15.407-4 Should-cost review
Source: FAR 15.407-4 on acquisition.gov
Should-cost reviews enable the government to identify and address inefficiencies in contractor operations, leading to more cost-effective contract negotiations and improved long-term performance.
Overview
FAR 15.407-4 outlines the requirements and procedures for conducting should-cost reviews, a specialized form of cost analysis used in government contracting. Unlike traditional cost analysis, should-cost reviews do not assume that a contractor’s historical costs are efficient or economical. Instead, they evaluate the contractor’s operations, workforce, materials, and management to identify potential cost savings and promote efficiency. There are two types of should-cost reviews: program should-cost reviews (focused on direct and associated indirect costs, typically for major systems) and overhead should-cost reviews (focused on indirect costs such as fringe benefits, plant maintenance, and general administration). These reviews are conducted by multi-functional government teams and are intended to inform negotiation objectives and drive both immediate and long-term improvements in contractor performance.
Key Rules
- General Requirements
- Should-cost reviews assess the efficiency and economy of contractor operations, not just historical costs, and are conducted by a team of government specialists.
- Types of Reviews
- Program should-cost reviews focus on direct and associated indirect costs, especially for major system acquisitions, and require a separate audit and team report.
- Overhead should-cost reviews focus on indirect costs and are often used to negotiate Forward Pricing Rate Agreements (FPRAs), also requiring a separate audit report unless conducted with a program review.
- Selection Criteria
- Reviews are prioritized based on factors such as contract value, government business volume, noncompetitive contracts, and organizational changes.
- Reporting and Follow-up
- Contracting officers must consider review findings in negotiations, report uneconomical practices, and establish follow-up plans to ensure corrective actions are implemented.
Responsibilities
- Contracting Officers: Initiate and plan should-cost reviews, ensure findings are considered in negotiations, report inefficiencies, and monitor corrective actions.
- Contractors: Cooperate with review teams, provide access to relevant data and personnel, and implement agreed-upon corrective actions.
- Agencies: Assign qualified personnel, conduct reviews per agency procedures, and oversee follow-up on identified issues.
Practical Implications
- Should-cost reviews help the government negotiate more realistic and cost-effective contract prices by identifying inefficiencies in contractor operations.
- These reviews can lead to significant cost savings and process improvements but require substantial planning and coordination.
- Contractors should be prepared for in-depth scrutiny of their operations and may need to address identified inefficiencies to remain competitive in future government contracts.
(a) General.
(1) Should-cost reviews are a specialized form of cost analysis. Should-cost reviews differ from traditional evaluation methods because they do not assume that a contractor’s historical costs reflect efficient and economical operation. Instead, these reviews evaluate the economy and efficiency of the contractor’s existing work force, methods, materials, equipment, real property, operating systems, and management. These reviews are accomplished by a multi-functional team of Government contracting, contract administration, pricing, audit, and engineering representatives. The objective of should-cost reviews is to promote both short and long-range improvements in the contractor’s economy and efficiency in order to reduce the cost of performance of Government contracts. In addition, by providing rationale for any recommendations and quantifying their impact on cost, the Government will be better able to develop realistic objectives for negotiation.
(2) There are two types of should-cost reviews-program should-cost review (see paragraph (b) of this subsection) and overhead should-cost review (see paragraph (c) of this subsection). These should-cost reviews may be performed together or independently. The scope of a should-cost review can range from a large-scale review examining the contractor’s entire operation (including plant-wide overhead and selected major subcontractors) to a small-scale tailored review examining specific portions of a contractor’s operation.
(b) Program should-cost review.
(1) A program should-cost review is used to evaluate significant elements of direct costs, such as material and labor, and associated indirect costs, usually associated with the production of major systems. When a program should-cost review is conducted relative to a contractor proposal, a separate audit report on the proposal is required.
(2) A program should-cost review should be considered, particularly in the case of a major system acquisition (see part 34), when-
(i) Some initial production has already taken place;
(ii) The contract will be awarded on a sole source basis;
(iii) There are future year production requirements for substantial quantities of like items;
(iv) The items being acquired have a history of increasing costs;
(v) The work is sufficiently defined to permit an effective analysis and major changes are unlikely;
(vi) Sufficient time is available to plan and adequately conduct the should-cost review; and
(vii) Personnel with the required skills are available or can be assigned for the duration of the should-cost review.
(3) The contracting officer should decide which elements of the contractor’s operation have the greatest potential for cost savings and assign the available personnel resources accordingly. The expertise of on-site Government personnel should be used, when appropriate. While the particular elements to be analyzed are a function of the contract work task, elements such as manufacturing, pricing and accounting, management and organization, and subcontract and vendor management are normally reviewed in a should-cost review.
(4) In acquisitions for which a program should-cost review is conducted, a separate program should-cost review team report, prepared in accordance with agency procedures, is required. The contracting officer shall consider the findings and recommendations contained in the program should-cost review team report when negotiating the contract price. After completing the negotiation, the contracting officer shall provide the ACO a report of any identified uneconomical or inefficient practices, together with a report of correction or disposition agreements reached with the contractor. The contracting officer shall establish a follow-up plan to monitor the correction of the uneconomical or inefficient practices.
(5) When a program should-cost review is planned, the contracting officer should state this fact in the acquisition plan or acquisition plan updates (see subpart 7.1) and in the solicitation.
(c) Overhead should-cost review.
(1) An overhead should- cost review is used to evaluate indirect costs, such as fringe benefits, shipping and receiving, real property, and equipment, depreciation, plant maintenance and security, taxes, and general and administrative activities. It is normally used to evaluate and negotiate an FPRA with the contractor. When an overhead should-cost review is conducted, a separate audit report is required.
(2) The following factors should be considered when selecting contractor sites for overhead should-cost reviews:
(i) Dollar amount of Government business.
(ii) Level of Government participation.
(iii) Level of noncompetitive Government contracts.
(iv) Volume of proposal activity.
(v) Major system or program.
(vi) Corporate reorganizations, mergers, acquisitions, or takeovers.
(vii) Other conditions (e.g., changes in accounting systems, management, or business activity).
(3) The objective of the overhead should-cost review is to evaluate significant indirect cost elements in-depth, and identify and recommend corrective actions regarding inefficient and uneconomical practices. If it is conducted in conjunction with a program should-cost review, a separate overhead should-cost review report is not required. However, the findings and recommendations of the overhead should-cost team, or any separate overhead should-cost review report, shall be provided to the ACO. The ACO should use this information to form the basis for the Government position in negotiating an FPRA with the contractor. The ACO shall establish a follow-up plan to monitor the correction of the uneconomical or inefficient practices.