FAR 49.206-2—Bases for settlement proposals.
Plain-English Summary
FAR 49.206-2 explains the approved bases for preparing termination settlement proposals and when each basis may be used. It covers the preferred inventory basis, the total-cost basis, the special situations where the inventory basis is still appropriate, the circumstances requiring advance approval to use the total-cost basis, and the rule that no other settlement basis may be used without higher-level approval. The section also identifies what cost elements must be itemized under each method, including materials, work in process, engineering and initial costs, subcontract settlements, settlement expenses, profit or loss adjustments, and deductions for advance payments, progress payments, disposal credits, and other known credits. In practice, this section is the roadmap for how a contractor should build a termination settlement proposal and how the Termination Contracting Officer (TCO) should evaluate whether the proposal is on the correct basis. It matters because the chosen basis affects what costs can be claimed, when the proposal can be submitted, and how deductions and profit/loss adjustments are applied. For contractors, the section is critical to avoid unsupported claims or premature submission; for contracting officials, it helps ensure settlements are prepared consistently and in accordance with FAR policy.
Key Rules
Inventory basis is preferred
The inventory basis is the default and preferred method for settlement proposals. Under this approach, the contractor may claim only costs allocable to the terminated portion of the contract, and the proposal must separately itemize the specified cost categories.
Inventory basis itemization required
The proposal must separately list materials and production items at purchase or manufacturing cost, engineering and initial costs, general and administrative costs, subcontract settlement costs, settlement expenses, and other proper charges. This itemization is intended to show exactly what was incurred for the terminated work.
Profit or loss adjustment applies
After the allowable costs are assembled under the inventory basis, the proposal must include an allowance for profit under FAR 49.202 or an adjustment for loss under FAR 49.203(b). The contractor must then deduct unliquidated advance and progress payments and any disposal or other credits known when the proposal is submitted.
Inventory basis fits certain contracts
The inventory basis is also appropriate for partial terminations of construction or related professional services contracts, partial or complete terminations of supply orders under terminated construction contracts, and complete terminations of unit-price professional services contracts. These are special cases where inventory-style accounting remains suitable.
Total-cost basis requires advance approval
If the inventory basis is not practicable or would unduly delay settlement, the total-cost basis on SF 1436 may be used only with advance approval from the TCO. The regulation gives examples such as preproduction-only costs, accounting systems that cannot readily establish unit costs, contracts without unit prices, and complete terminations involving letter contracts.
Total-cost basis has special deduction rules
For a complete termination under the total-cost basis, the contractor must itemize all incurred contract costs through the termination date, add subcontract settlement costs and settlement expenses, apply profit or loss adjustment under the applicable FAR provision, and deduct the contract price for delivered or deliverable accepted end items plus all unliquidated advance and progress payments and known credits.
Partial termination under total-cost basis waits for completion
When the total-cost basis is used for a partial termination, the settlement proposal cannot be submitted until the continued portion of the contract is completed. The proposal must then include all costs incurred through completion of the continued work, not just costs through the termination date.
Construction and lump-sum professional services have special total-cost rules
If a construction contract or a lump-sum professional services contract is completely terminated, the contractor must use the total-cost basis, omit Line 10 on SF 1436, and reduce the gross settlement by the total of all progress and other payments. This is a mandatory special rule for those contract types.
No other basis without approval
Settlement proposals may not be submitted on any basis other than the inventory basis or total-cost basis unless the chief of the contracting or contract administration office approves another basis in advance. This prevents contractors from inventing alternative settlement methods without authorization.
Responsibilities
Contractor
Prepare the termination settlement proposal on the correct basis, usually the inventory basis unless the total-cost basis is approved or required. Itemize the required cost elements, apply the proper profit or loss adjustment, and deduct all required payments and credits. For partial terminations under the total-cost basis, wait until the continued work is complete before submitting the proposal.
Termination Contracting Officer (TCO)
Determine whether the inventory basis is practicable or whether advance approval of the total-cost basis is justified. Approve use of the total-cost basis in advance when appropriate, review whether the proposal uses the correct SF 1436 treatment, and ensure required deductions and adjustments are applied.
Chief of the contracting or contract administration office
Approve any settlement proposal basis other than the inventory basis or total-cost basis before it is used. This office serves as the higher-level approval authority for nonstandard settlement approaches.
Agency/Contracting activity
Apply the FAR settlement framework consistently, ensure termination settlements are processed using the proper basis for the contract type, and support oversight of contractor submissions and TCO approvals.
Practical Implications
The biggest day-to-day issue is choosing the right settlement basis early, because using the wrong basis can delay settlement or require rework of the proposal.
Contractors should maintain accounting records that can support separate itemization of terminated-work costs, subcontract settlements, and credits; weak cost tracking is a common source of disputes.
Advance and progress payments are not optional deductions — they must be netted out, along with known disposal or other credits, which often reduces the final settlement amount more than contractors expect.
For partial terminations under the total-cost basis, contractors must wait until the continued portion is finished, so submitting too early is a common procedural mistake.
Construction contracts and lump-sum professional services contracts have special rules that override the general preference for the inventory basis, so parties should check contract type before preparing the proposal.
Official Regulatory Text
(a) Inventory basis. (1) Use of the inventory basis for settlement proposals is preferred. Under this basis, the contractor may propose only costs allocable to the terminated portion of the contract, and the settlement proposal must itemize separately- (i) Metals, raw materials, purchased parts, work in process, finished parts, components, dies, jigs, fixtures, and tooling, at purchase or manufacturing cost; (ii) Charges such as engineering costs, initial costs, and general administrative costs; (iii) Costs of settlements with subcontractors; (iv) Settlement expenses; and (v) Other proper charges. (2) An allowance for profit ( 49.202 ) or adjustment for loss ( 49.203 (b)) must be made to complete the gross settlement proposal. All unliquidated advance and progress payments and all disposal and other credits known when the proposal is submitted must then be deducted. (3) This inventory basis is also appropriate for use under the following circumstances: (i) The partial termination of a construction or related professional services contract. (ii) The partial or complete termination of supply orders under any terminated construction contract. (iii) The complete termination of a unit-price (as distinguished from a lump-sum) professional services contract. (b) Total cost basis. (1) When use of the inventory basis is not practicable or will unduly delay settlement, the total-cost basis ( SF 1436 ) may be used if approved in advance by the TCO as in the following examples: (i) If production has not commenced and the accumulated costs represent planning and preproduction or "get ready" expenses. (ii) If, under the contractor’s accounting system, unit costs for work in process and finished products cannot readily be established. (iii) If the contract does not specify unit prices. (iv) If the termination is complete and involves a letter contract. (2) When the total-cost basis is used under a complete termination, the contractor must itemize costs incurred under the contract up to the effective date of termination. The costs of settlements with subcontractors and applicable settlement expenses must also be added. An allowance for profit ( 49.202 ) or adjustment for loss ( 49.203 (c)) must be made. The contract price for all end items delivered or to be delivered and accepted must be deducted. All unliquidated advance and progress payments and disposal and other credits known when the proposal is submitted must also be deducted. (3) When the total-cost basis is used under a partial termination, the settlement proposal shall not be submitted until completion of the continued portion of the contract. The settlement proposal must be prepared as in paragraph (b)(2) of this section, except that all costs incurred to the date of completion of the continued portion of the contract must be included. (4) If a construction contract or a lump-sum professional services contract is completely terminated, the contractor shall- (i) Use the total cost basis of settlement; (ii) Omit Line 10 "Deduct-Finished Product Invoiced or to be Invoiced" from Section II of SF 1436 Settlement Proposal (Total Cost Basis); and (iii) Reduce the gross amount of the settlement by the total of all progress and other payments. (c) Other basis. Settlement proposals may not be submitted on any basis other than paragraph (a) or (b) of this section without the prior approval of the chief of the contracting or contract administration office.