FAR 42.705-1—Contracting officer determination procedure.
Plain-English Summary
FAR 42.705-1 sets out the procedure for determining final indirect cost rates when the contracting officer, rather than the auditor, is responsible for the determination. It explains who has cognizance over the rate-setting process for different types of contractors, including business units of multidivisional corporations, business units with resident administrative contracting officers, other business units where the cognizant official decides whether rates will be contracting officer- or auditor-determined, educational institutions, state and local governments, and nonprofit organizations. It also describes the end-to-end process for submitting an adequate final indirect cost rate proposal under the Allowable Cost and Payment clause, including the six-month submission deadline, possible written extensions for exceptional circumstances, auditor review for adequacy, escalation of unresolved inadequacies, and the requirement for supporting data. The section then addresses the audit and negotiation phase: the auditor’s advisory audit report, the composition and leadership of the Government negotiating team, the requirement to develop a negotiation position, and the statutory limits on resolving questioned costs without adequate documentation and the auditor’s opinion on allowability. Finally, it covers the contracting officer’s duties to conduct negotiations, prepare and sign the indirect cost rate agreement, document the negotiation in a memorandum, distribute the resulting documents, and notify the contractor of unallowable costs. In practice, this section is important because it governs how final indirect cost rates are established, how disputes over questioned costs are documented and resolved, and how the Government preserves a defensible record for audit, negotiation, and future contract administration.
Key Rules
Cognizance determines process
The applicable cognizant contracting officer or cognizant Federal agency official depends on the contractor type and organizational structure. The rule distinguishes corporate administrative contracting officer cognizance, resident administrative contracting officer cognizance, and other cases where the cognizant official decides whether the rates will be contracting officer- or auditor-determined.
Corporate units use coordinated rates
For business units of a multidivisional corporation under a corporate administrative contracting officer, that officer is responsible for the final indirect cost rate determination. Negotiations may be centralized or coordinated across business units depending on how centralized the contractor’s organization is.
Resident ACO may control rates
For business units not under a corporate administrative contracting officer but with a resident administrative contracting officer, that officer is responsible for the determination. A nonresident administrative contracting officer counts as resident if at least 75 percent of the officer’s time is devoted to a single contractor.
Proposal due in six months
The contractor must submit an adequate final indirect cost rate proposal within six months after the end of each fiscal year under the Allowable Cost and Payment clause. The contracting officer may grant written extensions only for exceptional circumstances and only when the contractor requests them in writing.
Adequacy review comes first
After receipt, the cognizant auditor reviews the proposal for adequacy for audit and provides written notice of any deficiencies to both the contractor and the contracting officer. If the contractor and auditor cannot resolve the deficiencies, the auditor elevates the issue to the contracting office.
Audit supports negotiation
Once the proposal is adequate for audit, the auditor performs the audit and issues an advisory audit report to the contracting officer or cognizant Federal agency official. The report must include any relevant advance agreements or restrictive terms from specific contracts.
Government team leads negotiation
The contracting officer or cognizant Federal agency official heads the Government negotiating team, with the cognizant auditor and needed technical or functional personnel included. Offices with significant dollar interest, and those that materially shaped the Government position, should be invited to participate.
Questioned costs need support
The contracting officer may not resolve questioned costs until obtaining adequate documentation and the auditor’s opinion on allowability. The auditor should be invited, whenever possible, to serve as an advisor during negotiations or meetings with the contractor.
Written agreement and memo required
The cognizant contracting officer must conduct the negotiations, prepare a written indirect cost rate agreement that conforms to the contracts, and prepare a negotiation memorandum for the contractor general file. The memorandum must address significant audit issues, reconcile questioned costs, explain departures from auditor or advisor recommendations, and identify any certified cost or pricing data relied upon.
Unallowables must be identified
The contracting officer must notify the contractor of the individual costs found unallowable and the specific amounts disallowed. Resulting documents must be distributed in accordance with FAR 42.706.
Responsibilities
Contracting Officer
Determine or lead the final indirect cost rate process where assigned; conduct negotiations; ensure questioned costs are not resolved without adequate documentation and the auditor’s opinion; prepare and sign the indirect cost rate agreement; prepare the negotiation memorandum; notify the contractor of unallowable costs; and distribute resulting documents as required.
Cognizant Federal Agency Official
Perform the same rate-determination and negotiation functions as the contracting officer when the contractor is under cognizance of a cognizant Federal agency official rather than a contracting officer.
Corporate Administrative Contracting Officer
For multidivisional corporations under corporate cognizance, establish the final indirect cost rates and coordinate with administrative contracting officers assigned to individual business units as needed.
Administrative Contracting Officer
For business units under resident ACO cognizance, establish the final indirect cost rates; review contractor submissions; participate in negotiations; and, when acting as a cognizant official, manage the adequacy and negotiation process.
Cognizant Auditor
Review the contractor’s final indirect cost rate proposal for adequacy for audit; provide written descriptions of inadequacies; elevate unresolved inadequacies to the contracting office; audit adequate proposals; issue an advisory audit report; and provide an opinion on allowability of questioned costs.
Contractor
Submit an adequate final indirect cost rate proposal and supporting data within six months after fiscal year end; request any extension in writing and only for exceptional circumstances; work with the contracting officer and auditor to resolve proposal deficiencies; and support questioned costs with documentation during negotiations.
Technical or Functional Personnel
Support the Government negotiating team as needed by providing technical, pricing, accounting, or program input relevant to the indirect cost rate determination.
Other Contracting Offices with Significant Dollar Interest
Participate in negotiations and preliminary discussions of critical issues when they have a significant dollar interest in the outcome.
Practical Implications
Contractors should treat the six-month proposal deadline as a hard planning milestone; late or incomplete submissions can delay rate establishment and final billing under cost-reimbursement contracts.
A proposal being ‘adequate for audit’ is not the same as being approved; contractors often need to provide additional support during the audit and negotiation phases, so they should keep backup documentation organized and accessible.
Questioned costs cannot be settled casually: the contracting officer must have adequate documentation and the auditor’s view on allowability, which means contractors should expect a documented, evidence-based negotiation rather than an informal compromise.
The negotiation memorandum is a critical record. Contracting officers should document why audit recommendations were accepted or rejected, because this file may be reviewed later in disputes, audits, or contract closeout.
Because the rule requires notice of unallowable costs and distribution of resulting documents, both sides should ensure the final rate agreement, audit report, and memorandum are consistent; mismatches can create downstream billing, reimbursement, and closeout problems.
Official Regulatory Text
(a) Applicability and responsibility. Contracting officer determination shall be used for the following, with the indicated cognizant contracting officer (or cognizant Federal agency official) responsible for establishing the final indirect cost rates: (1) Business units of a multidivisional corporation under the cognizance of a corporate administrative contracting officer (see subpart 42.6 ), with that officer responsible for the determination, assisted, as required, by the administrative contracting officers, assigned to the individual business units. Negotiations may be conducted on a coordinated or centralized basis, depending upon the degree of centralization within the contractor’s organization. (2) Business units not under the cognizance of a corporate administrative contracting officer, but having a resident administrative contracting officer (see 42.602 ), with that officer responsible for the determination. For this purpose, a nonresident administrative contracting officer is considered as resident if at least 75 percent of the administrative contracting officer’s time is devoted to a single contractor. (3) For business units not included in paragraph (a)(1) or (a)(2) of this subsection, the contracting officer (or cognizant Federal agency official) will determine whether the rates will be contracting officer or auditor determined. (4) Educational institutions (see 42.705-3 ). (5) State and local governments (see 42.705-4 ). (6) Nonprofit organizations other than educational and state and local governments (see 42.705-5 ). (b) Procedures. (1) In accordance with the Allowable Cost and Payment clause at 52.216-7 , the contractor is required to submit an adequate final indirect cost rate proposal to the contracting officer (or cognizant Federal agency official) and to the cognizant auditor. (i) The required content of the proposal and supporting data will vary depending on such factors as business type, size, and accounting system capabilities. The contractor, contracting officer, and auditor must work together to make the proposal, audit, and negotiation process as efficient as possible. (ii) Each contractor is required to submit the final indirect cost rate proposal within the six-month period following the expiration of each of its fiscal years. The contracting officer may grant, in writing, reasonable extensions, for exceptional circumstances only, when requested in writing by the contractor. (iii) Upon receipt of the proposal- (A) The cognizant auditor will review the adequacy of the contractor’s proposal for audit in support of negotiating final indirect cost rates and will provide a written description of any inadequacies to the contractor and contracting officer. (B) If the auditor and contractor are unable to resolve the proposal’s inadequacies identified by the auditor, the auditor will elevate the issue to the contracting office to resolve the inadequacies. (iv) The proposal must be supported with adequate supporting data, some of which may be required subsequent to finding that the proposal is adequate for audit in support of negotiating final indirect cost rates ( e.g. , during the course of the performance of the advisory audit). See the clause at 52.216-7 (d)(2) for the description of an adequate final indirect cost rate proposal and supporting data. (2) Once a proposal has been determined to be adequate for audit in support of negotiating final indirect cost rates, the auditor will audit the proposal and prepare an advisory audit report to the contracting officer (or cognizant Federal agency official), including a listing of any relevant advance agreements or restrictive terms of specific contracts. (3) The contracting officer (or cognizant Federal agency official) shall head the Government negotiating team, which includes the cognizant auditor and technical or functional personnel as required. Contracting offices having significant dollar interest shall be invited to participate in the negotiation and in the preliminary discussion of critical issues. Individuals or offices that have provided a significant input to the Government position should be invited to attend. (4) The Government negotiating team shall develop a negotiation position. Pursuant to 10 U.S.C. 3745 and 41 U.S.C.4305 , the contracting officer shall- (i) Not resolve any questioned costs until obtaining- (A) Adequate documentation on the costs; and (B) The contract auditor’s opinion on the allowability of the costs. (ii) Whenever possible, invite the contract auditor to serve as an advisor at any negotiation or meeting with the contractor on the determination of the contractor’s final indirect cost rates. (5) The cognizant contracting officer shall- (i) Conduct negotiations; (ii) Prepare a written indirect cost rate agreement conforming to the requirements of the contracts; (iii) Prepare, sign, and place in the contractor general file (see 4.801 (c)(3)) a negotiation memorandum covering- (A) The disposition of significant matters in the advisory audit report; (B) Reconciliation of all costs questioned, with identification of items and amounts allowed or disallowed in the final settlement as well as the disposition of period costing or allocability issues; (C) Reasons why any recommendations of the auditor or other Government advisors were not followed; and (D) Identification of certified cost or pricing data submitted during the negotiations and relied upon in reaching a settlement; and (iv) Distribute resulting documents in accordance with 42.706 . (v) Notify the contractor of the individual costs which were considered unallowable and the respective amounts of the disallowance.