Monday, December 14, 2009

Revised Compensation Cost Principle - Post Retirement Benefits

Post Retirement Benefits (PRBs) typically include health, dental, and vision befenfits that continue after employees retire. This category of cost does not include pensions or deferred compensation plans. At one time, PRBs were very popular at large corporations but because of astronomical rises in health care costs and people living longer, the liabilities have become too great for many companies to absorb and still remain competitive. Thus, most companies are phasing them out. PRB liabilities are one of the challenges facing U.S. automakers. For Government contractors with PRB plans, FAR allows three different methods for charging costs to Government contracts. First, contractors can use a pay-as-you-go method (also referred to as the cash basis). Secondly, contractors can base the costs on the terminal funding method where a contractor sets the liability through the purchase of group annuity contract. Finally, there is the accrual basis. Under accrual basis, contractors must actuarily calculate their ultimate liabilities and fund certain portions of that liability each year. When the accrual basis is used, FAR currently requires that costs must be measured based on the requirements of Financial Accounting Standard (FAS) 106. But, that is about to change.

For income tax purposes, the deductability of PRB costs is determined using a different measurement criteria (IRC Sections 419 and 419a). Sometimes, the FAS 106 amount exceeds the cost measured under the IRC. When it does, contractors are faced with a dilemma.  - whether to fund the entire FAS 106 amount to obtain Government reimbursement of the costs, regardless of tax implications, or fund only the tax deductible amount and not be reimbused for the some of the FAS 106 amount under their Government contracts.

Under the revised cost principle, contractors will have the option of measuring accrued PRB costs using criteria based on IRC 419/419a rather than FAS 106, thereby permitting the contracor to fund the entire tax deductible amount without having a portion potentially disallowed because it did not meet the FAR's current measurement criteria.

The effective date for this change is January 11, 2010.

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