When the Government evaluates proposals for the award of a cost-reimbursement contract (e.g. CPFF, CPIF, and CPAF), a prospective contractor's proposed estimated cost of contract performance is not considered controlling since, regardless of the costs proposed by the contractor, the Government is bound to pay the contractor its actual costs (as long as those costs are allowable, allocable, and reasonable). Consequently, a cost realism analysis must be performed by the agency awarding the contract to determine the extent to which an offeror's proposed costs represent what the contract costs are likely to be under the offeror's technical approach, assuming reasonable economy and efficiency (see FAR 15.305(a)(1), and (2).
A cost realism analysis is the process of independently reviewing and evaluating specific elements of each offeror's cost estimate to determine whether the estimated proposed cost elements are realistic for the work to be performed, reflect a clear understanding of the requirements, and are consistent with the unique methods of performance and materials described in the offeror's proposal (see FAR 15.404-1(d)(1)).
The Government will adjust an offeror's proposed costs when appropriate based on the results of the cost realism analysis (see FAR 15.404-1(d)(2)(ii)). Herein lies the basis for many bid protests. Sometimes, the Government will increase the estimated cost of an offeror's bid, sending it out of the competitive range. Appeals to the GAO (Government Accountability Office) usually question the propriety of the Government's adjustments by maintaining they were inappropriate, undocumented, or fundamentally changed the proposed technical approach. Most of the time, these appeals are unsuccessful. Because, FAR requires the Government to conduct cost realism reviews and adjust proposed prices if necessary, the GAO limits is review to determining whether the cost analysis was reasonably based and not arbitrary.
For more information on cost realism reviews, see our previous posts on the subject.