Originally published March 2004
In its latest Federal Acquisition Circular dealing with cost principles (FAC 2001-18), the Defense and Civilian Agency Acquisition Councils amended the compensation cost principle on: pensions, Federal Acquisition Regulation (FAR) 31.205-6(j);1 insurance, FAR 31.205-19; depreciation, FAR 31.205-11; and rental costs, FAR 31.205-36.2 These changes became effective on January 12, 2004. Additionally, the Councils have issued a second proposed rule to amend the training and education cost principle, FAR 31.205-44. A discussion of these changes follows.
Pension Costs and ESOPs
The subject of pension costs has been very controversial during the past decade. In 1989, the Councils amended the cost principle requiring contractors to refund or credit the government its "equitable share" of excess or surplus assets. In 1995, the Cost Accounting Standards (CAS) Board amended CAS 412 and 413, most notably in the realm of segment closures and refunds to the government for surplus assets. In 1997, the Armed Services Board of Contract Appeals issued the first segment closure decision under the original CAS 413 provisions.3 Just last year, the United States Court of Appeals for the Federal Circuit issued a decision on conflicting arguments involving both the original and the 1995 versions of CAS 413 segment closure provisions.4 Hence, it might be appropriate for contractors to hold their breath when the Council amends the pension cost principle once again. The current amendment, however, is a rather minor change. Its real import is regarding the subject of Employee Stock Ownership Plans (ESOPs) wherein the new controversy rages.
Regarding pension costs specifically, the Councils merely delete the definitions from the cost principle, relying instead on the definition that exists at FAR 31.001, which corresponds with the definition of a pension plan in the CAS. The Councils elected not to include proposed language that would have affected settlements on segment closures as set forth in the proposed rule. The Councils focused on the ESOP provisions, moving them into a new section 31.205-6(q).
Apart from the move to a separate section, the Councils made several substantive changes to the cost principle. First, the Council removed all provisions addressing the measurement, assignment and allocation of ESOP costs. For ESOPs that meet the definition of a pension plan, the new cost principle requires contractors to comply with CAS 412, regardless of whether the contract is CAS-covered. Similarly, for ESOPs that do not meet the definition of a pension plan, contractors must measure, assign and allocate costs in accordance with CAS 415 on deferred compensation. To the extent that a contractor would otherwise be subject to the CAS, this is inconsequential. For other contractors, however, this is a new requirement. Moreover, it begs the question whether the Councils are authorized to regulate on the subject of measurement, assignment and allocation of costs.
In response to comments that the revisions to the ESOP cost principle effectively incorporate the CAS, when by law the measurement, assignment and allocation of costs to cost objectives is assigned to the CAS Board, the Councils stated that "[i]t is the responsibility of the Councils, not the CAS Board, to promulgate rules for the measurement, assignment, and allocation of costs for non-CAS covered contracts."5 The law is somewhat unclear on this issue. Some cases have held that the Administration has the authority to adopt accounting practices and, under its exclusive authority to establish procurement policy, may condition allowance of costs on certain accounting methods and techniques.6 Those cases, however, are premised on decisions that interpret the enabling act for the original CAS Board, which since has changed.7
The Councils’ conclusion flies directly in the face of the Office of Federal Policy and Procurement Act that established the current CAS Board.8 In that Act, Congress declared, "the Board shall have the exclusive authority to make, promulgate, amend, and rescind cost accounting standards and interpretations thereof designed to achieve uniformity and consistency in the cost accounting standards governing measurement, assignment, and allocation of costs to contracts with the United States."9 Although Congress also determined that such standards should only apply to contracts in excess of $500,000, that determination does not change the exclusive authority of the CAS Board. Thus, Congress expressed its intent that contracts below a certain threshold, among other exceptions, need not be governed by special accounting standards. Nevertheless, the Councils have usurped a responsibility that Congress clearly did not intend.
Along these lines, it is important to recall that the CAS Board issued a Notice of Proposed Rulemaking that would amend CAS 415 specifically as it applies to ESOPs.10 The Councils acknowledge this proposal and suggest that further changes to the FAR will be made to the extent that CAS 415 is amended.
Second, the Councils removed from the ESOP cost principle the limitation that contributions made in any one-year could not exceed 15 percent of salaries and wages of employees participating in the plan. The FAR now provides a limitation on "contributions by the contractor in any one year that exceed the deductibility limits of the Internal Revenue Code for that year."
Finally, the Councils reorganized the provisions dealing with fair market value. Regarding contributions in the form of cash, the new cost principle provides that "stock purchases by the ESOT [Employee Stock Ownership Trust] in excess of fair market value are unallowable."
Insurance
By and large, the revisions to the insurance cost principle merely reorganize the format without changing the substance. It does eliminate the U.S. Treasury discount rate provision for computing actual losses. Like the changes to the ESOP cost principle, however, the new insurance cost principle requires contractors to comply with the CAS (here CAS 416) regardless of whether the contract is CAS-covered.
Depreciation
The final rule does not alter the depreciation cost principle greatly. It largely reorganizes the provisions of that cost principle. The most substantive change is in subsection (a), which eliminates the definition of depreciation and moves it to FAR 2.101. Subsection (a) also sets forth certain flexible standards regarding the determination of depreciable cost. For example, the new cost principle provides that "only estimated residual values that exceed 10 percent of the capitalized cost of the asset need be used in establishing depreciable costs" for tangible personal property.
Rental
FAR 31.205-36(a) has been amended to replace language regarding the treatment of capital leases, and merely includes a cross reference to FAR 31.205-11.
Training and Education
In 2002, the Councils proposed amendments to the training and education cost principle at FAR 31.205-44. In response to public comments, the Councils made extensive changes and elected to issue a second proposed rule, an action for which the Councils should be applauded for assuring effective public input. Comments are due on March 29, 2004.
The latest proposal trims the cost principle considerably, providing for a streamlined list of unallowable costs. The proposed rule no longer distinguishes between part-time and full-time education. The proposed rule eliminates provisions regarding vocational training, specialized programs and advance agreements.
New prohibitions include costs incurred where the purpose is to qualify for appointment to a particular position, overtime compensation, and the costs of undergraduate or graduate level classes during working hours, except when unusual circumstances do not permit attending classes outside of working hours.
Because the focus of the cost principle is now on types of cost that are unallowable, one may conclude that eliminating vocational training and specialized programs, the costs of which were previously expressly allowable, remain allowable subject to standards of reasonableness and allocability.
Footnotes
1 As discussed below, the most significant change is to the provision involving ESOPs.
2 68 Fed. Reg. 69,226 (Dec. 11, 2003).
3 Gould, Inc., ASBCA No 46759, 97- BCA ¶ 29,254 (1997).
4 Allegheny Teledyne Inc., v. United States, 316 F.3d 1366 (Fed. Cir. 2003).
5 68 Fed. Reg. 69226, 69252 (Dec. 11, 2003).
6 United States v. The Boeing Co., 802 F.2d 1390 (Fed. Cir. 1986).
7 The Boeing Co. v. United States, 680 F.2d 132 (Ct.Cl. 1982). The decision interpreted the Defense Production Act, 50 U.S.C. App. §2168(1)(A), which established the original CAS Board, but did not invest in that Board "exclusive" authority to promulgate cost accounting standards. More recent case law has focused on the distinction of whether the cost principle conflicts with a CAS, in which case the latter would prevail. Rice v. Martin Marietta Corp., 13 F.3d 1563 (Fed. Cir. 1993).
8 41 U.S.C. § 422.
9 Id. (emphasis added).
10 68 Fed. Reg. 50,111 (Aug. 20, 2003).
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