This response is based on the information provided.  We suggest you discuss with your contracting and finance team, program manager and/or legal department as appropriate.

This is a contracting officer determination.  What makes sense is to acknowledge the information from the contractor and state the Government is not requesting a change in the negotiated price.

Your team does not want to delay further the execution of the contract action (time is money).  The contract type is CPFF so we will only pay what is actually spent.  If the numbers hold up over time, the Government will get the reduction in the end.  Properly document the file with rationale for the course of action taken.