Cost and profit

Cost and profit is the Government of Canada's method for building a negotiated contract price. It is not an abbreviation or a single accounting term. It describes a process: establish a cost base using acceptable incurred costs, cost estimates, or both, then determine a fair profit under the applicable profit principles. Where appropriate, contractual incentives are added as a third component. PSPC Supply Manual Chapter 10 sets out the approach.

The goal of the negotiation is a fair and reasonable price. That price rests on costs calculated under Contract Cost Principles 1031-2, plus a fair profit. The method is also called cost-based pricing, and it applies when normal competition cannot establish the price.

How a negotiated price is built from cost base, profit and incentives

The first step in building a negotiated contract price is establishing the cost base. The cost base can use acceptable incurred costs, cost estimates, or both. Profit is then calculated under the profit principles in the Practitioner's Guide for Procurement Pricing, and the profit policy applies to negotiated contracts for both goods and services, subject to the applicability requirements in that guide (Supply Manual, Chapter 10).

CanadaBuys describes the resulting contract price as having three possible components: the cost base, profit layered onto that base, and contractual incentives (Supply Manual, Chapter 3). Incentives are not always present. They are included only where appropriate.

When PSPC applies cost-based pricing

PSPC generally uses the cost and profit approach in two situations. The first is a non-competitive contract for non-commercial goods or services. The second is a competitive process that produces only one compliant bid, where price negotiation may be required (Supply Manual, Chapter 1).

In both cases there is no competitive field to test the price, so the contracting authority builds and examines the price from its underlying costs. CanadaBuys publishes buyer guidance on cost and profit negotiations that walks buyers through this work.

The standards that define acceptable costs

Acceptable contract costs are determined using a defined set of instruments:

• Contract Cost Principles 1031-2, a Standard Acquisition Clauses and Conditions (SACC) instrument;
• the Costing Standard, under which costs must be attributable, appropriate and reasonable;
• Cost Accounting Practices (CAP) Submission requirements;
• Costing Discussion Papers; and
• the Practitioner's Guide for Procurement Pricing, which contains the profit principles.

Establishing a cost base means assessing whether estimated or actual costs are fair and reasonable under Contract Cost Principles 1031-2 and the Costing Standard criteria. The CanadaBuys page on how to analyze and negotiate costs describes this step. The federal procurement community competency framework also treats cost and profit as covering two skills: using contract cost principles to substantiate or negotiate a price, and applying the policy and guidelines for calculating profit on negotiated contracts (Treasury Board Secretariat).

The Cost and Profit Assurance Program in defence contracting

PSPC also runs a Cost and Profit Assurance Program. It provides auditing and assurance services, primarily for high-risk defence contracts, to assess whether actual procurement costs and pricing are fair and reasonable (PSPC briefing material). Suppliers on defence work should expect their costs to be examined against the same cost principles used in negotiation.

What cost and profit means for a supplier

If you are negotiating a sole-source contract, or you are the only compliant bidder, expect the price discussion to focus on your costs rather than on competing offers. Be ready to support estimated or actual costs under Contract Cost Principles 1031-2, and to show that each cost is attributable, appropriate and reasonable. Keep accounting records that match the Costing Standard and be prepared for Cost Accounting Practices submission requirements. Profit is negotiated separately under the profit principles, so build it into your pricing as its own element and not as a hidden margin inside costs.