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ample, 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 § 1-3.102, 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 contributions), 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 § 1-3.808-2. 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.

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(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.

(1) 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.

EDITORIAL NOTE: For a notice document relating to this section see 41 FR 44475 Oct. 8, 1976.

§ 1-3.808-3 Minimal fees or cost-shar.

ing 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) Prior to negotiation of any contract or modification resulting from a proposal in excess of $100,000 (including initial prices, estimated costs of costreimbursement types, interim and final price redeterminations, escalation, target, settlement of incentive types and modifications to formally advertised contracts), where the price will be based on cost or pricing data (§ 1-3.807-3) submitted by the contractor, the contracting officer or his authorized representative shall request an audit review by the contract audit activity. In arriving at the aggregate amount involved in a contract or modification, there shall be included all personal property and nonpersonal services (including construction) which would properly be grouped together in a single transaction. Requirements shall not be split into several contracts or modifications which are less

than $100,000, but which aggregate more than $100,000.

(i) The requirement for audit of proposals which exceed $100,000 may be waived by the contracting officer whenever it is clear that information already available is adequate for the proposed procurement. In such case, the contract file shall be documented to reflect the reason for any such waiver: Provided, however, That independent Government estimates of cost or price shall not be used as the sole justification for any such waiver (see § 1-3.811(a) (4)).

(ii) Audits should be requested for proposals of less than $100,000 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 included 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 indicate 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 include 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 status of the negotiation is such that a report would serve a useful purpose. The original of all technical reports received by the auditor shall be made a part of the audit report.

(7) The audit report, giving the financial effect of related technical and other evaluations, shall be forwarded by the auditor to the contracting officer. If any information disclosed subsequent to the receipt of the audit report is such as to significantly affect the audit findings, the contracting officer should promptly advise the auditor, who shall determine whether to issue a supplemental report.

(8) Information generated through sources other than the contractor's records may be available to the contracting officer which may affect the Government's negotiating position. The auditor shall not disclose to the contractor his conclusions and recommendations to the contracting officer on the contractor's proposal. No portion of the advisory audit report shall be furnished to the contractor without the concurrence of the contracting officer. The auditor shall not disclose to the contractor the results of technical analysis and similar information that would prejudice the Government's negotiating position. The above limita

tions are not intended to preclude disclosure of discrepancies or mistakes of fact such as duplications, omissions, and errors in computations, contained in the contractor's cost or pricing data supporting the proposal.

(9) If, in the opinion of the contractIng officer, or auditor, the review of a prime contractor's proposal requires audit reviews of subcontractors' cost estimates at the subcontractors' plants (after due consideration of reviews performed by the prime contractor), such reviews should be arranged through audit channels. Criteria as to necessity for audit of subcontracts shall be in accordance with guidelines applicable to prime contracts. Where technical reviews are needed they shall be arranged through the contracting officer.

(10) The audit report shall be made a part of the official contract file.

(c) Additional function of the contract auditor. (1) Under cost-reimbursement type contracts, the cost-reimbursement portion of fixed-price contracts, letter contracts which provide for reimbursement of costs, time and materials contracts, and labor-hour (negotiated or formally advertised) contracts:

(1) The auditor shall conduct periodic audits of contractors as is warranted by the financial condition, integrity, reliability of the contractor, prior audit experience, adequacy of the accounting system, and the amount of unaudited claims. Advisory audit reports shall be prepared by the auditor at such times when the report is needed or desirable. and (where possible) should be rendered no less frequently than once yearly. When the circumstances warrant, arrangements may be made for the contract auditor to examine contractor's reimbursement vouchers or invoices, and transmit those approved for payment to the cognizant contracting or disbursing officer. If the contract auditor questions costs or considers them unallowable, he shall provide the contracting officer with reasons and justification therefor. The contracting officer, if he agrees with the contract auditor, shall promptly notify the contractor in writing of the costs questioned and suspended, or disapproved. In the case of costs disapproved (including disapproval of costs previously questioned and suspended, where the difference cannot be resolved), the written notice to the contractor shall include a complete

statement, as prescribed by agency procedures or regulations, to the effect that the notice constitutes a final decision of the contracting officer, the effective date of such decision, the contractor's right to appeal therefrom, and the specific procedure to be followed if the contractor decides to make such an appeal.

(1) The contract auditor shall be responsible for performing audits of contracts in which pricing or payment is based upon cost or other financial information furnished by the contractor, when such audit is required or considered desirable.

(ii) The contract auditor shall be responsible for making appropriate recommendations to the contracting officer concerning the establishment of overhead rates (billing, provisional, or predetermined), when such rates are provided for in the contract (see Subpart 1-3.7, Negotiated Overhead Rates).

(2) Preaward surveys (see § 1-1.310-9) of potential contractor's competence to perform proposed contracts shall be arranged by the contracting officer. Where information is required on the adequacy of the contractor's accounting system or its suitability for administration of the proposed type of contract, such information shall always be obtained by the contracting officer from the auditor (see § 1-3.801-3(b) (3)). The contracting officer shall be responsible for compliance with the agency's implementing policies and procedures concerning the contractor's financial competence or credit needs (see also § 1-1.310).

(3) (i) The establishment. maintenance, and consistent use of formal cost estimating systems by contractors is to the mutual benefit of the Government and industry, particularly where a large portion of the contractor's business is Government work and there are a number of significant proposals requiring review. Procuring activities should encourage contractors to formalize and follow good estimating procedures. It is recognized that estimating procedures will vary among contractors, and may vary between plants or divisions of a contractor due to differences in products, size and methods of operations, production vs. research, and other factors. While formal systems do not eliminate the need for judgmental factors to be applied by contractors in developing cost proposals, they do provide a sound foundation for the systematic and orderly application

of these judgment factors to specific proposals. The consistent preparation of proposals in accordance with an acceptable estimating system is of material benefit in ensuring both the contractor and the Government that proposals are realistically and reasonably priced, that the § 1-3.807-3 requirements for utilizing current, accurate, and complete cost and pricing data in developing the proposal are met, and that underestimating and overestimating of contract costs are minimized. Some of the advantages of sound estimating procedures are: a greater degree of confidence can normally be placed in the accuracy and reliability of contractors' individual proposals; it expedites the negotiation process; it reduces the amount of detailed explanation of estimating processes on each individual proposal; and, as in the case of the well established practice regarding acceptable accounting systems, reduces the scope of reviews performed by audit and other technical and procurement personnel.

(ii) When an audit is performed pursuant to § 1-3.809(b) (1), the contract auditor shall determine whether the contractor's estimating systems or methods are acceptable to the Government. Among the matters to be considered in determining the acceptability of the estimating systems or methods are the following:

(A) Responsibilities within the contractor's organization for originating, reviewing, and approving estimates;

(B) Procedures followed in developing estimates for each of the direct and indirect elements of cost;

(C) The source of data used in developing the estimates and in ensuring that such data are current, complete, and accurate;

(D) The documentation developed and maintained by the contractor to support the estimate;

(E) Management support of the program review including approval of the estimate, controls established to ensure consistent compliance with estimating procedures; and personnel training and evaluation programs; and

(F) The extent of coordination and communication between the various elements of the contractor's organization responsible for the estimate.

(ii) If the contractor's estimating systems or methods are not acceptable to the Government, the contracting of

ficer shall determine whether an estimating system survey should be undertaken as a team effort (including the contract auditor and other qualified technical specialists) after consideration of criteria such as:

(A) The significance (including estimated cost or price) of all present and estimated future Government procurements, provided, that if only a one-time procurement is involved, other appro. priate methods may be used to establish the reliability and reasonableness of the contractor's cost or pricing data;

(B) The benefits which might accrue to the Government in view of the cost of the survey; and

(C) The findings and corrective actions taken in connection with previous estimating surveys, if any.

(iv) A copy of the survey report, together with a copy of the official notice of corrective action (see § 1-3.801-3(b) (3)) required, shall be furnished to each agency procuring activity having business with that contractor, and (upon request) to other procurement agencies. Any significant deficiencies in the system not corrected by the contractor shall also be considered in subsequent proposal reviews, and by contracting officers in negotiating with, and in determining the reasonableness of prices proposed by, that contractor. Where these deficiencies continue to exist and where they have adverse effect on prices, the problem should be brought to the attention of procurement officials at a level necessary to bring about corrective action.

(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:

(1) A contractor's disclosure statement (see § 1-3.1203 (a)), submitted as a condition of contracting, adequately describes the actual or proposed cost accounting practices as required by Public Law 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;

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

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