Gains and Losses on Disposition of Assets - Part I

Depreciable assets don't last forever. At some point, assets wear out and need to be replaced or become obsolete having outlived their usefulness. If assets have been depreciated down to zero dollars and the asset is dumped in a landfill, there is no gain or loss on the disposition of that asset. The book value is zero dollars and the market value (or real value) is zero dollars.

What happens though when the asset has not been fully depreciated and it is dumped? There is a loss on the disposition of that asset. Or what happens when it is sold for more than the book value? There is a gain on the disposition of that asset. There is a FAR cost principle (FAR 31.205-16) that deals with how gains and losses should be accounted for under Government contracts.

In short, the Government is going to share in either the gain or the loss when assets are disposed of. If there's a gain, the gain reduces the indirect expense pool for the year of disposal. If there's a loss, the loss increases the indirect expense pool for that year. Paragraph (a) of FAR 31.205-16 states:

Gains and losses from the sale, retirement, or other disposition of depreciable property shall be included in the year in which they occur as credits or charges to the cost grouping(s) in which the depreciation or amortization applicable to those assets was included. 

There are exceptions to this rule however. In the case of a business combination, no gain or loss shall be recognized as a result of the transfer of assets (more about this in FAR 31.205-52). Also, in the case of sales and leasebacks, there are some special rules that prevent the Government from paying more than they should - they'll accept the gain but won't absorb any of the loss:

• when costs of depreciable property are subject to the sale and leaseback limitation in 31.205-11(h)1) or 31.205-38(b)(2)
• The gain or loss is the difference between the net amount realized and the undepreciated balance of the asset on the date the contractor becomes a lessee, and
• When the application of (b)(1) of this subsection results in a loss
• The allowable portion of the loss is zero if the fair market value exceeds the undepreciated balance on the asset on the date the contractor becomes a lessee; and
• The allowable portion of the loss is limited to the difference between the fair market value and the undepreciated balance of the asset on the date the contractor becomes a lessee if the fair market value is less than the undepreciated balance of the asset on the date the contractor becomes a lessee.

The FAR cost principle also includes guidance for calculating and applying gains and losses:

Gains and losses on disposition of tangible capital assets, including those acquired under capital leases shall be considered as adjustments of depreciation costs previously recognized. The gain or loss for each asset disposed of is the difference between the net amount realized, including insurance proceeds from involuntary conversions, and its undepreciated balance. The gain recognized for contract costing purposes shall be limited to the difference between the acquisition cost (or for assets acquired under a capital lease, the value at which the leased asset is capitalized) of the asset and its undepreciated balance (except see subdivision (c)(2)(i) of this section).

The gain recognized for contract costing purposes shall be limited to the difference between the acquisition costs (or for assets acquired under a capital lease, the value at which the leased asset is capitalized) of the asset and its undepreciated balance 

Tomorrow we will look at a special kind of asset disposition, involuntary conversions.

Fines and Penalties - Part II

This is our second and final part in discussing FAR 31.205-15, Fines, Penalties and Mischarging Costs. Yesterday we discussed the "fines and penalties" section and today we will discuss the "mischarging costs" section.

Actually, this cost principle covers a whole lot more than just "msicharging". The entire section reads:

Costs incurred in connection with, or related to, the mischarging of costs on Government contracts are unallowable when the costs are caused by, or result from, alteration or destruction of records, or other false or improper charging or recording of costs. Such costs include those incurred to measure or otherwise determine the magnitude of the improper charging, and costs incurred to remedy or correct the mischarging, such as costs to re-screen and reconstruct records.

This section has caused a fair amount of confusion over the years. For one, the term "mischarging" is not defined in FAR. Second, is the question as to whether the mischarging is deliberate or inadvertent. The Government says both, contractors like to limit the applicability to "deliberate". This question has not been tested through the appeal process that we know of.

But the phrase that has caused a lot of ruckus over the years is "costs to re-screen and reconstruct records". A number of years back when the requirement to "certify" incurred cost submissions was instituted, many contractors withdrew their incurred cost claims and "scrubbed" them to ensure that all unallowable costs were identified and excluded. The Government took exception to these scrubbing costs. The Government reasoned that it had already paid for that service so why should they pay a second time. Additionally, contractors should have adequate systems in place to identify and exclude unallowable costs from their books and records used to support pricing and billings. Having to scrub those records a second time was tantamount to admitting that the accounting system was not adequate.

The auditors got aggressive and began to question "scrubbing" costs and any directly associated costs they could think of. Some contracting officers went along with the auditors but some did not. In order to ensure consistency, the Government added this provision in 1989.

These potentially unallowable activities still go on today but not nearly to the degree that they did back in the 1980s. Also, auditors have moved on to new hot-button issue and don't have time for this one. Thirdly, its difficult to compute a defensible cost impact as scrubbing activities are typically performed by indirect personnel who most likely, don't keep track of their time at this level of detail. Finally, contractors have made significant improvements in their systems for identifying and excluding unallowable costs from Government contracts.

Fines and Penalties - Part I

There is a FAR cost principle that addresses fines, penalties, and mischarging costs (see FAR 31.205-15). The "fines and penalties" part of this cost principle goes way back to 1940 and the "mischarging costs" portion was added in 1989.

The "fines and penalties" section of this cost principle provides that cost of fines and penalties resulting from violations of, or failure of the contractor to comply with Federal, State, local, or foreign laws and regulations, are unallowable except

• when incurred as a result of compliance with specific terms and conditions of the contract or 
• written instructions from the contracting officer. 

One would think that is fairly straight-forward however there have been a number of appeals over the years. Often times, the Government takes a position that any costs resulting from a contractor's violation of a law or regulation are in the nature of a fine or penalty. Is a payment made to an employee to settle an EEO claim a fine or penalty, or something else? The Government will usually argue that it is in the nature of a fine or penalty. But not necessarily.

There was a board case back in 1968 that illustrates this distinction. McDonnell Douglas had to pay additional workers compensation to the family of a worker killed on the job. California levied the additional workers compensation payments in order to penalize the employer for serious and willful misconduct.

The Board of Contract Appeals decided that the payments were awarded as the result of the serious and willful misconduct of the employer but not because of the violation of any law or regulation. Therefore, this cost principle was not applicable and the Government lost.

In another case, the Government used this cost principle to question payments that a contractor made to two job applicants who the EEOC (Equal Employee Opportunity Commission) found reasonable cause to believe that they had been discriminated against. The ASBCA found the cost allowable because the Government had not proved that the contractor had, in fact, discriminated against the applicants or otherwise violated any laws.

Tomorrow we will look at the "mischarging" element of this cost principle.

"Compensation" in the House Passed 2014 Defense Authorization Act

The House passed the 2014 National Defense Authorization Act earlier this month. Now its on to the Senate for consideration. This is a good time to take a look at what they've done with employee compensation recoverable by contractors under Government contracts.

First, it should be noted that the new coverage applies to all contractors, not just Defense contractors. Right now, there are different limits set on Defense, NASA, and Coast Guard contracts than for civilian agency contractors. That's confusing because contractors, with both Defense and non-Defense contracts must account for those difference when estimating and billing.

Secondly, there is a new definition for "senior executive". Currently it includes the five most highly compensated employees within each contractor component (e.g. division, subsidiary). Under the House version, it will apply to the five most highly compensated employees contractor-wide. Those five individuals will continue to be subject to the compensation cap methodologies that have been in place for some time. For fiscal year 2011, that cap is $763 thousand. The cap for 2012 has not yet been announced but is expected to top $900 thousand.

New to the compensation discussion is a cap on all contractor employees (except for the top five executives). The House NDAA would cap compensation for everybody at the $763 level and adjust that cap each year based on the U.S. Bureau of Labor Statistics Employment Cost Index for total compensation for private industry workers. The DoD or executive agency would be able to establish exceptions to those caps for positions in the science, technology, engineering, mathematics, medical and manufacturing fields upon a determination that such exceptions are needed to ensure that they have continued access to needed skills and capabilities.

The effective date for this proposed legislation would be 180 days after enactment. It seems to us that this provision, if enacted, is unlikely to impact a significant number of contractors. There doesn't seem to be that many contract employees whose compensation comes anywhere near that limit.

Proposal Adequacy - What Can Happen if You Don't Comply with Instructions

Last week we posted a four part series on the importance of ensuring that proposals comply with solicitation requirements, Table 15-2 of FAR 15.403, and other instructions. These are important issues and failure to comply can and probably will affect your chances of winning whatever contract you're bidding on. Lest you under-estimate the importance of complying, consider these recent appeal cases decided by the Comptroller General.

1. Compuline claimed that the Government did not reasonably evaluate its proposal. The Government argued that Compuline's proposal was appropriately rejected because it did not include some of the most basic information required by the RFP.

The Comptroller General (CG) evaluated the evidence and denied Compuline's appeal. The CG found that the Government appropriately rejected the proposal. Among other omissions, Compuline did not provide a required management or staffing plan, key personnel, past performance references, nor a cost proposal. In addition, the proposal did not follow the format required by the RFP.

2. Herman Construction submitted a proposal in PDF format when the solicitation very clearly required Excel format. Herman argued that PDF was an acceptable substitute for Excel. The CG did not sustain Herman's appeal because it deviated from clearly written solicitation instructions.

3. SMI challenged the Government's determination that its proposal was technically unacceptable. The CG looked at the evidence supporting the Government's action and sided with the Government. It found that SMI failed to provide a complete and realistic plan for satisfying performance objectives and that its proposal did not identify a plan and otherwise failed to address most of the requirements.

4. LC objected to the Government's evaluation of its proposal arguing that its proposal provided the Government with sufficient data and detail to demonstrate that it was technically capable of performing the contract. The CG looked at the evidence and found that LC had failed to demonstrate an acceptable technical approach in its proposal. LC insinuated that the Government was pretty dumb for not knowing the latest technology for producing the product. Had the Government understood, it would have properly evaluated the proposal (good way to win friends).

The CG sided with the Government stating, in effect, that LC's failure to comply with the requirements of the solicitation was reasonable grounds for rejecting the proposal.

These are just a few recent examples of cases where contractors failed to comply with the regulations and requirements and where their appeals were not sustained. It pays to follow instructions.

Department of Justice Settles Conflict of Interest Case

Here's an update to our post from March 4th of this year. In that post, we reported that the Department of Justice had indicted a former DCAA auditor for violating conflict of interest laws. According to the Department of Justice, this auditor left DCAA and went to work for Alaska Aerospace. While with Alaska Aerospace, she represented the company in a matter that she was personally involved in as a Government auditor.

Yesterday, the Alaska Daily News reported on how the case was settled.  The news article states:

An Anchorage woman, who is a former auditor for the Defense Department, was sentenced to two years' probation and ordered to pay a $5,000 fine for violating conflict of interest laws.

Jodi Ann Andres, 48, was sentenced in federal court on Monday, according to a media release from U.S. Attorney Karen L. Loeffler.

Andres broke a federal law by representing a contractor on issues she previously handled for the government.

Officials say Andres was an auditor with the Department of Defense from January 2003 to September 2006. She was the primary auditor of cost proposals, labor rates and claims for the Missile Defense Agency. But in September 2006, Andres left the DCAA to work for Alaska Aerospace as its controller.

In July 2008, Andres represented Alaska Aerospace during communications and negotiations with the DCAA about the same Missile Defense Agency contract she had previously audited. Prosecutors say this was a violation of a lifetime restriction that barred such communications.

Sounds to us like both sides of the issue wanted to close this case as quickly as possible. Two years probation and a $5 thousand fine is not all that significant, in the scheme of things.