Exploring Unallowable Costs @DHG_GovCon David Eck Mike Mardesich - - PowerPoint PPT Presentation

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government contracting

@DHG_GovCon

Exploring Unallowable Costs

David Eck Mike Mardesich

September 22, 2016

The Fundamentals of Government Contracting Webinar Series

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government contracting

@DHG_GovCon

Your Presenters

David Eck

Dixon Hughes Goodman LLP 214.334.3233 david.eck@dhgllp.com

Mike Mardesich

Dixon Hughes Goodman LLP 703.970.0508 mike.mardesich@dhgllp.com

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Fundamentals – Season 1

• Challenges of Contracting with the Federal Government (November 2015) -

Completed

• Contract Types and Associated Risks (December 2015) – Completed
• Year-End Closing (January 2016) - Completed
• An Introduction to the Incurred Cost Submission

– Part I: Who, What, Where, When, Why, and How? (February 2016) - Completed – Part II: Preparation and Adequacy Review (March 2016) - Completed

• Accounting Systems and Setups (April 2016) - Completed
• Accounting System Adequacy 101 (May 2016) – Completed
• The Composition of Total Cost (June 2016) – Completed
• Making Way for 2017 – Budgeting and Provisional Rates (July 2016) – Completed
• Procurement Systems: DFARS Business Systems Rule and Criteria (August 2016) -

Completed

• Exploring Unallowable Costs (September 2016) – You are Here!
• Policy and Procedures Manual: What’s In It and Why Do You Need One? (October

2016)

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government contracting

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Agenda

• Unallowable Cost Background and Guidance

– FAR and CAS – Penalties for Unallowable Costs

• FAR Cost Principles

– Expressly Unallowable Costs – DCAA Commonly Scrutinized Unallowable Costs – Directly Associated Unallowable Costs – Unallowable Cost “Grey” Areas

• Best Practices to Identify and Segregate

Unallowable Costs

• DCAA Guidance

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Unallowable Cost Background and Guidance

The Fundamentals of Government Contracting Webinar Series

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What is Cost?

• Total Cost
• Direct vs. Indirect Cost
• Allowable Cost

– Reasonableness – Allocability – Allowability – CAS or GAAP – Contract Terms

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Cost Principles - FAR Part 31

• Compliance Obligations

– Criteria for allocating costs – Defines allowability of costs – Requires exclusion of unallowable costs

• Penalties

– Disallowance of costs – Penalties for unallowable costs – Interest penalty

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Cost Accounting Standards 405

• CAS 405: Accounting for unallowable costs
• Compliance Obligations

– Criteria for the assignment and allocation of costs to government contracts – Disclosure of accounting practices – Notification of changes to accounting practices – Requires consistent application

• Penalties

– Contract price adjustment – No increased cost to government if practices change – Interest penalties – Statute of Limitations

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government contracting

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Allowability (FAR 31.201-2)

• Definition

– Not unallowable – Terms of the contract – Generally Accepted Accounting Principles

• Contractor must maintain adequate accounting

records – FAR 31.201(2)(c)

• Contractor must apply consistent practices – FAR

31.201(2)(b)

• Often subject to improper challenges due to poor chart
• f accounts or inadequate procedures

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government contracting

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Accounting for Unallowable Costs (FAR 31.201-6)

• Contractor has a responsibility to account

for unallowable costs

• Must have a mechanism for identifying

unallowable costs

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Segregation of Unallowable Costs

• FAR 31.201-6, CAS 405, FAR 52.216-7,

FAR 42.703-2

• Certification Issues:

– Directly associated costs – Access to unallowable cost detail – Include unallowables in base

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Penalties for Unallowable Cost

• If unallowable on clear and convincing evidence:

– Disallowed cost plus interest on any paid portion

• If known to be unallowable before proposal

submission:

– Disallowed cost plus interest on any paid portion – Additional two times unallowable cost – Other civil and criminal penalties provided by law

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Certificate of Indirect Costs

This is to certify that to the BEST OF MY KNOWLEDGE and belief: 1. I have reviewed the indirect cost proposal submitted herewith; 2. All costs included in this proposal [to establish billing or final indirect costs rates for . . .] are ALLOWABLE in accordance with the requirements of contracts to which they apply and with the cost principles of the Department of Defense applicable to those contracts; 3. This proposal DOES NOT INCLUDE ANY COSTS WHICH ARE UNALLOWABLE under applicable cost principles of the Department of Defense, such as (without limitation): advertising and public relations costs, contributions and donations, entertainment costs, fines and penalties, lobbying costs, defense of fraud proceedings, and goodwill; and 4. All costs included in this proposal are PROPERLY ALLOCABLE to defense contracts on the basis of a beneficial or causal relationship between expense incurred and the contracts to which they are allocated in accordance with applicable acquisition regulations. I declare UNDER PENALTY OF PERJURY that the foregoing is true and correct. Firm …………………………………… Title…………………………… Signature ……………………………. Date ………………………….. Corporate Official …………………..

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government contracting

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Unallowable Cost Challenges

• Auditor expectation for supporting

documentation

• DCAA audits in arrears and conflict with

record retention requirements

• Auditor access to budgeted and incurred

cost

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FAR Cost Principles

The Fundamentals of Government Contracting Webinar Series

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Personnel Costs

The Fundamentals of Government Contracting Webinar Series

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government contracting

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Compensation – FAR 31.205-6

• Allowable Compensation must be reasonable for

work performed based on comparisons to:

– Firms of the same size – Firms in the same industry – Firms in the same geographic area – Firms engaged in non-Government work

• Closely held business scrutinized more closely
• When elements are challenged - Offsets may be

considered between allowable elements of compensation within same job grade or level

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Compensation – Challenges

• Reasonableness – overall

– Bonuses – Lack of approval from ACO for changes to compensation programs – Lack of wage or salary survey to support

• Inconsistency
• Dependent Health Care Costs
• T&M Contracts - Resume and Labor Category

requirements

• Bonuses – need written plan that is consistently

followed

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Benchmark Compensation Cap

• The compensation cap is required by Section 39 of the

41 U.S.C. § 1127, and represents the maximum compensation amount that a contractor can include as an allowable cost for covered contracts awarded before June 24, 2014.

Statutory Formula Cap Amount Fiscal Year For Costs Incurred After $1,144,888 2014 1-Jan-2014 $980,796 2013 1-Jan-2013 $952,308 2012 1-Jan-2012 $763,029 2011 1-Jan-2011 $693,951 2010 1-Jan-2010 $684,181 2009 1-Jan-2009 $612,196 2008 1-Jan-2008 $597,912 2007 1-Jan-2007 $546,689 2006 1-Jan-2006 $473,318 2005 1-Jan-2005 $432,851 2004 1-Jan-2004

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government contracting

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Benchmark Compensation Cap

• Cap rules vary depending on the date of the contract

award and the customer agency.

• For covered contracts awarded on or after June 24,

2014, a cap of $487,000 applies pursuant to section 702

• f the Bipartisan Budget Act (BBA) of 2013.

Compensation Cap Rule

Agency Agency

DOD/NASA/CG Civilian agencies Statutory formula cap, top five senior executives Before Dec 31, 2011 Before Jun 24, 2014 Statutory formula cap, all contractor employees On/after Dec 31, 2011, and before June 24, 2014 N/A $487,000* BBA cap, all contractor employees (*will adjust for inflation) On/after Jun 24, 2014

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Compensation Considerations

• The statutory caps will impact those contractors who

choose to use a blended rate approach to compensation reimbursement in their blended rate calculations.

• The statutory cap does not limit the compensation a

contractor may pay an employee, only the amount reimbursable to the contractor.

• For cost reimbursement purposes, contractors must also

remember that the reasonableness test at FAR 31.205- 6(b) still applies even if total compensation does not exceed the cap.

– DCAA Guidance on Surveys and Benchmarking – DCAA Compensation Team – Recent Court Decisions

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• Aggregate costs are allowable:

– Improve working conditions – Improve employee morale – Improve employee performance

• Gifts are unallowable – not awards recognizing

employee achievements

• Recreation is unallowable – except for

sponsored teams or organizations

• FASA imposed significant changes in 1996

Employee Morale, Health, Welfare, Food Service, and Dormitory Costs and Credits – FAR 31.205-13

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government contracting

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Alcoholic Beverages – FAR 31.205-51

• Unallowable
• Company policy is important
• Auditor tactics can be a concern

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government contracting

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Travel Costs – FAR 31.205-46

• Travel must be for official business
• Approval expected
• Air Fair limitations - Coach travel and “lowest

available fare”

• Per diem vs. Actual costs
• Unallowable Costs

– Alcohol – Travel in excess of FTR daily rate – Lowest available airfare

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government contracting

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Travel Cost Challenges

• General rule of thumb – Travel cost should follow

the labor cost – [i.e. direct if labor is direct]

• Lack of receipts
• Reasonableness of cost
• No justification of business purpose
• Partial travel days
• Company policy conflicts

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Entertainment Costs - FAR 31.205-14

• Amusement
• Diversions
• Social activities
• Tickets to shows and sporting events
• Membership in social clubs
• All unallowable

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government contracting

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Relocation Costs - FAR 31.205-35

• Relocation for assignments of not less

than 12 months

• Move must be for the benefit of the

employer

• If employee quits within 12 months of

relocation - Government entitled to a credit for relocation costs

• Quite comprehensive listing of what is

allowable

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government contracting

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Trade, Business, Technical and Professional Activity Costs - FAR 31.205-43

• Memberships -- Allowable
• Subscriptions -- Allowable
• Meetings and symposiums where the

principal purpose is the dissemination of technical, business or trade information, the stimulation of production, or improved productivity -- Allowable

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government contracting

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Training & Education - FAR 31.205-44

• Vocational training - allowable
• Part-time college - fees and straight time not in

excess of 156 hours per year

• Full-time - Fees but not salary, if related to

employees field, for not more than 2 years

• Specialized training - not more than 16 weeks

per year

• Employee Dependents – not allowable

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government contracting

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Project Related Costs

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Material Costs – FAR 31.205-26

• Material costs are allowable
• Requires consideration of rebates or credits
• Allows for direct charging if the contract is

known at the time of purchase

• Requires the use of GAAP inventory valuation

techniques if there is an inventory

• Dictates transfer pricing procedures between

related parties

• DCAA guidance on commercial items

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government contracting

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Plant and Equipment Costs

The Fundamentals of Government Contracting Webinar Series

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Depreciation – FAR 31.205-11

• Systematic and logical assignment of assets to

benefitting cost accounting periods

• Reasonable if:

– Consistent with other cost centers – Reflected in books of accounts and financial statements – Both used and acceptable for tax purposes

• Acquisitions – No step up, no step down
• Use Charges

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Special Tooling and Test Equipment

– FAR 31.205-40

• Special tooling and test equipment is an

allowable direct cost – not indirect cost

• General purpose tooling and test equipment is

an allowable indirect cost (depreciation), not direct cost

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government contracting

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Gains and Losses on Disposition of Depreciable Property

• r Other Capital Assets – FAR 31.205-16
• Costs are credited or charged in the year in

which they occur to the same cost pool that the depreciation for that asset was charged

• No gain or loss as a result of a business

combination

• Limited to the amount of depreciation that

was charged

• Impairments – no write-off allowed

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government contracting

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Cost of Money – FAR 31.205-10

• A non-cost cost
• Imputed amounts using the Secretary of

the Treasury Interest Rate

• Can be waived by the contractor (due to

profit implications)

• Treated as an incurred cost for progress

payment and public voucher purposes

• Must be included in forward pricing

proposal to be an allowable incurred cost

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government contracting

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Rental Costs – FAR 31.205-36

• Real or personal property operating leases
• Must be reasonable
• Sale - leaseback limited to costs if sale had not
• ccurred
• Related parties limited to cost of ownership

unless personal property and established practices similar to unaffiliated lessees

• Potential impact of new lease rules

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government contracting

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Selling and Marketing Costs

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government contracting

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Selling Costs – FAR 31.205-38

• Direct selling costs are allowable if

reasonable

• Costs associated with marketing efforts to

export products purchased by the Government are allowable provided they are reasonable – including trade shows

• Commissions are allowable if paid to bona

fide employees or agencies

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government contracting

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IR&D and B&P Costs – FAR 31.205-18

• Allowable if reasonable
• Indirect people continue to charge indirect,

direct people charge IR&D and B&P projects

• IR&D not required to do a contract
• B&P preparing and supporting bids
• Challenging accounting requirements
• Good policies and procedures are critical
• New focus of Pentagon
• Congressional viewpoints

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government contracting

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Contingencies – FAR 31.205-7

• Forward pricing - reasonably foreseeable

and can be estimated within reasonable limits of accuracy - allowable

• Incurred cost - unallowable

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government contracting

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Contract Losses – FAR 31.205-23

• Loss is defined as cost in excess of

revenue [includes cost sharing]

• Losses on contracts are unallowable

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government contracting

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Precontract Costs – FAR 31.205-32

• Major red flag!
• Do it in writing!
• Must meet three tests:

– Incurred directly pursuant to negotiations and contract terms; – necessary to meet the contract schedule; and, – are otherwise allowable.

• FAR 31.109 for advance agreement

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government contracting

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Other Cost Principles

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government contracting

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Public Relations and Advertising Costs – FAR 31.205-1

• Allowable advertising

– help wanted – acquire materials – dispose of scrap

• Allowable public

relations

– required by contract – responding to inquiries – communicating with public – general liaison – community services – plant tours – keel laying – Trade Show Booths?

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government contracting

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Bad Debts – FAR 31.205-3

• Unallowable
• Directly associated costs – collection costs

and legal costs are unallowable

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government contracting

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Contributions or Donations – FAR 31.205-8

• Unallowable
• Cash, property or services
• Does not include FAR 31.205-1(e)(3) for

community services like blood drives

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government contracting

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Fines and Penalties and Mischarging Costs – FAR 31.205-15

• Fines and penalties are unallowable

unless approved by the contracting officer

• Cost of correcting records is unallowable if

the reason the records have to be corrected is due to the false or improper recording of cost

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government contracting

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Interest and Other Financial Costs – FAR 31.205-20

• Unallowable
• Some recent court cases allow ‘interest’
• n state income tax obligations where the

contractor was not delinquent or acted reasonably

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government contracting

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Lobbying & Political Activity Costs – FAR 31.205-22

• Any activity to influence Executive or

Legislative staff is unallowable

• Presentations on factual or technical

information about a contract are allowable if supported by documentation

• Requires a certification
• DCAA focuses on contractor Washington

DC area offices

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Organization Costs – FAR 31.205-27

• Costs for effort affecting the capital structure
• f the company
• Unallowable
• Lots of confusion and misinterpretation of

this principle with merger mania of the 1990’s

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Other Business Expenses – FAR 31.205-28

• Shareholder meetings, soliciting normal

proxy, preparing and publishing reports etcetera, etcetera, etcetera

• Allowable

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Patent Costs – FAR 31.205-30

• Only costs required by contract or for

general patent advice are allowable

• All other costs are unallowable

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Professional and Consultant Service Costs – FAR 31.205-33

• Generally allowable but must be reasonable
• Cannot be officers or employees of the

contractor

• Must be supported by:

– Details of agreement and actual services – Invoices with sufficient detail to allow an evaluation of what was done – Work product or memorandum of meetings

• Be familiar with current DCAA guidance

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government contracting

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Legal Costs – FAR 31.205-47

• Costs are unallowable if in connection with

violation of or failure to comply with laws and regulations (admitted wrong doing)

• Other legal costs are generally allowable,

but auditors will be asking for the 3 items required for professional and consultant services

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government contracting

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Recruitment Costs – FAR 31.205-34

• Cost of help wanted, employment office,

travel costs, etc.

• Generally allowable
• Ads must be for specific positions required

by the contract or be indirect positions

• Must not be public relations type costs

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government contracting

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Royalties and Other Costs for Use of Patents – FAR 31.205-37

• Allowable unless:

– Government owns license or has free use – Patent adjudicated to be invalid – Patent is considered to be unenforceable – Patent has expired

• Warns to be careful regarding

reasonableness of less-than-arms-length transactions

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government contracting

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Taxes – FAR 31.205-41

• Generally allowable
• Following are unallowable:

– Federal income and excess profits tax – Taxes associated with financing activities – Taxes for which exemptions could have been obtained – Special assessments on land that represent capital improvements – Taxes on real or personal property used only on non-government work – Taxes on accumulated funding deficiencies – Income tax accruals for timing differences

• Be careful on sales tax – may be questioned if

items are purchased on behalf of government

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government contracting

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Termination Costs – FAR 31.205-42

• Costs continuing after termination
• Initial costs
• Loss of useful value
• Rental under unexpired leases
• Alterations of leased property
• Settlement costs – Internal and External
• Subcontractor claims

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Business Combinations – FAR 31.205-52

• Tangible capital assets

– Purchase method of accounting – If prior depreciation or COM – book value of seller – If no prior depreciation or COM – fair value at time of acquisition

• Intangible capital assets

– Purchase method of accounting – no step up

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government contracting

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Directly Associated Costs

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government contracting

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Directly Associated Costs – FAR 31.205-6(e)

• Materiality of directly associated costs:

– The dollar amount – Cumulative effect of all directly associated costs in a pool – Ultimate effect on Gov’t contracts

• Salary expenses of employees who

participate in unallowable activities

• Only unallowable if material in amount

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Best Practices to Identify and Segregate Unallowable Costs

The Fundamentals of Government Contracting Webinar Series

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Best Practices

• Unallowable cost accounts clearly shown in

chart of accounts and submissions to the government (forward pricing proposals, incurred cost submissions)

• Point of entry screening
• FAR Part 31.201-6 provides for statistical

sampling if

– Plan and sampling must permit audit verification – Should have advanced agreement

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DCAA Guidance on Expressly Unallowable Costs

The Fundamentals of Government Contracting Webinar Series

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government contracting

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DCAA Guidance on Expressly Unallowable Costs

• January 2015 DCAA Memorandum for

Regional Directors

– Guidance to auditors on how to determine if cost is “expressly unallowable” – “Government must establish that it was ‘unreasonable for a person in the contractor’s position to conclude that the costs were allowable.’” – Previous audit alert issued in December 2014 was misleading – Source: http://www.dcaa.mil/mmr/14-PAC-022.pdf

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DCAA Guidance on Expressly Unallowable Costs

• In order for a cost to be expressly

unallowable, the cost principle must:

• i. State in direct terms that the costs are

unallowable, or leave little room for differences of opinion as to whether the cost meets the allowability criteria; and

• ii. Identify the specific cost or type of costs in

a way that leaves little room for interpretation

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Questions?

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Join us next month for “Policy and Procedures Manual: What’s In It and Why Do You Need One?”

• n Thursday, October 27, 2016

The Fundamentals of Government Contracting Webinar Series