What Is the Paid Cost Rule?
Contractors for the federal government typically operate under a predetermined budget negotiated by both parties before work begins. Depending upon the type of budget agreement the contractor has with the government, the contractor may be required to file costs with the government for reimbursement later. The paid cost rule dictates how contractors are compensated for the payments they make to subcontractors.
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Definition
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The paid cost rule requires contractors working for the federal government to pay subcontractors for services rendered before they can ask the federal government for reimbursement. Though the subcontractor expense may be incurred, the contractor must actually give physical cash to the subcontractor before the government recognizes it as an expense. Subcontractor expenses cannot be on the contractor's accounts payable journal if the contractor expects reimbursement. The paid cost rule applies to materials costs and labor expenses.
Example
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The National Aeronautics and Space Administration typically hires contractors to build space vehicles and other equipment for space exploration. For instance, NASA might hire an aerospace engineering firm to develop a rocket capable of launching satellites into space. If the aerospace engineering firm delegates some of the manufacturing process to subcontractors, the aerospace firm must pay all subcontractor fees and expenses out of pocket before NASA will reimburse it. The aerospace firm cannot pass expense invoices from the subcontractor to NASA for payment.
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Implications
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The paid cost rule can have a significant effect on the balance sheets of government contractors during the fiscal period. If a government project requires the use of many subcontractors to complete the job, a contractor may incur a large amount of expenses. A contractor must pay subcontractor expenses before it is reimbursed, which may stretch assets and available cash thin before the government reimburses costs. If a contractor does not have enough cash on hand to pay subcontractor expenses, it might face a serious budget shortfall.
Considerations
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According to the U.S. government, the paid cost rule does not apply to "small entities." This means that small businesses that perform contract work for the government do not follow the paid cost rule. If a small business hires a subcontractor to perform work, the small business can be reimbursed by the government before it pays expenses to the subcontractor.
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References
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