Changes to Cost Accounting Practices - Unilateral and Desirable Changes

Last week, we highlighted the CAS Cost Impact Adequacy Tool published by DCAA to help its audit staff assess the adequacy of contractor-submitted CAS cost impact proposals. Today we want to continue the discussion by identifying different types of cost accounting changes.

Cost accounting changes can be classed into three basic categories. There are changes required when new Cost Accounting Standards are promulgated. Since new standards have not been promulgated in 30 years, we don't need to consider these kind of "required" changes. Another "required" change might occur if the Government found an existing cost accounting practice to be noncompliant. This does not occur very often either.

The other two categories are unilateral changes and desirable changes. Some unilateral changes can be desirable.

Contractors may unilaterally change their disclosed or established cost accounting practices at any time. However, the Government will not pay any increased cost, in the aggregate, as a result of unilateral changes.

Prior to making any contract price or cost adjustments, the CFAO (Cognizant Federal Agency Official, i.e. the contracting officer assigned by the cognizant federal agency to administer CAS) shall determine that the contemplated contract price or cost adjustments will protect the Government from the payment of the estimated increased costs, in the aggregate, and the net effect of the contemplated adjustments will not result in the recovery of more than the increased costs to the Government, in the aggregate. This "in the aggregate" wording frequently causes a lot of problems between services because for example, the Army might benefit to the detriment of the Navy but in the aggregate, there is no impact to the Government.

Sometimes accounting changes are "desirable". A desirable change is a compliant change to a contractor's established or disclosed cost accounting practice that the CFAO finds is desirable and not detrimental to the Government. Desirable changes are not subject to the no increased cost prohibition provisions of CAS-covered contracts (and subcontracts) affected by the change (see FAR 52.230-6).

Until the CFAO has determined a change to be desirable, the change is a unilateral change. Factors that the CFAO might consider in determining whether a change is desirable include:

• The contractor must change the cost accounting practices it uses for Government contract and subcontract costing purposes to remain in compliance with the provisions of FAR Par 31.
• The contractor is initiating management actions directly associated with the change that will result in cost savings for segments with CAS-covered contracts over a period for which forward pricing rates are developed and the cost savings are reflected in the forward pricing rates
• Funds are available if the determination would necessitate an upward adjustment of contract cost or price.

Obviously, contractors will want any changes to be considered "desirable". Sometimes it takes great effort and skill to convince the Government that a change is desirable because the presumption among auditors and contracting officers is that changes are always made to benefit the contractor. Otherwise, why make a change?

CAS Cost Impact Adequacy Tool

Here is a tool that contractors with CAS (Cost Accounting Standards) covered contracts might find useful.

DCAA (Defense Contract Audit Agency) has published a "CAS Cost Impact Adequacy Tool" to help auditors determine whether contractor submitted GDMs (Gross Dollar Magnitude) and detailed cost impact proposals are adequate for audit.

The CAS Cost Impact Adequacy Tool can be downloaded here.

When a contractor with CAS covered contracts makes a change to its cost accounting practices, there is a strong presumption that costs will somehow shift between final cost objectives. Costs could shift from government contracts to commercial contracts and vice versa. Costs could shift from fixed-price contracts to cost-type contracts, and vice versa.

Examples of cost accounting changes from CAS regulations include:

• Contractor changes its actuarial cost method for computing pension costs
• Contractor uses standard costs to account for its direct labor. Labor cost at standard was computed by multiplying labor time standard by actual labor rates. The contractor changes the computation by multiplying labor time standard by labor-rate standard.
• Contractor changes its established criteria for capitalizing certain classes of tangible capital assets.
• Contractor changes its methods for computing depreciation for a class of assets.
• Contractor changes its general method for determining asset lives.
• Contractor changes its method of allocating G&A expenses.
• Contractor changes the accounting for hardware common to all projects
• Contractor merges operating segment A and B which use different cost accounting practices.

We always advise contractors to utilize any available DCAA checklist. That is a good way to self-assess the adequacy and sufficiency of internal processes and reduce the chances of "surprises" during the audit.

Cost Impact Proposals - Cost Accounting Standards

Under the FAR (Federal Acquisition Regulations) CAS (Cost Accounting Standards) clause (FAR 52.230-2), there are requirements for contractors to prepare and submit cost impact proposals is there are any increased costs to the Government resulting from (i) a failure to comply with CAS or (ii) a failure to follow consistently its disclosed cost accounting practices in estimating, accumulating, and reporting costs on CAS-covered contracts (and subcontracts). Additionally, cost impact proposals are required when a change from one accounting practice to another is required to comply with a cost accounting standard that subsequently becomes applicable to a contract or is necessary for the contractor to remain in compliance. Fourthly, cost impact proposals are required when a contractor wishes to change its methods for accumulating costs (voluntary accounting change). Some of those voluntary changes are fine. The CFAO (Cognizant Federal Agency Official) (usually the administrative contracting officer) may determine that an accounting change from one compliant practice to another is desirable and not detrimental to the Government. However, if the CFAO has not deemed the change desirable, the contractor may owe the Government some money if the change results in increased costs to the Government.

The purpose of this advisory is to alert contractors to the fact that if they fail to submit required cost impact proposals or fail to submit timely cost impact proposals, the Government is going to do it for you. And that is usually not a good thing.

FAR 52.230-6 provides that if the contractor fails to submit a cost impact proposal, the CFAO (Cognizant Federal Agency Official), with the assistance of the contract auditor (e.g. DCAA), shall estimate the cost impact on contracts and subcontracts containing the CAS clause. So realistically, the CFAO isn't going to have the information needed to estimate a cost impact so he/she will be relying upon DCAA to do it. But the auditor will not have all the information necessary to accurately estimate a cost impact so the auditor's estimates are sometimes nothing more than SWAGs.

The auditor will base his/her estimate on readily available data. The objective in such an exercise is not to relieve a contractor of its responsibility for preparing a required cost impact proposal, but to provide sufficient information upon which the CFAO can base a decision to withhold payment. Once the CFAO has made the decision to withhold payment, the burden of proof rests with the contractor to demonstrate, through a detailed analysis, the cost impact on each CAS-covered contract.

How much is the withhold? FAR provides that the CFAO can withhold up to 10 percent of each payment request until the cost impact has been recovered. That amount can seriously disrupt a contractor's cash flows.

If you owe the Government a cost impact, don't let it get to the point where the Government is going to estimate it for you.

PowerPoint Slides Do Not Trigger Statute of Limitations

The Boeing Company filed a motion with the ASBCA (Armed Services Board of Contract Appeals) to dismiss a government claim for $650 thousand plus interest. The issue, which isn't really relevant to this discussion, involved required cost accounting practice changes resulting from consolidating a couple of divisions.

Boeing contended that the Government's claim "accrued no later than February 2, 2007 whereas the Government contended that it accrued no earlier than February 16, 2007. One wouldn't necessarily think that two weeks would make any difference. However, this two-week difference is critical because of the contracting officer's final decision at issue was dated February 8, 2013, and the Contract Disputes Act contains a six-year statute of limitations on claims.

In July 2006, Boeing disclosed its intention to consolidate two of its sites in California in early 2007. From November 2006 to February 2007, the contracting officer repeatedly implored Boeing to comply with the cost accounting disclosure requirements contained in FAR. Boeing submitted a revised CAS Disclosure Statement and revised it twice. It met with the Government and made presentations on PowerPoint slides. However, throughout this process, Boeing never submitted was is referred to in FAR as a general dollar magnitude (GDM) of the change until February 8, 2007.

Although the GDM was not submitted until February 8, 2007, Boeing maintained that it had advised the Government of the cost impact before that date through PowerPoint presentations. Boeing placed a lot of emphasis on information convened in its PowerPoint slides used in its presentations in November 2006 and again in January 2007. Boeing requested the ASBCA to conclude that it conveyed enough information through those slides to trigger accrual of the claim. The ASBCA stated that Boeing's request was a "tall order" given that i) the Board was not at the meetings where the slides were discussed, ii) the Board did not hear live testimony (subject to cross-examination) from witnesses who were at the meetings; iii) the shorthand style of communication in the slides means that they are inherently subject to multiple interpretations and iv) the Board lacks a full appreciation of the highly complex business relationship between the parties - a relationship characterized by highly sophisticated contracts, people, and most of all, accounting practices - making it difficult to determine the accrual date of the government's claim using PowerPoint slides as a guide.

The Board concluded that Boeing did not convey sufficient information to the government in a timely manner to trigger the statute of limitations. As a result, the Board denied Boeing's motion. Now, the issue will need to be decided on its merits rather than thrown out on a technicality.

You can read the entire ASBCA decision here.

Cost Accounting Standards (CAS) and Accounting Changes

From time to time, Government contractors will need to make changes to their established cost accounting practices. There are many reasons for contractors to change their cost accounting practices. Perhaps they've acquired or spun-off a company, added a product line, consolidated operations, or simply want to improve the causal-beneficial relationship between indirect costs and their respective allocation bases.

Anytime an accounting change occurs, there will be a cost impact to contracts. That should be fairly obvious. Sometimes the cost impact will be significant and sometimes not. ACOs (Administrative Contracting Officers) do not particularly like to see accounting changes because it means more work - they have to review and negotiate cost impact proposals and modify contracts. They will make herculean attempts to declare cost impacts resulting from accounting changes to be immaterial. That way they don't have to exacerbate their already heavy workload. Contract auditors on the other hand are highly suspicious of accounting changes. Auditors worry that accounting changes are made simply to maximize contractor profits. Sometimes auditors' worries are justified. Accounting changes have been used to shift costs from commercial work to Government contracts, from fixed price to flexibly priced contracts, and from contracts in loss positions to contracts with room in the budget.

Contractors may, at anytime, voluntarily change their disclosed or established cost accounting practices (see FAR 30.602-3.(a)(1)). When changes are made, the price of Government contracts may be adjusted. However, increased costs resulting from a voluntary change may be allowed only if the ACO determines that the change is

• Desirable, and
• Not detrimental to the interest of the Government.

CAS covered contractors are required by the CAS clause (see FAR 52.230-5) to notify the ACO and submit a description of any voluntary cost accounting practice changes not less than 60 days before implementing the change. The ACO will review the proposed change for adequacy and compliance (see FAR 30-202-7). If the description of the change meets both tests (adequacy and compliance), the ACO will notify the contractor and request a cost impact proposal.

Once the cost impact proposal is received, the ACO will analyze the proposal and determine whether or not the proposed change will result in increase costs being paid by the Government. Usually, the ACO will request assistance from the contract auditor at this stage. After that analysis is completed, and if the impact is "material", the ACO  will negotiate contract price adjustments on behalf of all Government agencies.

Sometimes contractors do not make the required submissions - either the 60 day notification of the accounting change or the resulting cost impact proposal. This is usually not to their benefit. It allows the Government to estimate the general dollar magnitude of the cost impact and withhold money from billings. Generally, the Government will not be conservative in their general dollar magnitude estimates and contractors can experience sudden drops in their cash flows as a result.

DCMA and DCAA Cost Recovery Initiative

Last October, DCMA (Defense Contract Management Agency) and DCAA (Defense Contract Audit Agency) announced a joint Cost Recovery Initiative (CRI) to pursue a significant number of CAS cost impact issues requiring ACO dispositions and/or resolutions. The backlog of open CAS issues is significant by any measure. There are over 450 reportable CAS audits (meaning the audits are being tracked in someones database) waiting resolution and about 300 DCAA Form 1s (Notice of Costs Suspended and/or Disapproved) where the Government has reduced contractor billings.

DCMA and DCAA have now launched their joint agency CRI to proactively address these outstanding audit issues, making resolution of these issues one of their highest priorities. Most of these outstanding non-compliance issues were initiated by DCAA but require ACO action to resolve. When contractors make accounting changes or are found in noncompliance with a CAS standard, they are required by the terms of their contracts to prepare and submit a cost impact statement. When those cost impact statements are not submitted, the contracting officer has a difficult time assessing the materiality of the issues and ultimately resolving them.

Under the new initiative, where the contractor has not submitted a cost impact statement, DCMA will ask the DCAA to prepare a "rough order of magnitude" cost impact. The ROM is a high level estimate of the cost impact of the accounting change or noncompliant practice and would not be at the level of detail required of a contractor-prepared cost impact. The ROM will be used by the ACO to initiate a 10 percent withhold authorized by FAR Part 30. Although the ROM will be a good faith estimate based on available data, there is no expectation that the government will be "conservative" in its calculations. Additionally, it is only a stop-gap measure to protect the government's interest until the contractor prepares its own cost impact proposal.