Manufacturing and Production Engineering Costs (M&PE)

One of the least known FAR cost principles is FAR 31.205-25 covering Manufacturing and Production Engineering Costs (M&PE). In has remained unchanged since 1983 when it was expanded to expand upon the activities covered by the definition. The definition of allowable MP&E costs includes:

1. Developing and deploying new or improved materials, systems, processes, methods, equipment, tools and techniques that are or are expected to be used in producing products or services
2. Developing and deploying pilot production lines;
3. Improving current production functions, such as plan layout, production scheduling and control, methods and job analysis, equipment capabilities and capacities, inspection techniques, and tooling analysis (including tooling design and application improvements);
4. Material and manufacturing producibility analysis for production suitability and to optimize manufacturing processes, methods, and techniques.

The FAR definition of M&PE also includes a listing of the activities that are not included in the definition.

1. Basic and applied research effort related to new technology, materials, systems, processes, methods, equipment, tools and techniques. Such technical effort is governed by the IR&D (Independent Research and Development) FAR cost principle (see FAR 31.205-18)
2. Development effort for manufacturing or production materials, systems, processes, methods, equipment, tools and techniques that are intended for sale. Such effort is also governed by the IR&D FAR cost principle.

Sound confusing? Think of it this way. IR&D entails developing a potential new product. M&PE on the other hand entails developing a process or tool that is not intended for resale.

Prior to 1992, there were caps imposed on what the Government was willing to reimburse contractors for IR&D expenses. In some cases these caps were negotiated as advance agreements. In other cases, there were formula that escalated prior year expenditures. When the caps were lifted, the significance of this M&PE cost principle was diminished. The reason for that was because if a contractor came close to expending its IR&D budget, thereby not getting reimbursed for the expenditures, it would simply reclassify the activities into M&PE which was not subject to caps. There were several cases involving contractor attempts to reclassify IR&D costs into M&PE. In most cases, the contractor lost.

Now, since neither IR&D nor M&PE costs are capped, it makes seemingly little difference on how the costs are classified with one exception. Contractors can capitalize M&PE expenses and amortize those costs over a period of years. IR&D costs on the other hand, are considered period costs and must be expensed in the year incurred. This could make a difference for some contractors under certain circumstances.