Compensation - Part 15 - Postretirement Benefits Other Than Pensions

Post retirement benefits other than pensions (PRBs)" means exactly what it says. PRBs includes any benefits (other than cash benefits and life insurance benefits paid by pension plans) provided to employees, their beneficiaries, and covered dependents during the period following the employees' retirement. These include postretirement health care, life insurance provided outside a pension plan, and other welfare benefits such as tuition assistance, day care, legal services, and housing subsidies provided after retirement. This is not an all-inclusive listing but out of this listing, health care coverage for retirees is the most significant in terms of costs and the most likely to attract the attention of the Government.

There's a two-step process for determining whether PRBs can be charged to Government contracts. The first test is to determine whether the contractor is obligated to pay. To be allowable under this first test, PRBs must be incurred pursuant to

• law,
• employer-employee agreement, or
• an established policy of the contractor.

If it passes this first hurdle, then things get a little more complicated. The rules are different depending upon the way that funding is structured.

Pay-as-you-go plans - PRB costs are not accrued during the working lives of employees. Costs are assigned to the period in which

• Benefits are actually provided; or
• The costs are paid to an insurer, provider, or other recipient for current year benefits or premiums

Terminal funding - PRB costs are not accrued during the working lives of the employees
Terminal funding occurs when the entire PRB liability is paid in a lump sum upon the termination of employees (or upon conversion to such a terminal-funded plan) to an insurer or trustee to establish and maintain a fund or reserve for the sole purpose of providing PRB to retirees. Terminal funded costs shall be amortized over a period of 15 years.

Accrual basis - PRB costs are accrued during the working lives of employees. This method gets complicated very quickly. It requires actuarial assumptions on how long employees (or their dependents and beneficiaries) will live, healthcare inflation assumptions, investment earnings, and methods and time-frames for accruing actuarial gains and losses.

Needless to say, there are pros and cons to each of these methods. The first two methods (pay-as-you-go and terminal funding) saddle future work with past promises (e.g. look at the American auto industry). The accrual basis does the best job at matching expense with revenues but reduces short-term profits.

Next: Section (p) - Limitation on allowability of compensation for certain contractor personnel

Compensation - Part 14 - Employee Rebate and Purchase Discount Plans

This next prohibition/limitation on compensation is very straight-forward and almost needs no explanation. Based on our research, there has never been a board case that addressed this section of the FAR (Federal Acquisition Regulations).

The prohibition states:

Rebates and purchase discounts, in whatever form, granted to employees on products or services produced by the contractor or affiliates are unallowable.

There was a time when employee discounts were common and prior to this prohibition, there were questions surrounding the allowability of such costs. Back in the 1970s when Ford was in the aerospace business (Ford Aerospace), the company offered employees significant discounts on the purchase of Ford autos. Also, back in the 1970s, when GTE Sylvania was in the electronics business, it offered deep discounts to employees on its consumer products (Sylvania TVs, stereos, etc).

These days, except for airlines and universities, we do not see many examples where Government contractors offer discounts to employees on products they produce (It doesn't seem likely that Boeing will offer employee discounts on their 737).

Companies can still offer discounts to employees, they just cannot charge the discounts to the Government, either directly or indirectly.

Next: Section (o) - Postretirement benefits other than pensions (PRB).

Incurred Cost Proposals - Inadequacy Letters from DCAA

Recently, DCAA offices from around the U.S. that have been assigned the responsibility for clearing out the backlog of incurred cost proposals (ICPs), have been making assessments as to the proposals' adequacy. In many cases, the auditors have identified one or more deficiency and have returned the proposal to the contractor with a punch list of items requiring correction. Here in the Seattle area, DCAA brought the auditors together for what they termed a "get it done" day to review the adequacy of contractor ICPs that have been stacking up. Following are a few comments and observations.

1. Extensions of the requested due date for revising your ICP is usually obtainable. For convenience sake, requests should be addressed to the contracting officer with a copy to the cognizant auditor (see FAR 52.216-7(d)(2)(i)).
2. Most of DCAA's required corrections are understandable to accountants with contract costing experience. However, sometimes, DCAA rationale for calling something a deficiency is not clear at all. Do not hesitate to call the DCAA point of contact  for clarification. Sometimes they are helpful but they can only provide limited explanations before they cross the line and impair their independence. That's where firms like PNWC and other government contracting consulting groups can be helpful. 
3. One common misconception among contractors is to assume the ICP audit is over once DCAA accepts the ICP as meeting the requirements of an adequate submission. This is incorrect. DCAA uses a two-step approach that culminates in a rate agreement letter. The first step is to test the ICP to determine if it is likely to be adequately prepared. The second step is to perform an audit or a review, based on risk assessment. This second step could range from simple "desk" procedures to a full audit. Although the Government reserves the right to subsequently review and question direct costs, it is very rare for them to re-visit or re-audit your claimed incurred costs once both you and DCAA have signed the rate agreement letter. 
4. Sometimes the basis for inadequate claims are without merit. FAR 52.216-7(d)(2)(iii) lays out the data that constitutes an adequate claim; 15 items (and not all of those 15 items will be applicable). If it is not on that list, it cannot be used by DCAA or anyone else to claim that a proposal is inadequate. We saw one letter from DCAA last week claiming that a proposal was inadequate because the contractor did not provide copies of its IRS Forms 941. Those forms are not on the listing of data necessary for an adequate claim.

If you've received one of these letters and would like to talk to someone about it, contact David Koeltzow ("Kelso") at 866-849-4887, extension 6.

GAO Bid Protests

Filing a bid protest with the Comptroller General's Office (GAO) is very easy. There are no fees. There is no prescribed format, you do not need an attorney and you can mail, email, fax, or hand deliver your protest. Within 100 days, but usually much sooner, a decision is issued.

The GAO recently floated the idea of charging a fee for filing a protest. BusinessWeek called it a "Put Up or Shut Up" Fee. A flat fee of $240 would generate about $600 thousand and would fund an online docket system to help the Agency deal with a rising caseload.

In fiscal year 2012, there were 2,475 protests filed. These filings generated about 16 thousand e-mail messages that are manually filtered by GAO staff. An online docket system would improve and streamline how protests are handled and reduce the risk of mistakes and delays.

The GAO does not believe that a fee would significantly reduce the volume of protests filed but speculated that there are those in Congress who might oppose it because of the impact on small businesses.

Canadian Companies with DoD Contracts and Subcontracts

The Canadian Government (specifically Public Works and Government Services Canada or PWGSC) has been performing contract audits U.S. contracts and subcontracts awarded to Canadian companies. That is about to change. Beginning January 2013, the Canadian Government will no longer perform contract audits of contracts and subcontracts awarded to Canadian firms. Any audits and pricing evaluations that need to be performed, will need to be addressed by U.S. authorities.

The Department of Defense has now addressed this policy shift from the Canadian Government. For DoD contracts and subcontracts, the Defense Contract Audit Agency (DCAA) and the Defense Contract Management Agency (DCMA) will conduct audits as delineated in DFARS PGI 215.404-2(c). DCAA will perform proposal audits on fixed-price proposals exceeding $10 million and on cost-type proposals exceeding $100 million. Regardless of the amount being proposed, DCAA also will perform proposal audits if assistance is requested by a DCAA office. DCAA may also perform proposal audits under the audit threshold if exceptional circumstances are explained to the contracting office in the request for audit.

There is no word yet on how other Governmental agencies plan to address their audit/pricing needs when it comes to contracts awarded to Canadian companies.

DoD Publishes BBP 2.0 Initiatives

Last week, the Under Secretary of Defense for Acquisition and Logistics issued a memorandum to the Defense Acquisition Workforce introducing his preliminary version of the Better Buying Power 2.0 initiative. Although BBP 2.0 is intended for the acquisition workforce, "industry" stakeholders are also invited to comment on these 36 initiatives intended to improve the way that the Department does business.

We encourage contractors (and prospective contractors) to study these initiatives to determine their potential impact on operations. There are some that try to squeeze more product out of fewer dollars. Here's a sampling:

Better define value in "best value" competitions: In competitive bidding processes, industry tends to default to threshold performance levels because they are less costly and source selections seldom give predictable credit for performance above threshold. In addition, when the Department buys non-developmental items (NDI) or near-NDI products, it often must select among products with varying levels of performance and with inherent cost differentials. The Department needs to improve its ability to define the value to the Department of performance that is above minimum levels so that it can make appropriate source selections and so that industry can bid intelligently. This will spur innovation by providing a predictable basis by which companies can bid enhanced performance with he knowledge that any increased costs are within an acceptable range.

Many competitive awards list a variety of evaluation criteria, specify the relative importance of each and then states that the award will be based on "best value to the Government". A lot of contractors think that this phrase is the Government's opening to award the contract to whoever they want to award it to because it allows subjectivity and judgment in the selection process. So, this initiative seems pretty good to us.

Reduce backlog of DCAA Audits without compromising effectiveness: The Department has a significant backlog in both closeout and pre-award audits. DCAA, with the assistance of DCMA and DPAP, is increasing audit resources and developing a risk-based process for reducing the audit backlog. We expect to make major gains in reducing audit-associated delays in both contract closeouts and pre-award audits in 2013.

All contractors will appreciate having their backlog of completed contracts closed out. The interesting thing about this initiative is the comment that DCMA will be helping DCAA clear out this backlog. We wonder whether this represents a further dimunition of DCAA's authorities and responsibilities.

Proposed Caps on Compensation - Update

We've been bringing you periodic updates on the various attempts to lower the caps on compensation that the Government will reimburse under its contracts. The last update was about a month ago. There is nothing new on the legislative front since our last update but there is continued pressure (lobbying?) by various groups encouraging Congress to cap compensation at lower than current levels.

On November 13th, the same consortium of public interest, government accountability, research, and labor groups that we wrote about in our last update (plus one additional group, bringing the number to eleven), issued a similar letter to the Senate and House Financial Services Committees urging them to lower the compensation cap to $400 thousand for non-defense contracts. As you recall, the previous letter addressed a cap of $230,700 for defense contracts. These two caps are currently included in the Senate versions of the Fiscal Year 2013 Financial Services Appropriations Bill and the National Defense Authorization Act of 2013, respectively. Except for a bit of tweaking to specify the respective bills, the letters are identical.

These caps, if implemented, will likely affect many contractors, especially the $230,700 cap for defense contracts. There are many engineering, IT, and medical jobs that already exceed that amount, no matter what benchmark you use. The prospect of having dual caps, one for Defense and one for non-Defense will certainly complicate matters as well. It will affect both direct labor rates and indirect expense rates.

Some say that these bills do not limit what contractors can pay their employees. They only limit the amount of the reimbursement that contractors can receive from the Government. While true, the amount of unreimbursed salaries would have to be paid for with profits and we wonder whether contractors profits can absorb a significant amount of unallowable compensation.

Cost Accounting Standards - Proposed Revision to an Existing Exemption

Certain contracts are exempt from CAS (Cost Accounting Standards). There are ten general categories of exemptions found in 48 CFR 9903.201-1 including contracts awarded based on a sealed bidding process, commercial items, competitive awards and many others. Previously, we discussed the CAS Board's proposal to modify the (b)(15) exemption to include the word "certified" before the phrase cost or pricing data. This was to distinguish awards based on certified cost or pricing data from awards based on "other than cost or pricing data".

Yesterday, the CAS Board published a proposal to modify another exemption, the (b)(6) exemption which currently reads:

Firm fixed-priced, fixed-priced with economic price adjustments (provided that price adjustment is not based on actual costs incurred), time-and-materials, and labor-hour contracts and subcontracts for the acquisition of commercial items.

The proposed rule would eliminate the detailed listing of permissible contract and subcontract types and simply state:

Contracts and subcontracts for the acquisition of commercial items.

Over the years, the permissible contract types for the acquisition of commercial items has expanded. Statutes such as The Federal Acquisition Streamlining Act (FASA) of 1994, the Federal Acquisition Streamlining Act of 1994 (FARA) and the Services Acquisition Reform Act of 2003 (SARA) have added to the number of contract types that can be used for commercial item procurement. The CAS exemption listing permissible contract types is now too restrictive and has not kept pace with these and other statutes.

The current listing of all CAS exemptions can be found here.

GAO Bid Protest Statistics for FY 2012

Last week, the GAO (Government Accountability Office) released its fiscal year 2012 bid protest statistics. Companies files 2,475 bid protests in FY12 (fiscal year 2012), a five percent increase from FY11.  GAO closed slightly more than that number, 2,495. Of the cases that were closed, 570 were decided by a GAO merit decision. The remainder were closed because the cases were settled before a decision or were withdrawn.

The bid protest process is fairly quick. All cases are decided within the 100 days allowed under the Competition in Contracting Act. Most cases are decided within 30 days.

Of the 570 cases that were decided based on merit, 106 or 18.6 percent were decided in favor of the protestor. However, this statistic does not tell the entire story. The GAO report contains an "effectiveness rate" measured by a protestor obtaining some form of relief. In FY12, the effectiveness rate was 42 percent. This rate has not changed much. It was 42 percent in FY08, FY10, and FY11 as well. Only FY09 was different at 45 percent. The effectiveness rate not only includes cases where the GAO sustained a protest but also cases where an ADR (alternative disputes resolution) process were utilized and cases where the procurement agencies offered some form of relief before the GAO made a decision on the merits of the case.

All in all, 42 percent is pretty good odds. If you have a sound basis for filing a protest and you file in a timely manner, these are excellent odds for obtaining some form of relief.

Travel Costs - Additional Documentation Requirements

Why do Government auditors always seem to include travel costs when reviewing contractor incurred costs audits? Even where travel costs are not significant, auditors often spend a disproportional amounts of time reviewing travel costs. There are several reasons and those reasons have a lot to do with the explicit documentation requirements of FAR 31.205-46, Travel Costs. This is one of those "low hanging fruit" areas that we've talked about before. Contractors, especially small contractors with limited internal control systems, do not do a very good job of complying with the documentation requirements of this standard. The auditors know this and they can come up with some easy audit findings and cost disallowance and have a fair chance at sustaining the findings.

Besides what you would normally expect to document the allowability of costs (e.g. authorization, invoice, payment), the travel cost principle requires the following: additional documentation:

• Date and place (city, town, or other similar designation) of the expenses
• Purpose of the trip
• Name of person on trip and that person's title or relationship to the contractor

Additionally, this FAR cost principle requires that airfares be limited to the lowest priced airfare available to the contractor during normal business hours (with a few limited exceptions). Think about a contractor's difficulty in proving that it obtained the lowest priced airfare. Think about the added difficulty when the auditor begins the review several years after those costs were incurred and booked and the supporting data has been archived. Contractors need great internal control systems to ensure that they bought and claimed the lowest priced airfare as well as efficient documentation retention practices.

Travel Costs - Excess Over Maximum Per Diem

FAR 31.205-46, Travel Costs, requires that, except in special and unusual situations, costs incurred by a contractor for lodging, meals, and incidental expenses shall be considered to be reasonable and allowable only to the extent that they do not exceed on a daily basis the per diem rates in effect as of the time of travel as set forth in the Federal Travel Regulations (for the lower 48), the Joint Travel Regulations (Alaska, Hawaii, Puerto Rico, and other U.S. territories and possessions) and State Department Regulations (foreign travel).

What, according to FAR are the "special and unusual" situations  that would justify travel costs in excess of those limits? There are four.

1. Lodging and/or meals are procured at a prearranged place such as a hotel where a meeting, conference or training session is held.
2. Costs have escalated because of special events (missile launching periods, sporting events, World's Fair, conventions, natural disasters; lodging and meal expenses with prescribed allowances cannot be obtained nearby; and costs to commute to/from the nearby location consume most or all of the savings achieved from occupying less expensive lodging
3. Because of mission requirements
4. Any other reason approved within your organization.

FAR further requires a written justification for use of the higher amounts and this justification must be approved by an officer of the contractor's organization or designee to ensure that the authority is properly administered and controlled to prevent abuse. This approval justification must be retained as part of the contractors documentation to support actual costs. Also, receipts for expenditures greater than $75 must be retained as part of the documentation package.

Finally, whenever the actual expense method is used the amounts allowable under Government contracts can never exceed 300 percent of the maximum per diem rates specified in the JTR/FTR/State Department regulations.

Note, FAR 31.205-46 requires other documentation in connection with travel costs. We will discuss that tomorrow. In the meantime, contractors should ensure that their policies for justifying and documenting the incurrence of travel costs in excess of the maximum per diem amounts line up with these requirements. Failing to do so risks subsequent disallowance and perhaps penalties.

Compensation - Part 13 - Fringe Benefits

Fringe benefits are allowances and services provided by the contractor to its employees as compensation in addition to regular wages and salaries. Fringe benefits include, but are not limited to, the cost of vacations, sick leave, holidays, military leave, employee insurance, and supplemental unemployment benefit plans. Executive fringes may include such things as free parking, the use of a company-owned auto, life and disability insurance, and memberships in social, dining, or country clubs.

Except as provided otherwise in FAR Part 31.2, the costs of fringe benefits are allowable to the extent that they are reasonable and are required by law, employer-employee agreement, or an established policy of the contractor. Fringe benefits that may be unallowable based on other FAR criteria might include memberships in social, dining, or country clubs (see FAR 31.205-14, Entertainment Costs).

That portion of the cost of company furnished automobiles that relates to personal use by employees (including transportation to and from work) is unallowable regardless of whether the cost is reported as taxable income to the employee.

Auditors will sometimes become fixated on particular fringe benefits that they deem unreasonable even though not specifically unallowable. Executives seem to come under closer scrutiny than non-executives. At one time, incentives for employees to utilize public transportation was routinely challenged until the Government came up with its own program to subsidize public transportation costs for Federal workers. Then, those challenges quietly disappeared. We have heard of a couple of cases recently where auditors were challenging free parking provided to some but not all, employees (usually for the company executives).

Auditors frequently misapply the FAR reasonableness criteria but contractors can be better prepared to defend themselves by understanding and applying those criteria. Follow this link for a discussion on reasonableness criteria.

Next: Section (n) - Employee rebate and purchase discount plans.

Compensation - Part 12 - Compensation Incidental to Business Acquisitions

This is the so-called "Golden Parachute/Golden Handcuff" clause. Compensation that is paid or accrued incidental to business acquisitions are unallowable. Specifically FAR states that the following costs are unallowable.

1. Payments to employees under agreements in which they receive special compensation, in excess of the contractor's normal severance pay practice, if their employment terminates following a change in the management control over, or ownership of, the contractor or a substantial portion of its assets (Golden Parachutes).
2. Payments to employees under plans introduced in connection with a change (whether actual or prospective) in the management control over, or ownership of, the contractor or a substantial portion of its assets in which those employees receive special compensation, which is contingent upon the employee remaining with the contractor for a specified period of time (Golden Handcuffs).

These prohibitions were added in 1988.

Next: Section (m) - Fringe Benefits

Compensation - Part 11 - Deferred Compensation

Deferred compensation is an award made by an employer to compensate an employee in a future cost accounting period for services rendered prior to receipt of compensation. It does not include the normal year-end salary, wage or bonus accruals.

The costs of deferred compensation awards are allowable subject to the following limitations:

1. The costs shall be measured, assigned, and allocated in accordance with CAS 415, Accounting for the Cost of Deferred Compensation
2. The costs of deferred compensation awards are unallowable if the awards are made in periods subsequent to the period when the work being remunerated was performed.

The trick here is to charge only the present value of the award to the current accounting period. This means that contractors will need to reasonably estimate when the payouts will occur (one of the conditions of CAS 415).

Next: Section l - Compensation incidental to business acquisitions.

Whistleblower Action

The Justice Department announced in a press release yesterday that it has intervened in a whistleblower lawsuit against Fluor Corporation in the U.S. District Court for the Eastern District of Washington. The False Claims Act lawsuit was originally filed by a former employee of Fluor.

The whistleblower complaint alleges that, as a condition of receiving a Government contract, Fluor was required to certify that it would not use federal funds for lobbying activities. The complaint further alleges that between 2005 and 2008, Fluor ignored these restrictions and used Government funding to lobby Congress and executive branch officials for additional funding on an existing contract.

The complaint was filed under the False Claims Act, which authorizes private parties to sue on behalf of the United States and share in any recovery. The act authorizes the United States to intervene in such a suit and take over the responsibility for litigating it.

The claims asserted in this case are allegations only, and there has been no determination of liability. However, the Government, prior to intervening in the case, saw the evidence and based on that evidence, decided to join in the suit. Many times, the Government does not intervene in whistleblower suits because of there is not sufficient evidence to take the allegations forward.

There has been a marked increase in the number of whistleblower (qui tam) lawsuits in recent year. The potential of a big payday awaits those who persevere.  The Justice Department reported that a record of 638 qui tam lawsuits were filed in 2011, after hovering between 300 and 400 a year for most of the prior ten years. Contractors are advised to ensure that their system of internal controls, codes of conduct, and ethical practices are implemented and operating effectively.

Rent Paid to Related Parties

There's one final lesson we want to draw out of the ASBCA (Armed Board Services Board of Contract Appeals) decision that we've been discussing this week, ASBCA No. 57795, Thomas Associates, Inc. Thomas had included expressly unallowable costs in its 2004 incurred cost proposal. The auditor discovered the costs during the audit and the contracting officer levied a penalty. Thomas lost its appeal of the contracting officer penalty determination.

One of the expressly unallowable costs included in Thomas's incurred cost submission was facility rent paid to a related party; Thomas's president, Ms Thomas. To support the reasonableness of those rental payments, Thomas provided rental information on comparable properties in the area which, unsurprisingly, were higher than what Tomas was paying.

The problem here for Thomas was that FAR 31.205-36, Rental Costs, limits allowable costs to actual cost of ownership for related party transactions. The pertinent section of FAR 31.205-36 reads::

(3) Charges in the nature of rent for property between any divisions, subsidiaries, or organizations under common control, to the extent that they do not exceed the normal costs of ownership, such as depreciation, taxes, insurance, facilities capital cost of money, and maintenance (excluding interest or other unallowable costs pursuant to Part 31), provided that no part of such costs shall duplicate any other allowed costs...

We frequently encounter similar situations where small businesses (and some not-so-small businesses) lease facilities from related parties. It is surprising the number of times that these businesses have the mistaken notion that they can claim "market rates" for rental payments.

One final note, "normal costs of ownership" by definition includes facilities capital costs of facilities (FCCM). When tallying the normal cost of ownership, many contractors fail to include FCCM. As we've discussed here on this blog, FCCM, in many cases, can be significant, especially when real property is involved.

Excuses that Didn't Work

For the past two days, we've been discussing various aspects of the Thomas Associates (TAI) decision from the ASBCA (Armed Services Board of Contract Appeals). This case involved the inclusion of expressly unallowable costs in the contractors annual incurred cost claim and the eventual assessment of penalties and interest for doing so.

The ASBCA did not buy the contractor's argument that the costs were not expressly unallowable but just plain unallowable. Expressly unallowable costs carries a penalty while non-expressly unallowable costs do not. The contractor found out the hard way just how significant these penalties can become. Penalties and interest totaled 45 percent of the expressly unallowable amounts included in the incurred cost claim.

In its complaint, the contractor requested that the penalties be waived. FAR 42.709 allows the Government to waive penalties under three circumstances.

1. The contractor withdraws its proposal before the Government begins its audit
2. The amount charged to Government contracts is less than $10 thousand
3. The contractor can show that it had good policies and procedures for identifying and excluding unallowable costs from its proposal but there was an unintentional error notwithstanding the exercise of due care.

ASBCA denied TAI's waiver request.

The contractor first argued that the unallowable costs, individually, did not exceed $10 thousand. The ASBCA rejected the argument stating that the $10 thousand threshold is an aggregate amount.

The contractor then argued that the penalties represented a financial hardship. The Board rejected this on the basis that "there is no known regulatory or decisional authority for considering "financial hardship" as a basis to waive penalties".

Finally, the contractor argued that it had not been audited previously and that this was a "learning experience". The ASBCA ruled that "learning experience" was not a condition for waiver of penalty and there was no evidence that the contractor submitted the expressly unallowable costs "inadvertently" or due to "unintentional error".

Entertainment vs. Employee Morale

Yesterday we discussed a recent ASBCA (Armed Services Board of Contract Appeals) decision where the judge sided with the Government on the question of whether certain costs included in an annual incurred cost submission, were specifically unallowable under FAR cost principles. Claiming those costs resulted in the imposition of penalties and interest. There are other aspects of the decision that are instructive for contractors in identifying unallowable costs.

There were five items of cost involved in this case. Four of those were questioned by the auditors as unallowable entertainment (FAR 31.205-14). The contractor claimed that these costs were incurred to improve employee morale, fitness and teamwork and therefore unallowable under FAR 31.205-13 (Employee Morale). These expenses included executive membership to a private club, concert tickets, flowers, and a Christmas party (that included alcohol). The ASBCA did not buy these "employee morale" arguments.

These two cost principals, employee morale (FAR 31.205-13) and entertainment (FAR 31.205-14) need to be considered in concert when deciding whether costs are allowable or not. From the Government's perspective, if the cost do not meet the narrowly defined activities included in employee morale cost principle, they will be inclined to categorized the costs as unallowable entertainment.

The DCAA Contract Audit Manual (DCAM) is quite emphatic, stating it this way:

By statute, entertainment costs are expressly unallowable, without exception. Consequently, the entertainment cost principle at FAR 31.205-14 takes precedence over any other cost principle.

DCAM further states:

Entertainment costs are expressly unallowable, without exception. Therefore, even if the principal purpose for incurring an entertainment cost is other than for entertainment, the entertainment cost is unallowable. For example, while the cost of a contractor open house for employee families is generally allowable, the cost of entertainment provided as part of the open house is unallowable.

If the Government can find a way to classify a cost as entertainment, it will do so. Sometimes, however, they are not correct in their assessment. The arguments proffered by the contractor in this case, seem sophomoric and doomed from the start. However, contractors should not be dissuaded by this case from claiming costs that are truly expenses related to employee morale.

You can read the full ASBCA decision here.

Penalties for Unallowable Costs

Most Government contractors know that there are penalties involved when claiming specifically unallowable costs. In an ASBCA (Armed Services Board of Contract Appeals) decision handed down last month, a contractor found out the hard way how significant those penalties can become.

In 2007, DCAA finished its audit of Thomas Associates Inc's. (TAI) 2004 incurred cost submission. It found about $38 thousand in costs that were specifically unallowable according to FAR cost principles. The contracting officer agreed and levied penalties for including unallowable costs in its claim. TAI appealed to the ASBCA, offering a number of defenses, including the idea that the costs in question were not specifically unallowable but were unallowable as a matter of interpretation.

The ASBCA ruled that Government had "sustained its burden of proof" that the costs in question were specifically unallowable under the respective FAR cost principles involved and denied TAI's appeal.

The penalties together with interest totaled about $17 thousand or about 45 percent of the specifically unallowable costs. That's significant.

You can read the decision here.

Compensation - Part 10 - Pensions

There are essentially two types of pension plans, defined benefit and defined contribution. A defined benefit plan gives a retiree a certain amount of money for the rest of his/her life. Social Security is a defined benefit plan. A defined contribution plan  puts money into a workers account. Earnings on the account stay with the account. Upon retirement eligibility  the worker can start drawing from the account. The popular 401(k) plans are defined contribution plans.

FAR 31.205-6(j) requires contractors to follow CAS (Cost Accounting Standards) 412 and 413 to measure, assign, and allocate pension plan costs, even for contractors that are not CAS-covered. Pension costs are allowable subject to those Standards as well as other cost limitations and exclusions further enumerated in the FAR 31.205-6(j) cost principle.

We will not be discussing defined benefit pension plans in this post. Frankly, there are relatively very few of those types of plans remaining and they are almost non-existent at small Government contractors. These plans have turned out to be too costly and have contributed to the financial woes of many companies including the U.S. automobile industry.

For defined-contribution plans (including profit sharing, savings plans, and other such plans), allowable pension cost is limited to the net contribution required to be made for a cost accounting period after taking into account dividends and other credits, where applicable. For 401(k) plans, this is usually a fairly straight-forward computation and there is rarely any disputes with the Government as to the propriety of such costs. Just remember that if any employee compensation is determined "unreasonable" (e.g. it exceeds the OMB ceiling on employee compensation), any portion of pension plan contributions related to that excess amount should also be excluded from any proposal or incurred cost submission to the Government.

Contractors need to fund their plans on time. If by failing to fund the plans on-time a contractor must pay interest, the interest is unallowable. Also, any increased costs that result from contractors moving pension funds from one plan to another are unallowable.

Excess funding is not allowable. Any amount that exceeds what is "assignable" to a fiscal year is not allowable under Government contracts. Contractors cannot "make up" prior years' funding requirements in the current year.

Pension payments must be paid pursuant to an agreement entered into in good faith between the contractor and employees before the work or services are performed and to the terms and conditions of the established plan. Don't come to the end of the year, find out that you have a little extra cash on-hand and decide to pay it out to employees in the form of pension contributions. That scenario would not meet this requirement.

There is much more to this subject than can be summarized easily into a blog post. In summary, if you're a small contractor with a 401(k) plan that is being administered by a third party that specializes in retirement plans and are making timely contributions to the administrator of that plan, you're unlikely to run afoul of any restrictions contained in this section.

Next: Section (k) - Deferred Compensation other than Pensions.

Compensation - Part 9 - Changes in the Prices of Corporate Securities

This section of the compensation cost principle is unlikely to apply to most small companies.

Sometimes, executive compensation (and less often, employee compensation) includes payments in the form of the contractor's corporate securities such as stock options and stock appreciation rights.

In general, securities must be valued at their fair market value on the measurement date (i.e. the first date the number of shares awarded is known). Any accruals for the cost of securities before issuance to the employees must also take into account the possibility that the employees' interest in the accruals might be forfeited.

There are a number of other restrictions that apply.

• Any compensation which is calculated, or valued, based on changes in the price of corporate securities is unallowable.
• Additionally, any compensation represented by dividend payments or which is calculated based on dividend payments is unallowable. Presumably, this restriction is because dividends are normally distributions of profit.
• Finally, a contractor pay an employee cash in lieu of exercising the security. Specifically, the regulation states that if a contractor pays an employee in lieu of the employee receiving or exercising a right, option, or benefit which would have been unallowable under this paragraph, such payments are also unallowable.

These restrictions highlight the Government's long-standing position that compensation based on changes in securities prices is not compensation based on work actually erpformed and thus, is unallowable. Further, dividend payments are essentially a distribution of profits and likewise should not be reimbursed by the Government.

The application of this cost principle is not without controversy and if you are one of the few Government contractors who compensate employees with corporate securities, we recommend that you refer to the audit guidance in DCAA's Contract Audit Manual 7-2123.

Nect: Section (j) - Pension Costs