total amount paid or to be paid under the contract on account of subsequent redetermination of the specified subcontracts. This may be done by including in the contract modification a provision substantially as follows:

Promptly upon the establishment of firm prices for each of the subcontracts listed below, the Contractor shall submit, in such form and detail as the Contracting Officer may reasonably require, a statement of costs incurred in the performance of such subcontract and the firm price established therefor. Thereupon, notwithstanding any other provisions of this contract as amended by this modification, the Contractor and the Contracting Officer shall negotiate an equitable adjustment in the total amount paid or to be paid under this contract to reflect such subcontract price revision. The equitable adjustment shall be evidenced by a modification to this contract, signed by the Contractor and the Contracting Officer.

[List subcontracts]

(d) In considering cost-plus-fee subcontracts while negotiating prime contracts where cost analysis is performed, the contracting officer shall make every effort to insure (but in consenting to cost-plus-fee subcontracts, the contracting officer shall insure) that fees under such subcontracts never exceed the limits prescribed by agency procedures in accordance with § 1-3.405-5(c)(2). These limits should not be inserted in the prime contract because such action might tend to inflate fees customarily negotiated at lower rates.

§ 1-3.807-11 Overhead rate considerations. (a) Indirect costs commonly known as overhead are defined and described in § 1-15.203. Criteria for treatment and application of indirect costs to contracts are also set forth in § 115.203.

(b) In order to assure a reasonable approximation and allocation of indirect costs on an equitable basis to individual contracts, negotiators shall utilize audited overhead data or negotiated overhead rates, where available, in connection with negotiation of contracts and should not seek preferential overhead rates. However, contracting officers may examine such data or rates to determine whether they include elements of cost which individ

ually are not allocable with respect to the contract under consideration (see Part 1-15). Where a rate is found to include such elements of cost an overhead rate should be established which excludes those costs.

(c) If there is any question with respect to audited overhead data or negotiated overhead rates, or if such are not available, the negotiator should normally avail himself of the audit services of the agency in consonance with § 1-3.809.

[29 FR 10155, July 24, 1964, as amended at 30 FR 9593, July 31, 1965]

§ 1-3.807-12 Sole source items.

When purchases of standard commercial or modified standard commercial items are to be made from sole source suppliers, use of the techniques of price and cost analysis may not always be possible. In such instances and consistent with the volume of procurement normally consummated with the contractor, the contractor's price lists and discount or rebate arrangement should be examined and negotiations conducted on the basis of the "best user," "most favored customer," or similar practice customarily followed by the contractor. Such price negotiations should consider the volume of business anticipated for a fixed period, such as a fiscal year, rather than the size of the individual procurement being negotiated.

§ 1-3.808 Profit or fee.

A fair and reasonable provision for profit or fee cannot be made by simply applying a certain predetermined percentage to the cost estimate or selling price of a product. Rather, the profit or fee should be first established as a dollar amount, after considering the factors set forth in this § 1-3.808. Therefore, where a fee is involved and it is necessary to determine the percentage relationship between the fee and the estimated cost of the contract in order to comply with administrative and statutory limitations on fees for cost-reimbursement type contracts (see § 1-3.405-5(c)(2), the percentage shall be determined only after the

dollar amount of the fee has been established for negotiation purposes.

§ 1-3.808-2 Factors for determining fee or profit.1

The factors set forth in this § 13.808-2 should be considered in determining profit or fee in all contracts, whether for supplies or services; for construction work; or for experimental, developmental, or research work; and whether of the fixed-price type or of the cost-reimbursement type unless otherwise specified in the particular factor. All of the factors should be evaluated in the light of the basic policy set forth in § 1-3.801(a) which provides that supplies and services shall be procured from responsible sources at fair and reasonable prices calculated to result in the lowest overall cost to the Government.

(a) Effect of competition. When competition is effective and proposals are on a firm fixed-price basis, the contracting officer normally need not consider in detail the amount of estimated profit included in a price. When effective competition is lacking, and in all cases where cost analysis is performed in accordance with § 1-3.807-2(c) the estimate for profit, target profit or fee, or the proposed fixed fee should be analyzed in the same manner as all other elements of price, evaluating the factors set forth in this § 1-3.808.

(b) Degree of risk. The degree of risk assumed by the contractor should influence the amount of profit or fee a contractor is entitled to anticipate. For example, where a portion of the risk has been shifted to the Government through cost-reimbursement or price redetermination provisions, unusual contingency provisions, or other risk-reducing measures, the amount of profit or fee should be less than where the contractor assumes all risk.

(c) Nature of work to be performed. A major consideration in the determination of the amount of profit or fee, particularly in connection with experimental, developmental, or research work, is the difficulty or complexity of the work to be performed and any un

'For a document relating to this section, see Appendix-Temporary Regulations appearing at the end of Chapter 1.

usual demands of the contract, such as whether the project involves a new approach unrelated to existing equipment or only refinements on existing equipment, whether the caliber or class of engineer involved is that of an "idea-man," or whether the contractor is to be required by the contract to assign to the work unusually skilled talent.

(d) Extent of Government assistance. The Government encourages its contractors to perform their contracts with the minimum of financial, facilities, or other assistance from the Government. Where extraordinary financial, facilities, or other assistance must be furnished to a contractor by the Government, such extraordinary assistance should have a modifying effect in determining what constitutes a fair and reasonable profit or fee.

(e) Extent of the contractor's investment. The extent of a contractor's total investment (i.e., both equity and borrowed capital) in the performance of the contract will be taken into consideration in determining the amount of the fee or profits.

(f) Character of contractor's business. Recognition must be given to the type of business normally carried on by the contractor, the complexity of manufacturing techniques, the rate of capital turnover, and the effect of each individual procurement upon such business. For example, where a contractor is engaged in an industry where the turnover of working capital is low, generally the profit objective on individual contracts is higher than in those industries where the turnover is more rapid.

(g) Contractor's performance. In addition to the factors set forth in § 13.102, the contractor's past and present performance should be evaluated in such areas as quality of product, quality control, scrap and spoilage, efficiency in cost control (including need for and reasonableness of cost incurred), meeting delivery schedules, timely compliance with contractual provisions, creative ability in product development (giving consideration to commercial potential of product), engineering (including inventive, design simplification, and development con

tributions), management of subcontract programs, management of Government property, and any unusual services furnished by the contractor. Where a contractor has consistently achieved excellent results in the foregoing areas in comparison with other contractors in similar circumstances, such performance merits a proportionately greater opportunity for profit or fee. Conversely, a poor record in this regard should be reflected in determining what constitutes a fair and reasonable profit or fee.

(h) Subcontracting. (1) In negotiating the profit or fee, subcontracting as a factor shall be segregated for separate evaluation, particularly as it bears on the contractor's technical supervision and management responsibility, financial investment, and degree of risk, as outlined above in this § 13.808-2. The degree and nature of subcontract programs vary on a broad spectrum. While it is not possible to define the exact profit or fee treatment to be accorded each situation, the general guidelines which follow shall be taken into consideration.

(2) The evaluation of a contractor's subcontracting program should not consist merely of applying arbitrary percentages of profit to subcontract prices in negotiating the prime contract price. A relatively large amount of subcontracting by itself need not result in negotiation of correspondingly lesser profit or fee-the character and circumstances of the subcontracting and the effect on the prime contractor's costs must be taken into account. Although purchased material and subcontracted work are usually properly included in the base upon which profit or fee is computed, instances may arise in which a significant portion or portions of a contract are subcontracted in such a way that only a minimum amount of responsibility or risk remains with the prime contractor. In such case, in order to prevent unreasonable pyramiding of profit or fee, the amount of profit or fee attributable to the subcontracted work should be substantially less than where the contractor uses his own resources and retains substantial responsibility of risk. Of primary importance

is the degree to which the subcontracting provides a better product and lower costs, with timely delivery, and in which the contractor assumes heavy managerial and technical effort, responsibility, and risk. Consideration must be given to the relationship which the prime contractor's estimated profit or fee on subcontracted work bears to his cost of placing and managing such subcontracted work.

(3) In establishing a contractor's fee or profit, favorable consideration shall be given to:

(i) The company's policies and procedures which energetically support Government small business and labor surplus area programs;

(ii) Any unusual efforts which the contractor displays in subcontracting with small business and labor surplus area concerns, particularly for developmental type work likely to result in later production opportunities; and

(iii) Effectiveness of the company in subcontracting with and furnishing assistance to such concerns, as compared to other comparable contractors.

In this connection, it is the responsibility of the purchasing activity to examine the contractor's past and present effectiveness and plans for seeking out qualified small business and labor surplus area concerns, and to require the contractor during negotiations to document his past, present, and

planned performance in these areas.

(i) Unrealistic estimates. If records reveal that a contractor's actual costs are consistently lower than his estimated cost indicating a practice of excessive estimates), and if the contractor refuses to provide what seems to be a reasonable estimate of costs, a lower profit or fee should be considered.

§ 1-3.808-3 Minimal fees or cost-sharing

arrangements.

In certain circumstances, as where experimental, developmental, or research work is attractive because of direct or potential commercial applications, consideration should be given to using a contract providing for only a nominal or token fee, or no fee, or on a cost-sharing basis (see § 1-3.405-3).

§ 1-3.809 Contract audit as a pricing aid.

Contract audit as a pricing aid shall be utilized to the fullest extent appropriate as provided by this section, except as otherwise provided by the head of the agency if audit resources are unavailable.

(a) General. Contract auditors are professional accountants who, although organizationally independent, are the principal advisors to contracting officers on contractor accounting and contract audit matters. Contract audit services include:

(1) The submission of audit reports which set forth the results of auditors' reviews and analyses of cost data submitted by contractors as part of pricing proposals, reviews of contractors' accounting systems, estimating methods, and other related matters; and

(2) Personal consultation and advice to procurement and contract administration personnel in connection with analyses of contractors' cost representations and related matters, including counsel (with or without an audit) on accounting and financial subjects.

(b) Auditor's reports on contract price proposals. (1) The contracting officer or his authorized representative shall request an audit review by the contract audit activity in accordance with this paragraph (b). Audit reviews shall be requested prior to the negotiation of any contract or modification resulting from proposals in excess of $100,000 which are firm fixed-price or fixed price with economic price adjustment or proposals in excess of $250,000 of any other types when the price is based on cost or pricing data (§ 1-3.807-3) submitted by the contractor. These include initial prices, estimated costs of cost-reimbursement type contracts, interim and final price redeterminations, economic price adjustments, target prices, settlement of incentive type contracts, and modifications of formally advertised contracts. In arriving at the aggregate amount involved in a contract or modification, all supplies and services shall be included (including construction) which properly would be grouped together in a single transaction. Requirements shall not be split into several contracts or modifications which

individually would be less than (but in the aggregate would be more than) the amounts set forth in this paragraph (b)(1) for the type of contract anticipated.

(i) The requirement to audit (A) proposals in excess of $100,000 which are firm fixed-price or fixed price with economic price adjustment or (B) proposals in excess of $250,000 of any other types when the cost is based on cost or pricing data, may be waived by the contracting officer whenever it is clear that information already available is adequate for the proposed procurement. In such cases, the contract files shall be documented to reflect the reasons for any such waivers. However, independent Government estimates of cost or price shall not be used as the sole justification for a waiver (see § 1-3.811(a)(4)).

(ii) Audits should be requested for proposals which are (A) less than $100,000 and involve a firm fixed-price or a fixed price with economic price adjustment or (B) less than $250,000 and involve any other types when the cost is based on cost or pricing data, where a valid need exists, such as:

(A) Inadequate knowledge concerning the contractor's accounting policies, cost systems, or substantially changed methods or levels of operation;

(B) Previous unfavorable experience indicating doubtful reliability of the contractor's estimating, accounting, or purchasing methods; or

(C) Procurement of a new product for which cost experience is lacking.

(iii) The terms "audit review" and "audit" are used interchangeably to refer to examinations by contract auditors, of contractors' statements of (a) costs to be incurred (cost estimates), or (b) costs actually incurred, to the extent deemed appropriate by the auditors in the light of their experience with the contractors, and relying upon their appraisals of the effectiveness of contractors' policies, procedures, controls, and practices. Such audit reviews or audits may consist of desk reviews, test checks of a limited number of transactions, or examinations in depth, at the discretion of the auditor.

(2) The contracting officer shall establish the due date for receipt of the auditor's report and in so doing shall allow as much time as possible for the audit work. Within the time available the overall scope and depth of the audit shall be determined by, and be the full responsibility of, the contract auditor. Any particular areas identified by the contracting officer for special emphasis shall be specifically inIcluded in the report. Since time is highly important in most negotiation situations, the auditors should give sufficient priority to reports for forward pricing to meet established due dates. If the time available is not adequate to permit satisfactory coverage of the proposal, the auditor shall so advise the contracting officer and indiIcate the additional time needed. The contracting officer shall promptly advise the auditor whether the extension of the report due date can be granted.

(3) When requesting the contract auditor to review and evaluate a contractor's proposal, the contracting officer shall identify any areas where he desires particular pricing effort. If there are audit work program conflicts, priorities should be worked out jointly between the auditor and the contracting officer. Arrangements should be made by the auditor through the contracting officer for technical assistance, as needed.

(4) In accordance with Subpart 13.12, Cost Accounting Standards, and Part 1-15, Contract Cost Principles and Procedures, the cognizant contract auditor shall be responsible for making recommendations to the contracting officer as to whether:

(i) A contractor's Disclosure Statement (see § 1-3.1203(a)), submitted as a condition to contracting, adequately describes the actual or proposed cost accounting practices as required by Pub. L. 91-379, 50 U.S.C. App. 2168, as implemented by the Cost Accounting Standards Board;

(ii) A contractor's disclosed cost accounting practices are in compliance with Part 1-15 and applicable Cost Accounting Standards;

(iii) A contractor's or subcontractor's failure to comply with applicable Cost

Accounting Standards or to follow consistently his disclosed cost accounting practices has resulted, or may result, in any increased cost paid by the Government; and

(iv) A contractor's or subcontractor's proposed price changes, submitted as a result of changes made to previously disclosed or established cost accounting practices, are fair and reasonable.

(5) The auditor, as part of his report, shall set forth the basis and method used by the contractor in preparing his proposal. Also, the report shall clearly identify the contractor's original proposal and all subsequent written formal submissions to the contracting officer or to the auditor, of cost or pricing data identified as such by the contractor. In addition, cost or pricing data not submitted by the contractor but otherwise coming to the auditor which has a significant effect on the proposed cost or price shall also be described in the advisory audit report. If the auditor determines that the cost or pricing data submitted by the contractor is not accurate, complete, and current, the auditor shall describe the deficiency and explain its significance in the audit report. Where the resulting overall effect on the proposed cost or price is of such magnitude that the contractor's proposal is of little use as a basis for negotiation, the audit report shall so state. None of the above is intended to relieve the contractor of his obligation to submit accurate, complete, and current cost or pricing data.

(6) Reports of technical analysis and review should be furnished to the auditor at the earliest possible date, and, where practicable, at least 5 days prior to the due date of the audit report, to enable the auditor to inIclude the financial effect of technical findings in the audit report (for example, the necessary computations of dollar amounts arising from changes in proposed kinds and quantities of materials, labor hours, etc.). In the event the technical analyses are not available in time to be reflected in the audit report, the audit report shall so state. If technical analyses are received later by the auditor, he shall issue a supplemental report if the