When taking a class on the Cost Accounting Standards (CAS) last year, I came across a DCAA rule that made perfect sense to the auditors, but left some of the contracting officers scratching their heads. The rule deals with how to calculate the cost impact of a CAS noncompliance or accounting change on a cost-plus-award-fee (CPAF) contract.
Chapter 8 of the DCAA Contract Audit Manual (CAM) contains guidance on how to evaluate cost impact proposals submitted to the Government as a result of a CAS noncompliance or cost accounting practice change (see CAM 8-503). The CAM outlines a five-step process, which is shown in an abbreviated form below:
Step 1 Compute the increased/decreased cost estimates and/or accumulations for CAS-covered contracts and subcontracts.
Step 2 Combine the increased/decreased cost estimates and/or accumulations within each contract group.
Step 3 Determine the increased/decreased cost paid by the Government for each contract group, using the net impact on cost estimates, accumulations and profits/fees.
Step 4 Determine the increased costs paid by the Government in the aggregate by combining across contract groups the increased/decreased costs paid by the Government for both contract groups, as determined in step 3.
Step 5 Negotiate a settlement with the contractor.
The guidance stated under step 3 for determining increased costs to the Government states the following:
( c ) Profit/fee. Increased costs paid by the Government also occur when more profit/fee was negotiated than would have been contemplated by the contracting parties if the cost estimate had been based on changed or compliant practices. Accounting practice changes and estimating noncompliances affect fixed, target, and incentive fees. Accumulation noncompliances also affect incentive fees. Profit/fee that is not based on estimated costs (e.g., award fees) is generally not subject to adjustment.
There is a similar guidance for determining decreased costs to the Government.
Thus, the assumption is that the Government would have negotiated a lesser fixed, target, or incentive fee but for the contractor's CAS noncompliance or accounting practice change that caused the cost estimate to be higher than it should have been. For example, let's say a contracting officer negotiates a cost-plus-fixed-fee (CPFF) contract for an estimated cost of $1,000,000 and a fixed-fee of $100,000. The contractor completes the contract and is paid the fixed-fee of $100,000. However, it's later discovered that the contractor used a noncompliant estimating practice that caused the cost estimate to be higher than it should have been. If the contractor had used a compliant estimating practice, their estimated cost would have been $900,000. It is assumed that had the contracting officer known this, he/she would have negotiated a fixed-fee of $90,000. This may not be true in some cases, but it is reasonable as a general assumption.
This guidance is based on an interpretation in the FAR Appendix at 9903.306( c ), which states:
"The statutory requirement underlying this interpretation is that the United States not pay increased costs, including a profit enlarged beyond that in the contemplation of the parties to the contract when the contract costs, price, or profit is negotiated, by reason of a contractor's failure to use applicable Cost Accounting Standards, or to follow consistently its cost accounting practices. In making price adjustments under the Cost Accounting Standards clause at 9903.201-4(a) in fixed price or cost reimbursement incentive contracts, or contracts providing for prospective or retroactive price redetermination, the Federal agency shall apply this requirement appropriately in the circumstances."
So far, so good.
What's puzzling is the guidance stated in the last sentence of the above-quoted paragraph from the CAM:
Profit/fee that is not based on estimated costs (e.g., award fees) is generally not subject to adjustment.
Thus, the assumption is that, in the case of CPAF contracts, a contractor's cost estimate has no effect on the amount of award fee that a contractor is eventually paid. To illustrate this, let's say a contracting officer negotiates a CPAF contract with an estimated cost of $1,000,000 and an award fee pool of $100,000 (assume no base fee). After performance, the Government determines that the contractor is entitled to 100% of the available award fee and pays the contractor $100,000 (the typical practice is to determine award fee entitlement by applying the earned percentage to the award fee pool?this is a required practice in DoD). It is later found that the contractor used a noncompliant estimating practice which caused the cost estimate to be higher than it should have been. If the contractor had used a compliant estimating practice, their estimated cost would have been $900,000. In this case, it is assumed that had the contracting officer known this, he/she still would have negotiated an award-fee pool of $100,000. This may be true in some cases, but it is curiously inconsistent with the assumption made when calculating the cost impact on a CPFF contract.
Is it reasonable to assume that a contractor's estimated cost has no affect on the size of the award fee pool that a contracting officer negotiates?
While it is true that a structured approach to developing prenegotiation fee objectives, which relies heavily on prenegotiation cost objectives, is generally not required when developing a prenegotiation award-fee pool objective, it's quite a stretch to assume that prenegotiation cost objectives have no effect on the prenegotiation award fee pool objective (or the size of the award fee pool negotiated). Official guidance on negotiating award fee pools acknowledges that estimated cost can be a consideration. The Air Force Material Command Award Fee Guide offers the following guidance for establishing the award fee pool:
There are different methods that can be used to establish the award-fee pool.
The methods listed below are possible approaches:
- Review past acquisition history/experience
- Research current award-fee pools for similar efforts
- Use Weighted Guidelines Method as a reference point
- Establish evaluation criteria and apply a percentage based on risk and importance
- Cash flow analysis
The Navy-Marine Corps Award Fee Guide offers almost identical guidance.
In my experience, as well as that of some of my colleagues, a contract's estimated cost was a significant factor (if not the most significant factor) in negotiating the size of award fee pools in CPAF contracts. I would be surprised if my experience were atypical.
I'd be interested in hearing to what extent my readers consider estimated costs when negotiating an award fee pool for a CPAF contract. Let me know your experience.