Exploring Unallowable Costs @DHG GovConof the Bipartisan Budget Act (BBA) of 2013. Compensation Cap...

1government contracting

@DHG_GovConExploring Unallowable CostsDavid EckMike MardesichSeptember 22, 2016

The Fundamentals of Government Contracting Webinar Series


@DHG_GovConYour Presenters

[email protected]

MikeMardesichDixonHughesGoodmanLLP703.970.0508mike.mardesich@dhgllp.com


@DHG_GovConFundamentals – 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)


@DHG_GovConAgenda• 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


@DHG_GovCon

Unallowable Cost Background and Guidance



@DHG_GovConWhat is Cost?

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

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


@DHG_GovConCost 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


@DHG_GovConCost 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


@DHG_GovConAllowability (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 of accounts or inadequate procedures


@DHG_GovConAccounting for Unallowable Costs (FAR 31.201-6)

• Contractor has a responsibility to account for unallowable costs

• Must have a mechanism for identifying unallowable costs


@DHG_GovConSegregation 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


@DHG_GovConPenalties 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


@DHG_GovConCertificate of Indirect CostsThis 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 …………………..


@DHG_GovConUnallowable Cost Challenges

• Auditor expectation for supporting documentation

• DCAA audits in arrears and conflict with record retention requirements

• Auditor access to budgeted and incurred cost


@DHG_GovCon

FAR Cost Principles



@DHG_GovCon

Personnel Costs



@DHG_GovConCompensation – 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


@DHG_GovConCompensation – 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

18


@DHG_GovConBenchmark 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. StatutoryFormulaCapAmount FiscalYear ForCostsIncurredAfter

$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


@DHG_GovConBenchmark 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 of the Bipartisan Budget Act (BBA) of 2013.

CompensationCapRuleAgency Agency

DOD/NASA/CG Civilian agencies

Statutoryformulacap,topfiveseniorexecutives

BeforeDec31,2011 BeforeJun24,2014

Statutoryformulacap,allcontractoremployees

On/afterDec31,2011,andbeforeJune24,2014 N/A

$487,000*BBAcap,allcontractoremployees

(*willadjustforinflation)

On/afterJun24,2014


@DHG_GovConCompensation 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


@DHG_GovCon

• 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


@DHG_GovConAlcoholic Beverages – FAR 31.205-51

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


@DHG_GovConTravel 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


@DHG_GovConTravel 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

25


@DHG_GovConEntertainment Costs - FAR 31.205-14

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


@DHG_GovConRelocation 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


@DHG_GovConTrade, 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


@DHG_GovConTraining & 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


@DHG_GovCon

Project Related Costs



@DHG_GovConMaterial 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


@DHG_GovCon

Plant and Equipment Costs



@DHG_GovConDepreciation – 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


@DHG_GovConSpecial 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


@DHG_GovConGains and Losses on Disposition of Depreciable Property or 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


@DHG_GovConCost 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


@DHG_GovConRental Costs – FAR 31.205-36

• Real or personal property operating leases• Must be reasonable• Sale - leaseback limited to costs if sale had not

occurred• Related parties limited to cost of ownership

unless personal property and established practices similar to unaffiliated lessees

• Potential impact of new lease rules


@DHG_GovCon

Selling and Marketing Costs



@DHG_GovConSelling 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


@DHG_GovConIR&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


@DHG_GovConContingencies – FAR 31.205-7

• Forward pricing - reasonably foreseeable and can be estimated within reasonable limits of accuracy - allowable

• Incurred cost - unallowable


@DHG_GovConContract Losses – FAR 31.205-23

• Loss is defined as cost in excess of revenue [includes cost sharing]

• Losses on contracts are unallowable


@DHG_GovConPrecontract 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


@DHG_GovCon

Other Cost Principles



@DHG_GovConPublic Relations and Advertising Costs – FAR 31.205-1

• Allowable advertising– help wanted– acquire materials– dispose of scrap

• Allowablepublicrelations– requiredbycontract– respondingtoinquiries– communicatingwithpublic

– generalliaison– communityservices– planttours– keellaying– TradeShowBooths?


@DHG_GovConBad Debts – FAR 31.205-3

• Unallowable• Directly associated costs – collection costs

and legal costs are unallowable


@DHG_GovConContributions 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


@DHG_GovConFines 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


@DHG_GovConInterest and Other Financial Costs – FAR 31.205-20

• Unallowable• Some recent court cases allow ‘interest’

on state income tax obligations where the contractor was not delinquent or acted reasonably


@DHG_GovConLobbying & 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


@DHG_GovConOrganization Costs – FAR 31.205-27

• Costs for effort affecting the capital structure of the company

• Unallowable• Lots of confusion and misinterpretation of

this principle with merger mania of the 1990’s


@DHG_GovConOther Business Expenses – FAR 31.205-28

• Shareholder meetings, soliciting normal proxy, preparing and publishing reports etcetera, etcetera, etcetera

• Allowable


@DHG_GovConPatent Costs – FAR 31.205-30

• Only costs required by contract or for general patent advice are allowable

• All other costs are unallowable


@DHG_GovConProfessional 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


@DHG_GovConLegal 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


@DHG_GovConRecruitment 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


@DHG_GovConRoyalties 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


@DHG_GovConTaxes – 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


@DHG_GovConTermination 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


@DHG_GovConBusiness 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


@DHG_GovCon

Directly Associated Costs



@DHG_GovConDirectly 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


@DHG_GovCon

Best Practices to Identify and Segregate Unallowable Costs



@DHG_GovConBest 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


@DHG_GovCon

DCAA Guidance onExpressly Unallowable Costs



@DHG_GovConDCAA Guidance onExpressly 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


@DHG_GovConDCAA Guidance onExpressly 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


@DHG_GovConQuestions?


@DHG_GovCon

Join us next month for “Policy and Procedures Manual: What’s In It and Why Do

You Need One?”on Thursday, October 27, 2016


Exploring Unallowable Costs @DHG GovConof the Bipartisan Budget Act (BBA) of 2013. Compensation Cap...

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