needs to be included in the contract terms.

2. The use of a Cost Accounting Practices (CAP) Submission to identify and establish an agreement

with the contractor on accounting methods to be used for indirect cost allocations should be

considered in consultation with the Procurement Support Services Sector.

The use of practical capacity motivates the contractor to manage production capacity so as to avoid or

minimize un-allocable indirect costs associated with excess or idle capacity.

Application

Consider the below simplified calculation for clarity on how an indirect cost rate is determined.

A. Capacity of Resources

1,000 hours

B. Indirect Costs for Resources

$10,000

C. Indirect Cost Rate

$10/hour (B / A = $10,000 / 1,000)

The capacity of resources may be measured by the supply of capacity of the resources or the demand for

capacity of the resources. Ideally, a contractor’s supply of and demand for capacity should be:

• determined using the same measurement basis (“capacity bases” or “capacity basis types”);

• equal in order to avoid excess capacity; and

• simple to forecast (i.e. to calculate an accurate estimated indirect cost rate).

361 | Page Public Services and Procurement Canada August 2023

Based on the above premises, the indirect cost rates calculated using supply of capacity and demand for

capacity would be identical and accurate. However, as explained in this paper:

• different measurement bases are used in practise to determine supply of capacity and demand for

capacity;

• achieving equilibrium between supply of and demand for capacity is difficult and sometimes not

feasible, resulting in the incurrence of excess capacity costs for the contractor’s respective

resources; and

• forecasting supply of and demand for capacity is not simple.

Considering this, the amount of indirect costs allocated to a contract can vary depending on:

• the capacity basis type used to calculate the indirect cost rate; and

• whether the estimated indirect costs allocated to the contract are adjusted to reflect updated or actual

data points.

Example A5.3.5.a. – Purchase of Produced Goods

Canada has a cost reimbursable contract with a contractor to produce 500 units of armoured vehicle tires

over 2 years. Indirect labour costs are to be allocated to the contract based on the practical capacity of direct

labour hours. The contractor estimates that it will incur $100,000 of estimated indirect labour costs and that

each unit will require 10 direct labour hours to produce. Practical capacity was determined to be 10,000 direct

labour hours. After validation exercises, actual indirect costs were determined to be $90,000 and it took 10

direct labour hours to produce each unit.

Number of units produced

500

Direct labour hours/unit

Practical capacity (direct labour hours)

10,000

Estimated indirect costs

$100,000

Actual indirect costs

$90,000

Based on data given above:

1. If Canada agreed that contract pricing would be based on the allocation of estimated indirect costs, the

overhead rate and allocated indirect costs would be as follows:

• Estimated overhead rate = Estimated total indirect costs / Practical capacity

• Estimated overhead rate = 100,000 / 10,000

• Estimated overhead rate = $10/hour

• Allocated indirect costs = Units produced * Direct labour hours/Unit * $/Direct labour hour

• Allocated indirect costs = 500 * 10 * 10

• Allocated indirect costs = $50,000

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A periodic review and if applicable, an amendment, of overhead rates should be considered.

2. If Canada agreed that contract pricing would be based on the allocation of actual indirect costs, the initial

overhead rate would be based on the above estimates and an adjustment could be made for actual

indirect costs after year end.

• Allocated indirect costs would initially be $50,000 as above.

Actual indirect costs would be allocated as follows:

• Actual overhead rate = Actual total indirect costs / Practical capacity

• Actual overhead rate = 90,000 / 10,000

• Actual overhead rate = $9/direct labour hour

• Allocated indirect costs = Units produced * Direct labour hours/Unit * $/Direct labour hour

• Allocated indirect costs = 500 * 10 * 9

• Allocated indirect costs = $45,000

An adjustment of $5,000 would be made to reflect pricing based on the allocation of actual indirect costs.

Example A5.3.5.b. – Purchase of Produced Goods and Standby Capacity

There are exceptional situations when Canada may specifically create a contract for standby capacity. In

these cases, Canada is compensating the contractor for indirect costs such as overhead and maintenance

to keep production facilities open and available to exclusively produce goods for Canada. The cost for

standby capacity is an additional and separate cost from the cost of goods that Canada would normally

purchase from the contractor.

The following example demonstrates the application of allocating indirect costs based on practical capacity

and applying the overhead rate to determine costs associated with capacity utilised and standby capacity:

Canada formed a contract with Company X to purchase 500,000 flu vaccines per year for the next 5 years.

Each batch of 500 vaccines takes one (1) machine hour to complete. The contractor’s practical capacity was

determined to be 1,600 machine hours. The allocable indirect costs associated with producing the vaccines

at practical capacity is $400,000. Canada has agreed to pay for indirect costs associated with standby

capacity to ensure a sovereign supply of vaccines at practical capacity, if and when needed. Company X has

a separate contract with a private organization that requires 200,000 flu vaccines per year for the next five

years. The following table summarizes data relevant to this example for the first year:

Practical Capacity

1,600 machine hours

Capacity Utilised by Canada (500,000 / 500)

1,000 machine hours

Capacity Used for Private Contract (200,000 / 500)

400 machine hours

Standby Capacity (1,600 – 1,000 – 400)

200 machine hours

Estimated Total Indirect Costs to Produce Vaccines at

Practical Capacity

$400,000

Canada has agreed that direct labour and material will be burdened using an overhead rate based on

estimated total indirect costs over practical capacity. Therefore, the overhead rate is:

363 | Page Public Services and Procurement Canada August 2023

• $400,000 / 1,600 = $250/machine hour

The indirect costs charged to direct labour and materials for producing 500,000 flu vaccines for Canada is

$250,000, calculated as:

• $250 * 1,000 = $250,000

Standby capacity represents capacity that is not currently being used for sales to Canada or other customers

(200 machine hours). Indirect costs associated with standby capacity is still calculated based practical

capacity. Thus, the overhead rate remains the same, which results in a standby capacity cost of $50,000,

calculated as:

• $250 * 200 = $50,000

As Canada has agreed to pay for any standby capacity for a sovereign supply of vaccines, the above standby

capacity cost of $50,000 could be claimed separately by the contractor under the terms of the contract.

This example demonstrates how indirect costs should be allocated based on practical capacity to determine

an overhead rate to apply to capacity utilised and standby capacity. Note that the sum of indirect costs

associated with capacity utilised by all customers and standby capacity is the same as when Company X’s

production facility is producing at practical capacity.

Example A5.3.5.c. – Purchase of Services

The concepts in this discussion paper can be equally applied to contracts for services such as consulting,

accounting, and maintenance. The following example illustrates the use of practical capacity to establish an

overhead rate for a service contract.

Department of National Defence has availed the use of services by a contractor specializing in repair and

overhaul of Light Armored Vehicles (LAVs). The annual number of labour hours required by DND is 580 direct

labour hours. The contractor’s annual total available practical capacity is 600 direct labour hours. Total annual

estimated indirect costs are $75,000. The contracting officer decided to use estimated costs to determine the

overhead rates.

The following table summarizes data relevant to this example:

Practical Capacity

600 direct labour hours

Capacity Utilised

580 direct labour hours

Total annual estimated indirect costs to provide

repair and overhaul services

$75,000

Using practical capacity as a base, the overhead rate should be:

• 75,000 / 600 = $125/hour

Thus, the indirect costs charged to the contract for providing 580 direct labour hours of repair and overhaul

services is calculated as:

• $125 * 580 = $72,500

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This example demonstrates how indirect costs should be allocated using practical capacity to determine an

overhead rate that is applied to capacity utilized in a service arrangement. The underlying application is the

same regardless of nature of contract – i.e., services or goods.

Considerations for Practical Capacity

Forecasting Practical Capacity

A contractor will be required to forecast its practical capacity when the contract in question requires the use

of an estimated rate to allocate indirect costs. Contracting officers should be aware that forecasting practical

capacity is challenging due to the uncertainty of the below factors

1 The forecasted demand for the contractor’s goods. There may exist uncertainty surrounding the

impact of seasonal, cyclical, and trend factors (e.g. future economic conditions), on forecasted

demand for goods. Furthermore, there may exist uncertainty around the scope and the number of

goods required by a contractor’s existing or prospective customers. Such circumstances will make

accurately estimating forecasted demand for capacity, and correspondingly forecasted practical

capacity, difficult.

2 The future requirement for contractor excess capacity as a result of customer needs. A

contractor may incur excess capacity as a result of customer needs. The requirements for excess

capacity can be uncertain, making it difficult to accurately estimate forecasted practical capacity.

3 The contractor’s future resource mix. A contractor’s practical capacity will vary with the mix of

resource types used by the contractor. For example, a contractor may shift its reliance from primarily

labour resource types to automated equipment. Such a change would have an effect on both the

amount of demand for capacity and practical capacity of a contractor. Furthermore, the feasibility

and sensibility for a contractor to adjust its practical capacity levels, to match demand for capacity,

on a short-term basis, will vary with the mix of resource types and the resourcing model used by the

contractor.

4 The future efficiency of the contractor’s existing resources. A contractor’s demand for capacity

will vary with the efficiency of its resources. Resource efficiency of a contractor’s existing resources

can increase due to changes such as, but not limited to, labour learning curve effects, production

process improvement, and equipment upgrades. For example, a contracted project may take 10%

less time to complete than estimated due to learning curve effects realized by the contractor’s

employees. Conversely, efficiency can decline due to reduced employee morale, outdated

production processes and aging equipment. Such resource efficiency changes, and corresponding

capacity impacts, can be uncertain, making it difficult to accurately estimate forecasted practical

capacity.

Evidently, developing an accurate estimate of a contractor’s practical capacity can be challenging due to the

uncertainty of the above factors. The above factors can also have a significant impact for the contractor on

the amount of indirect costs incurred, the amount of goods produced, and the amount of resource capacity

used per good produced.

It should be noted that this list of factors is not necessarily inclusive. Internal contractor policy, external regulatory, and other factors could also impact the

forecast of contractor practical capacity. For purposes of this discussion paper, this list encompasses the significant/frequent factors that may the forecast of

contractor practical capacity.

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Supportability and Verifiability of Practical Capacity

The contractor’s reported practical capacity amount should be supported by proper evidence including, but

not limited to, documentation, data, assumptions, and supporting calculations. It is important for the

contracting officer to verify that the practical capacity amount, used to determine the corresponding indirect

cost rate, is traceable to this evidence and is accurate. If the contractor’s practical capacity amount is not

traceable and accurate, and subsequently misstated, the indirect costs allocated to a contract may not be

reasonable.

In order to verify the practical capacity amount, the contracting officer should:

• Review contractor supporting evidence;

• Assess the contractor’s reported practical capacity amount against sources of comparator

information including historical data, industry information, equipment information, labor regulations,

and others;

• Consider the involvement of an expert (e.g. price advisor or auditor) from the Procurement Support

Services Sector (PSSS) to assist in verification of reported practical capacity.

Note that open access to certain company information may be required to verify the practical capacity

amount. The contracting authority should ensure that appropriate open book or appropriate audit clauses

are included in the final contractual agreement as well as any subsequent changes made to the contract

terms.

Appendix

A. Measuring Capacity

The amount of supply of capacity of a contractor, as measured, in resource hours available

, at a point in

time, will vary depending on the types of resources being used by the contractor. Contractor resource types

are listed in the order of lowest to highest supply of capacity below.

1 outsourced resource (lowest supply of capacity – i.e. zero hours – since the resource is with another

company and is not an in-house resource);

2 labour (skilled or unskilled labour);

3 equipment (that relies on labour to operate); and

4 automated equipment (that relies on no or minimal labour to operate).

The amount of demand for capacity (i.e. normal or budgeted capacity) of a contractor, as measured in

resource hours required to satisfy the demand for goods, at a point in time, will vary depending on the types

and efficiency of the contractor’s resources. For instance, less demand for capacity is required for:

Considering that practical capacity is used as the measure for supply of capacity in this discussion paper, resource hours available is inclusive of normal idle

time (maintenance on equipment, employee vacations, etc.). The resource hours available is usually based on information such as, but not limited to, internal

contractor policies (e.g. vacation, equipment maintenance schedule, etc.) and jurisdictional regulations (e.g. employee working hours per week).

For awareness, capacity of resources can also be measured in other metrics such as space (e.g. square feet). For the purpose of this discussion paper,

resource hours are used as the metric to measure capacity.

It should be noted that although the supply of capacity for an outsourced resource, as measured for the contractor, is zero hours, the contractor would still incur

costs for this outsourced resource. These costs will have to be allocated to the respective contract, considering that the costs are attributable, appropriate, and

reasonable.

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• outsourced resources over in-house resources (i.e. the demand for capacity for an outsourced

resource would be zero hours since the resource is with another company);

• skilled labour over unskilled labour; and

• automated equipment (that relies on no or minimal labour to operate) over equipment (that relies on

labour to operate).

Ideally, a contractor’s amount of supply for capacity should be equal to its amount of demand for capacity.

However, achieving equilibrium between supply of and demand for capacity is difficult and sometimes

infeasible, resulting in the incurrence of excess capacity costs for the contractor’s respective resources.

B. Cost Adjustment Considerations for the Allocation of Indirect Costs

Basis of Payment Applicability for Cost Adjustments

There are four data points which are used to calculate indirect costs

• the amount of practical capacity for the contracted resources;

• the amount of indirect costs associated with the contracted resources;

• the amount of contractor goods required to be produced for the respective contract; and

• the amount of contractor resource capacity required per good produced.

For a fixed price or fixed unit rate basis of payment, pricing would be based on estimated indirect costs.

For cost reimbursable bases of payment, pricing can be based on estimated or actual indirect costs.

When a cost reimbursable contract uses a basis of payment that relies on cost estimates, the contract may

contain cost-adjustment clauses that identify when:

• the estimated indirect costs may have to be recalibrated during the course of the contract to reflect

updated data points; and/or

• the estimated indirect costs have to be reconciled and adjusted to reflect actual indirect costs.

The application of either of the above adjustments on the contract may result in alterations to the originally

estimated indirect costs – cost of capacity used and/or cost of excess capacity – allocated to the contract. A

cost-adjustment clause should be structured such that the clause is only activated when the following three

conditions are met.

1 a material discrepancy between estimated indirect costs and actual indirect costs exists or will

exist;

2 it would be fair to the contractor and Government; and

3 the benefits (i.e. being fair) of recalibration or reconciliation outweigh the respective costs of

tracking and determining updated or actual cost data.

These four data points can be used to calculate the cost of capacity used and the cost of excess capacity associated with the respective contractor resources.

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Factors that may trigger a Discrepancy between Indirect Cost Estimates and Actual Costs Incurred

There are four main factors, two external and two internal to the contractor, that may trigger a discrepancy

between estimated indirect costs and actual indirect costs incurred.

External factors

1 a change in the forecasted demand (amount and/or scope) for the contractor’s goods; and

2 a change in the requirements of contractor excess capacity due to customer needs.

Internal factors

1 a change in the contractor’s resource mix; and

2 a change in the efficiency of a contractor’s resources.

It should be noted that changes in internal contractor factors are less apparent. To detect changes in internal

factors, indicators including, but not limited to, the below could be considered:

• An indicator that the contractor’s resource mix may have changed include a shift in the contractor’s

customer base and/or nature of goods/services provided. For example, if a contractor doubles its

customer base, its resources mix will correspondingly change.

• An indicator that the contractor’s resources’ efficiency may have changed include a shift in the

quality or schedule performance of the contracted goods. For example, if the quality of the

contracted goods is lower than expected, but being produced quicker than expected, there exists

the risk that the contractor’s resources may be foregoing quality for the notion of increasing output

and saving costs.

Assessing Benefits vs. Costs of Recalibration and/or Reconciliation

The adjustment of estimated indirect costs for a contract should only be considered when the benefits (i.e.

being fair) of recalibration or reconciliation outweigh the respective costs (e.g. time and difficulty) of tracking

and determining revised cost data.

Recalibrating indirect cost rates would normally be less time-consuming than reconciling and adjusting for

actual indirect cost rates because of less administrative burden.

Correspondingly, the contractor and client department should openly communicate about anticipated factors

that may have an impact on original indirect cost estimate for the contract so that indirect cost rates can be

proactively and fairly recalibrated.

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ANNEX 5.3.6 DISCUSSION–PAPER - RESEARCH AND DEVELOPMENT COSTS

Context

This document provides guidance to contracting officers and contractors on costs acceptable to Canada,

when price or the assessment of contract performance depend on costs.

This guidance on research and development is intended to help inform practitioners in preparation for contract

negotiations and the management the contract through its lifecycle. Based on the scale and complexity of

the acquisition, this may require considerable support from the contracting team, which may include price

advisors, client department representatives and other subject matter experts.

Research and development (R&D) refers to the part of a company's operations that seeks knowledge to

develop, design and enhance that company's products, services, technologies or processes. Along with

creating new and innovative products and adding features to old ones, R&D connects various parts of a

company's strategy and business plan … such as the possibility for increased productivity or new product

lines.

Contract Cost Principles, SACC 1031-2, identifies R&D activities applicable to Canadian Government

contracts. These are general research and development activities and product development or improvement

activities associated with the product being acquired.

Associated costs are assessed for the reasonableness, as judged by the merit of the investments relative to

what is valued by the “customer”, including expected net-benefit and impact on the affordability of the

underlying government programs. Acceptance is contingent on expected benefits being aligned with what is

valued, as defined by the customer in conjunction with PSPC officials.

PSPC analysis should quantify the financial impact on Canadian Government Programs when contractor

investments in R&D activities are significant and should be evident in the sourcing and procurement strategy

documents.

Recommendation

In alignment with the contract cost acceptability criteria outlined in the Costing Standard, research and

development costs should be accepted for a contract when the costs are Attributable, Appropriate, and

Reasonable.

Assessing if research and development costs are acceptable for a Government contract is difficult because:

• Research and development activities may not always be successful or result in measurable benefits;

• The amount of time required to conduct research and development activities can be uncertain – thus

creating uncertainty around when corresponding potential benefits may be realized; and

https://www.investopedia.com/ask/answers/043015/what-are-benefits-research-and-development-company.asp

369 | Page Public Services and Procurement Canada August 2023

• The inclusion of research and development costs in a contract may be viewed as an unfair subsidy

or duplicating compensation already available through other government programs or Canada’s

income tax regime.

Such factors need to be considered when determining the amount of research and development costs for:

• Canada’s share of R&D investments to be recovered through the pricing of its contracts with the

contractor; or,

• The contractor’s investment targets, as defined by the contractor’s performance objectives.

The contract should clearly explain:

• the applicability of any research and development costs;

• any limits on amounts to be recovered through Canada’s contracts;

• the agreement on acceptable accounting methods to capture financial data and to report on R&D

activities; and

• validation requirements to ensure the reliability and integrity of the contractor’s accounting of its

investments and Canada’s share.

The Cost Accounting Practices (CAP) Submission is recommended to identify and establish an agreement

with the contractor on the acceptable R&D investments, associated limits and accounting methods to be used

to capture and report on the contractor’s incurred research and development costs.

Application

As detailed in the Costing Standard, research and development (R&D) activities are classified in two distinct

categories:

1. General Research and Development – “a planned investigation undertaken with the hope of

gaining new scientific or technical knowledge and understanding. Such investigation may or may not

be directed towards a specific practical aim or application.”

An example of a general research and development activity could be improving current production

functions such as plant layout, production scheduling and control, methods and job analysis,

equipment capabilities and capacities, inspection techniques, and tooling analysis.

2. Product Development and/or Improvement – “a systematic program of work, going beyond basic

and applied research, which is directed towards the creation of a new or improved product, system,

component or material, substantially in a marketable form, but excluding any manufacture beyond

completion of the new and improved product's prototype.”

An example of product development and improvement could be the design of new or improved materials for

a specific good.

Research and development costs may be an aggregate of other costs (e.g. compensation costs, rework

costs, etc.). Therefore, when assessing the acceptability of research and development costs, the criteria of

Attributable, Appropriate, and Reasonable should also be assessed for the respective aggregate costs.

When assessing the criterion of Attributable, below are some key factors to consider.

• Are the research and development costs supportable and verifiable?

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• Do the research and development costs contribute to the achievement of:

o Contract specific requirements;

o Strategic contract outcomes; or

o Financial, schedule, and quality benefits for the contracts that the Government has with the

respective contractor?

When assessing the criterion of Appropriate, below are two key factors to consider:

• Are the nature of the research and development costs consistent with available sources of

comparator information?

• Is the reimbursement of the research and development costs, as it pertains to the impact on fairness

and equity for other suppliers, acceptable?

When assessing the criterion of Reasonable, below are some key factors to consider:

• Is the cost amount consistent with available sources of comparator information?

• Is the cost amount net of applicable credits?

• Does the cost amount justify the expected return on benefits for the Government?

• Does the cost amount comply with any parameters that may have been pre-authorized in the

contract?

• Has the cost amount been allocated fairly between the Government and the contractor with

consideration for the benefits associated with the costs?

The above factors are presented in the logical order that contracting officers will need to follow when

assessing the acceptability of research and development costs. Details for these considerations are included

in Appendix A. It should be noted that the identified factors for assessing the criteria of Attributable,

Appropriate, and Reasonable are not exhaustive. As such, the identified factors should be consulted

alongside the applicable sections of the Costing Standard.

Appendix A – Factors to consider before accepting R&D Costs

The following contains criteria and examples to assess whether research and development costs are

Attributable, Appropriate, and Reasonable.

Is the Cost Attributable?

Sub-criteria

Example Considerations to Assess Sub-criteria

1. Are the research and

development costs

supportable and

verifiable?

Research and development costs should be readily identifiable

based on contract cost reports produced by the contractor. The

contract cost reports should:

• Disclose the nature and purpose of the research and

development costs;

• Identify direct research and development costs; and

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Is the Cost Attributable?

Sub-criteria

Example Considerations to Assess Sub-criteria

• Identify indirect research and development costs.

Disclosed information should include the type of research and

development activities, the research and development cost

breakdown (e.g., compensation costs, rework costs, etc.), and how

the costs contribute to the achievement of benefits for the contract.

2. Do the research and

development costs

contribute to the

achievement of:

a. contract specific

requirements;

b. strategic contract

outcomes; or

c. financial, schedule,

and quality benefits

for the contracts

that the

Government has

with the respective

contractor?

Research and development activities for specific product

development/improvement may be required for the achievement of

contract specific requirements. This could, for example, occur when

the contractor is engaged in a contract with Defence Research and

Development Canada (in the context of Defence contracts). The

contractor could be required to conduct research and development

activities in the following areas:

• emerging materials;

• weapon systems;

• cyber security;

• military medicine; or

• other areas of public safety and security science and

technology.

In this circumstance, research and development costs could

constitute 100% of the total contract cost.

3. Other Considerations

Research and development costs can improve the quality of the

contractor goods (e.g., through new or improved material) or reduce

the contractor’s production costs and time for its goods (e.g., through

improved production processes). Resultantly, this could create

potential cost savings, as well as more timely and quality

goods/services, for the Government across the contract(s) it has (or

will have) with the respective contractor.

The contracting officer should be aware that research and

development costs represent an investment risk. This investment

risk reflects that:

• research and development activities may not always be

successful and result in benefits; and/or

• the amount of time required to conduct research and

development activities can be uncertain – thus creating

uncertainty around when corresponding potential benefits

may be realized.

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Is the Cost Attributable?

Sub-criteria

Example Considerations to Assess Sub-criteria

As such, when assessing whether research and development costs

of the above nature are Attributable, the Government could provide

consideration to factors including, but not limited to, the following:

• Are the proposed research and development activities of a

specific or general nature? (It is presumed that general

research and development costs are a riskier investment

than specific research and development costs.)

• What is the purpose and what are the outcomes of the

respective contract(s)?

• What is the nature of the contractual relationship and its

potential duration?

• How long is the duration of existing contract(s)?

• Is the Government the primary customer of the contractor,

and does a potential for a long-term contracting relationship

exist?

• Do the research and development activities proposed for the

contract align with the core capabilities of the contractor,

and does the contractor have past experience conducting

research and development activities?

• What would be contractual terms for foreground intellectual

property ownership? This is particularly important when the

Government will not realize benefits from its research and

development investment during the duration of the current

contract, but rather in the longer term through the future use

of the developed intellectual property. The Government’s

Policy on Title to Intellectual Property Arising Under Crown

Procurement Contracts identifies that either the contractor

or the Government can retain intellectual property

ownership.

• What is the success rate and length of relevant research

and development activities in the contractor’s industry?

• Costs applicable to Product Development projects partially

funded by Canada are not acceptable as general research

and development costs.

Is the Cost Appropriate?

Sub-criteria

Example Considerations to Assess Sub-criteria

1. Is the nature of the

costs consistent with

available comparator

information?

The nature of Appropriate research and development costs should

be consistent with available comparator information. Sources of

comparator information include but are not limited to:

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Is the Cost Appropriate?

Sub-criteria

Example Considerations to Assess Sub-criteria

• internally available data from other contracts;

• accessible data for contracts from other government

procurement organizations;

• accessible documentation, including historical and forward-

looking financial reports, for the contractor;

• publicly available financial reports for other companies in the

contractor’s industry; or

• publicly available financial reports for other companies in the

contractor’s geography.

For example, if the contract in question requires research and

development activities in the field of military medicine, consideration

could be provided on assessing what types of research and

development costs typically occur during drug development in the

pharmaceutical industry.

In alignment with the Treasury Board Secretariat Contracting

Policy78 , contracts may be structured with due consideration of

strategic outcomes that:

• support long-term industrial and regional development and

other appropriate national objectives, including aboriginal

economic development; and

• comply with the government’s obligations under the various

trade agreements such as the World Trade Organization –

Agreement on Government Procurement and the

Agreement on Internal Trade

2. Is the reimbursement of

the costs, as it pertains

to the impact on

fairness for other

suppliers considered

acceptable?

The contracting officer should, with proper consultation, assess the

following.

• Is the inclusion of the research and development costs in

the contract due to the contract’s integration with other

Government of Canada mechanisms or programs (i.e., for

the purpose of achieving strategic outcomes)?

• Would the inclusion of the research and development costs

be viewed as an unfair subsidy that could result in a legal

challenge and/or harm to Canada’s reputation

internationally.

Value and Ethics Code for the Public Sector. Government of Canada, Treasury Board Secretariat of Canada. December 2011. http://www.tbs-

sct.gc.ca/pol/doc-eng.aspx?id=25049. Accessed 1 March 2018.

374 | Page Public Services and Procurement Canada August 2023

Is the Cost Reasonable?

Sub-criteria

Example Considerations to Assess Sub-criteria

1. Is the cost amount

consistent with

available sources of

comparator

information?

For example, the amount for Attributable and Appropriate research

and development costs could be compared to prior period research

and development costs to determine if there any anomalies in costs

from one period to the next. If there are anomalies (e.g., a large

increase in the amount of research and development costs for the

period), justification for the increase should be requested from the

contractor.

2. Is the cost amount net

of applicable credits?

The amount for Attributable and Appropriate research and

development costs should be reported net of applicable credits.

Applicable credits may include Government funding, such as grants,

subsidies or investment tax credits the contractor is receiving to

conduct research and development activities to achieve strategic

Government outcomes. The nature and amount of any related

funding or credits should be disclosed by contractors and the

research and development costs should be adjusted accordingly.

Please note: Previously, the Supply Manual guidance states

Investment Tax Credits (ITCs) shall not be deducted from related

research and development (R&D) expenditures when determining

the applicable costs, whereas it is proposed in the discussion paper

for research and development (R&D) expenditures to be reported

net of applicable credits, which include ITCs. ITCs and its

application to related R&D expenditures when determining the

applicable costs is under review and consultation for the next

iteration of the Guide.

3. Does the cost amount

justify the expected

return on benefits for

the Government?

It should be demonstrated that the amount of research and

development costs incurred by the contractor justifies the expected

return on benefits for the Government. Benefits for the Government

can be of either a quantitative nature (e.g., production cost savings)

or qualitative nature (e.g., achievement of strategic policy

outcomes).

When the primary intent of the research and development activities

is to reduce production costs for the contracts that the Government

has with the respective contractor, the contractor should

demonstrate that the production cost savings for these contracts is

at least equivalent to the respective research and development costs

that have been incurred.

When the incurrence of research and development costs are linked

to the achievement of strategic outcomes, a cost-benefit analysis

must be conducted in order to determine the level of costs to the

Government that would justify the achievement of the respective

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Is the Cost Reasonable?

Sub-criteria

Example Considerations to Assess Sub-criteria

benefits. This is particularly important when assessing benefits of a

qualitative nature

4. Does the cost amount

comply with any

parameters that may

have been pre-

authorized in the

contract?

A contract may contain limits for the amount of research and

development costs that can be reimbursed to the respective

contractor. The inclusion of parameters may be of more relevance

when the contractor has multiple active contracts with the

Government.

For example, there may be a limit for the percentage of contractor

general research and development costs that can be allocated to

Government contracts in relation to the total cost of the Government

contracts (i.e., contractor general research and development costs

can comprise up to X% of the total cost of the contractor’s

Government contracts).

5. Has the cost amount

been allocated fairly

between the

Government and the

contractor with

consideration for the

benefits associated with

the costs?

Research and development costs should be fairly allocated between

the contractor and the Government based on the benefits expected

to be realized by each party.

Specific considerations for the fair allocation of research and

development costs include, but are not limited to, the following:

• Are the research and development costs of a specific or

general nature?

• What is the level of investment risk for research and

development costs – how likely is it that benefits will be

realized and if so, is there certainty around the timing of

when the benefits will be realized?

• Do the research and development costs provide potential

commercial value to the contactor beyond the existing

contracts it has with the Government?

• What is the primary customer base of the contractor – the

Government or non-government organizations (e.g.,

industry)?

• Do the research and development costs have no or

unconfirmed commercial value to the contractor beyond the

existing contracts it has with the Government?

• What are the contract terms for intellectual property that is

generated during the contract – will the Government or the

contractor own the rights to the intellectual property?

As an example, if the research and development costs have no or

unconfirmed commercial value to the contractor beyond the existing

contracts it has with the Government, it would presumably be fair to

allocate a greater proportion of the costs to Government contracts.

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Is the Cost Reasonable?

Sub-criteria

Example Considerations to Assess Sub-criteria

On the contrary, when the research and development costs provide

potential commercial value to the contractor and potential qualitative

benefits to the Government, the results of a cost-benefit analysis

would inform the fair allocation of these costs between the contractor

and the Government.

Appendix B - Treatment of General Research & Development (R&D) vs. Specific Product Development

and/or Improvement Costs

The following provides additional guidance on the treatment of General R&D vs. Specific Product

Development/Improvement Costs.

General Research & Development

Costs acceptable as general R&D must relate to projects classified as basic research or applied research

(See definitions on research types in Appendix B below).

As per SACC 1031-2 and Section 4.15 of the Costing Standard, costs related to general R&D that are

considered applicable may be included in overhead and allocated to the contractor's total business activity

which would exclude items such as resale activity, warranty, etc., within the current fiscal year.

In those instances where the general R&D expenditures are the majority of the total General

& Administrative (G & A) cost pool, this fact must be highlighted in the cost rate negotiation report, or a

separate general research and development overhead rate developed.

Significant differences between the negotiated and actual costs incurred must be taken into consideration

when reviewing audited costs or negotiating future years general research and development costs.

Specific Product - Product Development/ Improvement

The costs for product development/improvement should not be included in overhead at the time it is

incurred. Proper treatment of these expenditures would be to extract them from overhead pools and

segregate these costs for later recovery against product sales.

Practitioners should consider, as an aspect of their negotiations, overhead applications to these product

development costs. In the case of G & A overhead, either the costs are applied at the time that the product

development costs are incurred, or at the time the product development costs are recovered against

product sales. For guidance on the timing of application of G & A overhead costs, negotiators may look at

other G & A recovery applications made to product development by the company.

The recovery of the contractor's product development costs should, in the majority cases, be accomplished

through the amortization of these product development costs against the sales of the family of products to

which the product development pertained.

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• Contractors proposing to amortize product development costs of the product developed against

future sales to Canada, must submit an annual cost schedule to the responsible Contracting

Authority.

The contractor may recover these expenses on the relevant product sales, including government sales,

even if the related expenditures have been written off to the profit and loss account in the year originally

incurred. In other words, the costs could be recognized for financial statement purposes in the year they

were originally incurred but deferred and recognized later for the purposes of the contract. However, in this

case the contractor must maintain sufficient records to demonstrate the costs to be recovered and also to

substantiate that these costs had not already been recovered in overhead.

Excluded Activity from General Research and Development and Product Development

The following are examples of activities that typically would be excluded from any general R&D and product

development/improvement project:

• engineering follow-through in an early production phase;

• quality control during commercial production, including routine product testing;

• troubleshooting in connection with breakdowns during production;

• routine, or periodic alterations to existing products, production lines, manufacturing processes, and

other ongoing operations, even though such alterations may represent improvement;

• adoption of an existing capability to a particular requirement, or customer's need, as part of a

continuing commercial activity;

• routine tools, jigs, mould, and dies design;

• activity, including design and construction engineering, related to the construction, relocation,

rearrangement, or facilities start-up, or equipment, whose sole use is for a particular R&D project,

unless specifically approved by the technical authority;

• all market research activities, including those directed at market development, verification,

identification, demonstration, preference, and customer acceptance development;

• pre-production and proposal costs;

• cost overruns on previous fixed price development contracts.

Appendix C – Investment Tax Credits (ITC) for Scientific Research and Experimental Development

Below is a short explanation of investment tax credits (ITC) that relate to Scientific Research and

Experimental Development (SR&ED) qualified expenditures and applicable rates.

Scientific Research and Experimental Development (SR&ED) is a tax incentive program aimed at promoting

the advancement of technology in Canada. Companies of all sizes and industry sectors making qualified

expenditures in connection with SR&ED activities in Canada are entitled to receive an investment tax credit.

To qualify, the work must meet the definition of scientific research and experimental development (SR&ED)

in subsection 248(1) of the Income Tax Act. The following is a definition of SR&ED

https://www.canada.ca/en/revenue-agency/services/scientific-research-experimental-development-tax-incentive-program/claiming-tax-incentives.html

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“scientific research and experimental development” means systematic investigation or search that is carried

out in a field of science or technology by means of experiment or analysis and that is:

(a) basic research, namely work undertaken for the advancement of scientific knowledge without a specific

practical application in view;

(b) applied research, namely work undertaken for the advancement of scientific knowledge with a specific

practical application in view; or

advancement for the purpose of creating new, or improving existing, materials, devices, products or

processes, including incremental improvements thereto;

and, in applying this definition in respect of a taxpayer, includes:

(d) work undertaken by or on behalf of the taxpayer with respect to engineering, design, operations research,

mathematical analysis, computer programming, data collection, testing or psychological research, where the

work is commensurate with the needs, and directly in support, of work described in paragraph (a), (b), or (c)

that is undertaken in Canada by or on behalf of the taxpayer,

but does not include work with respect to:

(e) market research or sales promotion;

(f) quality control or routine testing of materials, devices, products or processes;

(g) research in the social sciences or the humanities;

(h) prospecting, exploring or drilling for, or producing, minerals, petroleum or natural gas;

(i) the commercial production of a new or improved material, device or product or the commercial use of a

new or improved process;

(j) style changes; or

(k) routine data collection.”

ITCs reduce taxes payable and, for certain entities, the amount of credit in excess of taxes payable can be

refunded to the entity, providing valuable assistance to emerging businesses and others that are not

taxable in the year. Below is a summary of the investment tax credits and refund rates that apply to

qualified expenditures:

Geographic Region

Entity

Investment tax credit

(ITC) rate

Refund rate

Qualified SR&ED in

Canada

Qualifying Canadian-

controlled private

corporations (CCPCs)

35% of annual

qualified current

expenditures up to

threshold ($3 million or

less)

+ 15% of qualified

current expenditures

not eligible for the

35% rate (i.e., in

excess of the

expenditure limit)

100% of ITCs

computed at the 35%

rate

+ 40% of ITCs

computed at the 15%

rate

Other corporations

15%

n/a

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Individuals

40% of ITCs

Qualified property in

Atlantic provinces,

Gaspe region and

prescribed offshore

regions

Qualifying CCPCs

10%

40% of ITCs

Other corporations

n/a

Individuals

40% of ITCs

Appendix D – Guidance provided by Comparator Jurisdictions

The guidance for assessing the Acceptability of research and development costs provides, to practitioners,

enhanced clarity, completeness, and utility for determining appropriate treatment of these amounts. The

recommended guidance is consistent with current guidance in comparator jurisdictions (i.e. Australia and

United Kingdom)

in areas such as the treatment of investment tax credits.

The United Kingdom identifies that investment tax credits should be used to reduce the research and

development costs accepted for a contract.

Australia specifically identifies that investment tax credits should be used to reduce any general research

and development costs accepted for a contract.

Australian Government-Department of Defence-Capability Acquisition and Sustainment Group, Capability Acquisition & Sustainment Group Cost Principles,

October 2017, http://www.defence.gov.au/casg/Multimedia/CASG_Cost_Principles-9-8642.pdf , Accessed 1 March 2018.

Single Source Regulations Office, Single source cost standards-Statutory guidance on Allowable Costs, February 2018,

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/678280/Allowable_Costs_guidance_April_2018.pdf , Accessed 1 March 2018.

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ANNEX 5.3.7 DISCUSSION PAPER – RISK AND COST CONSIDERATIONS FOR SOCIO-

ECONOMIC AND ENVIRONMENTAL BENEFITS POLICIES AND PROGRAMS – UNDER

REVIEW

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ANNEX 5.4 PRICING DISCUSSION PAPERS

These discussion papers provide additional guidance on pricing related topics to support contracting

officers’ understanding of pricing in Canada. This includes discussion of pricing methodologies that may be

recommended for consideration in Canada in the future.

ANNEX 5.4.1 DISCUSSION PAPER – ALTERNATIVE APPROACHES TO COST-BASED

PRICING

Alternative Approaches to Cost-Based Pricing

Context

This discussion paper provides guidance to contracting officers in the negotiation of non-competitive

contracts or contracts where price negotiations with the successful bidder are required following a

competitive process.

This discussion paper is intended to help inform contracting officers, to prepare for contract negotiations

and to manage the contract through its lifecycle. Based on the scale and complexity of the acquisition, this

requires considerable support from the contracting team, which may include price advisors, client

department representatives and other subject matter experts. This discussion paper is not intended to be a

procedural document.

Why This Matters?

In most Government acquisitions, in Canada and internationally, price is established based on the

contractor’s cost plus a profit margin on top of the cost. Acquisitions that build on cost-based pricing generally

deliver value to Canada and meet Canada’s objectives of fairness and transparency.

Past reviews of Canada’s acquisition processes have identified an inherent imbalance between a focus on

cost and reward for effectively managing risk. Of particular concern, when cost-based pricing is applied in

contracts with Cost-Reimbursable, Fixed Time Rate/Unit and Firm Priced bases of payment (see Section

4.1) without consideration of efficiency or effectiveness. This may result in not fully incentivizing (and may

disincentivize) the contractor from proactively managing cost escalation; adopting a problem-solving and

preventative approach to production, delivery and service problems; or pursuing innovative solutions. It

should be noted that in a Fixed Price contract, risks related to cost fluctuations and resulting profits or

losses are fully borne by the contractor, providing full incentivization to proactively manage costs, as any

gains in efficiencies are retained by the contractor. See Section 4.1.1 for further details.

Potential Alternatives to Cost-Based Pricing in Government Acquisitions

While cost-based pricing meets Canada’s objectives of fairness and transparency, there are some situations

where alternatives to cost-based pricing might generate better value. Alternatives to cost-based pricing are

ways to buy goods and services where the price does not rely on the cost to the contractor of fulfilling the

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statement of requirements. Two alternatives to cost-based pricing are explored in this paper: outcome-based

pricing and value-based pricing.

In outcome-based pricing the price is set based on the achievement of a pre-agreed outcome for the client

department. At the time the contract is established the price may be expressed as a formula, for example a

percent of operational cost savings achieved or as a rate per unit of improved performance. The contractor’s

payment is (largely) at risk and the amount to be paid is not known until the work is complete and the client

department takes delivery of the produces and/or services.

In value-based pricing the price is set based on the anticipated value of the goods and/or services that are

being acquired. While value-based pricing is quite common in consumer and business to business

acquisitions, they are not widely seen in Government, and rarely in non-competitive acquisitions. The

exception to this is public private partnerships (PPPs) that transfer revenue risk to the contract, which are

described below.

PPPs that transfer revenue risk to the contractor (e.g., a toll highway) are one form of value-based pricing.

In such PPPs, the price is set based on the anticipated value of the business opportunity. Generally, the price

determined from the business opportunity would be quantified based on the discounted net present value of

anticipated cash flows over the term of the contract. (The net cash flow would be derived by estimating cash

inflows less outflows, where inflows would include revenues plus any grants or subsidies and outflows would

include capital investment, operating costs, debt repayment and interest charge and taxes.)

Advantage and Challenges of Alternatives to Cost-Based Pricing

In some situations, alternatives to cost-based pricing could yield substantial advantages over cost-based

pricing, including for example:

• aligning Government and contractor interests, for example by tying payment to efficient, timely

and/or enhanced performance of the work or providing the contractor with greater flexibility in how

to approach the work and manage risks;

• reducing the use of Government resources to undertake cost analysis, proposal evaluation, audits,

cost data collection, and contract management and oversight

• reducing the work and cost to the contractor of collect and report costs information; and

• attracting new suppliers for Government contracts (due in part to lower administrative burden

associated with contracting), which could encourage greater competition, and consequently (in the

long run) drive efficiencies and innovation.

That said, there are some important challenges that could be associated with the use of alternatives to cost-

based pricing in non-competitive acquisitions. These challenges include:

• inadequate information to confirm the contractor’s price is reasonable and fair; and

• an increased risk of excessive profits.

Recommendation

While they may generate value in certain circumstances, alternative pricing methods such as outcome-based

pricing and value-based pricing should be used selectively and judiciously, particularly in non-competitive

acquisitions.

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Assessing Potential Use of Alternatives to Cost-Based Pricing

The selection of an alternate to cost-based pricing should be based on a solid understanding of the respective

merits of each potential pricing method and an objective assessment of the applicability of the method to the

acquisition. At a minimum, the contracting officer should consider:

• the clarity and complexity of the client department’s statement of requirements;

• timeframes for delivery of the work;

• the complexity and predictability of risks associated with the acquisition, including for example:

o the likelihood of changes in the requirements as work progresses;

o the level of uncertainty regarding the effort and costs to meet the statement of

requirements;

o the maturity, history and experience of the contractor with work of a comparable nature,

size, scope and complexity to the statement of requirements;

o the contractor’s technical and financial capabilities;

o the intricacies of stakeholder issues;

o the complexity of external threats and opportunities associated with the work; and

• how the contracting officer might assess whether the contractor’s price is fair and reasonable.

No single factor in the above list of considerations is determinative, although a significant factor in all cases

is the overall risk associated with the acquisition. The objective is to select a pricing method (or methods)

that accommodates the full range of risks associated with the acquisition and facilitates appropriate risk

sharing between the Government and the contractor.

To non-competitively acquire goods and services using one of the alternatives to cost-based pricing

discussed in this paper, the contracting officer needs to assess whether the contractor’s price is fair and

reasonable.

Assessing the Contractor’s Price

When alternative pricing methods are being considered, an assessment of the planned/estimated

alternative pricing outcomes should be done in comparison to the expected outcome from the application of

cost-based pricing principles, to support a risk and benefit analysis of the alternative method. (See

Alternative Pricing Principles, Section 5.3 for further details on this process).

Other potential approaches to support the assessment of whether the contractor’s price is fair and reasonable

may include comparison of the proposed price to one or more of the following:

• the anticipated cost to deliver the statement of requirements using in-house resources (if this is

practical);

• benchmark pricing from comparable non-competitive acquisitions made by the client department,

another department or another jurisdiction (to the extent that benchmarks can be identified, and

pricing information obtained); and/or

• benchmark pricing from comparable acquisitions that were competitively bid (to the extent that

benchmarks can be identified, and pricing information obtained).

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Resource Limitations

Alternatives to cost-based pricing require substantial planning to structure and implement, including for

example development of the payment mechanism and key contract terms and conditions to support the

pricing method. Generally, contracting officers would require additional knowledge, skills and experience in

order to implement alternate pricing methods effectively. In many instances, support from internal subject

matter experts and external advisors can be a key success factor. Accordingly, in determining which pricing

method(s) to use, the contracting officer should weigh the potential merits of each pricing method, including

the anticipated investment of resources and time required to establish the price and manage the resulting

contract.

Analysis

Two alternatives to cost-based pricing are sometimes used to acquire products and services in certain

circumstances: outcome-based pricing and value-based pricing. Additionally, certain pricing methods can be

used to supplement a cost-based price.

A. Outcome-Based Pricing

Overview

Outcome-based pricing is when the price paid is linked to the achievement of a prescribed outcome, for

example a substantial improvement in the client department’s capability. During the initial contracting, a

formula is established that sets out how the contractor will be compensated. The actual payment to the

contractor is finalized once the work had been completed and the outcome measured in accordance with the

pre-established terms and conditions.

Outcome-based pricing can improve value to Canada in acquisitions when there is a high level of uncertainty

regarding the best method to achieve the desired outcome. If cost-based pricing were to be used in such an

acquisition it could result in substantial cost to the Government, with no guarantee that the client department’s

objective(s) would be achieved. In such a situation outcome-based pricing might ultimately establish a better

balance between the risks and rewards that the Government and the contractor are taking on. (This is in part

achieved because the contractor will not readily accept risks which impact the price it is paid unless it can

manage those risks.)

Generating Value in Outcome-Based Pricing Contracts

In outcome-based pricing the contractor’s revenue may be well above, or below, the contractor’s actual cost.

This creates substantial incentive for the contractor to achieve the defined outcomes on which payment is

calculated. If it fails to deliver the required outcome(s), the contractor might be out of pocket for the cost

incurred (in whole or in part). Alternately if the contractor successfully delivers the required outcome(s), it

may earn a profit well beyond the limits currently in place for cost-based contracts.

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Administering Outcome-Based Pricing

While outcome-based pricing can improve value to Canada when used appropriately, there are also

substantive risks associated with its use. These risks include:

• If the outcomes, and associated measurements upon which the contractor’s payment will be

calculated are not structured appropriately, there may be unintended consequences. For example,

if the measures do not fully align with the client department’s requirements, then the capability

anticipated from the acquisition may fall short in some areas.

• The contract will inevitably incorporate terms that transfer some risk back to the Government, and

failure to meet these provisions may trigger additional compensation to the contractor, and/or

excuse the contractor from its obligations. For example, in a transformation engagement where the

contractor is being compensated based on a percentage of cost savings, if the client department

fails to follow through with the recommended changes to its processes, the contractor might have a

right to payment notwithstanding that the savings were not actually realized.

• The contractor may ultimately walk away from the task if it determines that it will be unable to

achieve the desired outcomes or the actual costs that it will incur in achieving the outcomes are

greater than the payment that it would receive.

Use of Outcome-Based Pricing in Non-Competitive Acquisitions

While outcome-based pricing can, in principle, be used for non-competitive acquisitions, they are not

common, in part, because of the challenge of confirming that the contractor’s proposed price is fair and

reasonable.

When outcome-based pricing is being considered, an assessment of the planned/estimated outcome pricing

ranges should be done in comparison to the expected outcome from the application of cost-based pricing

principles. (See Alternative Pricing Principles, Section 5.3 for further details on this process).

Another potential method that may be used to support the assessment of whether the contractor’s proposed

price is fair and reasonable is by comparison of the contractor’s price to the anticipated cost to deliver the

required outcome using in-house resources (if this is practical).

A second alternate would be to benchmark the contractor’s price to comparable acquisitions to the extent

that they can be identified, and pricing information obtained. For example, if the contractor has provided

similar outcomes for another department or another jurisdiction, then its pricing there can inform the

appropriate pricing in a non-competitive acquisition.

A third alternative is to benchmark the contractor’s price to comparable outcome-based pricing acquisitions

that were competitively bid.

Example of Outcome-Based Pricing

One situation where outcome-based pricing is sometimes found is in transformation/operational improvement

initiatives. The price paid to the contractor engaged to support the transformation is calculated based on a

pre-established percentage share of the cost savings achieved by the department compared to historical

operating costs.

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B. Value-Based Pricing

Overview

In value-based pricing the contractor’s payment is set based on the anticipated value of the goods and/or

service that are being acquired.

In consumer and business to business acquisitions, value-based pricing is common. Buyers count on market

factors and competition among numerous potential suppliers to ensure that they receive a fair and reasonable

price. In contrast, in Government acquisitions, and especially for defence acquisitions, the goods and

services which are being acquired are often specialized with just a few potential suppliers. In addition,

compared with commercial items, many large-scale Government acquisitions (e.g., defence equipment and

infrastructure) tend to be much more complex and to entail much greater technological risk to develop. All of

these factors, greatly complicate the Government’s ability to determine a fair and reasonable price.

Accordingly, while value-based pricing is quite common in consumer and business to business acquisitions,

they are not widely seen in Government, and rarely in non-competitive acquisitions. The exception to this is

public private partnerships (PPPs) that transfer revenue risk to the contract, which are described below.

Overview of PPPs that Transfer Revenue Risk

PPPs that transfer revenue risk to the contractor are a form of value-based pricing. Effectively the price is

linked to a monopoly right to generate revenues. In this form of PPP virtually all the responsibilities and risks

of ownership are transferred to the contractor for an extended period, notwithstanding that title to the asset

typically remains with the government. The price is established based, in part, on the amount that the

contractor is willing to pay (or be paid) for the value of the monopoly to develop an asset and collect 10 for

its usage.

Generating Value in PPPs that Transfer Revenue Risk

PPPs are generally based on the premise that private sector efficiencies will generate greatest value when

the contractor is given flexibility to carry out the work with minimal input from government once the contract

is in place. PPPs involving the transfer of revenue risk are generally based on the synergies of combining

the revenue generation with the responsibility to develop and maintain the asset as well as simply generating

efficiencies/improvements from the revenue generation (e.g., the ability to effectively market the service).

Given the long term of most PPPs (typically between 25 and 35 years but sometimes longer when revenue

risks are involved), contracts generally include provisions requiring the contractor to comply with changes in

applicable standards and codes, and to deliver the project in line with all applicable leading practices

regarding the conduct of the work.

Administering Contracts for PPPs that Transfer Revenue Risk

Key risks associated with administration of this type of contract include:

• Loss of flexibility to change the statement of requirements over the life of the contract.

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• The contract requiring non-compete clauses which restrict the flexibility of future governments to

extend services through alternate means. For example, in PPPs for toll highways where depending

on the circumstances, there may be restrictions on what alternate free or tolled highways might be

developed within a set geographic area around the PPP highway and/or within a given timeframe.

• Due to the complex agreements associated with a PPP, the required substantive and consistent

administration by the client department to help ensure the contractor continues to perform in

accordance with the original intent of the acquisition.

• Difficulty holding the contractor to the operating and maintenance requirements in the latter years

of the contract. While the contract generally incorporates specific provisions to address hand back

conditions (e.g., third party inspection requirements in the years leading up to hand back and the

requirement to set up maintenance funds if the conditions fail to meet the pre-established condition

requirements).

Negotiating Changes in PPPs

Substantive amendments are rarely made once a PPP has been established and, in some jurisdictions, (such

as the European Union where PPPs are highly regulated) they are not allowed. For discrete (relatively minor)

changes, the price adjustment is generally negotiated based on the estimated cost of the change together

with a profit commensurate with the risk associated with the change in scope.

Use of Value-Based Pricing in Non-Competitive Acquisitions

While value-based pricing can in principle be used for non-competitive acquisitions, they are rare.

This is due, in part, to the size and scale of PPP projects (generally in excess of $100 million) and, in part,

because of the challenge of confirming that the contractor’s proposed price is appropriate. They are

sometimes seen as an outcome of an unsolicited proposal provided to the government by a contractor.

In the rare instances where a PPP is pursued on a non-competitive basis, the reasonableness of the

contractor’s proposed price could be assessed through comparison to the cost the government would incur

if it were to advance the work using traditional procurement models (such as a design bid build). This analysis

is commonly known as a public sector comparator and is often developed as part of the early planning for

the project to confirm the procurement strategy and again following the assessment of PPP proposals to

confirm the successful bid generate value.

To develop a public sector comparator, an independent team of subject matter experts would be established

to develop an estimate of the net cash flow (including a valuation of risks) that the government would expect

to generate over the proposed contract term if it were to take on the project itself. If the public sector estimate

is higher than the contractor’s proposed price, then the conclusion is that the price provides value to the

government.

Example of PPP using Value-Based Pricing

PPPs that transfer revenue risk are often used to develop new transportation facilities, such as new highways.

In exchange for the exclusive right to charge a toll for use of the highway, the contractor is responsible for

developing, operating and maintaining the road, any associated structures and tolling systems and services.

The price would be determined based on the anticipated cash inflow (i.e., toll revenue) less than the

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anticipated cash outflows (i.e., cost to design, build, finance and operate the highway and collect tolls) over

the term of the contract. If the anticipated inflows are less than the anticipated outflows, a subsidy is paid by

the government to the contractor. If the anticipated inflows are greater than the anticipated outflows, the

contractor makes a payment to the government. Some PPP highway procurements have generated billions

of dollars in payments from the contractor to the government for the right to develop highways in heavily

travelled corridors.

C. Supplementary Methods to Cost-Based Pricing

The remainder of this paper describes two supplementary pricing methods that could be used in combination

with a cost-based price in non-competitive acquisitions.

• Performance-based pricing, which imposes an adjustment framework whereby the contractor’s

payment is increased or reduced based on performance.

• Flexible pricing, wherein the contractor receives a higher ongoing amount for improved value (e.g.,

delivery of improved performance).

Note that a combination of these pricing methods may be used in a contract. For example, a contract where

a Fixed Price is paid for fulfilling the base requirements (i.e., meeting the statement of requirements), may

incorporate a performance incentive, where the payment amount is tied to added value (i.e., in excess of the

base requirement), rather than the contractor’s costs.

Performance-Based Pricing

Performance-based pricing compensates the contractor for delivering goods or services in excess of a

performance baseline (which is tied to the statement of requirements). Payments are made for the delivery

of specific outcomes based upon an agreed formula. Payment formulas and pricing models for performance-

based contracting vary by contract. The adjustment may incorporate financial and non-financial rewards and

remedies. (For details on these financial and non-financial rewards and remedies, please refer to Annex 5.2.1

Contract Incentives to Encourage and Reward Enhanced Value to Canada and Annex 5.2.2 Measures to

Manage Contractor Non-Compliance or Unacceptable Behavior) Performance-based pricing may or may not

build upon the underlying cost.

In establishing a performance-based payment, a performance baseline, against which the contractor can be

measured, should be formulated before contract initiation and agreed between Canada and the contractor.

Key considerations in establishing a performance measurement framework are discussed in Annex 5.2.1,

Contract Incentives to Encourage and Reward Enhanced Value to Canada.

Leading practice suggests that a performance framework can encourage innovation in service delivery and

promote a culture of continuous improvement. In the United Kingdom, for example, the Harrier and Tornado

aircraft fleet availability contracts are successful examples of performance-based contracting. The National

Audit Office reported that repair and maintenance costs decreased by a total of £1.4 billion over six years,

while meeting availability requirements largely due to the use of performance-based pricing.

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Example 1 Performance-Based Price Payment Calculation

G. Contractor’s payment for baseline performance

$100,000

H. Variable amount (for every 10 km/hr variance from target speed)

$1,000

I. Target speed as per the statement of requirements

500 km/hr

J. Actual speed for aircraft supplied by contractor

600 km/hr

K. Payment adjustment (= (D-C)/10 x B or (600 – 500)/10 x $1,000)

$10,000

L. Total payment (= A + E or $100,000 + $10,000)

$110,000

In Example 1 the variable payment is consistent throughout the range of potential performance. In practice

the payment calculation might be more complex. For example, while the first 10 km/hr in additional speed

might be tied to a payment of $1,000 as it may enable the aircraft to go materially faster than other aircraft.

In contrast the payment for achieving 610 km/hr rather than 600 km/hr. may be much lower because it does

not materially improve the functionality of the aircraft or may be assigned a value of 0 if it is too fast for

supporting equipment (e.g., software outside of the plane used to monitor and track activity).

Additional resources may be required of Canada to maintain regular measurement of the contractor’s

performance against an agreed baseline, and to validate the underlying data on which the measurements

are to be completed.

Flexible Pricing

Flexible pricing is a relatively new pricing method, which recognizes that there may be advantages to

adjusting the price of a contractor’s goods or services over time. Flexible pricing thus allows a contractor to

propose a price increase to realign the payment based on the substantiated value, generally to the client

department. The proposed price is tied to substantive evidence of incremental value above the requirements

by an independent authority. In establishing a flexible pricing arrangement, the contracting officer needs to

ensure sufficient budget is available to accommodate any potential price adjustments.

Flexible pricing does not reduce the price if the contractor’s product or service delivers less value for money

because flexible pricing is intended to incent innovation. Accordingly, a negative price adjustment is not

included—even if value to Canada is found to be lower than originally calculated. Ultimately, this pricing

method is intended to encourage innovation in situations when the full value of the product or service will not

be clear at the time of contract negotiation or initiation.

In the United Kingdom, for example, flexible pricing has been used for the acquisition of technology-based

outcomes

—when the full breadth of benefits of a technology are unknown and could be better assessed in

the future.

Concerning intellectual property (IP) ownership of a particular technology, the UK Ministry of Defence’s policy states that IP will normally belong to the

contractor generating the IP, in exchange for which the Ministry of Defence will expect the right to disclose and use the IP for UK government purposes.

390 | Page Public Services and Procurement Canada August 2023

A theoretical example where flexible pricing could be applied in a non-competitive acquisition follows:

• A contractor had two products:

o Product A meets the statement of requirements and is based on dated technology, and

o Product B meets the statement of requirements and has the potential to deliver substantive

operating cost savings to the client department because it incorporates new technology which

will enhance operational performance.

• The contractor has offered to provide product A at a price of $100 or product B at a price of $150.

• While the client department is interested in reducing operating cost, it is unwilling to commit to a

higher upfront price because product B’s performance, and the resulting potential to generate

operational savings, is unproven.

• The contractor is confident product B will deliver substantial savings to the client department and

would like to provide product B in order to demonstrate the potential benefits of the product.

• Flexible pricing might be used to find a middle ground that potentially benefits both parties.

Payment might be structured using a base payment (tied to the price for product A) and an

additional payment based on a percentage of the operational cost saving achieved by the

department.

Example 2 Flexible Pricing Calculation

A. Price of product A

$100

B. Client department’s current operating cost

$5,000

C. Contractor’s promised operational savings

20%

D. Negotiated share of actual operational savings to be paid

to the contractor

10%

E. Base payment (equal to the price of product A)

$100

F. Client department’s actual operating cost savings

(measured 1 year after product B is put into use)

15%

G. Actual adjusted fee

(= B x F x D or $5,000 x 15% x 10%)

$75

H. Final payment

(= E + G or $100 + $75)

$175

I. Maximum adjusted fee (= B x C x D or $5,000 x 20% x

10%)

$100

If Product B fails to deliver cost savings, the client department would be no worse off than if it had selected

Product A. On the other hand, if Product B reduces departmental operating costs, the additional payment to

the contractor is much less that the cost savings achieved.

391 | Page Public Services and Procurement Canada August 2023

When to Apply a Supplementary Pricing Method

In selecting an appropriate pricing method, contracting officers should consider the client department’s

acquisition objectives, outcomes, and risks associated with the particular goods or services.

The table below provides high-level guidance regarding the applicability of each pricing method described in

this discussion paper. Note that the table is not comprehensive and is a starting point only for a more

comprehensive consideration of the risks and circumstances inherent in a project.

Exhibit 2 Considerations of Applying Supplemental Pricing

Acquisition

Consideration

Performance-Based Pricing

Flexible Pricing

Clarity and complexity of

requirements, and the

likelihood of scope

changes

• Complex requirements with

substantial chance of change

as work progresses

• Can be appropriate to define

requirements as outcomes that

can be measured, enforced,

and do not change

Anticipated term of

contract

• Works well for procuring goods

and services with moderate to

long contract period because

the longer contract period helps

amortize the resources used to

establish the contract

• Works well for procuring goods

and services with moderate to

long contract period because

the longer contract period

allows time for shifts in the

underlying benefit of the good

and services

Upfront certainty of costs

• Cost estimates are more

reliable because payments by

Canada are based upon an

agreed set of outcomes and

formula

• Cost estimates are more

reliable because contractors

would be less likely to include

risk premium in pricing because

costs could be adjusted

Complexity and

unpredictability of risks

• Can help reduce risk premiums

in the acquisition of products

and services with complex and

unpredictable risks, because

the contractor may be

motivated by the performance

indicators to mitigate certain

risk

• Risk profiles vary by the terms

of the contract and concerned

goods and service

Characteristics of the

product or service

• Relevant technology may be

mature or proven, or presents

substantial opportunity for

innovation

• Relevant technology is

changing rapidly creating

substantial opportunity for

innovation

Potential suppliers’

technical and financial

capabilities

• Works well when suppliers are

entrepreneurial and relatively

innovative

• Works well when suppliers are

entrepreneurial and relatively

innovative

392 | Page Public Services and Procurement Canada August 2023

ANNEX 5.4.2 DISCUSSION PAPER – BASELINE PROFIT METHODOLOGY FOR

CONSIDERATION

The purpose of this annex is to explore the recommendation of adopting Baseline Profit Methodology as a

method for setting profit in negotiated procurements in Canada. This includes defining what this methodology

is, analysis of their advantages and disadvantages and recommendation surrounding the consideration of

Baseline Profit Methodology.

Although this methodology is recommended for consideration, full implementation of it is not feasible at this

time. A transitional approach where further data collection, analysis and refinement of the process is required

to determine whether or not the benefits of the methodology would bring better value than the current

methodology applied.

What is the Baseline Profit Methodology?

A baseline profit methodology relies on average industry profit and earnings data to establish a base for the

development of profit in a contract. The methodology under consideration is similar to that used for single

source qualifying defence contract in the United Kingdom (UK).

The baseline profit rate methodology would likely consist of baseline profit rates that are informed by the

average industry profit and earnings data and adjustments would then be made to this baseline for contract

specific risks such as Capital Employed and Contractual Risk.

Baseline Profit Illustration

Baseline

Profit Rate

(%)

Adjustment

for Capital

Employed

(%)

Adjustment

for

Contract

Risk (%)

Total Profit

Rate for

Contract

Please Note

A Baseline Profit Methodology is recommended for consideration in Canada, but will require further

feasibility analysis, consultation, a plan for a transitional approach and a trial period before full

adoption is considered.

Feedback from the procurement community, internal and external to the government, is important.

Please share your thoughts on this by providing any questions, comments, and feedback to the

Pricing and Professional Accounting Practices Group (TPSGC.padgamtp-appbipm.PWGSC@tpsgc-

pwgsc.gc.ca).

393 | Page Public Services and Procurement Canada August 2023

What are the Benefits of the Baseline Profit Methodology?

• Baseline profit rates would provide profit development base that is representative of Industry

earnings;

• The Baseline methodology would likely enhance consistency of application, as the variable factors

have a smaller impact; and

• Baseline profit rates are simple, clear and transparent for all stakeholders.

Key Concerns of the Baseline Profit Methodology

• Current methodology is well understood and highly comparable to benchmarked data with other

jurisdictions;

• Complexity concerns related to introduction of a new profit determination formula: The baseline

profit methodology in the UK, applied on a sample of contracts did not result in a significant

difference from the current methodology applied in Canada. Potentially, minimal benefit in

modifying the methodology; and

• Timeline and availability concerns related to external data acquisition, consolidation and review.

How is Canada considering implementing Baseline Profit Rates?

PSPC is considering the application of average industry financial earnings data to determine baseline profit

levels as either:

• A replacement factor within the current profit determination process; or

• A benchmarking factor available for the procurement community to assess reasonability.

Implementation considerations are contingent on PSPC’s ability to acquire relevant earnings data on a

regular basis. The ability to acquire relevant earnings data will allow for the availability of benchmarking

data for contracting officers to consult for the profit determination process and/or the implementation of the

baseline profit methodology itself.

394 | Page Public Services and Procurement Canada August 2023

ANNEX 6: TOOLS AND TEMPLATES

ANNEX 6.1 PROFIT DETERMINATION TEMPLATE

The Profit Determination Template below includes instructions and schedules to support the determination

of profit in accordance with the guidance as detailed in Section 5.2 (Profit Principles).

Please see the Profit Determination Template on BuyandSell.gc.ca at the following link: Profit

Determination Template

ANNEX 6.2 APPLICABLE RATES FOR PROFIT DETERMINATION TABLE

Please see the applicable rates for profit determination table on BuyandSell.gc.ca at the following link:

Applicable Rates for Profit Determination Table

ANNEX 6.3 CONTRACTUAL RISK ASSESSMENT TOOL

The following is the Contractual Risk Assessment Tool which provides key questions to support a

practitioner in the assessment of the level (likelihood and impact) of contractual risk in a contract.

Please see the Contractual Risk Assessment Tool on BuyandSell.gc.ca at the following link: Contractual

Risk Assessment Tool

395 | Page Public Services and Procurement Canada August 2023

ANNEX 7: GLOSSARY

Alternative pricing strategies

Method of buying goods and services that is not conventional because the price does not rely on the cost to

the contractor of fulfilling the statement of requirements.

Benchmarking

A management technique that consists of dynamically comparing the performance of goods, services,

processes or activities with the corresponding performance of other entities (competitors or not, of the same

group or not), recognized as being among the best.

Capital intensity

Measure of the amount of fixed capital investment required by the contractor to produce a good or service.

Capital lease

A lease that, from the point of view of the lessee, transfers substantially all the benefit and risk associated

with ownership of the leased property from the lessor to the lessee. Typically, a lessee would record the

underlying asset (property) as though it owns/purchased the asset.

Commercial pricing

Price of goods and services sold to the general public or entities for non-government purposes; price in

ordinary trade between buyers and sellers free of bargain.

Contractual risk

Risk of the possibility of financial loss, delay, or non-performance related to contract specific factors.

Contractual risk assessment tool

A summary tool of the guidance designed to support the assessment of contractual risk in a procurement in

order to establish an appropriate contract risk profit rate.

Cost

Cost is the asset laid down cost plus amount of consideration given up to, construct, develop, or better an

item of property, plant and equipment including installing it at the location and in the condition necessary for

its intended use less any applicable portion of any income, rebate, allowance, or any other credit relating to

any applicable direct or indirect cost, received by or accruing to the contractor and related capitalized

borrowing costs included in the cost of the asset. Costs as defined in Contract Cost Principles 1031-2 and

by the costing standard do not include estimated costs of dismantling and removing the item and restoring

the site on which it is located.

Cost Accounting Practices Submission (CAP Submission)

Formal disclosure of a contractor's cost accounting practices including the identification of direct and indirect

costs and disclosure of methodologies used to allocate indirect. costs.

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Cost-based pricing

Price based on costs incurred, cost estimates or actuals, or a combination of these factors with the possible

additional of a profit margin calculated in accordance with the Profit Principles.

Costing Standard

Provides supplementary guidance that includes explanations of Canada's expectations and core costing

principles (Attributable, Appropriate, and Reasonable) in determining the acceptability of a cost and the

amount claimed.

1. Attributable. A cost is attributable if it is incurred directly or indirectly for the fulfilment of the contract,

and it is necessary to fulfil the requirements of that contract.

2. Appropriate. A cost is appropriate if it, by its character and nature, represents a cost that is expected

to be incurred in the conduct of delivering the contract.

3. Reasonable. A cost is reasonable if by its nature it does not exceed what might be expected to be

incurred in the normal delivery of the contract in question, whether under a competitive or non-

competitive procurement.

4. Contract cost acceptability criteria: To be acceptable, a contract cost must meet the criteria of

Attributable, Appropriate, and Reasonable as defined in the Costing Standard.

Fixed capital employed

Amount of capital or money invested during the performance of a contract for assets of a durable nature that

are used over a long period. For example, equipment and facilities.

1. Fixed capital employed tier 1 approach. The simplified approach to determine return on fixed capital

employed for all contracts where the total estimated or acceptable contract costs are less than or

equal to $1,000,000.

2. Fixed capital employed tier 2 approach. The simplified approach to determine return on fixed capital

employed for contracts where the total estimated or acceptable costs are less than or equal to

$20,000,000, and contracts with lower fixed capital intensity level.

3. Fixed capital employed tier 3 approach. The approach to determine return on fixed capital employed

for contracts where the total estimated or acceptable contract costs are greater than $1,000,000 and

contracts that do not meet the criterial for fixed capital employed Tier 1 and Tier 2 or for Tier 1 or Tier

2 contracts where a contractor requests the full Tier 3 determination.

General business risk

Risks associated with the contractor’s industry environment and its management of resources and inputs in

daily operations that could compromise the ability of the entity to achieve goals, execute strategies, or setting

inappropriate goals and strategies.

Incentive remuneration profit sharing plan

A plan designed to link the performance of employees to the achievement of organizational objectives,

through the provision of additional compensation from the distribution of a defined portion of the

organization's net profit.

Laid-down cost

The cost incurred by a contractor to acquire a specific product. This includes the invoice price (less trade

discounts), charged to the contractor plus any applicable charges for incoming transportation, exchange,

customs duties and brokerage charges, but excludes sales tax (i.e., Goods and Services Tax and the

Harmonized Sales Tax.)

397 | Page Public Services and Procurement Canada August 2023

Lease

1. (The Chartered Professional Accountants (CPA) Canada.) This refers to the conveyance, by a lessor

to a lessee, of the right to use a tangible asset, usually for a specified period of time in return for rent.

2. Capital lease. A lease that, from the point of view of the lessee, transfers substantially all the benefits

and risks associated with ownership of the leased property from the lessor to the lessee. Typically, a

lessee would record the underlying asset (property) as though it owns/purchased the asset.

3. Operating lease. This refers to a lease in which the lessor does not transfer substantially all the benefits

and risks associated with ownership of the leased property.

Market based pricing

Price assessed and established based on the market when there exists sufficient competition to obtain more

than one competitive bid and price comparison.

Mobile repair party

An individual, or group of individuals performing work away from the contractor's plant, generally at the client’s

location(s).

Operating lease

The lessor does not transfer substantially all the benefits and risks associated with ownership of the leased

property.

Pricing Principles

Principles applied to all scenarios in which price negotiations are required and involve the establishment of

a cost-base, profit levels and price.

Pricing strategy

Method or plan used for the assessment of pricing considerations, options and potential risks.

Transfer pricing

The prices set for goods or services that are exchanged among related parties (affiliated or entities under

common control, joint control, or significant influence). The “Transfer Price” is the price at which a supplier

sells its goods or services to a related party buyer.

Working capital employed

Measures the level of current and short-term financial commitments from day-to-day activities in the

performance of the contract that would be required by the contractor.

1. Working capital employed tier 1 approach. The simplified approach to determine return on working

capital employed for all contracts where the total estimated or acceptable contract costs are less

than or equal to $1,000,000.

2. Working capital employed tier 2 approach. The approach to determine return on working capital

employed for contracts where the total estimated or acceptable costs must be greater than

$1,000,000 or for working capital employed Tier 1 contractors where a contractor requests a Tier 2

determination.