Compensation - Part 8 - Backpay

Backpay is a retroactive adjustment of prior years' salaries or wages. Backpay should not be confused with deferred compensation. While backpay is generally unallowable, deferred compensation is usually allowable if a deferred compensation plan is set up correctly.

This provision changed significantly in 2003. Prior to that, backpay included settlements for violations of Federal labor laws and the Civil Rights Act of 1984 (e.g. improper discharge or discrimination). Under the 2003 revision, backpay is defined as additional compensation for work performed.

According to FAR 31.205-6.(h), backpay is unallowable except for a few situations.

1. Payments to employees resulting from underpaid work actually performed are allowable, if required by a negotiated settlement order, or court decree. Contractor intending to claim backpay under this provision will most likely need legal assistance.
2. Payments to union employees for the difference in their past and current wage rates for working without a contract or labor agreement during labor management negotiation are allowable.
3. Payments to nonunion employees based upon results of union agreement negotiation are allowable only if
• A formal agreement or understanding exists between management and the employees concerning these payments, or
• An established policy or practice exists and is followed by the contractor so so consistently as to imply, in effect, an agreement to make such payments.

This rule effectively takes away situations where if a survey shows an employee is underpaid in a particular year, the contractor could make that underpayment up in a future year.

The allocation of backpay costs can be tricky. Usually settlements occur several years after the period to which backpay is allocable. If you have a backpay situation, we advise that you pursue an advance agreement (see FAR 31.109) with the contracting officer. Otherwise, you are risking time-consuming arguments with the auditors.

Next: Section (i) - Compensation based on changes in the prices of corporate securities

Compensation - Part 7 - Severance Pay

Severance pay is a payment, in addition to regular salaries and wages, by contractors to workers whose employment is being involuntarily terminated. Severance pay is only allowable under Government contracts to the extent that it is required by

• Law
• Employer-employee agreement
• Established policy that constitutes, in effect, an implied agreement on the contractor's part; or
• Circumstances of the particular employment.

These are pretty broad categories and we do not recall when a contractor's intention to pay or actual payment of severance pay was successfully challenged by the Government for failing to meet one of these four conditions.

Back in the 1970s and perhaps the early 1980s, as service contracts changed hands, winning contractors would hire the employees of the incumbent contractor and those employees would continue to do the same work that they had been performing. Sometimes, hiring incumbent employees was a requirement of the solicitation and other times, it was convenient and made business sense. However, upon losing the contract, incumbent contractors were paying their employees a severance pay and seeking reimbursement for those costs from the Government. That precipitated a new rule where payments made in the event of employment with a replacement contractor where continuity of employment with credit for prior length of services is preserved under substantially equal conditions of employment or continued employment by the contractor at another facility, subsidiary, affiliate, or parent company of the contractor are not severance pay and are unallowable.

There are two kinds of severance pay addressed in this cost principle; normal severance pay and abnormal severance pay.

Actual normal turn over severance payments shall be allocated to all work performed in the contractor's plant. However, if the contractor uses the accrual method to account for normal turnover severance payments, that method will be acceptable if the amount of the accrual is

• reasonable in light of payments actually made for normal severances over a representative past period, and
• allocated to all work performed in the contractor's plant.

Abnormal or mass severance pay is of such a conjectural nature that accruals for this purpose are not allowable. However, the Government recognizes its obligation to participate, to the extent of its fair share, in any specific payment. Thus, the Government will consider allowability on a case-by-case basis.

Specific requirements for foreign national employees. The costs of severance payments to foreign nationals employed under a service contract performed outside the US are unallowable to the extent that such payments exceed amounts typically paid to employees providing similar services in the same industry in the US. Further, all such costs of severance payments that are otherwise allowable are unallowable if the termination of employment of the foreign national is the result of the closing of, or the curtailment of activities at a US facility in that country at the request of the government of that country. This does not apply if the closing of a facility or curtailment of activities is made pursuant to a status-of-forces or other country-to-country agreement entered into with he government of that country before November 29, 1989. Applicable statutes permit the head of the agency to waive these cost allowability limitations under certain circumstances.

Next: Section (h) - Backpay

Mandatory Disclosure Requirements - A Reminder

In November 2008, FAR was amended to require mandatory disclosure requirements involving fraud and overpayments on contractors (and subcontractors). These disclosure requirements apply to contracts greater than $5 million and a performance period greater than 120 days. This disclosure requirement applies to most types of contracts including commercial items and contracts awarded and/or performed overseas.

FAR 52.203-13 requires timely disclosure of violations against criminal and civil laws. Criminal laws include fraud, conflict of interest, bribery, or gratuity violations. Civil laws include the False Claims Act. There must be credible evidence of a violation and the violation must have been committed by any contractor principal, employee, agent, or subcontractor.

Disclosures must be made in writing to the appropriate Inspector General (e.g. the DoD Inspector General for DoD Contracts) and the contracting officer. The reporting period extends from contract award to three-years after final payment. Many contractors do not realize that the reporting period extends beyond the contract period of performance.

The term "credible evidence" is undefined. but the FAR Councils have noted that the term indicates a higher standard than "reasonable grounds to believe". Implicit in this distinction is an allowance of time for a contractor to investigate matters to make a "credible evidence" determination. Failure to disclose credible evidence of criminal and civil violations (and significant overpayments) constitute grounds for suspension and debarment.

Sleeter Group Announces 2013 "Awesome Applications"

Each year since 2006, the Sleeter Group has culled through dozens of QuickBooks add-ons to select a few that rise above the others. They awarded these applications their "Awesome Add-on Award".  This year, the Sleeter Group changed its format to include non-specific QuickBooks products and renamed their promotion from "Awesome Add-ons" to "Awesome Applications. While some QuickBooks specific add-ons made the winner's circle, many of the applications are stand-alone, not requiring QuickBooks to function.

As consultants with many clients using QuickBooks, we are always interested in any improvements to the basic platform as well as improved or added functionality provided by third-party add-ons. With hundreds of add-ons available however, it is difficult to assess which ones are worthwhile and which should be avoided. Having reviews by an independent (and reputable) organization certainly helps in assessing a product's strengths  weaknesses, and value.

Click here to read about the winners of the 2013 Awesome Applications. Go here to read about previous winners.

Of the nine winners, the following three have the most potential for benefiting Government contractors and prospective contractors.

• BillQuick by BQE Software. This is a repeat winner. BillQuick is an integrated solution for time & expense tracking, billing and project management. Many Government contractors use this product.
• Cloud9 Real Time by Cloud9 Real Time. This application hosts all of your applications, data, and users in one central location, in the "cloud".
• Concur Small Business Edition by Concur. This is an office expense management and reporting application. Contractors who perform a lot of travel and have inefficiencies in collecting travel expense information might benefit from Concur SBE.

eFAACT, a QuickBooks solution for Government contractors was a finalist in this year's selection process. If you are looking for something to facilitate indirect rate development and billings under Government contracts, you might want to evaluate this product. Our impression? Powerful but expensive.

Preaward Accounting System Survey Checklist

FAR 16.301-3 states that a cost-reimbursement type contract may be used only when the contractor’s accounting system is adequate for determining costs applicable to the contract. Contracting officers must make this determination prior to the award of a contract. If the contracting officer has insufficient information to make this determination, it will request DCAA or another audit organization to perform a Preaward Survey of Prospective Contractor’s Accounting System (SF Form 1408).

DCAA has been instructing contracting officers to send out a preaward survey checklist to prospective contractors to complete prior to requesting a preaward survey of the accounting system. This checklist will help ensure that the contractors understand the requirements of the SF Form 1408 and to ensure that they are ready for DCAA to come in a perform an audit.

This checklist essentially mirrors the requirements of the SF Form 1408 however there are a few additional items that require contractor response. These are:

• Are you planning on bidding on cost type contracts?
• Are you ready for a DCAA audit?
• Have you read the requirements in the SF Form 1408?
• Have you read the "Information for Contractors" pamphlet?
• Please identify the DCAA office cognizant of your company.
• Please identify your company's point of contact.
• If an outside CPA/Consultant/Non DoD agency has reviewed your Accounting System, please provide a copy of the report.

This last bullet requires some clarification. The "review" that is referred to here is an attestation engagement performed in accordance with Generally Accepted Government Auditing Standards (GAGAS) a.k.a. a "Yellow Book" audit. It would not include the results of, say, an outside firm (like PNWC) performing a review to identify potential weaknesses in a contractor's accounting system and making recommendations, as appropriate, on improving the system to meet Government contracting requirements. Those are not "reviews"  conducted in accordance with GAGAS.

Companies looking to enter the Government contracting arena or existing contractors looking to bid on cost-reimbursable contracts, will find this checklist useful.

Update on Compensation Caps

The Senate version of the fiscal year 2013 Defense Authorization Act includes a provision that would cap compensation paid under DoD contracts at the Vice President's salary, $230,700. This represents a significant reduction from the current $763 thousand cap. The House version of the 2013 Defense Authorization Act does not include such a provision and so this difference will need to be resolved in "conference" at some point.

Last week, a consortium of ten public interest , government accountability, research, and labor groups issued a letter addressed to the Chairmen and Ranking Members of the Senate and House Armed Services Committees, urging them to adopt the Senate provision. Here's some of the points they make:

• It is fiscally irresponsible to allow private contractors to charge escalating and exorbitant rates to the government.
• Since 1998, the compensation cap has more than doubled, outpacing inflation by 53 percent.
• Private firms are free to pay their employees whatever they deem that they are worth, but the taxpayer should not have to pay exorbitant amounts.
• Capping salaries at $200 thousand would save the Government $5 billion per year.
• Contrary to what some contractors claim, compensation levels over $230 thousand are not required to find and retain a talented workforce.
• "Its grossly unfair to expect working people to pay for the inflated salaries for defense contractor employees.

Our concern here is one of practicality. Since this provision applies only to DoD contracts, Government contractors with a mix of DoD and other agency contracts (e.g. NASA, Dept of Energy, etc) will need a two-tiered direct and indirect rate structure, one for DoD contracts and one for everyone else. Well, the Government wants to create jobs and this will help.

Understanding Agencies Roles in Purchasing System Reviews

FAR Part 44 lays out the purpose for evaluating contractor purchasing systems. The objective of a contractor purchasing system review (CPSR) is to evaluate the efficiency and effectiveness with which the contractor spends Government funds and complies with Government policy when subcontracting. The review provides the administrative contracting officer (ACO ) a basis for granting, withholding, or withdrawing approval of the contractor's purchasing system.

The administrative contracting officer (typically Defense Contract Management Agency or DCMA) has primary responsibility for reviewing contractor purchasing systems. DCMA has a CPSR review team that specializes in performing these contractor purchasing system audits. DCAA (Defense Contract Audit Agency) plays a subordinate (and often unwelcome) role in the review. DCAA's audit objective is the adequacy of the internal controls over the system and the contractor's monitoring of compliance with its controls.

The DCMA CPSR normally covers many DCAA concerns regarding internal control objectives, but not always all of them. Therefore before commencing any audit of a contractor's purchasing system, the auditor is required to coordinate with the contracting officer. There should be mutual agreement in the planning stage on what additional audit steps will be necessary to address any DCAA concerns.

Where DCMA has planned a CPSR, but he scheduled CPSR does not coincide with DCAA's cycle for evaluating purchasing system internal controls, DCAA will, to the extent possible, adjust its schedule to perform the internal control evaluation as part of a joint DCMA/DCAA CPSR. If a CPSR has not recently been performed and if there is no CPSR scheduled within the normal DCAA cycle for accounting and management system audits but the Agency believes a purchasing system internal control audit is required based on risk, the DCAA auditor is to discuss those concerns with the cognizant ACO. Where the ACO agrees with those concerns, the auditor should perform a purchasing system internal control audit (not a CPSR). The key here is the term "based on risk". The auditor must have some basis for believing an immediate audit is critical for protecting the Government's interests.

Where agreement is not reached with the ACO, and the Agency believes that the Government is at risk, these concerns should be elevated to the regional office prior to any audit effort. It seems unlikely to us that this would ever occur.

If the auditor initiates a purchasing system audit without DCMA, you need to inquire as to why and request to know the risk factors they considered in scheduling the audit.

Purchasing Files - What's Required.

Contractors should organize and administer the purchasing department to ensure the effective and efficient procurement of required quality materials and parts at the most economical cost from responsible and reliable sources.

To this end, contractors prepare and maintain what is typically referred to as "purchasing files". The purchasing files should contain appropriate information to support the vendor selected and the price paid. Over the years, Defense Contract Management Agency (DCMA) and Defense Contract Audit Agency (DCAA) who jointly participate in reviewing purchasing systems, have developed a checklist of data that should be contained in a purchasing file, when applicable. These include:

1. The purchase order
2. The purchase requisition
3. The request for quotation
4. Copies of the vendors' quotes
5. A bid tabulation sheet that summarizes and compares vendor quotations
6. Certificates for the rent-free use of Government facilities
7. Vendor surveys or facilities capability reports
8. Source selection explanation
9. Price or cost analysis data
10. Negotiation summary
11. Basis for selection of contract type
12. Copies of technical data
13. Price re determination or termination data
14. Correspondence between the purchasing department and the bidders
15. Evidence of Small and Disadvantaged Business enterprise consideration
16. Information concerning the use of special terms and conditions and approve thereof
17. Departmental and management approvals, if required
18. Administrative Contracting Officer notification and consent
19. Certificate of Current Cost or Pricing Data if procurement meets the requirements.

Where these items are applicable but not found in the purchasing files, the Government will certainly make inquiries. Significant omissions could lead to disapproved systems and possible withholds. It would be useful to compare your files against this list to see how well you match up.

Accelerated Payments to Small Business Subcontractors

On July 11, 2012, OMB (Office of Management and Budget) issued a new policy directing that agencies should, to the full extent permitted by law, temporarily accelerate payments to all prime contractors, in order to allow them to provide prompt payments to small business subcontractors.

To implement this policy, OMB and the FAR Council developed a new contract clause to insert into all new solicitations and resultant contracts and, to the extent feasible, modify existing solicitations to insert the clause. Most agencies have now implemented the new clause including the big three, Defense, Energy, and NASA. The key part of the clause reads:

Upon receipt of accelerated payments from the Government, the contractor is required to make accelerated payments to small business subcontractors to the maximum extent practicable after receipt of a proper invoice and all proper documentation from the small business subcontractor.

The goal here is to expedite payments from 30 days to 15 days. This is only a goal however and does not confer any new rights under the Prompt Payment Act.

If you are a small business subcontractor and unaware of this new policy, contact your primes to get the program going.

What You Need to Know to Claim Cost of Money - Part 5

Today we conclude our series on cost of money with a few closing thoughts and comments. To read the earlier posts in this series, start here.

Calculate a ROM to see what it is worth to you. This is pretty simple and you should do it to determine whether it is worth pursuing. The more assets you have, the more likely it is that it will be worth your while to go through the exercise. Take the net book value of assets times the Treasury rate times the percentage of your negotiated Government contracts to your total business. A company with $100,000 in net book value of assets and with 50 percent negotiated contracts could earn an additional $875; not much but probably worth the effort.

Monitor the treasury rate. The treasury rate is now at an all-time low but three years ago it was higher than five percent. An increasing rate might make a difference on whether its worthwhile to propose/claim cost of money.

Become familiar with the form. Cost of money is proposed/claimed using Form CASB-CMF. This form is readily available on the web in both Word and PDF fill-in.

Track your assets in a manner that facilitates the completion of the CASB-CMF form. Most asset management software provides for fields or user-defined fields that can be used to sort and compile asset values that correspond to the fields in the CASB-CMF form. This will reduce the time it takes to prepare cost of money calculations.

Remember to use net book values for financial reporting purposes. Most companies have multiple depreciation schedules. There is one for financial reporting, another for federal income tax, another for federal alternative minimum tax, and possibly one for state income tax.

If you would like to discuss cost of money further, contact David Koeltzow toll free at 866-849-4887, Extension 6.

What You Need to Know to Claim Cost of Money - Part 4

We are progressing through a series of blog posts on the subject of cost of money. Today we are going to identify for you the eight building blocks needed to propose and claim cost of money (FCCOM). Many contractors do not avail themselves of this additional source of revenue. Some may think its too complicated. Others, not worth the effort. Still others, unaware of the provision. While it may be a bit complicated, it is, at its essence, no more difficult than many other analytic task performed every day. And, its also possible to "outsource" the process, as we discussed in our first posting in this series. Here then are the eight building block necessary for FCCOM.

1. FCCOM Rate: The FCCOM rate is a treasury rate that is adjusted every six months. The semi-annual base rates are at http://www.fms.treas.gov/prompt/rates.html. For future estimates, the FCCOM rate is the most current rate (1.75 percent) however, an exception exists for the costs in the first fiscal year when the blended rate for that year is already known.  For historical purposes (i.e., completing DCAA’s Incurred Cost Electronically {ICE}), the FCCOM rate is (i) the average of the two half year rates for contractors using a calendar year, or (ii) a weighted rate for contractors whose fiscal years are not calendar years. Note, a “major fluctuation” in asset value may require further refinement to ensure fairness. 

2. Net Book Value (NBV): This is the asset’s cost less book depreciation (or amortization). Book (not tax) depreciation should be used.  For most contractors, the average of the NBV at the start and end of the fiscal year is applicable; however, a weighted value is applicable when a “major fluctuation” in asset values occur (i.e., significant asset purchases).  Estimated future costs should use estimated future NBV.  Expensed assets have no NBV and goodwill is not includable.  See FAR 31.205-52 if the NBV includes the purchase method of accounting for a business combination.

3. Type of Asset: The FCCOM computations segregate assets into Land, Building, and Equipment. Note that FCCOM applies to all capital assets even though land is not typically depreciated and intangibles is not clearly listed.  Also note that the Government (i.e., Defense) has varied the profit rates for these asset types in an effort to “encourage” business investments.

4. What Indirect Expense Pool Benefits From the Asset: FCCOM computations segregate assets by indirect rate pools. Typically, depreciation or amortization by pool will provide that information. The value of the land (a non-depreciable asset) will need to be considered separately.

5. Total Applicable Indirect Allocation Bases: The FCCOM rates use the total indirect bases as the divisor. 

6. Proposed Allocation Bases on Government Contracts:  The FCCOM costs charged to the Government contracts is based on the FCCOM rates multiplied by the Government contracts’ indirect bases.This is just like the other Overhead costs.  FCCOM is just separately identified.  Note that the Government (i.e., Defense) often does not pay profit on FCCOM; although the pre-negotiation position of the Government excludes FCCOM from the base in computing profit, the negotiated base may include FCCOM.

7. Type of Ownership of Assets: The FCCOM computations segregate how assets are owned into Recorded, Leased, and Corporate/Group (Corporate). Leased assets are your capital leases and operating leases (i.e., related-party) that cost of ownership is being used on instead of lease rates.  Corporate assets are recorded or leased assets allocated from Corporate.  Recorded assets are the remaining assets on your books.

8. Extent Assets Are Distributed: FCCOM computations segregate distributed from undistributed assets. Distributed assets are those assets allocated using “any reasonable basis” that are solely applicable to a single indirect expense pool (i.e, Overhead).   Undistributed assets are all the rest, which are usually expensed via service centers.  Undistributed assets are either (i) allocated to the applicable indirect expense pool based on how depreciation would have been allocated (the “regular” method), or (ii) included as part of G&A (the “alternative” method; this requires Government agreement that it is immaterial or approximates the “regular” method).

Next: Final Comments

What You Need to Know to Claim Cost of Money - Part 3

Today we mark the midway point in our series on what contractors need to know and do to claim cost of money. You can read Part 1 and Part 2 here and here. Today we are answering the question on where cost of money (FCCOM) may be claimed.

FCCOM is most often calculated based on the net book value of assets used on Government contracts and the cost of facilities under construction. There is a second application, often overlooked, involving "cost of ownership" calculations where contractors are leasing or renting property from a source that does not involve an arms-length transaction.

Net Book Value of Assets (Including Assets Under Construction):  The most common scenario is when a business is charging for costs for an asset it owns without using lease rates.  For example, a business owns a new $1,000,000 office consisting of $750,000 for the building and $250,000 for the land.  The costs for the office (exclusive of maintenance, utilities, taxes, insurance, etc.) consists of (i) $25,000 for interest ($50,000 borrowed at 5%), and (ii) $19,231 for depreciation ($750,000 over 39 years).  The Government (i.e., DCAA – Defense Contract Audit Agency) questions the interest costs per FAR.  However, the business could claim FCCOM of $17,332 [$1.875% FCCOM rate x ($250,000 for land + $750,000 for building – $19,231/2 for depreciation on the building)].  The business would have a net reduction in allowable costs of $7,668 ($25,000 - $17,332) instead of the entire $25,000.  Please note, the administrative efforts for FCCOM may be significant as FCCOM should be continually documented and proposed for each contract award.

 Lease (or Use or Market) Rates:  DCAA routinely challenges the reasonableness of less than arms-length rental rates that are not based on “cost of ownership”.  Regardless of whether FCCOM has been proposed or approved before, FCCOM is usually includable in a contractor's support for the reasonableness of the lease rates.  For example, a business leases the same office as shown in the prior example but from a related party (i.e., the owner as an individual) at a rate less than the going market rate of $36,000 per year.  The business includes the $36,000 office rent in the overhead costs.  The owner’s personal income tax shows a loss on the office rental due to depreciation and $25,000 for interest.  DCAA questions $16,769 of the $36,000 based on allowing only $19,231 for depreciation.  However, the lease costs are reasonable and fully allowable since the claimed $36,000 is less than the allowable cost of ownership of $36,563 ($19,231 for depreciation and $17,332 for FCCOM).  This can make a big difference with minimal effort.  The administrative efforts are minimal for this as the FCCOM computations are only needed occasionally to support the reasonableness of the lease rates.  The DCAA Contract Audit Manual supports this approach where it states at 8-414.1 c. (1), “Since cost of money would be an allowable cost if the contractor had purchased the property, the cost of money should be included as an ownership cost in determining whether the allowable cost will be based on constructive ownership cost or leasing costs.”  Our March 22, 2011 blog on CAS 414 includes reference to a court case for Engineering, Inc. which ruled that FCCOM should be included.  

Next: The Eight Building Blocks of Cost of Money

What You Need to Know to Claim Cost of Money - Part 2

This is the second of a multi-part series on Cost of Money (aka. Facilities Capital Cost of Money, FCCM, and FCCOM) written by PNWC's David Koeltzow. If you missed the Part 1 introduction, you can read it here. Regulatory references can be found at:

• FAR 31.205-10 - Cost of Money
• 48 CFR 9904-414 Cost of money as an element of the cost of facilities capital (CAS 414)
• 48 CFR 9904-417 Cost of money as an element of the cost of capital assets under construction (CAS 417)

Who can claim FCCOM? Baring solicitation provisions to the contrary, any prospective Government contractor may propose FCCOM and any Government contractor may claim FCCOM. Generally, contractors must propose it in their initial pricing proposals in order to claim it or bill for it (FAR 31.205-10(b)(3). Some solicitations, notably SBIRs (small-business innovative research) solicitations specifically exclude cost of money.

As appropriate for the FCCOM worth shown below, most business with significant assets and Government contracts use FCCOM.  However, small businesses often appreciate even a few thousand more in extra revenue.

What is FCCOM Worth? This depends on the following factors:

1. The FCCOM (interest) rate?  As shown at http://www.fms.treas.gov/prompt/rates.html the FCCOM rate from 1980 to 2012 hit a high of 14.875% in 1981 and is now at an all time low of 1.75% for the second half of 2012.  The average rate from 1980 to 2012 has been about 7.25%.
2. The value of the land, buildings, and equipment needed to perform on the Government contracts?  We've served businesses with assets less than $10,000 and more than $10,000,000.  
3. How much of your business is for negotiated Government contracts?  We've served Government contractors with less than $500,000 and more than $100,000,000.

FCCOM for a company with $10 thousand invested in assets at today's rate is $175 (assuming it only provides services on negotiated Government contracts). For a company with $10 million invested in assets, FCCOM is an impressive $175 thousand. While the treasury rate is at an all-time low right now, it seems inevitable that it will raise some day. FCCOM revenues would be over four times higher if the Treasury rate was near the average of about 7.25%.

Next: How to Claim FCCOM.

What You Need to Know to Claim Cost of Money - Part 1

Today we begin a series of posts written by PNWC's David Koeltzow. One of David's specialties is Facilities Capital Cost of Money.

Facilities Capital Cost Of Money (FCCOM) is an additional source of revenue (it’s not part of profit nor is it an out-of-pocket expense) allowed on Government contracts that only cost contractors the administrative effort to document, compute, and propose it.  This blog strives to increase the use of this valuable option by clarifying Government rhetoric and improving your ability to compute FCCOM.  PNWC also offers to compute FCCOM for you at affordable rates.

Businesses with Government contracts often erroneously and unwittingly (i) include unallowable costs, and (ii) exclude allowable costs.  However, the most frequently allowable costs that we see businesses exclude knowingly is FCCOM.  Why?  The FCCOM regulations are difficult to understand and sometimes not worth the trouble.  This blog’s intention is to help you identify how much FCCOM is worth to you, decrease your efforts/costs to use FCCOM, and increase your revenues from Government contracts by allowing you to include FCCOM in support of your proposed and claimed costs.

Pacific Northwest Consultants (PNWC) is proficient in understanding and computing FCCOM and offers to develop and provide you with a detailed template that computes your FCCOM.  You may be able to use this customized template with minimal adjustment for multiple proposals and even multiple years.  Pricing for small contractors with simple scenarios begins at $150. Call us for a quick cost estimate for your situation 

What is FCCOM? FCCOM is the obscure replacement for interest that the Government agreed to allow following the uproar over the Government’s disallowance of all interest per Federal Acquisition Regulation (FAR) 31.205-20.  “Interest” was disallowed partly because it includes a factor for how risky a business is; certainly, tax payers should not provide extra funds to support a high risk business over a low risk business.  “Capital Cost of Money” is based on the Treasury rates and applies uniformly to all businesses.  “Facilities” covers the land, buildings, and equipment that you use for your regular business activity; this includes tangible (you can touch it) and intangible (i.e., software).  FCCOM is not applicable for idle facilities or land held for speculation.  Like depreciation, FCCOM is not chargeable for assets being developed or constructed until it’s placed into use.  Although it is easiest for most to think of FCCOM as being similar to interest, the Government doesn’t like that comparison.  In fact, claiming FCCOM is not contingent on you having any interest costs.  FCCOM became effective in 1976 via Cost Accounting Standards (CAS) 414 and the later 417 (for assets under construction).  Conformance to CAS is generally required for only very large Government contractors.  However, FCCOM is allowable to all Government contractors via FAR 31.205-10.  Peculiarly, FCCOM is not a cost on your books and payments for FCCOM simply increases your revenue.

Next: Who can claim FCCOM and what is it worth?

Too Big to Fail (or Too Big to be Suspended or Debarred)

Most of you remember 2010 when the President declared there were certain banks that were too big to fail and as a result, the Government stepped in and made costly bailouts to prevent a wreck of the entire economy. A similar thing happens in Government contracting. Normally, a suspended or debarred contractor cannot receive contracts. However, there are very large contractors who have been suspended or debarred but continue to be awarded Government contracts. All you need is for the head of some Agency to write up a "compelling reason" (see FAR 9.405).

FAR contains examples of "compelling reasons" but broadens the list be stating it is not all inclusive. Examples include:

• Only a debarred or suspended contractor can provide the supplies or services;
• Urgency requires contracting with a debarred or suspended contractor;
• The contractor and a department or agency have an agreement covering the same events that resulted in the debarment or suspension and the agreement includes the department or agency decision not to debar or suspend the contractor; or
• The national defense requires continued business dealings with the debarred or suspended contractor. 

These compelling reasons are broad enough so that the Government can pretty much do what it wants or needs to do, irrespective of whether a particular contractor has been suspended or debarred. Sometimes these compelling reasons are legitimate (how many companies can build ships, or planes, or tanks?). Other times, the justification seems contrived.

Information concerning suspended or debarred contractors is difficult to obtain. You can find the information in the Government's Excluded Party List System (EPLS) if you have the time and fortitude. Trying to find the Government's justification to override a suspension/debarment penalty however, is nearly impossible, although there is a DoD requirement to submit all compelling reason determinations to the General Services Administration (GSA).

More on DCAA's Adequacy Checklist for Forward Pricing Rate Proposals

A couple of days ago we alerted you to DCAA's (Defense Contract Audit Agency) new adequacy checklist for forward pricing rate proposals. The purpose was to alert you to the fact that this document exists and provide you an additional resource for ensuring adequate submissions.

Since our initial post, we've had a chance to review it more carefully. Based on our assessment now, we believe that DCAA has taken significant liberties in portraying or interpreting FAR and DFAR requirements for what constitutes an adequate forward pricing rate submission. While its not a bad checklist and can be used as a baseline for assessing your own proposal, the FAR and DFAR references that DCAA uses to support the checklist items simply do not say what DCAA wants them to say, in many cases.

Here's one example. Checklist item 9 states: Does the submission include a comparison of prior forecasted costs to actual results in the same format as the submission and an explanation/analysis of any differences (DFARS 252.215-7002(d)(4)(xiii))? The obvious impression here is that the cited DFAR regulation requires contractors to submit, along with its proposal, a comparison of prior forecasted costs to actual results.

But in reading DFARS 252.215-7002(d)(4)(xiii), you find that, first of all, that section discusses a requirement for contractors to provide a written description of their estimating system. Secondly, it only applies to contractors that received $50 million or more in DoD contracts and subcontracts in its previous fiscal year. Thirdly, the specific requirement requires that a contractor's estimating system provide for an internal review of comparisons between forecasted and actual rates. It says nothing about having to submit such comparisons as part of a forward pricing rate proposal.

We could cite additional examples but the point here is that if DCAA uses this checklist to reject your forward pricing rate proposal, you need to carefully review the basis for their assertions and determine whether there truly is a FAR or DFAR requirement to provide whatever it is that DCAA finds lacking.

What are "walk-through's"?

Government contractors are becoming increasingly familiar with one of DCAA's (Defense Contract Audit Agency) new buzzwords; the "walk-through". The term is being integrated into many of DCAA's standard audit programs as they go through their periodic updates. A "walk-through" is simply a meeting where the contractor identifies the basis and the supporting data/documentation for whatever proposal it has submitted or for an internal control system, or for any other "assertion" the contractor has made. It is nothing new. Its not a different approach to audit. It is certainly not innovative as auditors have been asking for these kinds of briefings ever since Senator Harry S. Truman drove his Plymouth around the country looking for waste at Military contractors. The only difference now is the requirement is being codified into standard audit programs.

In a forward pricing proposal situation, the purpose of a walk-through of the proposal is to gain an understanding of the basis of the proposal and related supporting documentation. As part of the walk-through, a contractor might be asked to

• explain the basis of estimate for significant costs, indirect rate pools and allocation bases, and cost elements
• explain the process used to develop estimates and the internal controls/policies and procedures related to those areas
• demonstrate how the number/amounts for the significant areas of costs are derived
• demonstrate how historical trend data was considered
• demonstrate the homogeneity of pool costs and allocation bases used are appropriate

Prospective contractors should plan on putting a fair amount of effort into these walk-throughs for the simple reason that it should help expedite the audit process. Listen carefully to auditor questions and any feedback they might provide. These might indicate potential weaknesses in your proposal or in the level of supporting detail that might need to be addressed.

New Adequacy Checklist for Forward Pricing Rate Proposals

When there is a substantial amount of pricing activity at a particular contractor location, the contractor and the Government sometimes tries to negotiate direct and indirect rates to be used for future proposals. The contractor first submits a forward pricing rate proposal (FPRP). If the contractor and the Government can reach agreement, the parties sign a forward pricing rate agreement (FPRA). When the parties cannot reach agreement, the Government will often issue a unilateral determination called a forward pricing rate recommendation (FPRR). When there is a FPRA, contract negotiations are simplified and expedited because there is no need to "negotiate" direct and indirect rates.

Both the contractor and the Government need to be in agreement that an FPRA is desirable. A contractor might want one but the Government might deem the level of pricing activity insufficient to warrant the effort involved in the process of negotiating an agreement. And vice versa.

The primary responsibility for reviewing and negotiating FPRA's is that of the Defense Contract Management Agency (DCMA). The Defense Contract Audit Agency (DCAA) participates when requested. Most of the time, DCAA's assistance is requested.

DCAA recently issued a checklist for FPRPs. This checklist should not be confused with the Agency's checklist for pricing proposals discussed here and available here. The former covers direct and indirect rates only. The latter covers the entire proposal.

Contractors who plan on submitting forward pricing rate proposals should become familiar with the checklist to improve their submissions and reduce the chance that such submission will be declared inadequate and returned to the contractor for correction. Having a proposal returned will significantly delay the process forward pricing rates.

The key to the checklist is the understanding that in submitting forward pricing rate proposals, contractors are still bound by the format/content requirements  of FAR 15.403-5. The requirements for adequately supported direct and indirect cost rates are not lessened when a contractor separately submits an FPRP for the rates.

See related post: More on DCAA's Adequacy Checklist
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For those expecting the continuation of the discussion on compensation, we will return to that series in a few days.

Compensation - Part 6 - Bonuses and Incentive Compensation

Imagine a situation where, toward the end of the year, the boss crunches some numbers and finds that the company enjoyed a record profit year. He is ecstatic and announces that every employee is going to get a $1,000 Christmas bonus. Would this bonus be an allowable cost under a Government contract? Not likely. It would not meet the allowability criteria for bonuses and the Government would probably view the action as a distribution of profits.

That does not mean that all bonuses and incentive compensation costs are unallowable. Such costs  are allowable under specific circumstances. First. the awards must be paid (or accrued) under an agreement entered into in good faith between the contractor and the employees before the services were rendered or pursuant to an established plan or policy followed by the contractor so consistently as to imply, in effect, an agreement to make such payment. Secondly, the basis for the award must be supported.

There are many ways to construct a bonus or incentive compensation plan that complies with these requirements. However, contractors must ensure that they are developed ahead of time, before the services are rendered. Increased production over a baseline amount or increased sales over prior years are a couple of "compliant" methods that come to mind.

The provision that bonuses paid pursuant to an established plan or policy followed by the contractor so consistently as to imply, in effect, an agreement to make such payments is often difficult for contractors to support. Unless a contractor is absolutely consistent in granting such awards (e.g. $1,000 every Christmas come rain or shine, good years and bad years), the Government is not going to accept it as an allowable compensation cost element.

Next: Section (g): Severance Pay

Compensation - Part 5 - Income Tax Differential Pay

The Federal procurement policy on income tax differential pay is very straight-forward and we have not seen much in the way of controversy surrounding the application of this principle. When employees take temporary assignments in another country or another state, their personal income tax situation often changes. They might owe foreign income tax or income tax to another state. If the assignment is a foreign assignment, contractors can provide an allowance for any increased income tax liability. If the assignment is domestic, such an allowance is unallowable. Domestic assignments might result in increased taxes if an employee, based in a non-income tax state, took a temporary assignment in a state with income taxes.

It is often necessary for contractors to provide incentives to encourage employees to take temporary assignments. After all, there is a personal hardship for being away from home for extended periods. A "site differential" is often used to compensate employees for such hardships, whatever those may be. The exact basis for the differential is often nebulous and could include many unstated and intangible factors. As long as compensation in total is reasonable, site differentials are allowable.

There is an exception to the prohibition against differential allowances for additional income taxes resulting from domestic assignments. FAR 31.205-35(a)(10) states that payments for increased employee income or social security taxes incident to allowable reimbursed relocation costs are allowable. In this case, a permanent employee relocation is necessary.

Next: Section (g) - Bonuses and Incentive Compensation

Compensation - Part 4 - Form of Payment

Compensation is more than cash. Although for most employees, cash is the only form of compensation they receive, there are sometimes other forms of compensation that must be considered when determining reasonableness. Corporate securities such as stocks, bonds and other financial instruments are considered a form of payment. No longer are such things reserved for top executives. Companies that offer corporate securities as incentive compensation to their employees represent a small but growing segment within the Government contracting community.

Another form of compensation delineated in this FAR cost principle is "other assets, products, or services". We suppose this is simply a "catch-all" phrase to include everything else. We recall a number of years ago where a defense contractor, owned by a U.S. automobile manufacturer, offered deep discounts on their automobiles to company employees. These discounts were considered reportable compensation to the employees and therefore the costs would have fallen under this "everything else" provision. We also recall a company offering employee discounts to some of its consumer electronics. The discounts in this case were considered "de minimis" and not considered compensation. "Materiality" is a factor in determining whether something is compensation. In the former example, the discount was material and therefore compensation. In the latter case, the discount was not significant and therefore not compensation. Materiality is something that is often in the eyes of the beholder and auditors will no doubt take different positions on similar situations.

This section also adds additional restrictions when compensation is paid with securities. These restrictions include:

• valuation placed on the securities is the fair market value on the first date the number of shares awarded is known determined upon the most objective basis available.
• accruals for the cost of securities before issuing the securities to the employee are subject to adjustment according to the possibilities that the employees will not receive the securities and that their interest in the accruals will be forfeited.

Next: Section (e): Income Tax Differential Pay

Compensation - Part 3 - Reasonableness

This section of the FAR compensation cost principle deals with the concept of reasonableness and is divided into two subsections, one for compensation pursuant to labor-management agreements and the other for situations where no labor-management agreement exists.

Labor-Management Agreement Exists: Compensation set by arm's length labor-management agreements are generally considered reasonable. We could not find any cases where reasonableness was challenged when a labor-management agreement was in place. However, the cost principle does identify exceptions to this general rule. These exceptions include:

• costs are unwarranted by the character and circumstances of the work
• costs are discriminatory to the Government

For example, the application of the provisions of a labor-management agreement designed to apply to a given set of circumstances and conditions of employment (e.g. work involving extremely hazardous activities) would be unreasonable if the Government contract involved less-hazardous duties.

It would also be discriminatory  against the Government if the labor-management agreement results in employee compensation in excess of that being paid for similar non-Government work under comparable circumstances.

Labor-Management Agreement Does Not Exist: Where there is no labor-management agreement, the presumption of reasonableness does not exist. Contractors must prove that compensation paid to individuals (or job class of employees) is reasonable. Even in situations where contractors have gone to great lengths to demonstrate reasonableness, the Government often conducts is own analysis by benchmarking contractor salaries against one or more salary surveys. This has become a very contentious are where the Government has recently lost two key cases. We blogged about them earlier this year and you can read about them here. In both of these cases, the contractors performed their own analysis to demonstrate reasonableness. The Government came along and performed their own "benchmarking" (which unsurprisingly resulted in lower compensation levels) and questioned the difference, without adequately explaining or demonstrating any deficiencies in the contractor's analysis. In one case, the ASBCA (Armed-Services Board of Contract Appeals) even termed the Government's analysis to be "fatally flawed".

The basic requirement in this subsection is that compensation for each employee or job class of employees must be reasonable for the work performed. This subsection further states that Compensation is reasonable if the aggregate of each measurable and allowable element sums to a reasonable total. When auditors test the reasonableness of compensation, they must consider factors determined to be relevant by the contracting officer. Many auditors fail to query the contracting officer about factors he or she determine to be relevant. This subsection identifies some of those factors that may be relevant. They include conformity with compensation practices of other firms -

1. of the same size
2. in the same industry
3. in the same geographic area; and
4. engaged in similar non-Government work under comparable circumstances.

Contractors that are being challenged by DCAA on their compensation levels need to keep in mind that the Agency has made up a lot of its own rules for assessing reasonableness levels (e.g. you cannot use a "free" compensation survey as a basis for comparison). None of those rules however have any statutory or regulatory basis behind them. Contractors should be able to defend their compensation levels but the method for determining reasonableness does not necessarily have to follow DCAA's script.

Next: Section (d) - Form of Payment

Compensation - Part 2 - General Principles

Last  Friday, we began a series on compensation costs for personal services. This will be a lengthy series because the compensation cost principle is a lengthy cost principle. Today, we will discuss Paragraph (a) of FAR 31.205-6, which is simply labeled "General".

The very first sentence of the FAR cost principle tells us that there is going to be some limitations to the compensation that can be charged to Government contracts. It states, "Compensation for personal services is allowable subject to the following criteria and additional requirements contained in other parts of this cost principle". The criteria and additional requirements contained elsewhere in this cost principle are many and varied.

The first criteria states that compensation must be for work performed by the employee in the current year and must not represent a retroactive adjustment of prior years' salaries or wages. There are two main points here. First, compensation must be for work performed by the employee. There have been many cases over the years where the Government will find so-called employees on the payroll who perform no or very limited services, and take exception to their salaries. Those salaries were not for work performed. The second aspect of this criteria is that the work must be performed in the current year. Sometimes, especially at small businesses and start-up businesses, shortages of working capital cause the owners to defer payment to themselves. When they try to make it up in a subsequent year, the costs are found to be unallowable because the costs were not payments for work performed in the current year (however, some forms of deferred compensation are allowable and we will be discussing deferred compensation later in this series).

The second criteria states that compensation must be reasonable for the work performed. This might seem rather obvious but many contractors find themselves in a position of having to prove that their compensation levels are reasonable. We will leave the subject of determining reasonableness for another day.

The third criteria states that the compensation must be based upon and conform to the terms and conditions of the contractor's established compensation plan or practice followed so consistently as to imply, in effect, an agreement to make payment. Large companies are likely to have formal compensation plans while small companies are going to rely on consistent practices. A key point here is that proposals to the Government must be consistent with a contractor's practices.

The fourth criteria lays the responsibility for proving reasonableness squarely on the contractor. It states that "no presumption of allowability will exist where the contractor introduces major revisions of existing compensation plans or new plans and the contractor has not provided the cognizant ACO, either before implementation or within a reasonable period after it, an opportunity to review the allowability of the charges." In other words, the Government must pre-approve major changes to compensation plans prior to (or soon after) their effective dates.

The fifth criteria simply states that costs considered unallowable under other cost principles are not allowable under the compensation cost principle merely because the contractor wants to label them "compensation".

Finally, the sixth criteria in this "general" discussion of compensation costs calls out certain individuals who "give rise to the need for special consideration. These individuals include owners of closely held corporations, members of limited liability companies, partners, sole proprietors, or members of their immediate families and  persons who are contractually committed to acquire a substantial financial interest in the contractor's enterprise. These "special considerations" include compensation levels that are reasonable for the personal services rendered and not be a distribution of profits. This "distribution of profits" is a real thorny issue with the Government because profits are not allowable contract costs.

Next: Section (b) - Reasonableness