Abstract
Contractor and government personnel are repeatedly misusing the terms “cost,” “price” and “estimate.” Many times it does not make any difference, but there are times when misuse of these terms causes a critical communication problem. This monograph explains the correct usage of these terms and the gray areas that one needs to be concerned about.
1. Confusion of Terms
It is easy to confuse and misuse the foregoing three terms. Professionals even do it: individuals talk about the cost of this or the cost of that when, in fact, it is really not the cost, but an estimate, or perhaps a pricing decision, that the company has made. That is permissible in informal discussions. Certainly in writing, however, when representations are being made to government customers, it should be made clear exactly what is being talked about.
Stating to government representatives that something is a “cost” when it contains elements of a price or elements of an estimate, and not disclosing that fact is (at the least) a mistake. It could be worse – a misrepresentation.
Be cautious in using these terms. Make sure your compliance documents relating to the finance and contracts departments are sensitive to this issue, and monitor the materials going outside the company to be sure these critical terms are being appropriately distinguished in people’s minds and in their written presentations.
2. Cost (or Actual Cost)
Cost (or elements thereof) is generally assumed to be the actual cost as provable from a company’s books or records. There may be allocations of costs from overhead pools to direct costs incurred, but generally there is an element of actual contemporaneous recording of costs by individual timekeepers, in cost records, or in purchase prices for materials on the company’s books. Thus, “costs” may be provable or displayable in many ways, but the contemporaneous keeping and creating of records is expected. DCAA will likely expect real contemporaneous records to exist for costs asserted to be actual.
However, when “costs” are recorded on breakdowns given to the government, those may well be actual “projected” or “forward looking costs.” Therefore, they are really much more like “estimates” of costs to be incurred, as discussed next. They should probably be so identified as “estimated costs.” “projected costs,” or “forward looking costs.”
There is nothing wrong with estimated costs – just don’t call something “actual” when it is really an estimate.
3. Estimate (of Costs)
An estimate is often an element of either price or cost. It should be labeled clearly as an estimate, and explained in terms of its basis and makeup. An estimate may be a build-up that a company has done based upon various figures, expectations, contingencies, etc. It generally does not represent actual costs incurred, and that should be made clear in writing. It may well represent a projection of expected future costs to be incurred.
To the extent that an estimate contains or includes in its backup some historical cost elements, such elements should probably also be explained. The DCAA Audit Manual gives high priority to the reliability of historical costs when determining payments to be made under federal government contracts. Do not miss the opportunity to use historical costs when available.
An estimate could also be entirely pricing – simply what the company wants to get to produce a particular item and then there is an estimating of elements in terms of how to get to that price. There is no direct relationship to cost.
An estimate could also attempt to reproduce what actual costs have historically been or will be in the future. Carefully express this to your customers, if this is what you intend the estimate to provide.
[Generally, all data underlying an estimate must be disclosed to the government in order to be in compliance with the Truth in Negotiations Act (“TINA”).]
4. Price
In contrast to actual cost and estimated cost, the “price” is whatever the company chooses to set for an item in a market. It can have no relationship whatsoever to “costs” or “estimates.” A company may choose to back-up its price with a “breakdown.” That breakdown should clearly state whether it is also simply elements of the price that the company wishes to obtain for various subparts of the item. It is most often not actual costs incurred, or to be incurred, and should so state.
Stating that the price is backed up by a cost breakdown, which is not accurate or has no historical basis, can produce serious problems and misperceptions by government evaluators, and auditors. [It is also an obvious potential TINA violation or worse.]
5. The Foregoing Distinctions and Their Relationship to the Truth in Negotiations Act (“TINA”)
Items 1-4 above cover the basics of cost, price and estimates. This is often the end of the analysis. There are many contracts and separate pricing actions such as modifications that are not TINA covered.
Nevertheless, understanding the foregoing distinctions and following them is important. These distinctions become additionally more important when TINA covers the transaction – as of this writing, most negotiated non-competitive pricing actions over $750,000. Then an error or mistake in using the terms can result in an obligation to make a refund to the government.
6. Can There Be False Estimates? Yes!
There has been some recent discussion of the situation that as all “estimates” are really only “judgments,” there cannot be liability of contractors for “estimates” because they cannot be inherently “false.”
This position is wrong and can create compliance problems. If elements of the estimate are false, or contain undisclosed factors or contingencies, that can be defective pricing or worse. And as most cost and pricing data is filled with many estimates, this is an area in which clarity is important.
7. The Estimating Process and TINA
Focus on the fact that it is the estimating process that contractors utilize to establish their prices. In one respect, TINA has nothing to do with that. The contractor should make his very best estimates and stick with it. If the government then also estimates too high, that, in essence, has nothing to do with TINA. It is just a debate during negotiations. No TINA violations come out of the competently prepared estimate that the contractor believes in.
The TINA problems begin to occur when the contractor bases his estimates, in part, upon facts—historical labor, material, or overhead figures that exist in his book and records. The TINA issues also occur when the contractor has three quotes for an expensive component and makes the choice judgment of a higher-priced person because of perceived better quality. TINA problems persist when the contractor has historical overhead, and make forward looking projections as to whether there will be increases or decreases, and the reason why. All of these TINA implicated issues go far beyond the historical or actual figures that the contractor utilizes. Why? Because there are likely other pieces of data affecting all of these issues that are arguably
8. Disregarding Estimates and Data after Disclosure to the Government
It is perfectly permissible for a company to say that it has provided all the necessary cost or pricing data, but that it does not intend to negotiate upon that data. Its reasoning may be that the data used is viewed as unreliable --- that risks and performance have changed to the point where the data will not produce a fair price.
The contractor has a right to make those statements and take those positions in negotiations. Remember: the only obligation under TINA is to disclose all available facts, not to negotiate based upon what is to be disclosed. This approach obviously takes a strong stomach and a willingness to walk away from the negotiations.
CONCLUSION
We have set out above the distinctions between the important terms of cost, price and estimate. Whether the contract or the pricing action is TINA covered or not, these terms should be used with a degree of precision and concern for the potential for miscommunication to the customer.
Simply because the government disagrees with the contractor’s reported price, cost or estimate is irrelevant. The contractor does not need to change or accede to the government’s position on any of these issues. It simply needs to be honest and transparent in telling the government what it truthfully believes is contained in its breakdowns or proposals.
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