Friday, January 16, 2015

Amortization and Depreciation in a Post-Merger Accounting Period

For the past few days, we've been discussing restrictions on depreciation and amortization costs when a business combination occurs, i.e. when one company buys another and Government contracts are involved. Today we'll conclude this series by focusing on what the contract auditor might ask for and look at when auditing incurred costs.

The first thing that the auditor will look for is whether the company (the entity) has engaged in any business combination activities, either as the acquiring party or the acquired party. If there is no such activity, there is obviously no risk to the Government so the auditor will simply move along to other areas. The ICQ (Internal Control Questionnaire), which most contractors are familiar with because they've been asked over and over to help fill it out, is used to document whether business combination activities have occurred.

If there has been business combination activities, the auditor request a certain level of data and information necessary to ensure that the Government is not overcharged. The expectation is that contractors will have all the documentation necessary for the auditor to make that assessment. And, the auditor is on solid grounds for asking for the information. For example, for contracts subject to TINA (Truth-in-Negotiations Act) FAR 52.215-19 requires contractors to notify the Government of any changes in contractor ownership which would impact asset valuations. The clause also expressly requires maintenance of the records and calculation of the expense amounts which are required in order to comply with FAR 31.205-52 (Asset Valuation Resulting from Business Combinations). As noted yesterday, this cost principle limits the amount of allowable amortization, depreciation, and cost of money to the total amount that would have been allowable had the combination never taken place.

Once the auditor has acquired the necessary records and documentations, audit guidance requires auditors to make three determinations.

First, the auditor must verify that contracts do not receive increased costs flowing from asset revaluation resulting from business combinations.

Secondly, the auditor must verify whether the acquired tangible capital assets generated depreciation or cost of money charges on Federal Government contracts or subcontracts negotiated on the basis of cost during the most recent cost accounting period. For tangible capital assets that generated such depreciation expense or cost of money charges, no write-up and no write-down of asset values is permitted and no gain or loss is recognized on asset disposition. For tangible capital assets that did not generate such depreciation or cost of money charges, asset values are written-up or written-down in accordance with CAS 404)

Finally, the auditor must verify that for contracts awarded after 1998, whether or not subject to CAS, the allowable depreciation and cost of money would be based on capitalized asset values measured and in accordance with CAS 404.50(d). This is one of those areas where CAS (Cost Accounting Standards) have been incorporated into FAR Cost Principles.

Refer to the DCAA Contract Audit Manual (CAM) Sections 7-1705 for further details on this audit guidance.

The most common problem encountered by contractors in this area involves the adequacy of records. Sometimes, after a few years, the visibility into asset valuations and historical depreciation amounts is lost. It doesn't help when the auditors have years of backlogged incurred cost audits waiting to be performed. If there are record retention issues that arise during an audit, contractors are advised to bring their contracting officers on-board right away to help resolve any issues that may arise.

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