FAR 49.203—Adjustment for loss.
Plain-English Summary
FAR 49.203 addresses how to adjust a termination settlement when the contractor would have incurred a loss if the entire contract had been completed. Its purpose is to prevent a contractor from recovering profit on a contract that was already projected to end in a loss, while still allowing payment of allowable settlement expenses and other properly supported amounts. The section applies in both inventory-basis settlements and total-cost-basis settlements, and it tells the Termination Contracting Officer (TCO) how to compute the loss adjustment in each case. It also requires the TCO to estimate the cost to complete the contract by considering expected production efficiencies and other factors that affect completion cost. In practice, this section is about making the settlement fair to both sides: the contractor is compensated for allowable termination-related costs, but not placed in a better position than if performance had continued to completion. It also interacts with other termination provisions, including settlement expenses, acceptable completed end items, initial costs, disposal credits, and advance or progress payments.
Key Rules
No profit on projected loss
If the TCO determines the contractor would have incurred a loss had the contract been fully performed, the settlement may not include profit. The TCO must identify the loss and reduce the settlement accordingly.
Estimate cost to complete
The TCO must estimate the cost to complete the entire contract when calculating the loss adjustment. That estimate must reflect expected production efficiencies and any other relevant factors affecting completion cost.
Inventory-basis settlement cap
For an inventory-basis settlement, the contractor cannot be paid more than the sum of settlement expenses, the adjusted contract price for acceptable completed end items, and the adjusted remainder of the settlement amount, reduced by disposal credits and unliquidated advance or progress payments.
Inventory-basis loss formula
The remainder of the settlement amount is reduced by a ratio comparing total contract price to total cost incurred before termination plus estimated cost to complete. This formula scales down the settlement to reflect the projected contract loss.
Total-cost-basis settlement cap
For a total-cost-basis settlement, the contractor cannot be paid more than settlement expenses plus the adjusted remainder of the total settlement amount, reduced by disposal and other credits, advance and progress payments, and all other amounts previously paid under the contract.
Total-cost loss formula
The remainder of the total settlement amount is reduced by a ratio comparing total contract price to the remainder plus estimated cost to complete the entire contract. This ensures the settlement reflects the loss position under the total-cost method.
Credits and prior payments offset recovery
All applicable disposal credits, other credits, unliquidated advance and progress payments, and other amounts previously paid must be deducted as required by the applicable settlement basis. These offsets prevent double recovery.
Responsibilities
Termination Contracting Officer (TCO)
Determine whether the contractor would have incurred a loss if the contract had been completed, estimate the cost to complete, negotiate or determine the amount of loss, and apply the correct settlement reduction formula under either the inventory-basis or total-cost-basis method.
Contractor
Submit a settlement proposal with accurate cost, credit, and payment information; support claimed settlement expenses and other allowable amounts; and provide data needed for the TCO to evaluate the projected loss and cost to complete.
Agency
Ensure termination settlements are calculated consistently with FAR Part 49, including proper treatment of loss adjustments, credits, and prior payments, and provide oversight so settlements do not include prohibited profit on a projected loss contract.
Practical Implications
This section often reduces the settlement amount significantly when the contract was trending toward a loss, so contractors should expect the government to scrutinize projected completion costs and profit assumptions closely.
The cost-to-complete estimate is a common dispute point. Small changes in expected efficiencies, labor rates, material costs, or subcontract performance can materially change the loss adjustment.
Contractors should document completed work, settlement expenses, disposal credits, and all prior payments carefully, because missing or unsupported data can lead to a lower settlement.
The inventory-basis and total-cost-basis formulas are different, so using the wrong method or mixing elements from both can produce an incorrect settlement.
TCOs should be careful not to treat the loss adjustment as a penalty; the goal is to remove unearned profit and align the settlement with the contract’s projected financial outcome, while still paying allowable termination costs.
Official Regulatory Text
(a) In the negotiation or determination of any settlement, the TCO shall not allow profit if it appears that the contractor would have incurred a loss had the entire contract been completed. The TCO shall negotiate or determine the amount of loss and make an adjustment in the amount of settlement as specified in paragraph (b) or (c) of this section. In estimating the cost to complete, the TCO shall consider expected production efficiencies and other factors affecting the cost to complete. (b) If the settlement is on an inventory basis (see 49.206-2 (a)), the contractor shall not be paid more than the total of the amounts in paragraphs (b)(1), (2), and (3) of this section, less all disposal credits and all unliquidated advance and progress payments previously made under the contract: (1) The amount negotiated or determined for settlement expenses. (2) The contract price, as adjusted, for acceptable completed end items (see 49.205 ). (3) The remainder of the settlement amount otherwise agreed upon or determined (including the allocable portion of initial costs (see 31.205-42 (c)), reduced by multiplying the remainder by the ratio of- (i) The total contract price to (ii) The total cost incurred before termination plus the estimated cost to complete the entire contract. (c) If the settlement is on a total cost basis (see 49.206-2 (b)), the contractor shall not be paid more than the total of the amounts in paragraphs (c)(1) and (2) of this section, less all disposal and other credits, all advance and progress payments, and all other amounts previously paid under the contract: (1) The amount negotiated or determined for settlement expenses. (2) The remainder of the total settlement amount otherwise agreed upon or determined (lines 7 and 14 of SF 1436 , Settlement Proposal (Total Cost Basis)) reduced by multiplying the remainder by the ratio of- (i) The total contract price to (ii) The remainder plus the estimated cost to complete the entire contract.