Exploring Unallowable Costs David Eck Mike Mardesich September 22, 2016

Transcription

1 Exploring Unallowable Costs David Eck Mike Mardesich September 22, 2016 The Fundamentals of Government Contracting Webinar Series 1

2 Your Presenters David Eck Dixon Hughes Goodman LLP Mike Mardesich Dixon Hughes Goodman LLP

3 Fundamentals Season 1 Challenges of Contracting with the Federal Government (November 2015) - Completed Contract Types and Associated Risks (December 2015) Completed Year-End Closing (January 2016) - Completed An Introduction to the Incurred Cost Submission Part I: Who, What, Where, When, Why, and How? (February 2016) - Completed Part II: Preparation and Adequacy Review (March 2016) - Completed Accounting Systems and Setups (April 2016) - Completed Accounting System Adequacy 101 (May 2016) Completed The Composition of Total Cost (June 2016) Completed Making Way for 2017 Budgeting and Provisional Rates (July 2016) Completed Procurement Systems: DFARS Business Systems Rule and Criteria (August 2016) - Completed Exploring Unallowable Costs (September 2016) You are Here! Policy and Procedures Manual: What s In It and Why Do You Need One? (October 2016) 3

4 Agenda Unallowable Cost Background and Guidance FAR and CAS Penalties for Unallowable Costs FAR Cost Principles Expressly Unallowable Costs DCAA Commonly Scrutinized Unallowable Costs Directly Associated Unallowable Costs Unallowable Cost Grey Areas Best Practices to Identify and Segregate Unallowable Costs DCAA Guidance 4

5 The Fundamentals of Government Contracting Webinar Series Unallowable Cost Background and Guidance 5

6 What is Cost? Total Cost Direct vs. Indirect Cost Allowable Cost Reasonableness Allocability Allowability CAS or GAAP Contract Terms 6

7 Cost Principles - FAR Part 31 Compliance Obligations Criteria for allocating costs Defines allowability of costs Requires exclusion of unallowable costs Penalties Disallowance of costs Penalties for unallowable costs Interest penalty 7

8 Cost Accounting Standards 405 CAS 405: Accounting for unallowable costs Compliance Obligations Criteria for the assignment and allocation of costs to government contracts Disclosure of accounting practices Notification of changes to accounting practices Requires consistent application Penalties Contract price adjustment No increased cost to government if practices change Interest penalties Statute of Limitations 8

9 Allowability (FAR ) Definition Not unallowable Terms of the contract Generally Accepted Accounting Principles Contractor must maintain adequate accounting records FAR (2)(c) Contractor must apply consistent practices FAR (2)(b) Often subject to improper challenges due to poor chart of accounts or inadequate procedures 9

10 Accounting for Unallowable Costs (FAR ) Contractor has a responsibility to account for unallowable costs Must have a mechanism for identifying unallowable costs 10

11 Segregation of Unallowable Costs FAR , CAS 405, FAR , FAR Certification Issues: Directly associated costs Access to unallowable cost detail Include unallowables in base 11

12 Penalties for Unallowable Cost If unallowable on clear and convincing evidence: Disallowed cost plus interest on any paid portion If known to be unallowable before proposal submission: Disallowed cost plus interest on any paid portion Additional two times unallowable cost Other civil and criminal penalties provided by law 12

13 Certificate of Indirect Costs This is to certify that to the BEST OF MY KNOWLEDGE and belief: 1. I have reviewed the indirect cost proposal submitted herewith; 2. All costs included in this proposal [to establish billing or final indirect costs rates for...] are ALLOWABLE in accordance with the requirements of contracts to which they apply and with the cost principles of the Department of Defense applicable to those contracts; 3. This proposal DOES NOT INCLUDE ANY COSTS WHICH ARE UNALLOWABLE under applicable cost principles of the Department of Defense, such as (without limitation): advertising and public relations costs, contributions and donations, entertainment costs, fines and penalties, lobbying costs, defense of fraud proceedings, and goodwill; and 4. All costs included in this proposal are PROPERLY ALLOCABLE to defense contracts on the basis of a beneficial or causal relationship between expense incurred and the contracts to which they are allocated in accordance with applicable acquisition regulations. I declare UNDER PENALTY OF PERJURY that the foregoing is true and correct. Firm Signature. Corporate Official.. Title Date.. 13

14 Unallowable Cost Challenges Auditor expectation for supporting documentation DCAA audits in arrears and conflict with record retention requirements Auditor access to budgeted and incurred cost 14

15 The Fundamentals of Government Contracting Webinar Series FAR Cost Principles 15

16 The Fundamentals of Government Contracting Webinar Series Personnel Costs 16

17 Compensation FAR Allowable Compensation must be reasonable for work performed based on comparisons to: Firms of the same size Firms in the same industry Firms in the same geographic area Firms engaged in non-government work Closely held business scrutinized more closely When elements are challenged - Offsets may be considered between allowable elements of compensation within same job grade or level 17

18 Compensation Challenges Reasonableness overall Bonuses Lack of approval from ACO for changes to compensation programs Lack of wage or salary survey to support Inconsistency Dependent Health Care Costs T&M Contracts - Resume and Labor Category requirements Bonuses need written plan that is consistently followed 18 18

19 Benchmark Compensation Cap The compensation cap is required by Section 39 of the 41 U.S.C. 1127, and represents the maximum compensation amount that a contractor can include as an allowable cost for covered contracts awarded before June 24, Statutory Formula Cap Amount Fiscal Year For Costs Incurred After $1,144, Jan-2014 $980, Jan-2013 $952, Jan-2012 $763, Jan-2011 $693, Jan-2010 $684, Jan-2009 $612, Jan-2008 $597, Jan-2007 $546, Jan-2006 $473, Jan-2005 $432, Jan

20 Benchmark Compensation Cap Cap rules vary depending on the date of the contract award and the customer agency. For covered contracts awarded on or after June 24, 2014, a cap of $487,000 applies pursuant to section 702 of the Bipartisan Budget Act (BBA) of Compensation Cap Rule Agency DOD/NASA/CG Agency Civilian agencies Statutory formula cap, top five senior executives Statutory formula cap, all contractor employees $487,000* BBA cap, all contractor employees (*will adjust for inflation) Before Dec 31, 2011 Before Jun 24, 2014 On/after Dec 31, 2011, and before June 24, 2014 On/after Jun 24, 2014 N/A 20

21 Compensation Considerations The statutory caps will impact those contractors who choose to use a blended rate approach to compensation reimbursement in their blended rate calculations. The statutory cap does not limit the compensation a contractor may pay an employee, only the amount reimbursable to the contractor. For cost reimbursement purposes, contractors must also remember that the reasonableness test at FAR (b) still applies even if total compensation does not exceed the cap. DCAA Guidance on Surveys and Benchmarking DCAA Compensation Team Recent Court Decisions 21

22 Employee Morale, Health, Welfare, Food Service, and Dormitory Costs and Credits FAR Aggregate costs are allowable: Improve working conditions Improve employee morale Improve employee performance Gifts are unallowable not awards recognizing employee achievements Recreation is unallowable except for sponsored teams or organizations FASA imposed significant changes in

23 Alcoholic Beverages FAR Unallowable Company policy is important Auditor tactics can be a concern 23

24 Travel Costs FAR Travel must be for official business Approval expected Air Fair limitations - Coach travel and lowest available fare Per diem vs. Actual costs Unallowable Costs Alcohol Travel in excess of FTR daily rate Lowest available airfare 24

25 Travel Cost Challenges General rule of thumb Travel cost should follow the labor cost [i.e. direct if labor is direct] Lack of receipts Reasonableness of cost No justification of business purpose Partial travel days Company policy conflicts 25 25

26 Entertainment Costs - FAR Amusement Diversions Social activities Tickets to shows and sporting events Membership in social clubs All unallowable 26

27 Relocation Costs - FAR Relocation for assignments of not less than 12 months Move must be for the benefit of the employer If employee quits within 12 months of relocation - Government entitled to a credit for relocation costs Quite comprehensive listing of what is allowable 27

28 Trade, Business, Technical and Professional Activity Costs - FAR Memberships -- Allowable Subscriptions -- Allowable Meetings and symposiums where the principal purpose is the dissemination of technical, business or trade information, the stimulation of production, or improved productivity -- Allowable 28

29 Training & Education - FAR Vocational training - allowable Part-time college - fees and straight time not in excess of 156 hours per year Full-time - Fees but not salary, if related to employees field, for not more than 2 years Specialized training - not more than 16 weeks per year Employee Dependents not allowable 29

30 The Fundamentals of Government Contracting Webinar Series Project Related Costs 30

31 Material Costs FAR Material costs are allowable Requires consideration of rebates or credits Allows for direct charging if the contract is known at the time of purchase Requires the use of GAAP inventory valuation techniques if there is an inventory Dictates transfer pricing procedures between related parties DCAA guidance on commercial items 31

32 The Fundamentals of Government Contracting Webinar Series Plant and Equipment Costs 32

33 Depreciation FAR Systematic and logical assignment of assets to benefitting cost accounting periods Reasonable if: Consistent with other cost centers Reflected in books of accounts and financial statements Both used and acceptable for tax purposes Acquisitions No step up, no step down Use Charges 33

34 Special Tooling and Test Equipment FAR Special tooling and test equipment is an allowable direct cost not indirect cost General purpose tooling and test equipment is an allowable indirect cost (depreciation), not direct cost 34

35 Gains and Losses on Disposition of Depreciable Property or Other Capital Assets FAR Costs are credited or charged in the year in which they occur to the same cost pool that the depreciation for that asset was charged No gain or loss as a result of a business combination Limited to the amount of depreciation that was charged Impairments no write-off allowed 35

36 Cost of Money FAR A non-cost cost Imputed amounts using the Secretary of the Treasury Interest Rate Can be waived by the contractor (due to profit implications) Treated as an incurred cost for progress payment and public voucher purposes Must be included in forward pricing proposal to be an allowable incurred cost 36

37 Rental Costs FAR Real or personal property operating leases Must be reasonable Sale - leaseback limited to costs if sale had not occurred Related parties limited to cost of ownership unless personal property and established practices similar to unaffiliated lessees Potential impact of new lease rules 37

38 The Fundamentals of Government Contracting Webinar Series Selling and Marketing Costs 38

39 Selling Costs FAR Direct selling costs are allowable if reasonable Costs associated with marketing efforts to export products purchased by the Government are allowable provided they are reasonable including trade shows Commissions are allowable if paid to bona fide employees or agencies 39

40 IR&D and B&P Costs FAR Allowable if reasonable Indirect people continue to charge indirect, direct people charge IR&D and B&P projects IR&D not required to do a contract B&P preparing and supporting bids Challenging accounting requirements Good policies and procedures are critical New focus of Pentagon Congressional viewpoints 40

41 Contingencies FAR Forward pricing - reasonably foreseeable and can be estimated within reasonable limits of accuracy - allowable Incurred cost - unallowable 41

42 Contract Losses FAR Loss is defined as cost in excess of revenue [includes cost sharing] Losses on contracts are unallowable 42

43 Precontract Costs FAR Major red flag! Do it in writing! Must meet three tests: Incurred directly pursuant to negotiations and contract terms; necessary to meet the contract schedule; and, are otherwise allowable. FAR for advance agreement 43

44 The Fundamentals of Government Contracting Webinar Series Other Cost Principles 44

45 Public Relations and Advertising Costs FAR Allowable advertising help wanted acquire materials dispose of scrap Trade Show Booths? Allowable public relations required by contract responding to inquiries communicating with public general liaison community services plant tours keel laying 45

46 Bad Debts FAR Unallowable Directly associated costs collection costs and legal costs are unallowable 46

47 Contributions or Donations FAR Unallowable Cash, property or services Does not include FAR (e)(3) for community services like blood drives 47

48 Fines and Penalties and Mischarging Costs FAR Fines and penalties are unallowable unless approved by the contracting officer Cost of correcting records is unallowable if the reason the records have to be corrected is due to the false or improper recording of cost 48

49 Interest and Other Financial Costs FAR Unallowable Some recent court cases allow interest on state income tax obligations where the contractor was not delinquent or acted reasonably 49

50 Lobbying & Political Activity Costs FAR Any activity to influence Executive or Legislative staff is unallowable Presentations on factual or technical information about a contract are allowable if supported by documentation Requires a certification DCAA focuses on contractor Washington DC area offices 50

51 Organization Costs FAR Costs for effort affecting the capital structure of the company Unallowable Lots of confusion and misinterpretation of this principle with merger mania of the 1990 s 51

52 Other Business Expenses FAR Shareholder meetings, soliciting normal proxy, preparing and publishing reports etcetera, etcetera, etcetera Allowable 52

53 Patent Costs FAR Only costs required by contract or for general patent advice are allowable All other costs are unallowable 53

54 Professional and Consultant Service Costs FAR Generally allowable but must be reasonable Cannot be officers or employees of the contractor Must be supported by: Details of agreement and actual services Invoices with sufficient detail to allow an evaluation of what was done Work product or memorandum of meetings Be familiar with current DCAA guidance 54

55 Legal Costs FAR Costs are unallowable if in connection with violation of or failure to comply with laws and regulations (admitted wrong doing) Other legal costs are generally allowable, but auditors will be asking for the 3 items required for professional and consultant services 55

56 Recruitment Costs FAR Cost of help wanted, employment office, travel costs, etc. Generally allowable Ads must be for specific positions required by the contract or be indirect positions Must not be public relations type costs 56

57 Royalties and Other Costs for Use of Patents FAR Allowable unless: Government owns license or has free use Patent adjudicated to be invalid Patent is considered to be unenforceable Patent has expired Warns to be careful regarding reasonableness of less-than-arms-length transactions 57

58 Taxes FAR Generally allowable Following are unallowable: Federal income and excess profits tax Taxes associated with financing activities Taxes for which exemptions could have been obtained Special assessments on land that represent capital improvements Taxes on real or personal property used only on non-government work Taxes on accumulated funding deficiencies Income tax accruals for timing differences Be careful on sales tax may be questioned if items are purchased on behalf of government 58

59 Termination Costs FAR Costs continuing after termination Initial costs Loss of useful value Rental under unexpired leases Alterations of leased property Settlement costs Internal and External Subcontractor claims 59

60 Business Combinations FAR Tangible capital assets Purchase method of accounting If prior depreciation or COM book value of seller If no prior depreciation or COM fair value at time of acquisition Intangible capital assets Purchase method of accounting no step up 60

61 The Fundamentals of Government Contracting Webinar Series Directly Associated Costs 61

62 Directly Associated Costs FAR (e) Materiality of directly associated costs: The dollar amount Cumulative effect of all directly associated costs in a pool Ultimate effect on Gov t contracts Salary expenses of employees who participate in unallowable activities Only unallowable if material in amount 62

63 The Fundamentals of Government Contracting Webinar Series Best Practices to Identify and Segregate Unallowable Costs 63

64 Best Practices Unallowable cost accounts clearly shown in chart of accounts and submissions to the government (forward pricing proposals, incurred cost submissions) Point of entry screening FAR Part provides for statistical sampling if Plan and sampling must permit audit verification Should have advanced agreement 64

65 The Fundamentals of Government Contracting Webinar Series DCAA Guidance on Expressly Unallowable Costs 65

66 DCAA Guidance on Expressly Unallowable Costs January 2015 DCAA Memorandum for Regional Directors Guidance to auditors on how to determine if cost is expressly unallowable Government must establish that it was unreasonable for a person in the contractor s position to conclude that the costs were allowable. Previous audit alert issued in December 2014 was misleading Source: 66

67 DCAA Guidance on Expressly Unallowable Costs In order for a cost to be expressly unallowable, the cost principle must: i. State in direct terms that the costs are unallowable, or leave little room for differences of opinion as to whether the cost meets the allowability criteria; and ii. Identify the specific cost or type of costs in a way that leaves little room for interpretation 67

68 Questions? 68

69 The Fundamentals of Government Contracting Webinar Series Join us next month for Policy and Procedures Manual: What s In It and Why Do You Need One? on Thursday, October 27,