(vi) Step Six: Estimate the Recurring Costs Incurred for the Canceled End Items.

Note: Skip this step if you are using Non-EOQ multi-year procurement. Take this step only if you intend to obtain approval to include recurring costs in the cancellation ceiling.

(A) In EOQ multi-year procurements, the contractor makes EOQ purchases and undertakes EOQ efforts to maximize efficiency and cost avoidance. EOQ purchases and efforts involve material and labor; in other words, recurring costs. By the time the cancellation would occur, the contractor will have probably bought or made some components for the out-year end items you are canceling. In this Step Six, you will estimate the amount actually incurred for these purposes.

(B) Before beginning the estimating process, you should become familiar with or remind yourself of the way EOQ purchases and efforts contribute to the production of end items. Figures 6.C and 6.D will assist you with this.

(1) Step Six A: Review the definition of recurring costs. "Recurring costs" means costs that vary with the quantity being produced, such as labor and materials. (This definition is from FAR 17.103)

(2) Step Six B: Itemize the recurring costs you expect the contractor will have incurred for the out‑year end items. Prepare a worksheet like the one in Figure 6.E, following Steps Six C through Six H.

(3) Step Six C: Complete Column 1 of the Worksheet Activity.

(i) In Column 1, list all EOQ Purchases, EOQ Efforts, and Long Lead Purchases. Add Long Lead Efforts that you expect to be on‑going during the year just preceding the potential cancellation. (For example, if you are estimating the cancellation ceiling for the cancellation that could occur at the end of Year 3, then Column 1 should include all activities you expect to be ongoing during Year 3.) If you can work with the contractor(s) while you are developing this cancellation ceiling estimate, you may want to ask the contractor to complete Column 1, indicating what it would intend to do on an EOQ and Long Lead basis.

(ii) All "activities" listed in Column 1 would involve "advance procurement." The EOQ activities would be undertaken for the purpose of saving money and the long lead activities would be undertaken for the purpose of meeting the production schedule. All these activities would contribute to the production of out-year end items, which would not be procured in the event of cancellation.

How EOQ Activity Contributes to the Production of End Items

	20 ship sets become part of	FY 1 END ITEMS (20 Flying Saucers)	The price the Government pays for the FY 1 flying saucers will cover the cost of these 20 ship sets.
EOQ Activity Purchase of 100 Ship Sets of Titanium Parts (Contractor issues purchase order multi-year contract.)	20 ship sets become part of	FY 2 END ITEMS (20 Flying Saucers)	If the contract is not canceled at the end of FY 1, the Government will fully fund the FY 2 end items at the beginning of FY 2. The price the Government pays for FY 2 flying saucers will cover the FY 2 cost of these 20 early in FY 1 ship sets.
	20 ship sets become part of	FY 3 END ITEMS (20 Flying Saucers)	If the contract is not canceled at the end of FY 2, the Government will fully fund the FY 3 end items at the beginning of FY 3. The price the Government pays for the FY 3 flying saucers will cover the FY 3 cost of these 20 early in FY 2 ship sets.
	20 ship sets become part of	FY 4 END ITEMS (20 Flying Saucers)	And so on.
	20 ship sets become part of	FY 5 END ITEMS (20 Flying Saucers)	And so on.
		Figure 6.C

How the Life of an EOQ Item Affects Your Cancellation Ceiling Estimate EOQ Activity: Purchase of 100 Ship Sets of Titanium Parts (from Figure 6.D) EOQ Item: One of the Ship Sets to be built into a FY 3 End Item Method of Payment: Unit Price paid upon delivery; no progress payments or partial payments involved.
Significant Milestones in the Life of the EOQ Item:	Prime Contractor’s Situation at Each Milestone:
1. Ordered by Prime Contractor	1. Committed to cover costs vendor incurs to produce the items
2. Produced by Vendor	2. Committed to cover the vendor’s full cost of producing the EOQ Item
3. Finished Product in Vendor’s Inventory	3. Committed to cover total cost of the EOQ Item
4. Delivered to Prime Contractor	4. By paying the vendor the agreed-upon price for the EOQ Item, the prime contractor incurs recurring cost
5. Held in Prime Contractor’s Inventory	5. Contractor is carrying the incurred cost
6. Used in Production of End Item	6. Full-up production support is underway and because it is part of a FY requirement “turned on” and fully funded by the Government, Contractor will recover cost of EOQ item in the price the Government eventually pays for the end item
7. Delivered (as part of an end item) to the Government	7. Receives payment from the Government, which covers the cost incurred for the EOQ item
Identify each of these milestones on the time line of your multi-year contract: For a cancellation at the end of FY 1, something less than the full cost of the EOQ Item will have to be included in the cancellation ceiling. For a cancellation at the end of FY 2, the full cost (to the contractor) of the EOQ Item would have to be included in the cancellation ceiling. For a cancellation at the end of FY 3, no part of the EOQ Item’s cost would have to be included in the cancellation ceiling.
Figure 6.D


EOQ Calculation Worksheet

(1)	(2)	(3)	(4)	(5)	(6)
Activity	Total Estimated Cost (TEC) $	Date to be Initiated	Date to be Completed	Portion of TEC Likely Built into Previous-Year and Current-Year End Items $	Portion of TEC Likely to be Incurred on Out-Year End Items By End of Current Year $
1. EOQ Purchases
a. Material
(1) ...
(n)
b. Parts
(1) ...
(n)
c. Subassemblies
(1) ...
(n)
d. Components
(1) ...
(n)
e. Other
2. EOQ Effort
a. Fabrication of Parts
(1) ...
(n)
b. Manufacture of Subassemblies
(1) ...
(n)
c. Other
3. Long Lead Purchases
a. Material
b. Parts
c. Other
4. Long Lead Efforts
a. Fabrication of Parts
b. Manufacture of Subassemblies
c. Other
Total

			Figure 6.E

(4) Step Six D: Complete Column 2 of the Worksheet: Total Estimated Cost (TEC). For each entry in Column 1, enter your estimate of the total cost to the Government of that purchase or effort.

(5) Step Six E: Complete Column 3 of the Worksheet: Date Activity to be Initiated.

(i) Enter in Column 3 the month and year in which you expect the contractor to initiate each activity listed in Column 1. For this purpose, "initiate" means either to issue the purchase order or to "turn on" the in‑house effort.

(ii) For example, if the contractor will produce 20 flying saucers a year for five years under the multi-year contract, an EOQ purchase might be 100 ship sets of titanium parts. The contractor would issue the purchase order for the 100 ship sets in the first year, but might not require delivery of the 100th ship set until the fourth year. Your worksheet for the first year of the multi-year contract would show "100 titanium ship sets" in Column 1 under "EOQ Purchases - Parts." The date in Column 3 would be the date the Contractor issued the purchase order.

(iii) For any Column 1 activity appearing on the worksheet you prepare for the second or a subsequent year of the multi-year contract, the Column 3 entry would be identical to that on your worksheet for the first year of the contract.

(6) Step Six F: Complete Column 4 on the Worksheet: Date Activity to be Completed. Enter in Column 4 the date by which each activity is expected to be completed (i.e., the date by which the last item would be delivered under a purchase order, or the date by which the last item would be completed in an in-house production effort).

(7) Step Six G: Complete Column 5 on the worksheet: Portion of TEC Built into Previous Year and Current Year End Items.

(i) If you are estimating the cancellation ceiling for the cancellation that could occur at the end of the first year of the multi-year contract, then:

(a) Enter "zero" if the first year involves only advance procurement (i.e., no end items are being acquired); or

(b) If end items are being acquired, estimate how much of the TEC of the activity will be built into the current (i.e., first) year's end items. Put another way, how much of the TEC will be covered by the unit prices the Government will pay for the first year's end items? Enter your estimate in Column 5.

(ii) If you are estimating the cancellation ceiling for any year after the first fiscal year in which end items are acquired, some of the TEC will have been built into previous year-end items and some will be built into current year items. Quantify these amounts and enter your estimate in Column 5.

(8) Step Six H: Complete Column 6 on the Worksheet: Portion of TEC to be Incurred on Out-Year End Items by End of Current Year.

(i) Column 6 is the place for you to enter your estimate of how much of each activity's total estimated cost will have been incurred, as of the time cancellation would occur, to support production of the out-year end items.

(ii) Review what you know at this point:

From Column 1 The activities going on in the current year (i.e., the one for which you are estimating the cancellation ceiling) that will generate recurring costs that contribute to the production of out-year end items.

From Column 2 The total estimated cost to the Government of each of those activities.

From Column 3 When each activity is expected to begin (and begin generating costs).

From Column 4 When each activity is expected to be completed (enabling final billing

and payment for the activity).

From Column 5 How much of the total estimated cost of each activity will be covered by

the price paid for non-canceled end items.

(iii) Consider the information in Columns 1 through 5 as well as:

• The rate at which the EOQ or long lead items will be produced (i.e., how many will be done and how many will be in process at the time of cancellation?)

• The delivery schedule for purchased items. How many will have been delivered to the contractor at the time of cancellation?

• For EOQ and Long Lead Purchases, the terms and conditions of the subcontract or purchase order involved. Will it provide for the contractor to make progress payments, partial payments, or one lump sum payment upon delivery of the entire order? Knowing when the contractor is likely to make payments will help you know when the contractor is likely to incur costs.

(iv) If you are estimating the cancellation ceiling in conjunction with doing a multi-year feasibility study, neither you nor the contractor(s) will have specific information on these points. In these cases, use the best available information (e.g., standard industry practice as regards terms and conditions of purchase orders for such items; historical production data; cost or pricing data from existing or past contracts involving the same types of purchases or efforts).

(v) The maximum amount you can enter in Column 6 is the difference between the total estimated cost of the activity (in Column 2) and the cost covered by the prices paid or to be paid for non-canceled end items (in Column 5). This maximum entry would only be appropriate in the last year for which the contract will need a cancellation ceiling. In all other cases:

Amount in Column 6 < (Amount in Column 2 less Amount in Column 5)

(9) Step Six I: Sum up all entries in Column 6.

The total of all Column 6 entries is your estimate of the recurring costs incurred for the canceled end items. Enter this estimate in Figure 6.A. This is the third building block of your cancellation-ceiling estimate.