Part V in a Series: Cost Analysis and Cost Realism and Their Expanding Roles in Contract Pricing. government contracting

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1 Part V in a Series: Cost Analysis and Cost Realism and Their Expanding Roles in Contract Pricing 1

2 Your instructor... Bill Walter, CPA Managing Director DHG GovCon Advisory 1410 Spring Hill Road, Suite 500 Tysons, VA (703)

3 The Cost and Price AnalysisSeries May 18 - Part I: Price Analysis and Fair and Reasonable Pricing June 15 - Part II: Commercial Item Pricing and Challenges in the Current Environment September 21 - Part III: Direct and Indirect Costs and a Little Thing Called G&A! October 19 - Part IV: Profit Yes, contractors are allowed to have some!? November 16 Part V - Cost Analysis and Cost Realism and Their Expanding Roles in Contract Pricing December 21 - Part VI: Defective Pricing Hazards & Defenses 3

4 A Quick Recap 4

5 Price Analysis Price analysis is the process of examining and evaluating a proposed price without evaluating its separate cost elements and proposed profit Required for every procurement Process to determine that price is fair and reasonable Contract pricing is the function that gathers, assimilates, evaluates and, in establishing objectives, brings to bear all the skills and techniques needed to shape the eventual pricing arrangement 5

6 Commercial Item Pricing Streamlined procurement methods Market Research is key No CAS No TINA DoD Challenges 6

7 Cost Analysis 7

8 Cost Analysis Definition Cost analysis is the review and evaluation of any separate cost elements and profit or fee in an offeror s or contractor s proposal, as needed to: determine a fair and reasonable price to determine cost realism And the application of judgment to determine how well the proposed costs represent what the cost of the contract should be, assuming reasonable economy and efficiency 8

9 When to Perform Cost Analysis Perform cost analysis in either of the following situations: When the Truth in Negotiations Act (TINA) applies and the offeror is required to submit cost or pricing data. In this situation, the offeror must provide complete, accurate, and current data to support all proposed costs and profit/fee. When you require an offeror to submit cost information other than cost or pricing data to support your decision on price reasonableness or cost realism. Require only the information necessary to determine price reasonableness or cost realism! 9

10 What is a Cost Proposal? 10

11 What is Cost? Direct Cost Direct Labor Direct Material Other Direct Costs Subcontracts Indirect Cost Overhead G&A Cost Cost of Money 11

12 Cost Allowability FAR Reasonableness Allocability Standards of the CASB or GAAP Terms of the Contract Cost Principle limitations 12

13 Reasonableness FAR Definition A cost is reasonable if, in its nature and amount, it does not exceed that which would be incurred by a prudent person in the conduct of a competitive business. Contractor has burden of proving reasonableness Normal concepts of reasonableness don t apply 13

14 Allocability FAR Definition Is incurred specifically for the contract Benefits both the contract and other work and can be reasonably distributed Is necessary for overall operation of the business Often draws improper disallowances Titles such as Commercial Selling lead to misunderstandings 14

15 Credits - FAR Income, rebate, allowance or other credit Cost reduction or cash refund Special rules on pension adjustments and asset reversions 15

16 Cost Principles - Personnel Compensation for Personal Services Employee Morale, Health, Welfare, Food Service, and Dormitory Costs and Credits Costs of Alcoholic Beverages Travel Costs Entertainment Costs Relocation Costs Trade, Business, Technical and Professional Activity Costs Training and Education Costs 16

17 Cost Principles - Other Contributions or Donations Fines and Penalties and Mischarging Costs Interest and Other Financial Costs Lobbying & Political Activity Costs Professional and Consultant Service Costs Recruitment Costs Taxes Termination Costs Costs Related to Legal and Other Proceedings 17

18 Accounting for Unallowable Costs - FAR Expressly unallowable costs or mutually agreed to be unallowable costs shall be identified and excluded from and billing, claim or proposal. Directly associated costs as well Contractor has a responsibility to account for unallowable costs CAS 405 incorporated by reference Unallowable direct costs must absorb their prorata share of indirect costs 18

19 Cost Analysis Techniques 19

20 Cost Analysis Techniques and Procedures Cost analysis includes the following techniques and procedures as appropriate: Verify cost or pricing data or information other than cost or pricing data. Evaluate cost elements, including: The necessity for and reasonableness of proposed costs, including allowances for contingencies; Projections of the offeror's cost trends, on the basis of current and historical cost or pricing data or information other than cost or pricing data; Reasonableness of estimates generated by appropriately calibrated and validated parametric models or Cost Estimating Relationships; and The application of audited or negotiated indirect cost rates, labor rates, cost of money factors, and other factors. 20

21 Cost Analysis Techniques.. II Evaluate the effect of the offeror's current practices on future costs. Ensure that the effects of inefficient or uneconomical past practices are not projected into the future. In pricing production of recently developed complex equipment, perform a trend analysis of basic labor and materials even in periods of relative price stability. Compare costs proposed by the offeror for individual cost elements with: Actual costs previously incurred by the offeror; Previous cost estimates for the same or similar items; Other cost estimates received in response to the Government's request; Independent Government cost estimates by technical personnel; and Forecasts of planned expenditures. 21

22 Analyzing Direct Material Identify and evaluate the methodology used by the offeror to estimate direct material cost Identify any proposed direct material that does not appear necessary to the contract effort Identify any proposed direct material that should be classified as an indirect cost Identify any proposed direct material costs that merit special attention because of high-value or other reasons Assure that preliminary concerns about material cost estimates are well documented 22

23 Analyzing Direct Labor Identify and evaluate the methodology used by the offeror to estimate direct labor cost. Identify any proposed direct labor cost that does not appear reasonable. Identify any proposed direct labor cost that should be classified as an indirect cost. Identify any proposed direct labor cost that merits special attention because of high value or other reasons. Assure that preliminary concerns about direct labor cost estimates are well documented. 23

24 Analyzing Other Direct Costs Identify any proposed other direct cost that apparently should be classified as an indirect cost. Identify any proposed other direct cost that appears to duplicate another proposed direct cost. Identify any proposed other direct cost that does not appear reasonable. Identify any proposed other direct cost that merits special attention because of high value or other reasons. Assure that concerns about other direct cost estimates are well documented. 24

25 Analyzing Indirect Rates Steps for Indirect Cost Rate Analysis. There are six general steps that you should follow as you analyze indirect cost rate estimates: Develop an analysis plan. Identify unallowable costs. Analyze the indirect cost allocation base estimate. Convert the indirect cost allocation base and the indirect cost pool to constant-year dollars. Analyze the base/pool relationship. Develop and document your pricing position. 25

26 Analyzing FCCM For each accounting period, the factor-development process follows a 7-step procedure: 1. Determine the appropriate cost of money rate. 2. Accumulate net book value of business-unit facilities capital. 3. Allocate facilities capital net book value to indirect cost pools. 4. Sum facilities capital net book value for each pool. 5. Calculate the facilities capital cost of money for each pool. 6. Identify the appropriate allocation base for each facilities capital cost of money pool. 7. Calculate facility cost of money factors. 26

27 Cost Analysis Techniques... III Verify that the offeror's cost submissions are in accordance with the contract cost principles and procedures in FAR Part 31 and any applicable Cost Accounting Standards. Determine whether any cost or pricing data necessary to make the contractor's proposal accurate, complete, and current have not been either submitted or identified in writing by the contractor. If there are such data: Attempt to obtain the data and negotiate using the data obtained, or Make satisfactory allowance for the incomplete data. Analyze the results of any make-or-buy program reviews, in evaluating subcontract costs. 27

28 Cost Analysis Sources Statement of Work and Specifications Request for Proposal Program History Independent Government Estimate 28

29 Relevancy of Data - Offeror Proposals Technical Proposal Identifies methods proposed to satisfy requirements Identifies resources necessary to meet requirements No cost data here! Cost or Business Proposal Quantifies resource requirements Should agree with Technical proposal for quantity requirements 29

30 Relevancy of Data - Government Reviews Technical Reviews Reviews the technical proposal to ensure program requirements can be satisfied Compares to Independent Government Estimate Government position on Proposed Savings Financial Audits Review general rates and factors System reviews Not a comprehensive cost analysis 30

31 Relevancy of Other Cost Analysis Data Market Research Previous Prices Paid Price Index Values Historical Costs Economic Forecasts Cost Estimating Relationships Improvement Curves 31

32 Profit/Fee Analysis 32

33 Profit/Fee Analysis Statutory Limitations General Factors Affecting Profit or Fee Weighted Guidelines Profit Analysis 33

34 Profit Motivation The underlying assumption behind Government structured approaches to profit/fee analysis is the belief that contractors are motivated by profit/fee. Structured approaches provide a discipline for ensuring that all relevant factors are considered in developing Government profit/fee negotiation objectives. It is in the Government's best interest to offer contractor's opportunities for financial rewards sufficient to: Stimulate efficient contract performance; Attract the best capabilities of qualified large and small business concerns to Government contracts; and Maintain a viable industrial base to meet public needs. 34

35 Inconsistent Practices If the Government is to use profit/fee to motivate contractor performance and achieve the above goals, practices primarily intended to reduce profit/fee or diminish the impact of profit/fee analysis are not in the Government's best interest. The following are practices that are inconsistent with Government profit/fee goals: Negotiations aimed at reducing prices by reducing profit/fee without proper consideration of the profit function. Negotiation of extremely low profits/fees. Use of historical average profit/fee rates without regard to the unique circumstances of the immediate negotiation. Automatically applying predetermined profit/fee percentages without regard to the unique circumstances of the immediate negotiation. 35

36 Statutory Limitations Cost Plus Fixed Fee Experimental or Developmental 15% All other CPFF 10% 36

37 Cost Realism 37

38 The Process What is Cost Realism What Cost Realism is Not Other Types of Reviews Price Analysis Cost Analysis Should Cost Analysis 38

39 Cost Realism is... Definition - Cost realism analysis is the process of independently reviewing and evaluating specific elements of each offeror's proposed cost estimate to determine whether the estimated proposed cost elements: Are realistic for the work to be performed; Reflect a clear understanding of the requirements; and Are consistent with the unique methods of performance and materials described in the offeror's technical proposal. When to Use Cost Realism Analysis All cost-reimbursement contract offers to determine the probable cost of contract performance may be used in evaluating competitive offers for fixed-price incentive contracts or, in exceptional cases, on other fixedprice contracts. 39

40 Cost Realism is NOT... Determination of a Fair and Reasonable Price A Detailed Review and Evaluation of the Separate Elements of Cost and Profit through Verification of the Data to Determine the Necessity for and the Reasonableness of the Costs The Bottoms-Up Review of the Methods, Processes and Associated Costs of an Offeror s Estimate for the Purpose of Determining the Most Efficient and Economical Approach to Meeting Contract Requirements 40

41 Price Realism -- Most Important Factor Judgement 41

42 Cost Realism Applied Objective Getting Started Preliminary Assessment Global Comparisons Discrete Comparisons Final Adjustments 42

43 Objective of a Cost Realism Analysis The objective of cost realism is to determine the most probable cost to the government based on the contract requirements and to ensure that the work proposed by the offeror is realistic and is based on a clear understanding of the requirements. 43

44 Preliminary Assessment Do Proposed Costs Reflect An Understanding Of The Requirements? Are Proposed Costs Consistent With The Various Elements Of The Technical Proposal? Is Contractor Likely To Complete The Contract Satisfactorily On Time At The Proposed Price? Does The Proposal Contain A Work Breakdown Schedule (WBS)? Does WBS Reflect Cost By WBS Element? Does WBS Satisfy The Contract Requirements? 44

45 Preliminary Assessment How Do The Overall Costs Appear Relative To The Government s Independent Estimate? Based Upon The Technical Review And The Entire Proposal, Are There Any Concerns That The Offeror Can Perform On The Contract At The Price Offered? The Preliminary Assessment Should Be Documented To Prove Or Disprove The Original Assessment After Further Inquiry. 45

46 Global Comparisons Are The Costs Proposed In A Manner Consistent With Disclosed Practices? Are There Any Accounting Issues Which Are Unresolved At The Proposal Date Which Might Impact Costs? Do Any Costs Appear To Represent New Accounting Practices? 46

47 Discrete Comparisons - Direct Labor Productive Man-year Used? Basis For Labor Rates? Annual Escalation Rate And Method? Basis For Labor Staffing And Mix? Use Of Overtime Or Uncompensated Overtime? Labor Rates Consistent With Area? Labor Rates Consistent With Staff loading? 47

48 Discrete Comparisons - Direct Labor [Continued] Labor Loading Consistent With Needed Experience, Education, & Expertise? Use Of Exempt/Non-exempt Staff? Use Of Part-time Staff? 48

49 Discrete Comparisons - Material and Subcontract Cost Purchasing System Approved For Government Contracting Purposes? Bill Of Material Appropriate? Are The Quantities Of Material Required For The Work? Evidence Of Make-or-buy Analysis? 49

50 Discrete Comparisons - Material and Subcontract Cost Any Material Or Subcontract Issues Regarding Allocation Of Costs? Does Proposed Method For Material/Subcontract Allocation Differ From Stated Accounting Practices? Has Offeror Performed Price Analysis Or Cost Analysis On Subcontract Costs? What Decrement Factor Was Employed By The Offeror On Purchased Parts? What Collateral Costs Are Associated With The Acquisition Of Materials? 50

51 Discrete Comparisons - Material and Subcontract Cost Have Scrap And Rework Factors Been Incorporated Into The Proposed Costs? Any Improvement Curves Used? If The Proposed Effort Is Different Than Prior Performance, Were Any Complexity Factors Added And Are They Adequately Explained? 51

52 Discrete Comparisons - Other Direct Costs Purchasing System Approved? Will ODC s Have Overhead/G&A Applied? ODC Costs Broken Down In Sufficient Detail In The Proposal? Nature Of Travel Costs In Proposal? Are Consultants Included In The Effort Needed And At Reasonable Costs? If Special Tooling Or Equipment Is Proposed, Is The Rationale Stated And Supported in the Technical Proposal? 52

53 Discrete Comparisons - Other Direct Costs Is The Treatment Of Special Tooling Or Equipment Consistent With The Stated Practices of the Offeror? Is The Extent And Amount Of Special Tooling Or Equipment Correct For The Contract Requirements? Are Any Costs Quoted As Other Direct Costs Which Historically Have Been Treated As Indirect? Are Any Costs For ODC s Duplicated By Any Other Direct Effort Without Adequate Explanation? 53

54 Discrete Comparisons - Indirect Costs Are There Any Forward Pricing Rate Agreements (FPRA) In Effect? Are Indirect Rates Quoted Consistent With FPRA? Are There Any Indirect Rates Quoted Not Listed On FPRA? Does The Cost Proposal Explain Indirect Rates Were Used? Are Indirect Costs Applied To Direct Costs Applied In Manner Consistent With Stated Practices? 54

55 Discrete Comparisons - Overhead Costs Is The Composition Of Fringe Benefits Consistent With Past Practices? Are Fringe Benefits Applied To SCA Labor Categories? If Man-loading Schedules Take Into Account Paid Absences, Are The Fringe Benefits Applied to the Proposal In Concert With Such Schedules? Is The Fringe Benefit Plan Consistent With Compensation/Pension Plans of the Offeror? 55

56 Discrete Comparisons - Overhead Costs Are There Any Unusual Overhead Costs Included In The Proposal Which Should Be Charged Direct To The Effort? Was The Basis Of The Overhead Rate Applied To The Effort Adequately Explained And Consistent With Trends? 56

57 Discrete Comparisons - G&A Expenses Is The G&A Rate Consistent With Past Practices And Trends? Was The Basis For The Application Of The G&A Rate Adequately Explained? Was The Rationale For Any Buy-in Rate Adequately Explained? 57

58 Discrete Comparisons - Proposal Elements Does The Cost Proposal Track With Both Technical And Management Proposals With Respect To: The Level Of Effort Required; The Resources Of Time, Personnel, Equipment; And, The Ability To Perform? Does The Technical Proposal Track To The Offeror s Cost Proposal As To The Cost of Performance? 58

59 Discrete Comparisons - Proposal Elements Are Any Apparent Cost Discrepancies Resulting From the Technical Or Management Proposals Adequately Explained And Cross-Referenced? Is The Cost Proposal Cross-Referenced To The Technical And/or Management Proposals? Is The WBS In The Technical Proposal Costed By Major Element In The Cost Proposal? 59

60 Discrete Comparisons - Proposal Comparison Does The Technical Proposal Track To The Government Estimate And The Government Technical Review As To The Level of Effort Required And The Resources Needed To Perform The Effort? Does The Cost Proposal Track To The Government Estimate And To Any Audit Review of Proposed Costs? Are Additional Explanations Required? 60

61 Summarizing the Effort At The Completion Of Your Analysis, Document Your Findings. Highlight Areas Of Apparent Cost Discrepancies - Either High Or Low, And The Basis For Those Concerns. Review Appropriate Concerns With Your Team. Prepare For The Final Steps. 61

62 Final Steps Prepare a report for the Contracting Officer. Identify Independent Government Estimate Contractors Proposed Cost Government Evaluated Cost Be Prepared To Provide Copies Of All Your Workpapers And Documentation To Assist The Contracting Officer. Be Prepared for Protest 62

63 Questions & Answers 63