**APPENDIX C**

**DCAA CAM 9-1000 SECTION 10**

**REVIEW OF PARAMETRIC COST ESTIMATES**

**NOTE**: This is an excerpt from the Defense Contract Audit Agency
Contract Audit Manual. The last page of this appendix includes an order
form to obtain the entire manual.

**APPENDIX C**

**9-1000 SECTION 10 - REVIEW OF PARAMETRIC COST ESTIMATES**

**9-1001 INTRODUCTION**

This section contains an overview and general guidance on reviewing
cost-to-noncost estimating relationships, primarily in the context of
contractor price proposals. This section also contains guidance on the
use of estimating standards in price proposals. This supplementary
guidance contains criteria contractors should meet before submit­ting
proposals based on parametric cost estimates.

**9-1002 PARAMETRIC COST ESTIMATING TERMINOLOGY**

**9-1002.1 Definition of Parametric Cost Estimating**

a\. Parametric cost estimating (\"parametrics\") has been defined as a
technique employing one or more cost estimating relationships (CERs) to
estimate costs associated with the development manufacture, or
modification of an end item. A CER expresses a quantifiable correlation
between certain system costs and other system variables either of a cost
or technical nature. CERs are said to represent the use of one or more
independent variables to predict or estimate a dependent variable
(cost).

b\. Parametrics encompasses even the simplest traditional arithmetic
relationships among historical data such as simple factors or ratios
used in estimating scrap costs. However, for audit purposes our guidance
will limit special consideration of parametrics to more advanced or
complex applications. These may involve extensive use of cost-to-noncost
CERs, multiple independent variables related to a single cost effect, or
independent variables defined in terms of weapon system performance or
design characteristics rather than more discrete material requirements
or production processes. EDP data bases and/or computer modeling may be
used in these types of parametric cost estimating systems.

c\. Parametric estimating techniques may be used in conjunction with any
of the following estimating methods:

\(1\) Detailed---also known as the bottoms-up approach. This method
divides proposals into their smallest component tasks and are normally
supported by detailed bills of material.

\(2\) Comparative---develops proposed costs using like items produced in
the past as a baseline. Allowances are made for product dissimilarities
and changes in such things as complexity, scale, design, and materials.

\(3\) Judgmental---subjective method of estimating costs using estimates
of prior experience, judgment, memory, informal notes, and other data.
It is typically used during the research and development phase when
drawings have not yet been developed.

**9-1002.2 Distinction Between Cost and Noncost Independent Variables**

a\. Although the basic criteria for cost-to-cost and cost-to-noncost
CERs are generally comparable, the supplementary criteria in this
section pertain to cost-to-noncost CERs. Audits of traditional
cost-to-cost estimating rates and factors are covered in other sections
of this chapter and in referenced appendixes.

b\. Cost-to-noncost CERs are CERs which use something other than cost or
labor hours as the independent variable. Examples of noncost independent
variables include end-item weight, performance requirements, density of
electronic packaging, number or complexity of engineering drawings,
production rates or constraints, and number of tools produced or
retooled. CERs involving such variables, when significant, require that
the accuracy and currency of the noncost variable data be audited.
Special audit considerations are described in 9-1003 and 9-1004.

**9-1002.3 Uses of Parametric Cost Estimates**

a\. Parametric cost estimating is used by both contractors and
government in plan­ning, budgeting, and executing the acqui­sition
process. Parametric cost models are generally made up of several CERs
and can be used to estimate the costs for part of a proposal or the
entire proposal. The cost models are often computerized and may be made
up of both cost-to-cost and cost-to-noncost interrelated CERs. The
guidance contained in this chapter is intended to assist in the review
of parametric estimates, CERs, and/or cost models used in developing
price proposals for negotiation of government contracts.

b\. Parametric cost estimates are often used to cross-check the
reasonableness of estimates developed using other estimating methods.
Generally, it would not be prudent to rely on parametric techniques
based on a broad range of data points to estimate costs when directly
applicable program or contract specific historical cost data is
available, as in the case of follow-on production for the same hardware
in the same plant. Nor would parametric techniques be appropriate for
contract pricing of specific elements such as labor and indirect cost
rates which require separate forecasting considerations such as time and
place of contract performance. The use of a parametric estimating method
is considered appropriate, for example, when the program is at the
engineering concept stage and the program definition is unclear, or when
no bill of materials exists. In such cases, the audit evaluation should
determine that:

\(1\) the parametric cost model was based on historical cost data and/or
was calibrated to that data, and

\(2\) the contractor has demonstrated that the CER or cost model
actually reflects or replicates that data to a reasonable degree of
accuracy.

**9-1003 PARAMETRIC ESTIMATING CRITERIA FOR PRICE PROPOSALS**

When a contractor uses parametric cost estimating techniques in a price
proposal, the auditor will apply all pertinent criteria applicable to
any proposal along with the supplemental criteria provided in 9-1004.

**9-1003.1 Disclosure of Parametric Estimating Data**

a\. The purpose of the Truth in Negotiations Act, 10 U.S.C. 2306(a), is
to provide the government with all facts available to the contractor at
the time of certification and that the cost or pricing data was current,
complete, and accurate. Parametric estimates must meet the same basic
disclosure requirements under the act as detailed estimates.

b\. Although the principles are no different, proposals supported in
whole or in part with parametric estimating will present new fact
situations concerning cost or pricing data which is required to be
submitted. A fundamental part of the definition of cost or pricing data
is \"all facts \... which prudent buyers and sellers would reasonably
expect to have a significant effect on price negotiations\" (FAR
15.801). Reasonable parallels may be drawn between the data examples
provided in FAR for discrete estimating approaches and the type of data
pertinent to parametric estimating approaches. For example, if a
contractor uses a cost-to-noncost CER in developing an estimate, the
data for the CER should be current, accurate, and complete.

c\. Many contractors use parametric cost estimating for supplementary
support or for cross-checking estimates developed using other methods.
Judgment is necessary in selecting the data to be used in developing the
total cost estimate relied upon for the price proposal. In
distinguishing between fact and judgment, FAR states the certificate of
cost or pricing data \"does not make representations as to the accuracy
of the contractor\'s judgment on the estimated portion of future costs
or projections. It does, however, apply to the data upon which the
contractor\'s judgment is based\" (FAR 15.804-4\[b\]). Therefore, if a
contractor develops a proposal using both parametric data and discrete
estimates, it would be prudent to disclose all pertinent facts to avoid
later questions about full disclosure.

d\. The auditor should address the following questions during the
evaluation of Parametric cost estimates:

\* Do the procedures clearly establish guidelines for when parametric
techniques would be appropriate?

\* Are there guidelines for the consistent application of estimating
techniques?

\* Is there proper identification of sources of data and the estimating
methods and rationale used in developing cost estimates?

\* Do the procedures ensure that relevant personnel have sufficient
training, experience, and guidance to perform estimating tasks in
accordance with the contractor\'s established procedures?

\* Is there an internal review of and accountability for the adequacy of
the estimating system, including the comparison of projected results to
actual results and an analysis of any differences?

**9-1004 SUPPLEMENTAL ESTIMATING CRITERIA**

The auditor should also consider the following supplemental criteria
when evaluating parametric cost estimates.

**9-1004.1 Logical Relationships**

The contractor should demonstrate that the cost-to-noncost estimating
relationships used are the most logical. A contractor should consider
all reasonably logical estimating alternatives and not limit the
analysis to the first apparent set of variables. When a contractor\'s
analysis discloses multiple alternatives that appear logical,
statistical testing (9-1004.3) of selected logical relationships may be
used to provide the basis for choosing the best alternative.

**9-1004.2 Verifiable Data**

The contractor should demonstrate that data used for parametric cost
estimating relationships can be verified. In many instances the auditor
will not have previously evaluated the accuracy of noncost data used in
parametric estimates. For monitoring and documenting noncost variables,
contractors may have to modify existing information systems or develop
new ones. Information that is adequate for day-to-day management needs
may not be reliable enough for contract pricing. Data used in parametric
estimates must be accurately and consistently available over a period of
time and easily traced to or reconciled with source documentation.

**9-1004.3 Statistical Validity**

The contractor should demonstrate that a significant statistical
relationship exists among the variables used in a parametric cost
estimating relationship. There are several statistical methods such as
regression analysis that can be used to validate a cost estimating
relationship, however, no single uniform test can be specified.
Statistical testing may vary depending on an overall risk assessment and
the unique nature of a contractor\'s parametric data base and the
related estimating system. Proposal documentation should describe the
statistical analysis performed and include the contractor\'s explanation
of the CER\'s statistical validity.

**9-1004.4 Cost Prediction Results**

The contractor should demonstrate that the parametric cost estimating
relationships used can predict costs with a reasonable degree of
accuracy. As with the use of any estimating relationship derived from
prior history, it is essential in the use of parametric CERs for the
contractor to document that work being estimated is comparable to the
prior work from which the parametric data base was developed.

**9-1004.5 System Monitoring**

The contractor should ensure that cost-to-noncost parametric rates are
periodically monitored in the same manner as cost-to-cost rates and
factors. If a CER is validated and will only be used in a one-time major
new pricing application, rate monitoring capability is not essential
(see 9-1004.2). However, if it is expected that the rates should be
considered as an ongoing estimating technique, CER monitoring is
critical. The contractor should revalidate any CER whenever system
monitoring discloses that the relationship has changed.

**9-1005 AREAS FOR SPECIAL CONSIDERATION IN PARAMETRIC COST ESTIMATING**

**9-1005.1 Parametric Estimating for Change Orders**

Change order pricing using parametric cost estimating relationships may
need to be considered in a different light than initial contract pricing
actions. The contractor may use cost estimating relationships which are
unique to change order proposals. In general, contractors do not
segregate costs separately for individual change orders Therefore, it is
important that the contractor have a system in place to validate,
verify, and monitor CERs unique to change orders. However, if the CER
was applicable to the basic contract and change orders, the CER could be
validated without cost segregation.

**9-1005.2 Forward Pricing Rate Agreements**

a\. Contractors may submit proposals for forward pricing rate agreements
(FPRAs) or formula pricing agreements (FPAs) for parametric cost
estimating relationships to reduce proposal documentation efforts and
enhance government understanding and acceptance of the contractor\'s
system. Government and contractor time can be saved by including the
contractor\'s most commonly used CERs in FPRAs or FPAs. (See FAR 15.809
for basic criteria.) However, such an agreement is not a substitute for
contractor compliance at the time of submitting a specific price
proposal. FAR requires that the contractor describe any FPRAs in each
specific pricing proposal to which the rates apply and identify the
latest cost or pricing data already submitted in accordance with the
agreement. All data submitted in connection with the agreement is
certified as being accurate, complete, and current at the time of
agreement on price on each pricing action the rates are used on, not at
the time of negotiation of the FPA or FPRA (FAR 15.809 \[d\]).

b\. Key considerations in auditing FPRA/FPA proposals for parametric
CERs follow:

\(1\) FPRAs/FPAs do not appear practicable for CERs that are intended
for use on only one or few proposals.

\(2\) Comparability of the work being estimated to the parametric data
base is critical. FPRA proposals for CERs must include documentation
clearly describing circumstances when the rates should be used and the
data used to estimate the rates must be clearly related to the
circumstances.

\(3\) Validation of all the parametric criteria (9-1003) is especially
important if a single CER or family of CERs is to be used repetitively
on a large number of proposals.

**9-1005.3 Subcontract Pricing Considerations**

a\. FAR 15.806-2(a) requires that when a contractor is required to
submit certified cost or pricing data, the contractor will also submit
to the government accurate, complete, and current cost or pricing data
from prospective subcontractors in support of each subcontract cost
estimate that is:

\(1\) \$1,000,000 or more,

\(2\) both more than \$100,000 and more than 10 percent of the prime
contractor\'s proposed price, or

\(3\) considered to be necessary to adequately price the prime contract.

Use of parametric CERs does not relieve a contractor of its
responsibility to disclose planned subcontract procurements and the
related subcontractor cost or pricing data.

b\. When proposed material costs are based on parametric estimates the
contractor must demonstrate that the type of materials required for the
proposal are the same as included in the CER data base. The auditor
should perform audit procedures to determine if:

\(1\) materials included in the CER data base are not estimated
separately in the proposal, and

\(2\) adjustments have been made to the CER data base for those items
which were previously manufactured in-house and now are being purchased.
If the CER data base has not been adjusted, the contractor should
provide a detailed cost estimate for purchased materials.

c\. The contractor should explain any major differences between
parametric estimates of subcontract costs and the subcontractor\'s
quoted price and provide the rationale for using the parametric estimate
instead of the quote.

d\. Consistency in subcontract cost estimating must be maintained within
the contractor\'s estimating system. Any significant deviations from
normal practices in the proposal must be identified and justified by the
contractor.

**9-1005.4 Parametric Estimating Efficiency**

a\. A primary justification for using parametrics is reduced estimating
and negotiation costs. Contractors should perform a cost-benefit
analysis before implementing an elaborate parametric estimating model.
Their analysis should show that implementation and monitoring costs do
not outweigh the benefit of reduced estimating costs. In many instances,
new reporting systems may have to be developed to provide reliable
noncost independent variables. In addition, the costs of CER validation
and monitoring may be substantial.

b\. When the contractor\'s cost-benefit analysis indicates that the
parametric system implementation costs might outweigh the benefits of
reduced estimating costs and/or increased estimating accuracy, the
matter should be pursued for potential cost avoidance recommendations.

**9-1005.5 Data Base Adjustment Considerations**

a\. One basic criterion (9-1004.4) is that the parametric data base be
comparable to work being estimated. However, a contractor may have to
adapt a partially comparable data base to its cost history using a
\"calibration\" factor An example would be an adjustment to the data
base to estimate the savings as a result of continuous improvement
initiatives such as TQM. The utilization of complexity factors and/or
adjustments to modify contractor developed in-house CERs is a valid
technique. However, the use of such factors or adjustments should be
fully documented and disclosed. In addition, this approach increases the
contractor\'s burden to document compliance with the other criteria.

b\. If a contractor does not support the adjustment factors, the
contracting officer should be promptly notified (see 9-1005.7). In
addition, the auditor should determine if a qualified or adverse opinion
is required. The audit report should disclose the costs associated with
the unsupported factors.

**9-1005.6 Contract Administration Interface**

a\. Upon receipt of a request to review a price proposal, the auditor
will coordinate with the Plant Representative/ACO to make arrangements
for any needed technical reviews of the proposal. Because of the special
nature of cost-to-noncost estimating relationships, and the possibility
of limited cost history and added audit testing, complete coordination
is especially important when parametric estimates are involved.

b\. While the auditor will address special areas of concern as requested
by the PCO and/or the Plant Representative/ACO, the audit scope will be
established by the auditor in accordance with the auditing standards,
unless the PCO only requests a review of part of a price proposal.

c\. Auditors should be available, on request, to explain applicable
price proposal criteria and identify any prospective audit concerns to
both government and contractor personnel. An example of such audit
advice would be to identify operating reports or records that have not
been previously used to forecast costs and would therefore require added
contractor support and audit testing. Such advance coordination will
help avoid unnecessary contractor system development costs.

**9-1005.7 Reporting of Estimating Deficiencies**

All proposal and estimating deficiencies found during the review of the
parametric estimating technique should be immediately reported to the
Plant Representative/ACO. These may include incorrect, incomplete, or
non-current data and use of inappropriate estimating techniques. When a
proposal evaluation discloses estimating system deficiencies, a separate
report entitled \"Estimating System Deficiency Disclosed during
Evaluation of Proposal No. XXX\" will be issued immediately after the
proposed audit report.

**9-1006 ESTIMATING STANDARDS**

**9-1006.1 Distinction Between Estimating Standards and Parametric Cost
Estimating**

a\. In terms of historical evolution and sophistication, the terminology
of estimating standards as covered in this paragraph might be viewed as
falling between traditional cost-to-cost estimating rates and factors
and the more advanced types of parametric estimating systems (see
9-1002). However, a contractor may elect to use any combination of these
evaluating methods, perhaps in the same proposal.

b\. Estimating standards are normally developed through the use of
motion time-measurement studies performed by industrial engineers.
Parametrics, on the other hand, are developed by relating historical
costs to one or more noncost drivers. While estimating standards usually
represent cost-to-noncost relationships they have traditionally been
limited to narrower or more discrete elements of estimated cost than may
be the case in more complex parametric CERs. Also, the logic of the
estimating relationship and the appropriateness of the mathematics in
estimating standards will usually be readily apparent.

c\. Estimating standards will not necessarily require validation under
the criteria for parametric cost estimating relationships contained in
9-1003 and 9-1004. Especially when such standards (e.g., hours/pound,
hours/drawing, hours/page) have been in place and accepted by government
personnel, the evaluation guidance in this paragraph will likely be
sufficient.

**9-1006.2 Use of Estimating Standards**

a\. Estimating standards may be established by relating engineering
and/or production costs (efforts time, and/or materials) to specific
characteristics of a product such as composition, weight, size or
duration. This approach is designed to save estimating effort and has
been used frequently in estimating construction costs and costs of
recurring job orders such as printing. Many contractors use the
technique in shop-order budgeting and production control.

b\. Estimating standards may be used to estimate the cost of a single
material item required for the work, or the cost of a single labor
operation, for example, welding electrodes per ton of structural steel,
press operations time per page, or guard service costs per week. More
complex, composite standards may be used to estimate costs of groups of
components or broader classes of labor operations.

c\. Use of estimating standards may be appropriate in contract cost
estimating situations when there is a close correlation between an
amount of production cost and the related product or process
characteristic. The data sets being correlated must have been measured
in a uniform manner. The cost data used should be verifiable by
reasonable means. The units of measure used for base characteristics
should be uniform and readily identifiable; the quantity or value of a
characteristic should be readily determinable. Standards may be derived
from industry-wide statistics but should be relevant and verifiable to
the experience of the particular contractor using them.

**9-1006.3 Applicability to Price Proposals**

Traditionally, estimating standards have been used to estimate costs in
lump sums, often including supervision, indirect costs, and occasionally
general and administrative expense. To comply with the SF 1411 and cost
accounting standards the contractor will normally have to factor the
estimate to identify the costs by cost element or function.
Alternatively a proposed cost based on an estimating standard might
qualify for submission as an \"other\" cost element if the cost can be
tracked as such and is a relatively minor pan of the total proposal.

**9-1006.4 Audit Procedures**

a\. Depending on materiality and risk of the costs estimated, the
auditor should examine the development and application of estimating
standards to determine whether their use is proper in the circumstances.
Evaluate all cost and noncost data applicable to each significant
estimating standard and determine whether the data has been properly
used in the computations. Assure that the measurements and correlation
are adequate for the purpose. Determine whether the basis for the
standard (for example, the product mix, production rates, and production
methods) is sufficiently similar or comparable to that contemplated in
the estimate at hand.

b\. When changes are contemplated in the design or production of an end
item or the rate or method of production, the contractor\'s adjustments
of the estimating standards require special scrutiny. Review by
government technical specialists may be necessary in this situation.

c\. During audits of historical costs, sufficient information may be
readily available from which the auditor could develop estimating
standards to use as one means of appraising recurring contractor
estimates. However, this will not substitute for audit review of cost
estimates as submitted by the contractor.

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