Entertainment Costs - Part 3

Today we finish off our short series on entertainment costs. In Part 1, we discussed the essence of the cost principle. In Part 2, we discussed some of the Board decisions (Boards of Contract Appeals) concerning entertainment costs. In this final part, we will take a look at some of the things that DCAA tells its auditors to be alert for when reviewing entertainment costs. Most of the following is found in DCAA Contract Audit Manual Section 7-1100.

In its guidance, the Agency repeatedly states that entertainment costs are expressly unallowable and auditors should never be dissuaded into believing that such costs might be allowable under competing cost principles. Contractors always have the obligation to adequately support all costs but in this case, DCAA emphasizes the requirement. If the Government challenges the allowability of claimed costs, it is the contractor's responsibility to establish that the cost is for an allowable activity.

Entertainment costs are expressly unallowable, without exception. Therefore, even if the principal purpose for incurring an entertainment 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. In this example, contractors would be expected to analyze cost and exclude unallowable costs from any proposal or claim to the Government.

The statutes and cost principles at 31.205-13 (Employee Morale) and 31.205-14 (Entertainment) are closely related. Taken together, the cost principles expressly disallow costs which some conntractors may have considered reasonable and allowable prior to the 1995 effective date of the current rule. Examples of such costs include, but are not limited to:

• Entertainment provided as part of public relations, employee relations, or corporate celebrations;
• Gifts to anyone who is not an employee;
• Gifts to employees which are not for performance or achievement or are not made according to an established plan or policy;
• Compensation awards of entertainment, including tickets to shows or sports events, or travel; and
• Recreational trips, shows, picnics, or parties.

Finally, auditors are specifically guided to look for entertainment costs that might be buried in other accounts. Accounts that are considered high risk for inclusion of potentially unallowable entertainment costs include:

• Public relations costs
• Business meetings

Entertainment Costs - Part 2

Yesterday, we introduced the FAR (Federal Acquisition Regulations) cost principle governing the allowability of entertainment costs. Entertainment is not allowable under Government contracts and entertainment by any other name is still unallowable. Thus, you cannot argue that some example of entertainment is good for employee morale and therefore is allowable under the employee morale cost principle (FAR 31.205-13).

Most forms of entertainment are obvious and Government contractors by and large do a pretty good job of identifying and excluding such costs from proposals and billings. However, there have been a number of board cases (Boards of Contract Appeals) that have had to decide whether a certain cost is a form of amusement, diversion, or social activity.

In one case, the city of Seattle wanted to honor Boeing's 50th anniversary with a banquet. Boeing paid for printing and mailing invitations. When the event was to take place, there was an airline strike so Boeing chartered an aircraft to bring important guests to the banquet. The Government took the position that the banquet was entertainment and therefore the cost of the invitations and mailings and the charter aircraft were directly associated to entertainment activities and therefore unallowable. The Board did not agree. The Board stated that Boeing did not plan the banquet but stepped in and did what a prudent businessman would do in the circumstances, considering the responsibilities to the owners of the business, his employees, his customers, the Government and public at large.

In another case, the Board sustained the Government's position that a luncheon for visiting businessmen and Government employees were unallowable entertainment expenses because the luncheons were not for dissemination of technical information or stimulating production.

In contrast to the previous ruling, the Board ruled in 1990 that the cost of luncheons and dinner meetings were allowable. The contractor had demonstrated that they had discussed business matters. Moreover, the amounts involved were modest, the meetings were not excessive in number and were reasonable in nature and amount.

Finally, in a case from 1991, the Board ruled that a company holiday party was unallowable entertainment because clients were invited and the primary purpose of the event was entertainment. The Board stated that "To be an allowable cost, it must be clearly documented that an event's purpose was to improve employee morale, that the event benefited employees and not outside participants (such as spouses or other non-government clients), and that the costs were reasonable".

The key point from these cases is that documentation is absolutely critical to fending off challenges to allowability. Secondarily, be careful who you invite to your business luncheons and dinners.  Contemporaneous records are the best evidence but, as illustrated in one of the cases described above, affidavits were used to prove that the luncheon served a business purpose.

Click here to go to Part 3

Entertainment Costs

Today we'r going to tackle a discussion on the "entertainment" cost principle. A few weeks ago, we looked at employee morale and identified some of the challenges in deciding whether particular costs should be classified as employee morale or entertainment. Its an important distinction because while employee morale costs (however narrowly defined) are generally allowable under Government contracts, entertainment costs are not.

The entertainment cost principle found in FAR 31.205-14 is rather brief. It states:

Costs of amusement, diversions, social activities, and any directly associated costs such as tickets to shows or sports events, meals, lodging, rentals, transportation, and gratuities are unallowable. Costs made specifically unallowable under this cost principle are not allowable under any other cost principle. Costs of memberships in social, dining, or country clubs or other organizations having the same purposes are also unallowable, regardless of whether the cost is reported as taxable income to the employees.

The middle sentence, "Costs made specifically unallowable under this cost principle are not allowable under any other cost principle" was added in 1995 to prevent just such arguments. Auditors might questions costs as unallowable entertainment but contracting officers were often persuaded to give those costs back because they would arguably meet the definition of one or more other cost principles. Congress had to act to tighten things up.

Auditors are ever on the alert for entertainment type activities. It could be entertainment that is part of a company's open house (the open house should be allowable but the entertainment portion is not) or entertainment that is part of a business meeting (business meetings are allowable with restrictions but a business meeting at an expensive resort is going to open up a line of inquiry.

Tomorrow, we will look at a few Board cases that help us define what is and is not allowable under this cost principle. Click here to go to Part 2.

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.