Liubov Shvechykova,
Senior Accountant at Audit Invest
Table of Contents
The price of a state defense procurement contract is established not under general rules, but under a specific, wartime legal framework. We examine which resolutions are in force and which are suspended, how to categorize costs, what maximum profit margins can be included in the price, and which expenses are prohibited from inclusion in the prime cost of unmanned systems and electronic warfare equipment.
Regulatory Framework: What Applies and What Is Suspended
The mechanism for calculating and establishing the prime cost of goods, works, and services for the repair of defense goods was approved by Resolution of the Cabinet of Ministers of Ukraine No. 309 of March 17, 2021.
IMPORTANT! For the duration of martial law, provisions regarding the determination of the state contract (agreement) price based on calculation-estimating materials established by the Procedure approved by CMU Resolution No. 309 and the Procedure approved by CMU Resolution No. 363 of March 3, 2021, “Issues of Defense Procurement,” do not apply. The first paragraph of clause 49 of Procedure No. 363 is also suspended.
Accountants should refer to the following list of regulatory legal acts:
Profit Component in Price: Position of the Ministry of Economy
In Letter No. 3302-07/51034-03 dated July 17, 2024, the Ministry of Economy of Ukraine addressed the issue of the profit margin included in state contract (agreement) prices.
1. Resolution No. 335: Contract Price Based on Cost CalculationOn March 20, 2022, Resolution No. 335 was adopted, defining the specifics of forming contract prices based on cost calculations for defense sector needs. At the same time, this resolution stipulated that for the period of martial law, the Procedure approved by CMU Resolution No. 309 is not applied.
KEY TAKEAWAY:
Sub-clause 1 of clause 1 of Resolution No. 335 establishes that the contract price is determined based on cost calculations prepared by the state contractor. At the same time, Resolution No. 335 does not establish a fixed profit rate and contains no conditions capping the profit margin calculated by the contractor when preparing a contract price proposal.
2. Resolution No. 363: Clause 49 and the Profit FormulaResolution No. 309 did not define profit limits. However, the section “Concluding State Contracts (Agreements) under Closed Procurements” of the Procedure approved by CMU Resolution No. 363 dated March 3, 2021, contains clause 49, according to which profit within the price constitutes:
1% of the domestic entity’s expenses on purchasing components (semi-finished products), specialized machinery/equipment, works (services) from other entities + 30% of the remaining costs within the production prime cost of defense goods, works, and services. Taxes and duties are excluded from the profit calculation.
When Resolution No. 335 was adopted, the previously established statutory provisions regulating contractor profit restrictions (approved under Resolution No. 363) were not amended, nor were any new profit caps or regulations introduced.
3. Resolution No. 1275: What Has Been SuspendedFollowing the government’s adoption of Resolution No. 1275 on November 11, 2022, the Procedure approved by Resolution No. 363 remained valid and was not repealed. However, Resolution No. 1275 suspended clauses 64–67 of Procedure No. 363 for the duration of martial law (these rules remained active until amendments to Resolution No. 1275 were enacted, most recently on July 18, 2023).
The Specifics of Defense Procurement during Martial Law, approved by CMU Resolution No. 1275, clarify that a military unit, agency, or institution may also act as a state defense customer if authorized by a primary state defense customer to carry out defense procurements and conclude state contracts.
PLEASE NOTE! Sub-clause 1 of clause 3 of CMU Resolution No. 1275 establishes the non-application of provisions concerning the determination of state contract prices based on calculation-estimating materials.
According to Part 3 of Article 30 of the Law of Ukraine “On Defense Procurement”, the following rules apply when pricing state contracts entered into during martial law:
- The price of a state contract for the supply of goods, performance of works, and provision of services to meet the needs of the security and defense sector includes all expenses, including taxes, duties, and statutory mandatory charges, as well as the contractor’s profit;
- If procurement is performed under a non-competitive procedure or without statutory procurement procedures, the profit level within the contract price cannot exceed the maximum profit margin established by the Cabinet of Ministers of Ukraine at the time the contract is executed;
- If the Cabinet of Ministers of Ukraine has not established a maximum profit margin, the price of goods, works, and services under non-competitive procedures is determined in accordance with the contractor’s proposal, taking into account that contractor’s calculated profit.
Cost of Repair Works for Defense-Related Goods
The prime cost of repair works for defense goods includes costs incurred directly by the state contractor, as well as expenses incurred for work performed by third-party business entities.
The contract price for defense-related goods, works, and services includes all taxes and duties, general production costs, administrative, operational, and other expenses related to production and performance, as well as the contractor’s profit (supplier fee).
Repair cost calculations are compiled based on technical defect assessment findings conducted when the defense item is admitted for repair.
Cost Calculation Items for Repairs:
Expenses are grouped into the following cost calculation categories:
LIABILITY:
The state contractor bears full legal liability for the calculation accuracy, cost justification by item, and the validity of all supporting documents. Detailed cost itemization forms are determined by the state customer and provided to state contractors.
Cost of Unmanned Systems, EW Equipment, and Active Countermeasure Systems
The costing mechanisms for unmanned systems, electronic warfare (EW) equipment, and active countermeasure systems are governed by CMU Resolution No. 256 of March 24, 2023, and CMU Resolution No. 1275 of November 11, 2022.
Price Calculation and Maximum Profit Margin
According to clause 8 of Resolution No. 256 and clause 5 of Resolution No. 1275, domestic contractors negotiating a defense contract for the manufacture and supply of unmanned systems must provide the defense customer with a price calculation in accordance with Annex 1.
MAXIMUM PROFIT MARGIN — 25%:The contractor’s profit margin in the contract price may not exceed 25 percent of the production prime cost of the goods, works, and services. Statutory taxes and duties are excluded from the profit calculation base. The contractor bears full responsibility for the accuracy of the calculation. When procuring an individual component of an unmanned system, clause 2 of Annex 1 does not apply.
Expenses EXCLUDED from the Price Calculation of UAVs and EW
Under clause 9 of Resolution No. 256, price calculations include all taxes, duties, and general manufacturing, administrative, operational, and other expenses directly related to producing unmanned systems, except for the following non-allowable expenses:
- Organizational expenses, annual general meeting expenses, representation and entertainment costs, and trade fair/exhibition costs;
- Business travel expenses of administrative management staff that are not directly related to contract execution or operational oversight of the contract;
- Property insurance costs and fees for professional services (legal, audit, asset valuation, etc.) that are not required by law or contractual obligations;
- Scrap and waste costs (excluding technically unavoidable scrap and the costs of rectifying such unavoidable scrap);
- Work-in-progress shortages, as well as inventory shortages and spoilage within production workshops (unless contractually agreed otherwise);
- Downtime and idle-time payments;
- Bad debt write-offs and allowances for doubtful accounts;
- Inventory write-downs;
- Recognized fines, penalties, and contractual forfeits;
- Sales commissions paid to sales agents, brokers, or internal marketing/distribution personnel;
- Advertising and market research (marketing) expenditures;
- R&D expenses unrelated to the state contract or incurred prior to contract execution, unless specifically provided for by the contract;
- Losses from operating non-production social amenities (excluding reasonable maintenance costs for facilities on contractor premises required by law, such as first-aid stations);
- Fees for forensic/expert assessment of estimated drone/EW costs by specialized expert bodies under this Procedure.
ADVICE FOR ACCOUNTANTS:
It is best practice to formally record this list of non-allowable expenses within your accounting policy and cost calculation methodology using dedicated cost centers or sub-accounts.
What the Contractor Needs to Consider:
Specific Cabinet of Ministers resolutions and wartime rules apply during martial law.
For unmanned systems, EW equipment, and active countermeasures, the maximum profit margin is 25% of the production prime cost. For repair services of defense goods, the formula is 1% on acquired components and 30% on remaining production costs.
The contractor is fully accountable for the accuracy of calculations, legitimacy of expenses, and document validity.
If you have any questions regarding cost structure, price calculations, or preparing cost-estimating documentation for a state defense contract, contact the specialists at Audit Invest. We will help you navigate regulatory requirements and accurately prepare all required calculations.
