Direct Material Costs

7/25/2019 Direct Material Costs

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Ch 6 - Anal yzi ng Di r ect Mat er i al Cost s

6. 0 - Chapt er I nt r oduct i on 6. 1 - I dent i f yi ng Di r ect Mat er i al Cost s For Anal ysi s

o 6. 1. 1 - I dent i f yi ng Mat er i al Cost El ement s

o

6. 1. 2 - I dent i f yi ng Col l at er al Cost so

6. 1. 3 - I dent i f yi ng Rel at ed Cost so 6. 1. 4 - Pl anni ng For Fur t her Anal ysi s

6. 2 - Anal yzi ng Summar y Cost Est i mat es 6. 3 - Anal yzi ng Det ai l ed Quant i t y Est i mat es 6. 4 - Anal yzi ng Uni t Cost Est i mat es 6. 5 - Recogni zi ng Subcont r act Pr i ci ng Responsi bi l i t i es

6. 0 Chapt er I nt r oduct i on

Di r ect mat er i al cost s of t en account f or mor e t han hal fof t ot al cont r act cost . Thi s chapt er wi l l pr esent poi nt s t oconsi der when you devel op a pr enegot i at i on posi t i on ondi r ect mat er i al cost s.

Fl owchar t of Di r ect Mat er i al Cost s Anal ysi s:
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6.1 Identifying Direct Material Costs For Analysis


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Thi s sect i on wi l l i dent i f y t he t ypes of cost that maybe cl assi f i ed as di r ect mat er i al cost s and poi nt s t oconsi der i n pl anni ng f or f ur t her anal ysi s.

6. 1. 1 - I dent i f yi ng Mat er i al Cost El ement s

6. 1. 2 - I dent i f yi ng Col l at er al Cost s 6. 1. 3 - I dent i f yi ng Rel at ed Cost s 6. 1. 4 - Pl anni ng For Fur t her Anal ysi s

6.1.1 Identifying Material Cost Elements

Material Cost ( FAR 31. 205- 26) . The cost of mat er i al s usedt o compl et e a cont r act normal l y i ncl udes more t han j ust t hecost of t he mat er i al s t hat act ual l y become par t of t hepr oduct . Cost s t ypi cal l y i ncl ude:

Raw mater i al s, part s, subassembl i es, component s, andmanuf act ur i ng suppl i es t hat act ual l y become par t oft he pr oduct ;

Col l at er al cost s, such as f r ei ght and i nsur ance; and Mat er i al t hat cannot be used f or i t s i nt ended pur pose

( e. g. , over r uns, spoi l age, and def ect i ve par t s) .

Direct vs. Indirect Material Cost ( FAR 31. 202 and 31. 203) .Each f i r m i s r esponsi bl e f or det er mi ni ng whet her a speci f i ccost wi l l be char ged as a di r ect cost or an i ndi r ect cost ,

and you wi l l f i nd t hat account i ng and est i mat i ng t r eat mentwi l l var y f r om f i r m t o f i r m. Thi s sect i on descr i bes t hegener al pr act i ces t hat you can use t o i dent i f y di r ectmat er i al cost s f or anal ysi s.

Direct Material Cost. A di r ect mat er i al cost i s anymat er i al cost t hat can be i dent i f i ed speci f i cal l y wi t ha f i nal cost obj ect i ve ( e. g. , a par t i cul ar cont r act) .

o Mat er i al cost s i dent i f i ed speci f i cal l y wi t h apar t i cul ar cont r act are di r ect cost s of t hecont r act and must be charged t o t hat cont r act .

o

Mater i al cost s must not be charged t o a cont r actas a di r ect cost i f ot her mat er i al cost s i ncur r edf or t he same pur pose i n l i ke ci r cumst ances havebeen char ged as an i ndi r ect cost t o t hat cont r actor any ot her cont r act .

o Al l mat er i al costs speci f i cal l y i dent i f i ed wi t hot her cont r act s ar e di r ect cost s f or t hose
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cont r act s and must not be char ged t o anot hercont r act di r ect l y or i ndi r ect l y.

Indirect Material Cost. An i ndi r ect mat er i al cost i sany mat er i al cost not di r ect l y i dent i f i ed wi t h asi ngl e f i nal cost obj ecti ve, but i dent i f i ed wi t h t woor mor e f i nal cost obj ect i ves or an i nt er medi at e costobj ect i ve. For r easons of pr act i cal i t y, any direct

material cost of minor dollar amount may be t r eated asan i ndi r ect cost i f t he account i ng t r eat ment :

o I s consi stent l y appl i ed t o al l f i nal obj ect i ves,and

o Pr oduces subst ant i al l y t he same r esul t s ast r eat i ng t he cost as a di r ect cost .

Accounting for Materials. The f ol l owi ng t abl e mat chesmat er i al t ypes wi t h t hei r most common account i ng t r eat ment .Thi s t abl e i s onl y a gener al gui de. Pr oper account i ngt r eat ment wi l l var y wi t h di f f er ent acqui si t i on envi r onment sand the speci f i c account i ng gui dance adopt ed by t he f i r m.

Material

Type*Description Accounting

Treatment

Raw Mat er i al s Mat er i al s t hat r equi r ef ur t her pr ocessi ng

Normal l y adi r ect cost

Par t s I t ems whi ch, when j oi nedt oget her wi t h anot her i t em,ar e not nor mal l y subj ect t o

di sassembl y wi t houtdest r uct i on or i mpai r ment ofuse

Normal l y adi r ect costbut possi bl y

an i ndi r ectcost i f pr i cei s ver y smal l

Subassembl i es Sel f - cont ai ned uni t s of anassembl y t hat can be removed,r epl aced, and r epai r edsepar at el y


Component s I t ems whi ch gener al l y havet he physi cal char act er i st i csof r el at i vel y si mpl e har dwar ei t ems and whi ch ar e l i st ed i n

t he speci f i cat i ons f or anassembl y, subassembl y, or endi t em


Manuf actur i ngSuppl i es

I t ems of suppl y t hat ar er equi r ed by a manuf act ur i ngpr ocess or i n suppor t ofmanuf act ur i ng act i vi t i es

Normal l y ani ndi r ect cost


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* The mat er i al t ypes i n t hi s t abl e ar e dr awn f r om FAR31. 205- 26( a) , Mat er i al Cost s. The t er ms r ef l ect amanuf act ur i ng or i ent at i on. When anal yzi ng mat er i al cost spr oposed f or servi ces or const r uct i on, compar e t hepr oposed use of t he mat er i al s wi t h t he def i ni t i ons i n

t hi s t abl e f or t he most appr opr i at e account i ngt r eat ment . Al so, consi der t he gener al gui dance of f er edon t he pr evi ous page.

6.1.2 Identifying Collateral Costs

Collateral Cost Accounting Treatment ( FAR 31. 205- 26( a) ) .Col l at er al cost s ar e expenses associ at ed wi t h get t i ngmat er i al s i nt o t he of f er or ' s pl ant . I nbound t r anspor t at i onand i nt r ansi t i nsurance ar e two common exampl es. These

cost s may ei t her be t r eat ed as di r ect cost s or i ndi r ectcost s dependi ng on t he gui del i nes est abl i shed by t he f i r m.I f t hey ar e t r eat ed as di r ect cost s, t hey ar e nor mal l yt r acked wi t h t he cost of t he associ at ed mat er i al i t em.

As you per f orm your cost anal ysi s, make sur e t hat t hepr oposed t r eat ment i s consi st ent wi t h the f i r m' s t r eat mentof si mi l ar cost s under si mi l ar ci r cumst ances. Al so makesur e t hat t he of f er or i s not char gi ng t wi ce f or t he samet r anspor t at i on and i nsurance cost . The cogni zant Gover nmentaudi t or wi l l be abl e t o assi st you i n det er mi ni ng whet hert he pr oposal cor r ect l y recogni zes t r anspor t at i on cost sconsi st ent wi t h t he of f er or ' s pr escr i bed account i ngpr act i ces.

For example: When an i t em i s bought f . o. b. dest i nat i on t hepr i ce nor mal l y i ncl udes del i ver y to a poi nt desi gnat ed byt he buyer . Unl ess some t ype of speci al handl i ng i sr equi r ed, t he buyer shoul d not have any addi t i onalt r anspor t at i on or i n- t r ansi t i nsur ance cost s.

Inbound Transportation ( FAR 31. 205- 26( a) and 31. 205- 45) .I nbound t r anspor t at i on cost , al so known as f r ei ght - i n

expense, i s t he cost of t r anspor t i ng mat er i al t o t he pl aceof cont r act per f or mance. I t may be t he cost oft r anspor t at i on f r om t he suppl i er ' s pl ant or somei nt er medi at e shi ppi ng poi nt . Thi s cost i s al l owabl e as l ongas i t i s r easonabl e, but r emember t hat t hi s cost shoul d bei ncl uded i n any pr i ce quot ed f . o. b. dest i nat i on.
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Intransit Insurance ( FAR 31. 205- 19, 31. 205- 26( a) , and31. 205- 45) . The i nt r ansi t i nsur ance expense r el at ed t omat er i al i s t he cost of i nsur ance f or i nbound mat er i al . Anycost s of i nsur ance requi r ed or appr oved by t he Governmentand mai ntai ned by t he cont r act or under a Gover nmentcont r act ar e al l owabl e. The cost of i nt r ansi t i nsur ance notspeci f i cal l y requi r ed or appr oved under a Gover nmentcont r act must meet appropr i at e FAR and CAS r equi r ement s.The most basi c r equi r ements ar e t hat t he t ypes and ext entof i nsur ance must f ol l ow sound busi ness pract i ce, and t her at es and premi ums must be r easonabl e.

6.1.3 Identifying Related Costs

Accounting for Related Materials ( FAR 31. 205- 26( b) ) .I dent i f y est i mat es of excess mat er i al s t hat t he of f er orpr oposes t o pur chase t o assur e t hat suf f i ci ent mat er i al i savai l abl e f or pr oduct i on of t he i t em. Est i mat es may i ncl udecost s r el at ed t o mat er i al over r uns, scrap, spoi l age, ordef ect i ve par t s.

Some of f er or s wi l l devel op a si ngl e est i mat e whi chencompasses al l of t hese cost s. When a si ngl e est i matei s used, i t i s usual l y r ef er r ed t o as scr ap.

Ot her of f er or s wi l l devel op separ at e est i mat es f orsever al of t he di f f er ent t ypes of excess mat er i al

cost . When a f i r m devel ops separate est i mates, makesur e t hat each t ype of excess mat er i al cost i s cl ear l ydef i ned and t hat t he same cost s do not appear i ndi f f er ent est i mat es.

Est i mat es of t hese cost s ar e usual l y devel oped usi ng acost est i mat i ng r el at i onshi p ( CER) - - a r el at i onshi pbetween t he cost and some i ndependent var i abl e rel at ed t o apar amet er of t he i t em or ser vi ce bei ng acqui r ed or ar el at ed cont r act cost . The pr oposal and r el at eddocument at i on must provi de adequat e anal ysi s and

st at i st i cal dat a t o i dent i f y and suppor t any CER used i nest i mat i ng di r ect mat er i al cost .

Remember t hat mat er i al over r uns, scr ap, spoi l age, ordef ect i ve par t s not used on t he pr oposed cont r act wi l lst i l l have r esi dual val ue. The of f er or mi ght use t hi smat er i al i n pr oduci ng ot her pr oduct s, or sel l i t f orr ecl amat i on or r epr ocessi ng. As a resul t , t he est i mat ed
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cont r act cost must be adj ust ed t o consi der t hat r esi dualval ue. The of f er or mi ght adj ust t he pr oposal by subt r act i ngt he est i mat ed r esi dual val ue f r om t he est i mat ed di r ectmat er i al cost . Mor e commonl y, of f er ors wi l l est i mat e t her esi dual val ue of such mat er i al f or al l cont r act s f or t heyear and then subt r act t hat est i mated amount f r om anappr opr i ate over head account . Each cont r act pr oposalest i mate i s t hen r educed by use of t he l ower over head r at e.

Overruns. Si mpl y st at ed, over r uns ar e t he pur chase orpr oduct i on of more uni t s t han ar e r equi r ed by the j ob.

For example: A mi ni mum order quant i t y requi r ement i s acommon exampl e. An assembl y requi r es 25 uni t s of a speci alf ast ener t hat can onl y be bought i n quant i t i es of 100. I ft he f ast ener can onl y be used on t he one cont r act , youshoul d expect t o pay f or al l 100 uni t s. On t he ot her hand,i f t he f ast ener has gener al appl i cat i on t o ot her i t emspr oduced by t he f i r m, you shoul d expect t o onl y pay onl yf or t he uni t s used on your cont r act .

Scrap. Scrap i s mat er i al t hat i s no l onger usabl e f or t hepur pose f or whi ch i t was or i gi nal l y pur chased.

For example: A cast i ng may r equi r e machi ni ng pr i or t o i t suse as part of a l arger assembl y. The mater i al r emoveddur i ng the machi ni ng pr ocess i s scr ap. A sheet of met al mayhave a var i et y of shapes cut f r om i t . The l ef t over pi eces

t hat ar e t oo smal l t o cut i nt o the r equi r ed shapes arescrap.

Spoilage. There are many ki nds of spoi l age. Some of t hemor e common t ypes of spoi l age ar e:

Shelf-life. Shel f - l i f e i s t he l engt h of t i me somemat er i al s r et ai n t hei r usabl e pr oper t i es whi l e wai t i ngt o be used, af t er t hat t i me they must be di scarded.

For example: I ndust r i al si l i con r ubber compounds are used

as coat i ngs or adhesi ves i n many manuf actur i ng pr ocesses.I f t hese compounds ar e not used wi t hi n a cer t ai n t i meper i od ( t hei r shel f - l i f e) , t hey l ose t hei r usabl epr oper t i es and have t o be di scarded.

Losses. Mat er i al l osses ar e di scr epanci es bet weeni nvent or y recor ds and physi cal i nvent or y. Nor mal l y,t hese di scr epanci es ar e di scover ed dur i ng physi cal


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i nvent or i es. The i nvent or y recor ds i ndi cat e t hat t hemat er i al i s t her e, but an act ual count f i nds t hat t hemat er i al i s no l onger avai l abl e. When i nvent or yr ecor ds i ndi cat e that t he i nvent or y i ncl udes mor emat er i al t han t he physi cal count , t he excess mat er i almust be r emoved f r om t he i nvent ory r ecords or "wr i t t enof f . "

For example: Lost mater i al s may have been st ol en,i nadver t ent l y di scar ded, or mi spl aced.

Obsolescence. Thi s can occur anyt i me t here i s a l ar gei nvent or y t hat wi l l meet needs f or a l ong per i od.Mat er i al s may become obsol et e due t o desi gn changest hat r equi r e new par t s or mat er i al s, t hus r ender i ngt he ol d i nvent or y usel ess.

For example: I t em speci f i cat i ons are changed. A pr oduct i onpar t i s now obsol et e because i t i s no l onger needed f orpr oduct i on.

Defective Parts. Def ect i ve par t s ar e i t ems t hat f ai l t omeet r equi r ed speci f i cat i ons. Dependi ng on t he sever i t y oft he def ect , such part s can be scr apped, r eworked, or "usedas i s. " Def ect i ve par t s are al so known as " yi el d. " Whet hera def ect i ve par t i s usabl e as i s, r ewor kabl e, or j ustscr ap, t her e ar e cost s associ at ed wi t h t he act i on t hat mustbe consi der ed i n a cost est i mat i ng and anal ysi s.

Scrap. I f t he def ect i ve par t cannot be used f or i t si nt ended pur pose or made usabl e, i t wi l l usual l y becharged as scr ap.

Rework. Thi s i s t he process of t aki ng t he def ect i vepar t and wor ki ng on i t agai n t o cor r ect t he i dent i f i eddef ect s. I f , af t er r ewor k, t he i t em meet sspeci f i cat i ons, i t can be accept ed. I f t he r ewor kedi t em f ai l s i nspect i on agai n, i t may be ei t her r ewor kedagai n or scr apped.

Rework cost i s normal l y seen i n l abor expense. However ,r ework does hel p reduce scr ap cost s. Dependi ng on theof f er or ' s account i ng syst em, t he mat er i al used dur i ngr ework may be account ed f or separat e f r om normal scr ap.

Use as is. Thi s means t hat , whi l e t he par t does notmeet al l cont r act r equi r ement s, t he def ect does not


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af f ect t he par t ' s abi l i t y t o per f or m i t s i nt endedf unct i on.

Af t er a par t has been pr oper l y exami ned and appr oved f oruse by t he of f er or ' s qual i t y syst em, a "use as i s" par t , i t

can be i ncor por ated i nt o t he end pr oduct . The cost sassoci at ed wi t h maki ng t he "use as i s" deci si on ar enormal l y qual i t y assur ance l abor and over head. The val ue oft he par t i s not af f ect ed unl ess a speci f i c cost r educt i oni s negot i ated by t he cont r actor and the Gover nment .

6.1.4 Planning For Further Analysis

Points to Consider. As you pr epar e your pl an f or di r ectmat er i al cost anal ysi s, l ook f or i ndi cat or s of uneconomi calor i nef f i ci ent pr acti ces. Mat er i al i t ems wi t h a l ar gedol l ar val ue or unusual r equi r ement s nor mal l y r at e i n- dept hanal ysi s. I f an el ement of pr oposed mat er i al cost appear ssuspi ci ous, concent r at e mor e anal ysi s ef f or t on t hatel ement t han on a l ess suspi ci ous cost el ement of si mi l ardol l ar val ue. As you pl an:

I dent i f y and eval uat e t he methodol ogy used by t heof f er or t o est i mat e di r ect mat er i al cost

I dent i f y any pr oposed di r ect mat er i al t hat does notappear necessary t o the cont r act ef f or t

I dent i f y any pr oposed di r ect mat er i al t hat shoul d becl assi f i ed as an i ndi r ect cost

I dent i f y any pr oposed di r ect mat er i al cost s t hat mer i tspeci al at t ent i on because of hi gh- val ue or ot herr easons

Assure t hat pr el i mi nar y concer ns about mat er i al costest i mat es are wel l document ed

Identify and Evaluate Estimating Methodology. To i dent i f yand eval uat e t he methodol ogy used by t he of f eror t oest i mat e di r ect mat er i al cost , ask quest i ons such as t he

f ol l owi ng:

Is the estimate a summary-level or a detailed

estimate?

I n a summary est i mate, mater i al cost i s est i mated on at ot al - cost basi s wi t hout t he benef i t of a det ai l ed costbr eakdown of mat er i al uni t s and cost per uni t . I n a


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det ai l ed- l evel est i mat e, mat er i al cost i s est i mat ed basedon est i mates of t he number of mater i al uni t s r equi r ed andt he cost per uni t .

Does the methodology appear appropriate for the

current estimating situation?

The met hod sel ect ed shoul d use t he i nf or mat i on avai l abl e t opr oduce r easonabl e and equi t abl e r esul t s. I f t hemethodol ogy used by t he of f eror does not appearappr opr i at e, consi der usi ng a di f f er ent met hodol ogy t odevel op your pr i ci ng posi t i on.

Is the estimating methodology consistent with

estimating assumptions?

I f any par t of t he est i mat e i s not consi st ent wi t h st at edest i mat i ng assumpt i ons, quest i on the cost s i nvol ved.

Identify Apparently Unnecessary Material Cost. To i dent i f yany pr oposed di r ect mater i al t hat does not appear necessaryt o t he cont r act ef f or t , ask quest i ons such as t hef ol l owi ng:

Is the material necessary?

The r easons f or any di r ect mat er i al not obvi ousl y r equi r edf or cont r act per f or mance shoul d be cl ear l y descr i bed i n t he

pr oposal .

Should the item be purchased, not made (or vice

versa)?

Mark any i t em wher e t he make- or - buy deci si on does notappear t o r esul t i n t he best val ue t o t he Gover nment . Ther emay be good r easons why such a deci si on wi l l produce t hebest val ue t o the Government , but t he deci si on may al sor epr esent an at t empt by the of f er or t o gai n advant age atGover nment expense ( e. g. , gai n capabi l i t y i n new t echnol ogy

cur r ent l y avai l abl e f r om pot ent i al subcont r act or s at al ower t ot al cont r act cost ) .

Can less expensive material be substituted, in whole

or in part?

Somet i mes, pr oposed mater i al may be over speci f i ed ( i . e.excessi vel y t i ght t ol er ances) . Consi der usi ng val ue


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engi neer i ng t echni ques t o i dent i f y l ess expensi ve par t s( e. g. , a commer ci al par t mi ght be avai l abl e to repl ace apar t made t o uni que Gover nment r equi r ement s) .

Is the material acceptable under terms of the

contract?

I f t he cont r act r equi r es new mat er i al s, or mat er i alcer t i f i cat i ons i n accor dance wi t h speci f i cat i ons orst andards, t hen t he pr oposed mat er i al s must meet t hoser equi r ement s.

Identify Any Material That Should be Indirect. To i dent i f yany pr oposed di r ect mat er i al t hat shoul d be cl assi f i ed asan i ndi r ect cost , ask quest i ons such as t he f ol l owi ng:

Has the offeror consistently treated material similar

to the proposed material as direct material?

I f si mi l ar mat er i al has been t r eat ed as an i ndi r ect costunder si mi l ar ci r cumst ances, pr oposed mat er i al shoul dl i kel y al so be an i ndi r ect cost. I f t he of f er or c l assi f i essi mi l ar mat er i al as a di r ect cost i n one si t uat i on and asan i ndi r ect cost i n a si mi l ar si t uat i on, t her e i s a goodchance t hat you ar e bei ng doubl e charged - - once as adi r ect cost and a second t i me as an i ndi r ect cost ! I f i ndoubt , cont act t he cogni zant Gover nment audi t or f orassi st ance.

Is the material cost proposed and accounted for in a

manner consistent with the contractor's disclosure

statement and documented accounting practices?

Quest i on any appar ent i nconsi st enci es. I f you have anyquest i ons, check wi t h t he cogni zant Gover nment audi t or .

Identify Material Costs Which Merit Special Attention. Toi dent i f y any pr oposed di r ect mat er i al cost s t hat mer i tspeci al at t ent i on because of hi gh- val ue or ot her r easons,

ask quest i ons such as t he f ol l owi ng:

Is any material estimate a large portion of the entire

material cost estimate?

Many t i mes a si ngl e est i mat e wi l l be a l ar ge par t of t heent i r e est i mat e. That est i mat e wi l l nor mal l y mer i t speci alat t ent i on because of t he dol l ar s i nvol ved.


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Is any material uniquely critical to contract

performance?

Many t i mes a speci f i c mat er i al i t em i s essent i al f orcont r act per f ormance. Rel ated est i mat es may mer i t speci al

at t ent i on, because t he of f er or may be wi l l i ng t o pay "anypr i ce" f or t he mat er i al .

Document Material Cost Concerns. To assur e t hatpr el i mi nar y concer ns about mat er i al cost est i mat es ar e wel ldocument ed, ask quest i ons such as t he f ol l owi ng:

Have you identified material estimates that merit

special attention?

I f t he answer i s " yes" document t he areas of concer n f orr ef er ence as you per f or m mor e i n- dept h anal ysi s.

Has the offeror had an opportunity to answer your

concerns?

Consi der r ai si ng t hese concer ns i n f act - f i ndi ngconver sat i ons wi t h t he of f er or . I f t he pr obl em i s an er r ori n t he pr oposal , br i ng t he er r or t o t he of f er or ' s at t ent i onso t hat i t can be cor r ect ed pr i or t o f or mal negot i at i ons.

6.2 Analyzing Summary Cost Estimates

Steps for Summary Estimate Analysis. I n a summary mat er i alcost est i mat e, mat er i al cost i s est i mat ed on a tot al costbasi s wi t hout t he benef i t of a det ai l ed cost br eakdown ofuni t s and cost per uni t . Summary est i mat es may be round-t abl e or compar i son est i mat es. Round- t abl e est i mat escommonl y use wor ds such as " engi neer i ng est i mat e" or"pr of essi onal j udgment . " Compar i son est i mat es i nvol ve t heuse of some f or m of compar i son based on dat a f r om ef f or t scompl et ed or i n pr ogr ess.

As you conduct your anal ysi s of summary di r ect mater i alcost est i mat es:

Gi ve speci al at t ent i on t o any di r ect mat er i al concer nsi dent i f i ed dur i ng your pr el i mi nar y revi ew of t hemat er i al mi x.


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Det ermi ne whet her use of summar y cost est i mat es i sappr opr i at e f or t he est i mat i ng si t uat i on.

Det ermi ne whi ch summary est i mat i ng t echni que( s) wasused i n pr oposal devel opment .

Det er mi ne i f cost est i mat i ng r el at i onshi ps ( CERs) used

i n t he pr oposal wer e pr oper l y devel oped and appl i ed. Det er mi ne i f di r ect compar i sons used i n t he pr oposalhave been pr oper l y devel oped and appl i ed.

Devel op and document your pr enegot i at i on posi t i on ondi r ect mat er i al cost .

Determine If Summary Estimates Are Appropriate. Todet ermi ne whet her t he use of a summar y cost est i mat e i sappr opr i at e f or t he est i mat i ng si t uat i on, ask quest i onssuch as t he f ol l owi ng:

Does the item cost warrant the expense of a detailed

estimate?

The t i me and ef f or t put i nt o an anal ysi s needs t o becommensurate wi t h t he cost of t he mat er i al i nvol ved. As t hedol l ar s and per cent age of t ot al cost i ncr ease, emphasi s onobt ai ni ng a det ai l ed est i mat e shoul d al so i ncr ease.

Do the cost accounting data provide a clear history?

I f det ai l ed cost dat a do not pr ovi de a cl ear mat er i al costhi st ory, t hen summary est i mat i ng t echni ques may be t he most

vi abl e al t er nat i ve.

Would the summary-level analysis be as accurate as a

detailed analysis?

I f t he summar y- l evel est i mat e i s as good as a det ai l edanal ysi s, t hen i t i s mor e cost ef f ect i ve t o use t he l esscost l y summary anal ysi s.

Determine Which Summary Estimating Technique Was Used. Todet ermi ne whi ch summary est i mat i ng t echni ques were used i n

pr oposal devel opment , ask quest i ons such as t he f ol l owi ng:

Has the offeror estimated direct material cost using a

cost estimating relationship (CER)?

Est i mat ors can use a CER t o est i mat e cost s based on anest abl i shed r el at i onshi p bet ween t he cost and somei ndependent var i abl e. The i ndependent var i abl e may be a


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par amet er of t he i t em or ser vi ce bei ng acqui r ed ( e. g. , i t emsi ze or speed) , or anot her cont r act cost ( e. g. , di r ectl abor cost) .

For example: An of f eror mi ght use a CER t o est i mat e

mat er i al cost f or a research and devel opment ( R&D)cont r act . Si nce t he pur pose of an R&D cont r act i s t o l earnabout t he unknown, t her e i s l i kel y no f i r m l i st of mat er i alr equi r ement s t o use as a basi s f or est i mate devel opment .However , i t may be possi bl e t o devel op a CER based on t her el at i onshi p bet ween mat er i al cost and a r el at edi ndependent var i abl e ( e. g. , mat er i al cost per di r ect l abordol l ar or mat er i al cost per di r ect l abor hour ) . Of cour set he of f eror shoul d cl ear l y document devel opment and use oft he CER.

Has the offeror estimated direct material cost using a

direct comparison with the cost of a similar contract

effort?

A di r ect compar i son i s j ust t hat , a compar i son wi t h t hecost of a si mi l ar cont r act ef f or t . The si mi l ar ef f or t coul dbe a cont r act or cont r act s f or t he same pr oduct or asi mi l ar pr oduct . The assumpt i on i s t hat cont r act s wi t hsi mi l ar mat er i al r equi r ement s wi l l have si mi l ar mat er i alcost s. I f t hi s assumpt i on i s val i d, t he est i mat or can uset he hi st or i cal cost t o est i mat e t he cost of t he newcont r act . When pr epar i ng the est i mat e, t he est i mat or shoul d

consi der t he need t o adj ust hi st or i cal cost s f ordi f f er ences i n t he acqui si t i on si t uat i on ( e. g. , changi ngval ue of t he dol l ar , l abor i mpr ovement , and di f f er ences i nwork compl exi t y) . The pr oposal shoul d cl ear l y document t hesi mi l ar i t y i n mat er i al r equi r ement s and t he r at i onal e f orany adj ust ment s r equi r ed t o compensat e f or di f f er ences i nt he acqui si t i on si t uat i on.

Determine If CERs Were Properly Developed and Applied. Todet er mi ne i f cost est i mat i ng r el at i onshi ps ( CERs) used i nt he pr oposal wer e pr oper l y devel oped and appl i ed, ask

quest i ons r el at ed t o t he i ssues and concer ns associ at edwi t h CER devel opment .

Does the available information verify the existence

and accuracy of the proposed relationship? Is there any trend in the relationship? Is the CER used consistently? Has the CER been consistently accurate in the past?


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How current is the CER? Would another independent variable be better for

developing and applying a CER? Is the CER a self-fulfilling prophecy? Would use of a detailed estimate or direct cost

comparison with actuals from a prior effort produce

more accurate results? Does the CER estimate consider the changing value of

the dollar?

Determine If Direct Comparisons Were Properly Developed and

Applied. To det er mi ne i f di r ect compar i sons used i n t hepr oposal have been pr oper l y devel oped and appl i ed, ask t hef ol l owi ng quest i ons:

Is the basic nature of the new contract effort similar

enough to the historical effort to make a valid

comparison? Does data analysis consider the changing value of the

dollar? Were there significant cost problems or inefficiencies

in the historical effort that would distort the

estimate on the new effort? Have there been significant changes in technology or

methods that would distort the estimate on the new

effort? If the historical costs have been adjusted in any way,

are the adjustments reasonable?

Are there any significant differences in the materialmix between the two efforts?

Did the offeror assume any improvement from historical

effort to the current effort? If not, why not? If so,

does the estimate properly consider improvement curve

theory?

Develop and Document Your Prenegotiation Position. As youdevel op and document your pr enegot i at i on posi t i on on di r ectmat er i al cost :

I f you accept t he of f er or ' s summary est i mate, documentt hat accept ance.

I f you do not accept t he summar y est i mat e, documentyour concer ns wi t h t he est i mat e and devel op your ownpr enegot i at i on posi t i on f or cost s cover ed by t heest i mat e.

I f you can i dent i f y i nf or mat i on t hat woul d per mi t yout o per f or m a mor e accur at e anal ysi s of mat er i al cost s,


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use t he avai l abl e i nf or mat i on. Your anal ysi s i s notbound by t he est i mat i ng methods used by t he of f eror .

6.3 Analyzing Detailed Quantity Estimates

Detailed Direct Material Cost Estimates. A det ai l ed costest i mate i s more cost l y t o devel op and anal yze t han asummary est i mat e. However , when pr oper l y compl et ed, t heaccur acy of a detai l ed est i mate shoul d compensat e f or t headdi t i onal cost.

To prepar e a detai l ed di r ect mat er i al cost est i mat e t heest i mat or must f i r st pr epar e an est i mat e of t he mat er i alquant i t i es r equi r ed t o compl et e t he cont r act and t henest i mat e t he uni t pr i ce f or t hat mat er i al . Est i mat edmat er i al quant i t i es wi l l i ncl ude t he mat er i al t hat wi l lbecome part of t he pr oduct and any addi t i onal mater i alr equi r ed t o compensat e f or mat er i al over r uns, scr ap,spoi l age, and def ect i ve par t s. Est i mat ed pr i ces mustconsi der t he t ot al quant i t i es r equi r ed.

Bill of Materials ( FAR Tabl e 15- 2) . A bi l l of mat er i al s i sa l i st i ng of al l t he mat er i al s, i ncl udi ng t he par t number sand quant i t i es of al l t he par t s r equi r ed t o compl et e t hecont r act . When t he cont r act i s compl ex, t here may bei ndi vi dual bi l l s of mat er i al f or di f f er ent cont r act t asks

or l i ne i t ems. I f t he est i mat e i ncl udes mor e t han one t askor i t em bi l l of mat er i al s, t he of f er or must submi t aconsol i dat ed bi l l of mat er i al s f or al l i t ems, wi t h abr eakdown sui t abl e f or anal ysi s. The est i mat e must i dent i f yt he i t em, t he sour ce, t he quant i t y, and t he pr i ce.

For suppl y and const r uct i on cont r act s, t he est i mat orshoul d est i mat e base mat er i al r equi r ement s f or t he bi l l ofmat er i al s usi ng cont r act dr awi ngs and speci f i cat i ons.Est i mat es of addi t i onal mat er i al r equi r ement s t o compensat ef or mat er i al over r uns, scrap, spoi l age, and def ect i ve par t s

shoul d be based on of f er or exper i ence and cont r actr equi r ement s.

Ser vi ce cont r act s may not i ncl ude dr awi ngs andspeci f i cat i ons, but di r ect mat er i al quant i t y est i mat es wi l lst i l l be based on an anal ysi s of cont r act r equi r ement s andof f er or exper i ence. These quant i t y est i mates may be basedon a det ai l ed anal ysi s of cont r act r equi r ement s or on
http://www.acqnet.gov/far/current/html/15.html#15.408http://www.acqnet.gov/far/current/html/15.html#15.408


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compar i sons wi t h t he mat er i al quant i t i es act ual l y r equi r edt o compl et e si mi l ar cont r act s.

The t abl e bel ow pr esent s an exampl e of a pr i cedconsol i dat ed bi l l of mat er i al s t o pr oduce 500 uni t s of a

pr oduct .

Part

NumberItem and Source

InformationQuantity

per

Assembly

Scrap

Factor

Total

Quantity

Unit

PriceTotal

Price

9876543 Housi ng cast i ng.( Vendor: PI CCorp. PO 351522,i ssued 12/ 20,compet i t i ve)

1 4% 520 ea. $84. 72 $44, 054. 40

9876542 Bear i ng.( Vendor : Sun Co.PO 351480,

i ssued 12/ 5,noncompet i t i ve) .

2 12% 1120 ea. $14. 87 $16, 654. 40

9876541 Gear , 14 t oot h.( Vendor : AUTOCO,compet i t i ve )

4 8% 2160 ea. $4. 18 $9, 028. 80

9876540 Cabl e Assembl y( Vendor : RockwayCor p. ,noncompet i t i ve)

1 4% 520 ea. $328. 00 $170, 560. 00

9876539 Br acket , mai n.( Vendor : Cee CeeCorp. , pr i orpr i ce was $22. 19ea. ( PO 341110)8% added i nmaki ng est i mat e,t wo year s si ncel ast buy)

3 1% 1515 ea. $23. 97 $36, 314. 55

9876538 Race assembl y.( Si mi l ar i t embought 5/ 25 f r omHUP, I nc. f or$150 ea.Engi neer i ngest i mat es t hatnew i t em wi l l

cost 1/ 3 more)

1 2% 510 ea. $200. 00 $102, 000. 00

9876537 Sol enoi d.( Engi neer i ngest i mat e)

1 3% 515 ea. $90. 00 $46, 350. 00

9876536 Gear , dr i ve.( Engi neer i ngest i mat e)

1 3% 515 ea. $24. 00 $12, 360. 00

Total Material $437, 322. 15


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Points to Consider When Analyzing Detailed Quantity

Estimates. As you conduct your anal ysi s of det ai l ed di r ectmat er i al quant i t y est i mat es:

Gi ve speci al at t ent i on t o any di r ect mat er i al quant i t yconcer ns i dent i f i ed dur i ng your pr el i mi nar y r evi ew oft he mat er i al mi x.

Sel ect a sampl i ng st r at egy f or anal ysi s. Determi ne t he r easonabl eness of t he base est i mat e of

di r ect mat er i al quant i t i es r equi r ed t o compl et e t hecont r act.

Determi ne t he reasonabl eness of any adj ust ment s t o t hebase est i mat e of di r ect mat er i al quant i t i es r equi r edt o compl et e t he cont r act .

Devel op and document your pr enegot i at i on posi t i on ondi r ect mat er i al quant i t i es r equi r ed t o compl et e t hecont r act.

Sampling Strategy for Analysis. I f t he pr oposal i ncl udesonl y a f ew mater i al i t ems, you may have t i me to revi ew al lbi l l of mat er i al s i t ems. For l ar ger pr oposal s wi t h mor ei t ems, you wi l l pr obabl y need t o l i mi t your r evi ew t o ani t em sampl e.

Consi der usi ng st r at i f i ed sampl i ng pr ocedur es t hatper mi t you t o gi ve mor e at t ent i on t o hi gh- val ue i t ems, but

st i l l consi der al l bi l l of mat er i al s i t ems. You can t henadj ust i t em est i mat es based on anal ysi s r esul t s. Ar educt i on t o pr oposed cost s i s commonl y cal l ed a decrement,and t he per cent age adj ust ment a decrement factor.

For example: You dr aw a sampl e f r om al l mat er i al i t ems wi t han extended cost of $1, 000 or l ess. I n anal yzi ng t hatsampl e, you f i nd t hat t he sampl ed i t ems ar e over pr i ced byf i ve per cent . The pr oposed cost of al l i t ems i n t he sampl edst r at um ( $1, 000 or l ess) shoul d be r educed by f i ve per cent .The r educt i on i s r ef er r ed t o as a decr ement and t he f i ve

per cent i s a decr ement f act or .

Determine the Reasonableness of the Base Estimate. Thebase quant i t y est i mat e i s t he quant i t y of mat er i al t hatwi l l act ual l y be used i n t he f i nal pr oduct . Techni calper sonnel shoul d be abl e t o ver i f y t hi s quant i t y bycompar i son wi t h dr awi ngs and other r el evant cont r actr equi r ement s.


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Determine the Reasonableness of Any Adjustments. Theact ual di r ect mat er i al r equi r ed t o pr oduce a pr oduct wi l ll i kel y exceed t he mat er i al t hat wi l l be i ncl uded i n t hepr oduct . The r easons f or t hi s di f f er ence t ypi cal l y i ncl udemat er i al over r uns, scrap, spoi l age, and def ect i ve par t s.Al l t hese cost s ar e nor mal l y est i mat ed usi ng costest i mat i ng r el at i onshi ps ( CERs) based on t he base est i matesof di r ect mat er i al r equi r ed t o pr oduce t he pr oduct . Youranal ysi s shoul d cent er on assur i ng t hat t he est i mat e i sr easonabl e.

I n t he bi l l of mat er i al s exampl e above, exami ne theest i mat e f or Par t Number 9876543. A t ot al of 520 par t s mustbe pur chased t o compl et e assembl i es r equi r i ng 500 part s.The addi t i onal 20 par t s ar e est i mat ed t o be scr ap.

Adj ust ment f actors are normal l y based on account i ngdat a and st at i st i cal anal ysi s or ot her r el evant exper i ence.The most common met hod of cal cul at i on i s a movi ng average,i ncor por at i ng 6 t o 12 mont hs of dat a.

For example: CERs used t o est i mat e t he cost of scr ap may becal cul at ed usi ng ei t her dol l ar s or uni t s of mat er i al andare commonl y cal cul ated i n one of t he f ol l owi ng ways:

Scr ap Dol l ar sor Scr apUni t s

Tot al Assembl y Mat er i alDol l ar s Tot al Assembl yMat er i al Uni t s

Scr ap Dol l ar sor Scr apUni t s

Mat er i al Dol l ar sPur chased Mat er i alUni t s Pur chased

As you anal yze any adj ust ment s t o t he base bi l l ofmat er i al s quant i t i es, consi der t he answer s t o the f ol l owi ngquest i ons:

If a CER (e.g., a scrap factor) is used to estimate

adjustments, did the offeror consider the issues and

concerns associated with CER development?


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Quant i t at i ve Techni ques f or Cont r act Pr i ci ng ( Vol ume I I )i dent i f i es a ser i es of quest i ons r el at ed t o i ssues andconcerns t hat you shoul d consi der when eval uat i ng any CER.

Do you know what types of material costs are covered

by the CER?

Mater i al cost s est i mated usi ng a CER must not dupl i catemat er i al cost s est i mat ed usi ng some ot her met hod. A CERdevel oped t o est i mat e t he cost of scr ap f or el ect r oni ccomponent s shoul d normal l y not be used to est i mat e t he costof scr ap f or met al component s.

Is the method used to apply the CER in the estimate

consistent with the method used in rate calculation?

The i ndependent var i abl e used as a base f or appl yi ng t heCER ( e. g. , t ot al assembl y mat er i al dol l ar s) must be t hesame as t he base used to cal cul at e t he CER and t he val ue oft he i ndependent var i abl e must be cal cul at ed usi ng t he sameprocedures used i n CER devel opment .

Does related estimate information indicate that the

additional material amounts are consistent with past

experience?

A CER or anot her met hod of adj ust ment may pr oduce resul t st hat do not appear r easonabl e based on past exper i ence. I n

such si t uat i ons, consi der t he need f or f ur t her anal ysi s.

Are the materials, tolerances, and processes similar

to those used to calculate the CER?

Not e t hat di f f er ent i t ems i n t he consol i dat ed bi l l ofmater i al s exampl e above have di f f er ent scr ap r ates. Somemat er i al s t end t o pr oduce mor e scr ap t han ot her s i n si mi l arpr ocesses. Ti ght er t ol er ances t end t o pr oduce mor e scrap.Di f f er ent pr ocesses pr oduce di f f er ent r at es of scrap.

Are the data used to calculate the CER changing overtime?

Exper i ence wi t h t he same mat er i al and pr ocesses shoul dr educe scr ap r at es. Many CERs t hat are used t o est i mat eaddi t i onal mater i al r equi r ement s are devel oped usi ng movi ngaver ages t o smoot h var i at i ons i n t he data. A l onger movi ngaver age ( e. g. , 12 mont hs) may mask i mprovement . A shor t er


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( e. g. , 6 mont hs) movi ng aver age wi l l r eact f ast er t oi mprovement , but may over r eact t o a r andom change i n t hedat a.

Is the amount of the adjustment for material overruns,

scrap, spoilage, and defective parts reasonable from ashould-cost viewpoint?

The CER may be based on hi st or y, but does t hat hi st or yr epr esent ef f i ci ent and ef f ect i ve oper at i ons. Consi dert hese rel at ed quest i ons:

o Ar e potent i al pr ocess i mpr ovement s t hat woul dr educe mat er i al cost consi der ed by t hi sadj ust ment ?

o Woul d a di f f er ent t ype, si ze, or shape ofmat er i al r educe t he need f or t hi s adj ust ment ?

o

What i s t he of f er or doi ng t o reduce t he need f ort hi s adj ust ment ?

Does the proposal consider the residual value of the

material overruns, scrap, spoilage, and defective

parts?

Mat er i al t hat cannot be used f or i t s i nt ended pur pose i spr obabl y not wor t hl ess, and t he of f er or must consi der t hatr esi dual val ue i n t he pr oposal . Dependi ng on t he of f er or ' saccount i ng met hods, t hi s r esi dual val ue may be cr edi t ed

di r ect l y t o t he cont r act or cr edi t ed t hr ough an appr opr i at eover head r at e r educt i on.

Develop and Document Your Prenegotiation Position. As youdevel op and document your pr enegot i at i on posi t i on on di r ectmat er i al quant i t i es, consi der t he f ol l owi ng:

I f you accept t he of f er or ' s quant i t y est i mat e,document t hat accept ance.

I f you do not accept t he quant i t y est i mate, documentyour concer ns wi t h t he est i mat e and devel op your own

pr enegot i at i on posi t i on f or di r ect mat er i al cost scover ed by t he est i mate.

I f you can i dent i f y i nf or mat i on t hat woul d per mi t yout o per f or m a mor e accur at e anal ysi s of mat er i al cost s,use t he avai l abl e i nf or mat i on. Your anal ysi s i s notbound by t he est i mat i ng methods used by t he of f eror .


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6.4 Analyzing Unit Cost Estimates

Points to Consider When Analyzing Unit Cost Estimates.Af t er you have est abl i shed t he quant i t y of mat er i alr equi r ed t o compl et e t he cont r act , you must anal yze t he

pr oposed uni t cost s. As you conduct your anal ysi s:

Gi ve speci al at t ent i on t o any di r ect mat er i al uni tcost concer ns i dent i f i ed dur i ng your pr el i mi nar yr evi ew of t he mat er i al mi x.

Det er mi ne i f t he of f er or used an appr opr i at e base f orest i mat i ng uni t mat er i al cost s.

Det er mi ne t he reasonabl eness of mat er i al uni t costest i mates based on cur r ent quot es.

Det er mi ne t he reasonabl eness of mat er i al uni t costest i mat es based on hi st or i cal quot es or pur chasepr i ces.

Det er mi ne t he reasonabl eness of mat er i al uni t costest i mat es based on i nvent or y pr i ci ng.

Det er mi ne t he r easonabl eness of i nt er or gani zat i onalt ransf ers.

Devel op and document your pr enegot i at i on posi t i on onuni t cost s f or di r ect mat er i al s.

Determine Appropriateness of Estimating Bases. Ther e ar et hr ee gener al bases commonl y used f or est i mat i ng di r ectmat er i al uni t pr i ces f or f ut ur e cont r act per f or mance. Uset he f ol l owi ng t abl e as you determi ne whether t he base used

by t he of f er or i s appr opr i at e under t he ci r cumst ances.

Use

estimates

based on:

When the following conditions exist:

Cur r entQuot es

Work wi l l be per f ormed usi ng mater i al s notcur r ent l y i n i nvent or y;

Mat er i al pr i ces may var y si gni f i cant l y f r omcur r ent i nvent or y val ues;

Ther e i s suf f i ci ent l ead t i me t o acqui r emat er i al s bei ng est i mat ed; and

Ther e i s suf f i ci ent proposal prepar at i ont i me f or t he of f er or t o sol i ci t and r ecei vevendor quotes.

Hi st or i cal Wor k wi l l be per f or med usi ng mat er i al s not


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Quot es orPur chasePr i ces

cur r ent l y i n i nvent or y;

Pr i ce changes ( or l ack of changes) bet weenpr i ce hi st or y and cont r act per f or mance ar er el at i vel y or pr edi ct abl e; and

Ther e i s suf f i ci ent l ead t i me t o acqui r emat er i al s bei ng est i mat ed.

( Not e: Thi s met hod i s par t i cul ar l yappr opr i at e when t her e i s i nsuf f i ci entpr oposal pr epar at i on t i me f or t he of f er or t osol i ci t and r ecei ve vendor quot es. )

I nvent or yPr i ci ng

Wor k wi l l be per f or med by usi ng mat er i al s i nt he exi st i ng i nvent or y.

Analyzing Current Quotes. As you eval uate t her easonabl eness of mat er i al uni t cost est i mat es based oncur r ent quot es, consi der t he answer s t o t he f ol l owi ngquest i ons:

Are the quotes for quantities required to complete the

contract?

Make sur e t he vendor quotat i ons match t he quant i t i esnecessary f or t he pr oposed work. For exampl e, i f 1, 000uni t s of a part are needed, t he quot e shoul d be based on

1, 000 uni t s. I f t he of f er or i s pr oposi ng t o make f i vepur chases of 200 uni t s, t he uni t s ar e l i kel y to beover pr i ced, because l arger quant i t y pur chases usual l y meanl ower uni t pr i ces.

Exceptions. There ar e t wo gener al except i ons t o t hi s r ul e.

o I f t he i t ems bei ng est i mat ed are used on moret han one cont r act , quant i t i es f or al l par t sr equi r ed dur i ng the t i me per i od shoul d becombi ned i n or der t o obt ai n t he best possi bl e

pr i ces t hr ough quant i t y pur chasi ng.o I f t he i ncreased cost of hol di ng t he pr oductexceeds t he pot ent i al savi ngs f r om quant i t ypr ocur ement . Then t he cont r act or may be abl e t oj ust i f y buyi ng t he product i n smal l er l ot s atdi f f er ent t i mes i n t he pr oduct i on pr ocess.


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Did the proposal consider probable negotiated price

reductions?

I f t he of f er or has a hi st or y of negot i at i ng r educt i ons f r omsubcont r act pr i ce quot es, t he pr oposed mat er i al pr i ce

shoul d r ef l ect t he hi st or i cal pr oposal r educt i on( decr ement ) . Even when mul t i pl e pr ospect i ve subcont r actorshave submi t t ed "compet i t i ve quot es, " be on t he l ookout f orpur chase or der s pl aced at pr i ces l ess t han t he quot e.

Most cont r act or s wi l l t r y t o negot i at e r educt i ons even wi t hcompet i t i ve quot es. Techni ques t he of f er or may empl oy t or educe quot ed pr i ces i ncl ude: aski ng vendor s f or anot herr ound of best and f i nal of f er s; cont i nui ng negot i at i ons;swi t chi ng t o a l ower pr i ced vendor ; and i ncr easi ng or derquant i t i es t o gai n quant i t y di scount s.

I f t he pr oposal di d not consi der negot i at ed pr i cer educt i ons, consi der devel opi ng your own decr ement f act or .For exampl e, i f hi st ory shows t hat t he of f er or commonl ynegot i at es pr i ces f i ve per cent bel ow t he pr i cessubcont r act or s propose, you coul d use a f i ve per centdecr ement f act or t o consi der t he ant i ci pat ed r educt i on.

Did the proposal properly consider subcontract terms

and conditions?

Somet i mes, speci al condi t i ons i n t he busi ness ar r angement s

bet ween t he of f er or and vendor r esul t i n savi ngs t o theof f er or . These savi ngs shoul d be passed on t o t heGover nment . Some exampl es i ncl ude:

o Quotations with escalation already included.

Somet i mes t he of f er or wi l l ask a vendor t o quotepr i ces f or or der s pl aced over an extended per i odof t i me. The vendor wi l l most l i kel y i ncl ude someescal at i on i n t he pr i ce f or cost i ncreases. Whi l et hi s i s accept abl e, i t woul d be unaccept abl e f ort he of f er or t o add an addi t i onal escal at i on

f act or t o a vendor quot e t hat al r eady i ncl udesescal at i on f or t he same per i od of t i me.

o Quantity discount rebates. Occasi onal l y, you maysee an ar r angement wher e t he vendor wi l l charge aset pr i ce on each i ndi vi dual or der and at t he endof t he year of f er a rebat e based on t he t ot alquant i t y pur chased. I f t he Gover nment pays t hei ndi vi dual or der pr i ce, t he cont r act or coul d


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r eal i ze excessi ve pr of i t s t hr ough t he rebat e. Theof f er or shoul d pr oj ect t he est i mat ed quant i t y f ort he year and di scount t he cur r ent quoteconsi der i ng t he est i mated amount of t he rebat e oruse t he est i mat ed rebat e t o reduce any i ndi r ect

mat er i al .cost r el at ed t oo

Priced options. Whi l e t he of f eror may pr opose acur r ent quote, t her e may be an exi st i ng orderwi t h a pr i ced opt i on f or addi t i onal quant i t i es ata pr i ce l ower t han t he cur r ent quot e. The pr i cet he of f er or r eal l y expect s t o pay t he vendor i st he l ower pr i ced opt i on pr i ce, and t hat i s t hepr i ce t hat shoul d be used t o est i mat e di r ectmat er i al cost .

Has the prime contractor completed subcontract

negotiations?

You wi l l l i kel y f i nd i t harder t o negot i at e pr i cer educt i ons af t er t he of f er or has agr eed t o a subcont r actpr i ce. However , i f t he subcont r act has been negot i at ed, donot accept a subcont r act cost t hat you bel i eve i sunr easonabl e j ust because t he pr i ce has been negot i ated.

Will some (or all) of the contract material come from

existing inventory?

Det er mi ne i f t he of f er or wi l l pur chase t he ent i r e quant i t y

or i f some of i t wi l l come f r om exi st i ng i nvent or y.Remember t hat t he i nvent ory val ue may be l ess t han t hecur r ent mar ket pr i ce.

Are there any other significant price-related factors

that should be considered in estimating direct

material unit cost?

Det er mi ne what pr i ce- r el at ed f act or s ar e bui l t i nt o ( orexcl uded f r om) t he mat er i al quot es. For exampl e, i f a quot ei ncl udes sur f ace t r anspor t at i on cost t o t he pr i me' s pl ant ,

do not accept addi t i onal sur f ace t r anspor t at i on costest i mat es f or t hat mat er i al .

What is the nature and adequacy of the subcontract

price competition?

I n your eval uat i on of subcont r act compet i t i on, ask t he samequest i ons about t he exi st ence and adequacy of pr i ce


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compet i t i on t hat you woul d ask i n eval uat i ng of f er s f or aGovernment cont r act .

How do quotes compare with commercial prices,

historical prices, pricing yardsticks, or Independent

Government Estimates?

Be war y of subcont r act quot es t hat ar e subst ant i al l ydi f f er ent t han commer ci al pr i ces, hi st or i cal pr i ces,pr i ci ng yar dst i cks, or I ndependent Gover nment Est i mat es.Ask t he of f er or t o expl ai n t he di f f er ences, and, i n l i ghtof t hose di f f er ences, j ust i f y t he r easonabl eness of t hequot ed pr i ces.

Analyzing Historical Quotes or Purchase Prices. As youeval uat e t he r easonabl eness of mat er i al uni t cost est i matesbased on cur r ent quotes, consi der t he answer s t o thef ol l owi ng quest i ons:

Was the historical quote or subcontract price

reasonable?

Be caut i ous as you r evi ew mat er i al uni t cost est i mat esbased on vendor quotes or cont r act pr i ces pai d by t he pr i mecont r act or . Such est i mat es assume t hat t he hi st or i cal pr i cewas r easonabl e. That may not be t r ue. I f you havequest i ons, r evi ew t he of f er or ' s subcont r act f i l es andr el at ed mar ket i nf or mat i on.

Are there other historical quotes or subcontract

prices that support or refute the reasonableness of

the estimated price?

Ver i f y that t he subcont r act pr i ce quot e used by the of f er ori s not unusual l y hi gh ( or unusual l y l ow) f or t he quant i t yr equi r ed. For exampl e, t he most r ecent pur chase may havebeen at a r el at i vel y hi gher uni t pr i ce because t hecont r act or acqui r ed an unusual l y l ow quant i t y.

Are current material item requirements the same as thehistorical requirements?

Changes i n speci f i cat i ons can af f ect mat er i al pr i ces. I f apar t i cul ar pr ocess, i nspect i on, or speci f i cat i on has beenel i mi nat ed, t he cost of pr oduci ng t he i t em wi l l most l i kel ydr op. I f t hi s ci r cumst ance exi st s, t he hi st or i cal pr i cemust be adj ust ed accor di ngl y.


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How has the offeror's specific purchasing situation

changed?

You need t o underst and t he cont r act or ' s acqui si t i onsi t uat i on as i t exi st ed i n t he pr evi ous pur chase and how

t he cur r ent acqui si t i on si t uat i on di f f er s. As a mi ni mum,you shoul d consi der t he pr obabl e af f ect of changes i n:

o

Number of sources;o Qual i t y of sour ces and compet i t i on;o Quant i t i es pur chased;o Pr oduct i on / del i ver y r at es;o St ar t - up cost s; ando

Terms of pur chase.

Has the item's production status changed?

I t em pr i ces t ypi cal l y decrease when a par t i s i n cont i nuouspr oduct i on. I f t he i t em was i n cont i nuous pr oduct i on, buti s no l onger pr oduced, t he vendor may i ncur st ar t - up cost st o begi n manuf act ur i ng t he i t em agai n. I f an i t em' spr oduct i on st at us has changed, t he est i mat or shoul d ei t heradj ust hi st or i cal pr i ces t o consi der st ar t - up cost s andr el at ed i nef f i ci enci es or use anot her base to est i mat edi r ect mat er i al cost .

Remember t hat t he opposi t e si t uat i on can al so occur . I f t hel ast pur chase i ncl uded nonr ecur r i ng cost s ( e. g. , t ool i ng,

set - up, or f i r st ar t i cl e expenses) t hat shoul d not bechar ged agai n. The cost of t he cur r ent i t em shoul d r ef l ectonl y r ecur r i ng pr oduct i on cost s.

How has the general economic situation changed?

Economi c changes are r ef l ect ed i n t he gener al l evel ofi nf l at i on or def l at i on r el at ed t o t he mat er i al i t em. Pr i cei ndex number s can be i nval uabl e t o you i n anal yzi ng pr i cechanges.

Is there more recent pricing information available?

Be al er t t o possi bl e di scr epanci es bet ween est i mat i ngsyst em i nf or mat i on and t he pur chasi ng syst em i nf or mat i on.The of f er or shoul d al ways provi de you wi t h t he most up- t o-dat e i nf or mat i on. However , i f t he f i r m' s est i mat or s do notcommuni cat e ef f ect i vel y wi t h the f i r m' s buyer s, t heest i mat or s may st i l l be r el yi ng on hi st or i cal cost s even


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t hough the f i r m' s buyer s have obt ai ned cur r ent quotes andpr i ces.

Analyzing Inventory Pricing ( FAR 31. 205- 26( d) and App B,9904. 411- 50) . When t he f i r m i nt ends t o use exi st i ng

i nvent or y to per f or m t he cont r act , t he di r ect mat er i alest i mate shoul d be based on one of t he f i ve accept abl emet hods of i nvent ory pr i ci ng: f i rst - i n- f i rst - out , l ast - i n-f i r st - out , wei ght ed aver age, movi ng aver age, and st andar dcost . As you eval uat e t he r easonabl eness of mat er i al uni tcost est i mat es based on i nvent or y pr i ci ng, consi der whet hert he of f er or consi st ent l y uses one ( and onl y one) of t hoseaccept abl e methods.

First-in-first-out (FIFO). Thi s met hod of i nvent or ypr i ci ng works j ust as t he name i mpl i es. For account i ngpur poses, you assume t hat t he f i r st uni t i nt o t hei nvent or y i s t he f i r st uni t t o be dr awn out . Thei nvent or y val ue assi gned t o t he uni t dr awn out i s t heval ue of t he f i r st uni t r ecor ded as sti l l bei ng i ni nvent or y. I t does not mat t er whi ch uni t i s physi cal l ydr awn out of i nvent or y. I t coul d act ual l y be t he l astuni t added t o i nvent or y. Under FI FO, t he val ueassi gned woul d st i l l be t hat of t he f i r st uni tr ecorded as bei ng on- hand.

For example: A f i r m usi ng FI FO has f i ve wi dget s i ni nvent or y. The f ol l owi ng ar e t he acqui si t i on cost s i n or der

of r ecei pt :

Uni t A @ $100

Uni t B @ $110

Uni t C @ $105

Uni t D @ $115

Uni t E @$120

Dur i ng t he year , t he f i r m per f or ms t hr ee j obs r equi r i ng onewi dget each. Di r ect mat er i al cost s f or each j ob woul d be:

Uni t A @ $100 J ob 1 cost = $100

Uni t B @ $110 J ob 2 cost = $110
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Uni t C @ $105 J ob 3 cost = $105

Uni t D @ $115

Uni t E @$120

The r emai ni ng i nvent or y val ue woul d be $235 ( $115 + $120) .

Last-in-first-out (LIFO). As wi t h FI FO, LI FO i s whatt he name i mpl i es. Pr i ci ng i s based on t he assumpt i ont hat t he l ast , or most r ecent uni t r ecei ved, wi l l bet he f i r st dr awn out . Usi ng t he same si t uat i on asabove, but wi t h LI FO, you woul d get t he f ol l owi ng:

For example: A f i r m usi ng LI FO wi t h t he f ol l owi ng f i vewi dget s i n i nvent or y and t hr ee j obs r equi r i ng one wi dgeteach woul d have t he di r ect mat er i al cost i ndi cat ed f or eachj ob:

Uni t A @ $100

Uni t B @ $110

Uni t C @ $105 J ob 3 cost = $105

Uni t D @ $115 J ob 2 cost = $115

Uni t E @$120 J ob 1 cost = $120

The r emai ni ng i nvent or y val ue woul d be $210 ( $100 + $110) .

Weighted Average. Under t hi s met hod i nvent ory uni tpr i ces are recal cul at ed at desi gnat ed t i mes dur i ng theyear ( e. g. , quar t er l y) . The wei ght ed aver age i scal cul at ed by di vi di ng t he t ot al cost of t he i nvent or yon- hand by t he number of uni t s on- hand.

For example: A f i r m usi ng the wei ght ed aver age met hod ofi nvent or y pr i ci ng wi t h t he f i ve wi dget s bel ow i n i nvent or y

and thr ee j obs r equi r i ng one wi dget each woul d have adi r ect mat er i al cost of $110 f or each j ob.

Uni t A @ $100 J ob 1 cost = $110

Uni t B @ $110 J ob 2 cost = $110

Uni t C @ $105 J ob 3 cost = $110


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Uni t D @ $115

Uni t E @ $120

Tot al $550 f or f i ve uni t s

The i nvent or y pr i ce f or each wi dget woul d be t he wei ght edaver age $110 ( $550/ 5) . Note: I n t hi s exampl e, t he wei ght edaver age pr i ce i s t he same as t he si mpl e aver age pr i cebecause t her e i s onl y one uni t at each uni t pr i ce.

The r emai ni ng i nvent or y val ue woul d be $220 ( $110 x 2) .

Moving average. A movi ng aver age i s cal cul ated i n t hesame way as a wei ght ed aver age except t hat t hecal cul at i on i s done ever y t i me t her e i s a new addi t i ont o i nvent or y.

For example: Fi ve wi dget s l i st ed i n t he Or i gi nal I nvent or ybel ow ar e i n i nvent or y. Dur i ng t he year , t hr ee j obs wer eper f ormed r equi r i ng one wi dget each. Af t er t he compl et i onof J ob 1, an addi t i onal uni t was added t o i nvent or y, andi nvent or y pr i ces r ecal cul at ed.

Or i gi nal I nvent or y:

Uni t A @ $100 J ob 1 cost = $110

Uni t B @ $110

Uni t C @ $105

Uni t D @ $115

Uni t E @ $120

Tot al $550 f or f i ve uni t s

The i nvent or y pr i ce f or each of t he or i gi nal f i ve wi dget s

woul d be t he wei ght ed aver age $110 ( $550/ 5) .

I nvent or y af t er Compl et i on of J ob 1 and addi t i on of Uni t F:

4 Uni t s @ $110 = $440 J ob 2 cost = $112

Uni t F @ $120 = $120 J ob 3 cost = $112


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$560

The new movi ng aver age pr i ce woul d be $112 ( $560/ 5) .

The r emai ni ng i nvent or y val ue woul d be $336 ( $112 x 3) .

Standard cost. Under t hi s met hod of i nvent or y pr i ci ng,t he val ue of i nvent or y equal s t he number of uni t st i mes t he uni t st andar d cost . St andar d cost s ar eusual l y based ei t her on expect ed pr i ces f or t he per i odi n quest i on ( somet i mes as shor t as a week) or onpr i ces pr evai l i ng at t he t i me t he st andar ds ar e set .St andar d cost s do not change i n r esponse t o shor t - t er mf l uct uat i ons i n vol ume, quant i t y, or uni t cost s.

The di f f er ence between t he acqui si t i on cost andst andar d cost of i nvent or y uni t s i s cal l ed a variance.Var i ance adj ust ment s may be handl ed by maki ng costadj ust ment s on each j ob, or i f t he cost i s i nsi gni f i cant ,i t can be done as an overhead adj ust ment .

Ther e may be subst ant i al di f f er ences between cont r act ori nvent or y st andard cost syst ems. I f you encount er ani nvent or y st andard cost syst em, ask t he cont r act or t oi dent i f y the sour ce of t he appl i ed st andar ds and t o expl ai nany var i ances. Wher e possi bl e, cont act t he cogni zantGover nment audi t or f or assi st ance.

Inter- Organizational Transfers ( FAR 15. 403- 1( b) and31. 205- 26) . I nt er or gani zat i onal or i nt er di vi si onalt r ansf er s ar e mat er i al s, suppl i es, or ser vi ces t hat ar esol d or t r ansf er r ed bet ween di vi si ons, subsi di ar i es, oraf f i l i at es of t he cont r act or under a common cont r ol . Theyr equi r e speci al anal ysi s because any pr of i t i ncl uded i n ani nt er or gani zat i onal t r ansf er per mi t s a cont r act or t opyr ami d pr of i t s by i ncl udi ng pr of i t ( f or ot her el ement s oft he over al l f i r m) i n cont r act cost s. A f i r m coul dconcei vabl y creat e mor e di vi si ons and t r ansf er mat er i alback and f or t h bet ween t hose di vi si ons t o f ur t her i ncr ease

t ot al pr of i t f or t he t ot al cor por at e ent i t y.

Transfers at cost. To prevent cont r act or s f r ompyr ami di ng pr of i t s usi ng i nt er or gani zat i onalt r ansf er s, t he Gover nment has adopt ed t he pol i cy t hati nt er or gani zat i onal t r ansf er s must be made at cost . I not her wor ds, t he t r ansf er must not i ncl ude any pr of i tf or t he di vi si on, subsi di ar y, or af f i l i at e maki ng t he
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t r ansf er . Fur t her mor e, t he cost s of t hat di vi si on,subsi di ar y, or af f i l i at e ar e subj ect t o audi t andanal ysi s, j ust l i ke any ot her cont r actor cost s.

Transfers at price. However an i nt er or gani zat i onalt r ansf er may be made at pr i ce ( wi t h pr of i t ) , when al lof t he f ol l owi ng f our condi t i ons ar e met :

o I t i s t he est abl i shed pr acti ce of t het r ansf er r i ng or gani zat i on t o pr i cei nt er or gani zat i onal t r ansf er s at ot her t han cost( wi t h pr of i t ) f or commer ci al wor k of t hecont r act or or any di vi si on, subsi di ar y, oraf f i l i at e of t he cont r act or under common cont r ol .

o

The i t em bei ng t r ansf er r ed qual i f i es f or anexcept i on t o st at ut or y r equi r ement s f or cost orpr i ci ng dat a.

o

When the t r ansf er pr i ce i s based on a cat al og ofmar ket pr i ce, t he pr i ce shoul d be adj ust ed t o

r ef l ect t he quant i t i es bei ng acqui r ed and may beadj ust ed t o r ef l ect t he act ual cost of anymodi f i cat i ons necessar y because of cont r actr equi r ement s.

o The cont r act i ng of f i cer does not deter mi ne t hatt he pr i ce i s unr easonabl e.

6.5 Recognizing Subcontract Pricing Responsibilities

Privity of Contract Concept. The t erm "pr i vi t y ofcont r act" r ef er s t o t he di r ect r el at i onshi p t hat exi st sbet ween cont r act i ng par t i es.

The Government has a cont r act wi t h t he pr i mecont r actor , t her ef or e t her e i s pr i vi t y of cont r actbet ween t he Gover nment and t he pr i me cont r act or .

The pr i me cont r act or has a cont r act wi t h i t ssubcont r act or s, so pr i vi t y of cont r act exi st s bet weent he pr i me cont r act or and i t s subcont r act or s.

However , t he Gover nment does not have a cont r act wi t h

any subcont r act or , so no pr i vi t y of cont r act exi st sbet ween t he t wo par t i es. Si nce no pr i vi t y of cont r actexi st s, you cannot :

o Negot i at e di r ect l y wi t h t he subcont r act or ; oro Di r ect t he subcont r act or t o t ake any act i on.


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Whi l e t he Gover nment has an i nt er est i n t he act i vi t i esand per f ormance of t he subcont r actors, you must be car ef ulnot t o vi ol at e t he cont r actual r el at i onshi p.

Responsibility to Analyze Subcontract Proposals ( FAR

15. 404- 3( b) ) . The f i r m awar di ng t he subcont r act ( t heof f er or or a hi gher - t i er subcont r actor) , i s r esponsi bl e f orsubcont r act pr i ci ng. At t he same t i me, t he cont r act i ngof f i cer i s r esponsi bl e f or t he t ot al pr i ce pai d by t heGover nment , and must be sat i sf i ed t hat each subcont r act i ngt i er has per f or med an adequat e cost or pr i ce anal ysi s ofeach subcont r act pr oposal . Par t of t hat r esponsi bi l i t y i st o assure t hat t he subcont r act i ng act i vi t y has per f or med anappr opr i at e pr i ce or cost anal ysi s.

Price Analysis. The f i r m awar di ng a subcont r act mustper f or m a pr i ce anal ysi s when no cost anal ysi s i sper f or med and shoul d per f or m a pr i ce anal ysi s i nconj unct i on wi t h any cost anal ysi s t o ensur e over al lpr i ce r easonabl eness. Thi s anal ysi s shoul d be si mi l art o one t hat you woul d per f or m i n pr i ci ng a si mi l arcont r act under si mi l ar ci r cumst ances.

Cost Analysis. The f i r m awar di ng a subcont r act mustanal yze:

o Any r equi r ed subcont r act or cost or pr i ci ng dat a,and

o Any subcont r act or cost i nf or mat i on ot her t hancost or pr i ci ng dat a r equi r ed t o det er mi ne cost

r easonabl eness or cost r eal i sm.

The f i r m awar di ng a subcont r act must i ncl ude t her esul t s of t hese anal yses as par t of i t s own cost orpr i ci ng dat a submi ssi on. Lower - t i er subcont r act anal ysesbecome par t of hi gher - t i er submi ssi ons, and event ual l y t hepr i me cont r actor ' s submi ssi on t o the Gover nment .

The r esul t s of t hese anal yses shoul d hel p t he f i r mawar di ng t he subcont r act t o ar r i ve at a f ai r and r easonabl esubcont r act pr i ce. Those same resul t s shoul d pr ovi de you

wi t h i nf or mat i on t hat wi l l hel p you ar r i ve at a f ai r andr easonabl e cont r act pr i ce.

Consi der a f i r m' s f ai l ur e t o anal yze subcont r act cost sas a pot ent i al l y si gni f i cant est i mat i ng syst em def i ci ency.I f you bel i eve t hat an anal ysi s i s i nadequat e or t hat t hesubcont r act pr i ce i s unr easonabl e, quest i on t he cost si nvol ved. Remember t hat a f i r m' s f ai l ur e t o per f or m and
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submi t an adequate anal ysi s coul d l ead to cont r actover pr i ci ng.

Responsibility to Obtain Subcontract Cost or Pricing Data( FAR 15. 404- 3( c) ) . Unl ess t he subcont r act qual i f i es f or an

except i on t o st at ut or y cost or pr i ci ng dat a r equi r ement s,any cont r act or or subcont r act or r equi r ed t o submi t cost orpr i ci ng dat a must al so obt ai n cost or pr i ci ng dat a bef or e:

Awardi ng any subcont r act or purchase order expect ed t oexceed t he cost or pr i ci ng dat a t hr eshol d, or

I ssui ng any modi f i cat i on wi t h a pr i ce adj ust mentamount expect ed t o exceed t he cost or pr i ci ng dat at hr eshol d.

Responsibility to Submit Subcontract Cost or Pricing Data( FAR 15. 404- 3( c) ) . An of f er or r equi r ed t o submi t cost orpr i ci ng dat a to t he Government must al so submi t ( or causesubmi ssi on of ) cost or pr i ci ng dat a f r om pr ospect i vesubcont r act or s i n suppor t of each subcont r act pr i ced at t hel ower of ei t her :

$10, 000, 000 or more, or Bot h more t he cost or pr i ci ng dat a t hr eshol d and more

t han 10 percent of t he pr i me cont r actor ' s pr oposedpr i ce, unl ess t he cont r act i ng of f i cer bel i eves suchsubmi ssi on i s unnecessar y.

The cont r act i ng of f i cer may r equi r e subcont r act or costor pr i ci ng data bel ow t hese t hr eshol ds when t he data ar econsi der ed necessar y f or adequat el y pr i ci ng the pr i mecont r act.

Exceptions to Subcontract Cost or Pricing Data Requirements( FAR 15. 404- 3( c) ) . I f you ar e sat i sf i ed t hat a subcont r actwi l l be pr i ced on t he basi s of one of t he except i ons t ost at ut or y r equi r ement s f or cost or pr i ci ng dat a, do notr equi r e submi ssi on of subcont r act cost or pr i ci ng dat a.

I f t he subcont r act est i mat e i s based upon t he cost orpr i ci ng dat a of t he pr ospect i ve subcont r act or most l i kel yt o be awarded t he subcont r act , do not r equi r e submi ssi on t ot he Gover nment of dat a f r om more t han one proposedsubcont r act or f or t hat subcont r act .

Responsibility to Support Subcontract Estimates ( FAR15. 404- 3) . Requi r e t he of f er or t o suppor t subcont r act or
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cost est i mat es bel ow t he cost or pr i ci ng dat a t hr eshol dwi t h any dat a or i nf or mat i on ( i ncl udi ng ot her subcont r act orquot at i ons) needed t o est abl i sh a r easonabl e pr i ce.

To provi de adequat e cost est i mat e suppor t , t he of f er or

may need t o obt ai n i nf or mat i on ot her t han cost or pr i ci ngdat a f r om pr ospect i ve subcont r act or s.

Responsibility for Updating Subcontract Cost or Pricing

Data ( FAR 15. 404- 3( c) ( 4) ) . The of f er or i s r esponsi bl e f orassur i ng t hat subcont r act or cost or pr i ci ng dat a ar eaccur at e, compl et e, and cur r ent as of t he dat e of pr i ceagr eement or , i f appl i cabl e, anot her dat e agr eed uponbet ween t he par t i es, gi ven on t he cont r act or ' s Cer t i f i cat eof Cur r ent Cost or Pr i ci ng Dat a. Accor di ngl y, t he of f er ori s al so r esponsi bl e f or updat i ng a pr ospect i vesubcont r act or ' s cost or pr i ci ng dat a.

Remember t hat subcont r act pr oposal s are an i nt egr alpar t of pr i me cont r act pr oposal s. As a r esul t , when apr ospect i ve subcont r act or ' s cost or pr i ci ng dat a ar e notaccur at e, compl et e, and cur r ent , t he pr ospect i ve pr i mecont r act or ' s pr oposal cannot be accur at e, compl et e, andcur r ent .
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