Pricing, Cost Realism, and the DCAA Audit

Pricing is where many strong technical proposals fail, not because the number was too high or too low, but because the underlying cost structure could not withstand the scrutiny it was about to receive. A NASA contracting officer evaluating a cost-reimbursement proposal is not simply checking arithmetic. They are assessing whether the entire cost story is realistic, supportable, and consistent with an accounting system capable of tracking it once the contract begins.

Contract types and the risk they allocate

FAR Part 16 organizes contract types along a spectrum of risk allocation between the government and the contractor.

• Firm-fixed-price (FFP): the contractor is paid a set price regardless of actual cost incurred. The contractor bears the risk of a cost overrun and keeps the benefit of an underrun. Preferred by the government whenever requirements are well defined.
• Cost-plus-fixed-fee (CPFF): the government reimburses allowable costs and pays a fixed fee set at award, unaffected by the final cost outcome. Used when requirements carry enough technical uncertainty that a fixed price would be unreasonable to ask a contractor to absorb.
• Cost-plus-award-fee (CPAF): allowable costs are reimbursed, and some or all of the fee is earned based on a subjective government evaluation of performance against criteria established in an award fee plan.
• Cost-plus-incentive-fee (CPIF): allowable costs are reimbursed, and fee varies according to a formula tied to objective performance targets, most often cost control, sharing overruns and underruns between government and contractor at a predetermined ratio.
• Time-and-materials (T&M): the government pays fixed hourly labor rates that include profit, plus the actual cost of materials. FAR 16.601 treats T&M as a contract type of last resort because it provides no positive incentive for cost control, and its use requires a determination that no other type is suitable.

Direct cost, indirect cost, and rate structure

A direct cost is one that can be identified specifically with a final cost objective, such as the labor hours a particular engineer charges to a particular contract, or materials bought specifically for that job. An indirect cost benefits more than one cost objective and cannot be traced to a single contract, such as facility rent, corporate management salaries, or company-wide IT support. Indirect costs are pooled and allocated across contracts using rates.

The typical structure most contractors build has three layers:

1. Fringe: the pool of employee benefit costs, such as health insurance and payroll taxes, allocated as a rate applied to direct labor.
2. Overhead: costs associated with supporting direct labor at the operating level, such as supervision or facility costs tied to a specific location or contract group, applied as a rate on direct labor or on labor plus fringe.
3. General and administrative (G&A): company-wide costs of running the business as a whole, such as executive salaries and corporate accounting, typically applied as a rate against a total cost input base.

Every dollar in these pools must be an allowable cost under FAR Part 31, which excludes categories such as most entertainment, alcoholic beverages, and certain lobbying and advertising costs, regardless of how a company might classify them internally.

Cost realism versus price reasonableness

Price reasonableness is the broader question, asked on essentially every procurement: is this price fair, judged against competition, historical prices, or independent government estimates. Cost realism is a narrower, more technical question asked specifically on cost-reimbursement work, and sometimes on fixed-price work where unrealistically low costs would signal a misunderstanding of the requirement: do the proposed costs reflect what the work will actually take, given the offeror's own proposed technical and staffing approach. Under FAR 15.404-1(d), the government may adjust an offeror's proposed cost upward for evaluation purposes, without changing what they are contractually obligated to bid, if the evaluators conclude the proposed costs are unrealistically low for the proposed approach.

Adequate accounting systems

Before award of most cost-reimbursement contracts, FAR 16.301-3 requires a determination that the contractor's accounting system is adequate to properly segregate and accumulate costs under the contract. DCAA frequently performs this review using the Standard Form 1408 pre-award survey criteria, examining whether the system can distinguish direct from indirect costs, track costs by contract, and exclude unallowable costs from billing. A company pursuing its first cost-reimbursement NASA contract should treat accounting system readiness as a prerequisite to pursuit, not a task to solve after award.

Provisional rates, final rates, and the incurred cost submission

Indirect rates used for billing during the year are provisional, based on budget projections or the prior year's experience, and are trued up after year-end. A contractor with cost-reimbursement contracts submits an annual incurred cost submission reporting actual costs against those provisional rates. DCAA may audit that submission, and the outcome establishes final indirect rates for that fiscal year, which can result in the contractor owing money back to the government or being owed additional reimbursement, depending on whether provisional rates ran high or low against actual experience.

What DCAA actually examines

DCAA performs audit work for NASA as well as the Department of Defense, and its scope typically includes accounting system adequacy reviews, forward pricing rate reviews used to evaluate proposed rates before award, incurred cost audits performed after the fact, and floor checks or timekeeping reviews that verify labor charges are actually supported. Contractors sometimes treat a DCAA relationship as adversarial by default; in practice, a contractor with a genuinely compliant system and clean books tends to find the audit process procedural rather than combative. The companies that struggle are almost always the ones that built their accounting practices around convenience rather than the FAR Part 31 standards DCAA is checking against. Chapter 17 covers the broader set of post-award compliance obligations this pricing foundation feeds into, andChapter 11 explains where the specific FAR cost principles governing allowability actually live.