exist, as in the case of sole source vendors, the contractor's source for estimating mate
rial prices should be given close analysis.
9-404.3 Using Previous Purchase Order Prices
The contractor may use prices paid for the same items in previous purchases to esti
mate the material cost of follow-on procurements when current vendor bids have not been obtained. Determine the extent to which;
(1) recent purchase orders were selected to obtain applicable prices and adjusted, where necessary, to reflect price trends,
(2) purchase order prices selected are for comparable quantities required for the follow-on procurement,
(3) quantity discounts were given when increased quantities are to be purchased, and
(4) consideration has been given to eliminating high start-up costs.
9-404.4 Pricing of Company-Produced Components
Under certain circumstances, contractors may propose materials and supplies based on price rather than cost when they are sold or transferred between any division, subsidiary or affiliate of the contractor under common control. In these cases, ascertain whether the specific circumstances meet the criteria described in 6-313. If the audit discloses items that are improperly based on price rather than cost, appropriate adjustments should be made to eliminate the intracompany profit (plus any inapplicable indirect costs).
9-404.5 Pyramiding of Costs and Profit on Material Purchases
a. Most major programs require the use of subcontractors, not only to obtain facilities and skills which may not be available within the upper-tier contractor, but to broaden the procurement base and to meet requirements for utilizing small business. However, the auditor should be alert to instances where a proposal may be excessive because of unrea
sonable pyramiding of costs and profits. This may occur between divisions, plants, or sub
sidiaries of a company or between subcontractors and upper-tier contractors. The contrac
tor's procurement program should be reviewed to determine whether the planned subcontracting pattern is reasonable. The auditor should not limit his or her considerations to first-tier subcontracts, but should coordinate with auditors at subcontractor locations to disclose unreasonable pyramiding of costs or profits at any of the levels of the procure
ment chain where significant costs are involved.
b. Situations likely to result in excessive or unreasonable pyramiding of costs include the following (where questionable practices seem to exist, consult with Government tech
nical and procurement personnel as appropriate):
(1) Intracompany transactions through which items are charged to the contract at a list price (see 9-404.4) or at a cost plus unnecessary or unreasonable handling charges.
(2) Purchases from a subcontractor who acts merely as an intermediary/agent rather than as a manufacturer. Items may be drop-shipped direct to the upper-tier contractor's plant
or they may pass through the subcontract plant for minor additions, changes, or testing which could be done more economically and as well at a lower or an upper-tier contractor's plant.
(3) Purchases by an upper-tier contractor of items which are identical with or simi
lar to items being purchased by the Government and which could more economically be supplied as Government-furnished property.
c. When proposed material costs include loadings added by the prime contractor and upper-tier subcontractors, and the added amounts appear to be disproportionate com
pared to their planned work contribution, the audit report should comment on the in
creased costs and profit attributable to the pyramiding. The report should state:
(1) the estimated savings which will result by eliminating the intermediary and shortening the procurement chain,
(2) the considerations underlying the treatment of the direct procurement as Gov
ernment-furnished items, and
(3) the degree to which the component or item involved can be treated independent
ly from the system for which it is to be procured.
9-404.6 Subcontract Decrements
a. Vendor quotations and contract prices are frequently subject to change. These changes occur when:
(1) vendors agree to make voluntary price adjustments and refunds in the event purchases exceed a predetermined level,
(2) vendors agree to reduce a competitive quote, or (3) profits become excessive.
If significant amounts of these changes are attributable to inefficient prime contractor purchasing practices, the auditor should recommend corrective measures be taken in
cluding:
(a) improving the prime or upper tier subcontractor's purchasing practices and (b) recognizing the impact of the changes in cost proposals.
The auditor at the prime or upper tier subcontractor level should also advise the auditor at the (lower) subcontractor level to reappraise the subcontractor's estimating proce
dures.
b. Information concerning patterns of reductions from quotes to actual prices paid may be useful in evaluating a cost estimate. Information about historical reductions is cost or pricing data and should be disclosed to the Government. In addition, DFARS 252.215-7002(d)(4)(ix) requires contractors to use historical experience when appropri
ate. Contractors should, therefore, analyze the pattern of historical reductions, determine its applicability to the subject procurement, disclose the analysis, and reduce proposed cost, if appropriate. None of these steps, however, relieves the contractor of its respon
sibility for performing cost or price analyses as required by FAR.
c. If there is a pattern of price reductions, review the prime contractor's or upper tier subcontractor's analyses of quotes and subcontract prices. Determine whether the con
tractor considered the pattern in estimating material and subcontract costs. Evaluate the method used to analyze the price reductions. The contractor may apply a decrement to cost estimates based on patterns that are company-wide, program-wide, contract specif
ic, or vendor specific. Ascertain what cost data were used to develop the decrement fac
tor and confirm that the factor is properly and consistently applied to vendor-quoted
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9-405 base costs. For example, if the decrement factor was developed using both competitive and noncompetitive quotes, the factor should be applied to both competitive and non
competitive quotes. The data used to develop the decrement should be accurate, current, and representative. If the contractor has failed to use experience adequately in estimating costs, it may be necessary to develop a decrement for use in evaluating material estimates.
9-404.7 Using Trade Information
Regularly published trade information may be useful when evaluating the reasonableness of estimated prices. Information on industry-wide cost trends may also be useful, especially when contractors' estimates for follow-on procurement include increases in direct material prices based primarily on unsupported percentages. Information published in financial and industry papers usually reflects prices of basic commodities, trends and forecasts of wage increases by industry, and opinions by experts on economic trends. Trade publications can be of assistance in evaluating the contractor's material price estimates for aluminum and steel, especially when purchase orders are "future" commitments based on prices for the delivery date. Follow-on orders for large quantities may result in prices lower than are indi
cated by general market conditions discussed in trade publications because of quantity dis
counts or improved vendor efficiency.
9-404.8 Use of Consolidated Material Requirements
a. DFARS 217.7503 and PGI 217.7503 provide for an acquisition strategy entitled, Spares Acquisition Integrated with Production --- SAIP where spare part orders are to be combined with prime contract orders for production components to achieve lower bill of material component unit prices. Furthermore, a review of previous direct material purchases (see 9-404.3) may disclose that bill of material components are required for two or more contractor programs. When appropriate, proposed bill of material component unit prices should be based on the total production schedule quantity requirements (i.e., for both produc
tion and spares).
b. When SAIP requirements are utilized by the contracting officer, the auditor may be requested to, as part of his/her overall proposal audit, ascertain if the contractor or subcon
tractor has complied with the SAIP agreement. An evaluation, as determined by the auditor, will be conducted to ensure that prices for spares and identical items used in the production of end items reflect savings as a result of combined ordering.
9-405 Make or Buy Decisions – Direct Material Cost Estimates
A contractor must decide whether to make or buy parts and components. Responsibility for this decision is usually delegated to key personnel from the production, tooling, engineer
ing, accounting, production planning, and purchasing departments. Factors considered in arriving at a make or buy decision include:
(1) previous experience, (2) future requirements, (3) relative costs, (4) market conditions, (5) delivery schedules,
(6) available capacity, (7) finances,
(8) staffing,
(9) subcontractors' capabilities, and (10) availability of materials.
Review the guidance in 14-600 as part of the evaluation of the contractor's proposed make or buy decisions.
9-405.1 General Considerations
A contractor's make or buy decisions may have a significant impact on direct material cost estimates. In determining the scope and extent of the proposal audit, evaluate the ade
quacy of the contractor's make or buy policies and procedures. This should include deter
mining whether:
(1) the factors listed in the preceding paragraph have been considered,
(2) the contractor was effective in communicating with its estimators to ensure that the estimate properly reflects the make or buy decisions,
(3) past make or buy decisions reflected in prior estimates were followed, and (4) the results of operations audits of the various manufacturing functions involved in a make decision indicates any weaknesses.
9-405.2 Special Considerations in Make or Buy
Be alert to special factors involved in make or buy decisions. These include:
(1) intracompany procurement, (2) changes in make or buy,
(3) simultaneous actions involving both the making and the buying of the same parts, and
(4) an extensive time lapse between the proposal submission date and the actual contract date.
These factors are discussed below.
a. Purchases by a contractor from one of its divisions, affiliates, or subsidiaries may be classified as either "make" or "buy" depending on circumstances. When the reimburse
ment to the subsidiary is on a cost basis, the purchase would be considered a decision to make the item. When the reimbursement is based upon a competitive price, the purchase would be considered as a decision to buy the item. Evaluate make items involving signifi
cant direct material estimates of the contractor and its subsidiaries, affiliates, and divi
sions. The cost estimates for make items should not include charges by both the affiliate and the contractor in areas such as engineering, field service, and product warranty. Eval
uation techniques for buy items are similar to those used for competitive outside vendors.
Special attention, however, must be given to determining whether contractor practices permit affiliates to obtain business by meeting the lowest bid submitted by outside ven
dors. This practice may not result in fair pricing and may reduce and tend to eliminate competition on future procurements. The audit report should include comments on any intracompany procurement practices which do not result in fair prices.
b. It is not unusual for a contractor to change make or buy decisions. When a con-tractor's plant facilities or those of its affiliates are not operating at full capacity there
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