Defective Pricing Indicators

Government contractors know and understand that where they were required to submit certified cost or pricing data and where the Government relied on that certified cost or pricing data when negotiating the contract price, are also subject to "defective pricing" audits after the contract is awarded. A defective pricing audit looks for factual information that existed at the time negotiations were completed, were not disclosed to the Government, but if had been disclosed, would have had a significant impact on the negotiated price.

Contract auditors routinely perform defective pricing audits - not on every contract but on select contracts. The larger the contract, the higher probability it will be selected for a defective pricing audit. The type of contract also has a bearing on the audit selection. Fixed price have a higher probability of being selected because of the potential for a greater return. On a fixed price contract, defective pricing findings will result in a dollar for dollar reduction in the contract price. On a cost-reimbursable contract, the impact only affects how much fee a contractor is entitled to.

In order to expend resources wisely, contract auditors perform risk assessments designed to identify and explore conditions suggesting possible defective pricing. Items normally examined for indications of defective pricing include historical unit cost records, vendor quotes, purchase orders, voluntary refunds or credits from suppliers, cost trend records, sales and manufacturing volume projections, profit and loss statements, and product cost and profit analyses. Over the years, auditors have developed a corpus of "indicators" that if present, suggests a possibility (not a probability) that defective pricing occurred. These indicators include the following:

a. Significantly lower actual cost of individual items and cost elements as compared with the amounts included in the last submitted proposal. When this condition exists, auditors will perform additional tests to determine whether the lower costs reflect defective data.

b. Operations not actually performed or items of cost not incurred, although included in the contractor's proposal. (For example, changes made in the make-or-buy program, a special testing program not performed, or Government-owned equipment rental not paid.) Contract auditors will explore the reasons for not incurring the cost.

c. Items of direct cost included in the contract pricing proposal at prices higher than appropriate based on information available to the contractor (and not disclosed to the Government) at the time of contract price agreement. Examples include

• After submitting the original proposal but before price agreement, the contractor receives a firm quote from an established source which is significantly below the cost included in the original proposal. 
• A previously used supplier not solicited this time but who normally submits a low bid. The contractor later purchases the material from this vendor at a price lower than proposed. 

d. Closing or cutoff dates for recording transactions or for computing summary indirect cost rates or production cost data that did not coincide with the date negotiations concluded. For instance, the contractor's proposal included indirect or other cost data as of a prior cutoff period. In this case, the contractor is responsible for the currentness of its certified cost or pricing data, if a cutoff date for this information was not agreed to and identified on the Certificate of Current Cost or Pricing Data, the Government would consider significant matters in the books or records on the date of price agreement as reasonably available to the contractor for purposes of defective pricing.

If advised that the Government plans to perform a defective pricing audit of a particular contract, these indicators can be used by contractors as a self-assessment prior to the audit.