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Legal Structures Can Influence Cost Allocations

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Most of the time, cost allocations for a government contractor don’t care about legal structures. Legal structures are the province of lawyers and tax accountants, for the most part. When we talk about FAR and CAS allocation requirements, we talk about functions and activities, and home offices and segments and business units. We talk about cost objectives—both intermediate and final. We don’t talk about the legal structure of the corporate entity. One legal entity or one hundred: it really doesn’t affect how costs are collected and allocated to places where the costs get collected and billed.

Most of the time.

Recently, though, a dispute at the Civilian Board of Contract Appeals (CBCA) turned on a contractor’s legal structure. The dispute involved payment of taxes to the Afghanistan government. Having dealt with the topic in the past (to a small extent) I was interested in what the Board thought of the situation. What I learned, when reading the case, was that the Board seemed to be frustrated by the lack of information and facts. In particular, the Board seemed to be frustrated and confused over the Appellant’s legal structure.

(If you’re going to read the rest of this blog article, I suspect you will be similarly frustrated. You may want to keep a separate list of all the legal entities involved.)

The Appellant, International Development Solutions, LLC (IDS), provided security services to the Department of State in the country of Afghanistan. According to IDS, the Afghani government imposed taxes on it based on the contract work it had performed in country. The Board wrote that IDS “seeks payment for three years of tax and penalty payments under cost-reimbursement provisions of two task orders.”

The Board found that IDS had not provided sufficient evidence that it had actually incurred the costs associated with those tax payments, or that the tax payments related to the two task orders. A particular concern of the Board seemed to be the lack of transparency of the legal structure of the contractor—a lack of transparency that was exacerbated by testimony.

Legal entities mentioned during the case included: ACADEMI Training Center, Inc.; ACADEMI LLC; Constellis Holdings LLC; and Constellis LLC. The Board was clearly confused in trying to trace the relationships between the entities.

It was undisputed that the Department of State awarded a contract to IDS in 2010, and that IDS provided the services under the contract. The two task orders at issue were worth $400 million. It seemed that the corporate headquarters of IDS was located in McLean, Virginia.

Then things got murky.

Less than two years later (May, 2012)—

… a person signing as director of contracts for “ACADEMI” wrote to the State Department contracting officer [stating], ‘As of May 10, 2012, ACADEMI Training Center, Inc. (‘ACADEMI’), previously the 49% owner of [IDS], purchased the remaining 51% membership interest . . . to become the sole owner. ACADEMI now requests a novation of the 2010 contract and associated task orders ‘from its subsidiary, IDS, to itself’.

(Footnotes and internal citations omitted, as always.)

Thus, it appears that IDS was, itself, a partially owned subsidiary of an entity called ACADEMI Training Center, Inc. (“ACADEMI”) when it won the original contract. Was that disclosed to the Department of State prior to contract award? We don’t know. Was a 49 percent ownership enough to exert control over IDS? Again, we don’t know.

But we do know that, less than two years later, ACADEMI purchased the remaining 51% of the ‘membership interest’ of IDS. (N.B.: According to the Board, “it appears that a Delaware limited liability company has ‘member’ interests rather than ‘stock’ shares.) Purchased from whom? We don’t know.

After the purchase of the remaining membership interests, IDS was 100% owned by ACADEMI and ACADEMI requested that the State Department acknowledge that ownership through a novation. A novation, of course, “is the act of replacing a contract with another contractual obligation, requiring the consent of all parties involved.” Novations are discussed at FAR 42.12. Let’s quote from that FAR Subpart, below—

The Government may, when in its interest, recognize a third party as the successor in interest to a Government contract when the third party’s interest in the contract arises out of the transfer of-

(1) All the contractor’s assets; or

(2) The entire portion of the assets involved in performing the contract. … Examples of such transactions include, but are not limited to-

(i) Sale of these assets with a provision for assuming liabilities;

(ii) Transfer of these assets incident to a merger or corporate consolidation; and

(iii) Incorporation of a proprietorship or partnership, or formation of a partnership.

(b) A novation agreement is unnecessary when there is a change in the ownership of a contractor as a result of a stock purchase, with no legal change in the contracting party, and when that contracting party remains in control of the assets and is the party performing the contract. However, whether there is a purchase of assets or a stock purchase, there may be issues related to the change in ownership that appropriately should be addressed in a formal agreement between the contractor and the Government (see 42.1203(e)).

(c) When it is in the Government’s interest not to concur in the transfer of a contract from one company to another company, the original contractor remains under contractual obligation to the Government, and the contract may be terminated for reasons of default, should the original contractor not perform.

(Emphasis added.)

As we highlighted above, there is no need to process a novation agreement when there is a stock purchase with no change in the contracting party. Indeed, that is the rationale used by the contracting officer to reject the request for novation, writing “Given that IDS still exists . . . and has all of the necessary resources and support of ACADEMI to continue fully meeting its contractual obligations . . . no action [by] the Government is required. Therefore, IDS should continue to fulfill its contractual obligation as agreed to under the [2010] contract.”

The murk continued to grow, as the Board wrote in its decision.

Notwithstanding State’s July 2012 letter, IDS contends that ‘following denial of the requested novation . . . ACADEMI Training Center, Inc. became prime contractor and real party in interest . . . . In the alternative, IDS remained prime contractor with ACADEMI Training Center, Inc. as subcontractor[.]’ By contrast, a former board member and ‘lead investor’ of a company he called simply ‘Academi’ testified at the hearing, when asked ‘which entity still legally held the . . . contract and the task orders’ after July 2012, ‘Well, since [the contract] wasn’t novated IDS did. And the only way to get that out to a different name was if they [State] agreed to novate it.’

The Board was getting frustrating at the lack of opacity. The Board’s frustration was expressed in Footnote #3.

The record is rife with ambiguity and confusion as to which entity witnesses meant when they referred to ‘Academi.’ The former board member testified when asked to clarify to which board he belonged, ‘That was, well, there’s so many names of these companies. At the time I believe it was Academi. . . . It was Xe Services, and then Academi, and then Constellis. For that period of time [2010 to 2013] I don’t think Constellis was relevant. It was Academi.’ He was asked on cross-examination, ‘[D]id you purchase an interest in one of the entities with the name Academi?’ He answered, ‘I believe Academi was formed as successor entity or it was renamed. I can’t remember to be honest with you.’ Asked when he acquired an interest in ‘Academi LLC,’ he testified, ‘I don’t know if we ever acquired that entity. I believe we created that entity . . . at the end of 2011.’ Asked to distinguish ‘between Academi LLC and Academi Training Center,’ he testified, ‘If those two entities exist, which I trust they do because you’re referring to them,’ the latter ‘would have been [only] the actual training center in Moyock, North Carolina.’ We gather from this that by ‘Academi’ this witness primarily meant ACADEMI LLC.

It was unclear as to whether IDS even existed. The Board’s decision included this quote from testimony—

Q And how were payments from the State Department handled . . . after the State Department rejected the proposed novation?

A Well, they continued to pay IDS, because it held the contract. So, that’s the entity they paid. It was paid literally to an account that was only set up to receive payments. And then those payments were transferred to Academi, because Academi paid all the bills. And we had all the—incurred a lot of costs. Being a wholly owned entity it was more of a balance sheet checking account mission for us, and more headaches.

That sounds like an accountant testifying, doesn’t it? It seems that nobody cares about the accounting workload when they start playing legal and tax games with the corporate structure. (But perhaps we digress.)

Now Constellis comes into play. As the Board wrote—

Another witness for IDS, who said he had been vice president of financial compliance since November 2020 of an entity he called simply ‘Constellis’ (see below), testified based on his knowledge of ‘Constellis’ records:

Q As of or after the Department declined to sign the proposed novation agreement, what changes, if any, were made to the IDS accounting system?

A There are no changes made to the IDS accounting system per se. However, from, you know, flow of funds there’s a slight change. For example, invoices continued to be generated from IDS. The State Department would make payments to an IDS bank account, but . . . [t]hose funds that went into the IDS receipts account would be swept into an Academi account out of which disbursements were made.

Q Could you describe that a little bit more, what you meant when you said that the payments were deposited in an IDS account and then swept into the Academi account?

A Yes. Due in part to the fact that the contracts were not novated, the original contract was awarded to IDS. And so, the company then maintained that structure adding IDS, the legal entity, that would invoice the State Department. The remittance went to a legacy IDS bank account. But then, after Academi acquired them, they converted that account to what’s referred to as a zero balance account, meaning that funds would come into that account but then get swept into a master Academi account and reimbursements on behalf of the company would go into the Academi account.

Q And, just to clarify, you referenced a zero balance account. Which company had what you referred to as the zero balance account?

A So, the IDS bank account, essentially, was the zero balance account, meaning that payments would be made into that, wired into that account, but they were transferred into an Academi account.

The lack of transparency caused the presiding judge to get involved.

JUDGE CHADWICK: . . . Does there currently exist an entity called Academi LLC?

THE WITNESS: Yes, sir. A legal entity, Academi LLC.

JUDGE CHADWICK: Does that Academi LLC, does that own Academi Training Center LLC?

THE WITNESS: Again, I’d have to look at the—or that’s more a question for our legal team, in terms of that structure.

JUDGE CHADWICK: Is there an entity currently in existence called Constellis LLC?

THE WITNESS: Yes, Your Honor.

JUDGE CHADWICK: Is there also something called Constellis Holdings, with some corporate designator?

THE WITNESS: Yes, Your Honor.

JUDGE CHADWICK: What, if any, ownership relationship exists between Constellis LLC and Constellis Holdings?

THE WITNESS: Actually, I can’t confirm what the—I mean, you have the umbrella company and I’m embarrassed to say I forget which one is the umbrella company with all the affiliates below it.

JUDGE CHADWICK: . . . As between Constellis LLC and Academi LLC, does one own the other?

THE WITNESS: Constellis is the holding company of Academi LLC, is my understanding.

JUDGE CHADWICK: Okay, but you just said Constellis again, and we’re not clear—it sounds to me from your previous answer, you said Constellis, but you may not be sure whether you mean Constellis Holdings or Constellis LLC.

THE WITNESS: That is correct. It’s a complex legal structure.

Turning to the entity that was taxed by the Afghani government, the record was similarly muddied. For example—

In approximately 2017, Afghanistan issued assessments of taxes and penalties to ACADEMI LLC for Afghan tax years 1389 to 1394 (roughly March 2010 to March 2015). The taxpayer used an outside lawyer based in Washington, D.C., to address the tax issues. The lawyer testified in the hearing that his client in the engagement was ‘Constellis Holdings.’ Throughout his testimony, he referred to the taxpayer as ‘Academi.’ …

Bank records show that in January, April, May, and July 2017 and July and September 2018, Academi LLC and Constellis Holdings LLC wired six payments denominated in dollars to the Afghan Ministry of Finance. Academi LLC made the first three payments; Constellis Holdings LLC made the last three. Each transfer record lists the ‘Debit Account Name’ as ‘Academi Training Center Inc [sic] AP [accounts payable].’

In summary, the government of Afghanistan levied taxes against ACADEMI LLC. The taxpayer was ACADEMI. The payments were made to the Afghani government by two legal entities: Academi LLC and Constellis Holdings LLC. The payments were then recorded as costs of Academi Training Center Inc.

Thus, when IDS submitted claims for $36.7 million related to those tax payments, the Board was naturally confused. As a Footnote stated—

The Constellis witness testified that the organization internally ‘allocated’ the tax payments to the two task orders ‘[o]n a revenue basis, so, basically, as mentioned, within the system they accumulate revenue for their respective task orders. And so, it’s kind of pro rata allocation.’ IDS does not rely on this testimony, which we understand to mean that the organization had already decided that the payments related to the two task orders and chose an accounting method to record that conclusion.

It should not be surprising to our readers to learn that the CBCA found that IDS had not incurred any costs, either on its own or via allocation from a home office. “We further find no basis to allocate the payments made to Afghanistan by the two holding companies to IDS’s performance of task orders 9 and 11. … IDS’s failure to meet its ‘burden of proving’ that the claimed ‘costs were . . . allocable to this [particular] contract’ and the task orders is an independent basis to deny relief.” The Board continued, writing—

Were we able to find that IDS incurred the costs and that they were allocable, substantial doubt as to IDS’s entitlement to reimbursement would remain. Among other issues, although we know ACADEMI LLC and Constellis Holdings LLC settled assessments by the Afghan Government of taxes and penalties, we fundamentally do not know why those companies did so. The Board learned nothing, via expert testimony or otherwise, about the tax laws of Afghanistan in this case. We do not know on what basis in Afghan law the Afghan officials issued the demands to ACADEMI LLC to begin with. … As there is ‘no presumption of reasonableness . . . simply because [a contractor] incurred . . . costs,’ this would be a challenging record on which to show reasonableness, even without reaching the issue of allowability under the task orders.

So, yeah. No.

Which brings us back to our initial thoughts. Legal structures don’t normally impact on government contract cost accounting concerns—until they do. Taxes are one area in which cost accounting is impacted, since legal entities are taxable entities.

As government contract cost accountants, it’s important to be able to trace tax payments from the legal entity making them to the cost accounting entity in which costs are being accumulated (and/or allocated). In that regard, see the cost principle at FAR 31.205-41, CAS 403, and the DCAA Selected Areas of Cost Guidebook (Chapter 68). Those reference sources lead to an inescapable conclusion that proper and compliant allocation of tax payments is a complex undertaking.

Don’t make the effort to properly allocate tax payments even more difficult by creating complex, opaque, legal structures.

Last Updated on Tuesday, 05 April 2022 16:47

Retain Evidence

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A recent ASBCA decision contains a reminder that contractors should retain evidence and other documentation, even stuff that might not seem to matter now—but will matter in any dispute that goes to litigation.

Strategic Technology Institute, Inc. (STi) had received its first cost-type contract from the US Navy in 2008. As required by contract terms (i.e., clause 52.216-7), STI timely submitted its proposals to establish final billing rates (commonly called an Incurred Cost Proposal or ICP) for the two years of contract performance.


STi asserted that it timely submitted its ICPs; however, the government—particularly DCAA—had no record of receipt. STi (allegedly) submitted its proposals but no auditors ever showed up to audit the submissions. The situation stayed that way until 2014.

In July, 2014, “DCAA was auditing STi’s 2010 ICP, which would have been submitted in June 2011 -- three years earlier. The auditor found reference to 2008 and 2009 costs, and requested from STi copies of its 2009 and earlier ICPs. STi promptly provided the 2008 and 2009 submissions to DCAA. At this point in July 2014, the 2008 ICP had been prepared five years earlier.”

DCAA audited 2008 and 2009 and, based on that audit report, three years later the DCMA contracting officer issued a Final Decision demanding $1.1 million. The COFD was issued in November, 2018—"over nine years after the 2008 ICP was prepared, but less than four-and-a-half years after DCAA requested the ICPs from STi in July 2014.”

Before the Board, STi argued that the government’s claims were time-barred by the Contract Disputes Act’s six-year Statute of Limitations. The Board didn’t buy that argument—primarily because STi was unable to provide any evidence that it had actually submitted the proposals when the company said it had done so. Moreover, STi said that the passage of time prevented the company from actually disputing the government claim. Thus, if the Statute of Limitation argument failed, the company had nothing else to faill back on.

The argument failed.

The Board’s decision stated—

We hold that the contract required STi to submit its ICPs, and that STi has not established, by a preponderance of the evidence, that it submitted its ICP prior to July 2014. Additionally, we hold that the government did not know and had no reason to know of its claims against STi until it received the 2008 and 2009 ICPs in July 2014. Accordingly, we sustain the government’s claim, reject STi’s statute of limitation defense and deny the appeals.

The lesson here is simple: retain evidence that the proposals were submitted. Do not rely on the government agreeing with you as to when (and if) they were submitted. Obtain confirmation. Print out the confirmation and retain it in your ICP support files.

You have ICP support files, don’t you?

You are going to experience turnover in personnel. You are going to have documents sent to storage or otherwise purged. Consequently, you are going to want to have robust files related to all significant decisions made during the account “scrub” and proposal preparation process.

If you don’t have such files, you risk ending up as STi did, with no ability to dispute DCAA’s audit findings, because you simply lack the documentary evidence to disagree with them. Not a great place to be in, is it?

I remember when we went to support the government audit of our 1986 proposal to establish final billing rates. This was back in the day when general ledgers were printed out, bound, and retained. We had taken all the old general ledgers and put them in an unused room, awaiting audit. When the audit finally came (in the late 1990’s—please don’t ask why it took so long), we went to pull the 1986 general ledger to show the auditors how our ICP reconciled … only to find that somebody had “cleaned” the office by throwing out all the documents that we had carefully retained.

What did we expect was going to happen? The office was unused, and filled with papers more than a decade old. Of course somebody was going to clean up the mess! (Or so it was explained to us.)

Anyway, that made the audit support of the 1986 ICP rather challenging, to say the least.

Don’t be like STi or like the company I worked for in the late 1990’s. Retain your documents. Label them. Ensure they are not thrown away.

If you do all that, your audit will go better, I’m sure.


Compliance with Labor Law Stuff

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I’m always surprised when government contractor personnel don’t want to cooperate with auditors’ requests for information. What did they expect was going to happen when they accepted that government contract?

To be clear, though, there are boundaries that should be enforced. Government auditors aren’t entitled to everything. They are, however, entitled to request and review most things. Knowing those boundaries is a key part of what every compliance practitioner needs to know. The other aspect of knowing those boundaries is explaining them to employees—often executives—who don’t know and probably don’t care, and most certainly do not want to provide to the auditors what they have requested.

They signed the contract but they didn’t read the fine print, the part in Section I where those pesky “clauses incorporated by reference” are listed. Too bad because, if they’d known what they were signing up for, they might not have signed. Or—more likely—they would have signed anyway, because revenue. But at least they would have had a clue.

Now, either during performance or perhaps after performance is complete, a government audit is happening. Auditors are requesting information, and they (quite reasonably) expect the company to provide the information requested. But somebody doesn’t want to provide the information. Why? Maybe they’re too busy right now, overwhelmed with all the other stuff they need to be doing. Or maybe they see the audit request as being unreasonable, over-the-line, beyond the pale. Government overreach. They’re just objecting based on principle.

Or maybe they have something to hide.

There’s very often no way to tell what’s really going on. Nobody can read minds. (Or, if you can read minds, then you are definitely in the wrong line of work.) But what’s often forgotten in the internal debate over what can and should be provided to the auditors is the point that the auditors can’t read minds either. They don’t know why the company won’t provide what they’ve requested—and they often default to the worst position: the company won’t provide the information because there is something to hide.

We were reminded of the rules about what can and should be provided versus what should not be provided by this news brief issued by the Department of Labor. As you can see (if you follow the link), the Department of Labor Administrative Law Judges have ordered a government contractor to provide information and documents related to a review of the contractor’s affirmative action program.

As we reviewed the case, it seems that this issue has been in play since 2013. Yes, that’s right. For eight years, a government contractor has disputed the Department of Labor’s right to review its affirmative action plans.

Anyway, after eight years of dispute (and eight years of paying attorney fees), the government contractor was told in no uncertain terms to comply “upon penalty of debarment and contract termination.” That would be quite a hit to the company’s revenue, we believe. Not a great hill to die on, in our view.

The DoL Judge found that the contractor “violated 41 C.F.R. § 60-1.12(c)(2) by failing to provide its written affirmative action programs and supporting data upon request, and that Defendant did not have good cause to excuse the violation.” This was after the contractor had argued that the audit requests were “unconstitutional under the Fourth Amendment because OFCCP has failed to articulate a basis for having selected any of [the contractor’s] facilities for compliance review according to a neutral administrative plan. [The contractor] further argues that the number of document requests is unreasonably burdensome….”

Yeah, no.

Defendant [the contractor], through its officers, directors, partners, representatives and agents, jointly and individually, shall provide all information Plaintiff [the Department of Labor] requested in the scheduling letters that were identified in the administrative complaints filed in these consolidated cases. Defendant shall provide the information to Plaintiff’s representatives no later than 4:00 PM on the business day next following the thirtieth calendar day after this Order becomes final under the law.

Should Defendant fail to comply with the Order set forth above, Plaintiff is directed to take all administrative steps necessary to terminate all existing Government contracts held by Defendant, jointly and individually, and to debar Defendant from receiving and participating in any future Government contracts for a period of at least three years or until Defendant complies with the provisions of EO 11246, the VEVRAA, the Rehabilitation Act, and 41 C.F.R. Chapter 60, whichever period is longer.

The next time some executive in your company wants to dispute the government’s right to request, receive, and review documents for which it clearly has the authority to request, receive, and review, we suggest you mention this little lesson.


Recorded Versus Incurred Costs

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An accrued expense refers to when a company makes purchases on credit and enters liabilities in its general ledger, acknowledging its obligations to its creditors. In accounting, it is an expense incurred but not yet paid. … An accrued liability represents an expense a business has incurred during a specific period but has yet to be billed for.” – The Corporate Finance Institute

It’s always been a bit of a pet peeve that GAAP-compliant accrual accounting is insufficient for compliance with government contract cost accounting—primarily the FAR and CAS requirements that drive “allowable” costs. Most companies that have to prepare, submit, and support an audit of their “proposal to establish final billing rates” (popularly but incorrectly called “the incurred cost submission”) know this fact.

Adjusting GAAP-compliant general ledger balances to create compliant “claimed costs” and the resulting indirect cost rates is time-consuming and, in general, subject to human error. It would be so much easier (and cheaper) to just submit the year-end balances, let an independent public accounting firm audit them, and then let the government rely on the results! But we don’t do that, do we?

Instead, we make adjustments. One of the most common adjustments is to “true-up” year end bonus/incentive compensation accruals to the amounts actually paid. For example, let’s assume the company has a 12/31 year-end (calendar and fiscal years match). Let’s say that, before the books close for the year on 12/31, the company budgets annual bonus payments at $10,000,000. But the company won’t pay that amount to its employees until next February. So it accrues the liability on the books. The company knows that it will pay, and the auditors know that the obligation to pay the bonuses is real and the bonuses are related to the current year’s results—but the company and the auditors (and the employees) know the bonuses won’t be paid for roughly 60 days. It’s a legitimate accrual of a known liability.

Because the liability was recorded, an accrued expense entry is also recorded. This is because the accrued expenses related to current period’s operations and results. In other words, the famous “matching principle” requires the expense to be matched to the revenue to which it relates. If the expense entry weren’t made, then profits for the year would be overstated.

Okay so far? I mean, this is a really simplistic view of things—but I’m trying to get across the important concepts. GAAP requires that the liability to pay bonuses be recognized, and the recording of the liability triggers the recording of an accrued expense. All based on budgeted (or estimated) values. This is fine. This is normal.

But then government contract accounting says “wait a minute!” The auditors show up and ask how much was really paid in February? It’s not exactly $10,000,000! Why not? Well, because several people left the company in January and February, forfeiting their right to collect their bonuses. The company thought it was going to pay the bonuses when it accrued them in December, but it turned out that those particular payments weren’t actually made in February. Let’s say the company paid-out $9,500,000 instead of the $10,000,000 it had accrued. In that case, government auditors expect that the company will “true-up” its claimed expenses by reducing them by $500,000.

What’s good for GAAP isn’t necessarily good for government contract cost accounting.

Shrug. It’s just the way it is. Court after court after court has accepted the notion that GAAP and FAR/CAS don’t always match up. (Though Congress directed that the CAS Board “conform” CAS to GAAP as much as possible … still waiting for any official movement on that.) So we accept it and deal with it, and continue to make those adjustments so that GAAP-compliant expense ledgers are now FAR and CAS compliant claimed costs.

A recent case at the ASBCA caused Judge O’Connell to review the differences between “incurred” and “actual” costs—or, as we would say, between “recorded” and “actual” costs. Because yes, indeed, there is a difference.

Cellular Materials International (CMI) had several cost-type contracts with the Department of Defense (DoD). As required by the Allowable Cost and Payment clause (52.216-7), CMI submitted its proposals to establish final billing rates for its Fiscal Years 2010 through 2014. As Judge O’Connell wrote—

Initially, the Defense Contract Audit Agency (DCAA) informed CMI that its proposals were low risk and would not be audited. But after receiving this notice, CMI revised its 2010-2014 proposals to add $425,000 ($85,000 per year) in general and administrative (G&A) costs for a consultant, Mr. Haydn Wadley.

(References and citations omitted, as they will be from all direct quotes from the decision.)

Let’s start there. CMI submitted its proposals, was told they would not be audited and, upon receiving that notice, decided to add in some more costs. Yeah, like that wasn’t going to raise red flag.

What were the additional costs? They were for a consultant. A consultant who just happened to be “CMI’s largest shareholder, owning up to about 39% of the shares during this period.” Um, yeah. Not suspicious; not at all—right?

Surprising nobody who reads this blog, DCAA auditors questioned the additional costs. All of them. Apparently, another $86,119 of other G&A expenses were questioned as well. (The decision doesn’t address them.)

The Contracting Officer issued a final decision, unilaterally establishing the final indirect cost rates at rates that included a disallowance of $511,119.

CMI appealed and, during discovery—

… it produced to the government various documents, including 31 canceled checks, that resulted in the government agreeing that CMI had made $219,583.23 in payments to Mr. Wadley and that these payments were allowable costs. The parties were also able to resolve the portion of the dispute that did not relate to Mr. Wadley, which amounted to an additional $86,119.

Leaving $205,416.57 still in dispute before the Board.

CMI believed that it had supported the majority of the costs still in dispute. To that end—

… CMI has provided the government 27 promissory notes executed each month from October 2012 to December 2014 in which CMI promised to pay Mr. Wadley the amount of $7,083.33, for a total amount of $191,249.91. The notes do not provide for interim payments or contain a date for repayment, other than to state that they are payable five days after demand. As an explanation, Les Gonda, President and Chief Executive Officer of CMI, and Mr. Wadley, in a joint affidavit, state that Mr. Wadley did this ‘due to his belief in the future potential of CMI’. Mr. Wadley has not demanded payment … CMI also represented to the government that it issued checks to Mr. Wadley totaling $14,166.66 in December 2011 and September 2012 that remain uncashed.

As noted above, Judge O’Connell had to delve into the meaning of FAR 51.216-7(d). He wrote—

The contractor is required to submit a final indirect cost rate proposal. FAR 52.216-7(d)(2)(i). The rates it proposes ‘shall be based on the Contractor’s actual cost experience for that period.’ FAR 52.216-7(d)(2)(ii) (emphasis added). The government contends that ‘actual cost experience’ is synonymous with ‘actually paid’ and because CMI has not made any payments on the promissory notes, these costs are not allowable.

FAR 31.0013 provides that ‘actual costs means... amounts determined on the basis of costs incurred, as distinguished from forecasted costs...’ The FAR does not provide further guidance as to when a cost may be considered to have been incurred and when it is merely forecasted.

The Judge cited several legal decisions. As part of his analysis, Judge O’Connell noted that the Federal Circuit had cited to Black’s Law Dictionary. (“The Federal Circuit cited Black’s Law Dictionary to define incur as meaning “to suffer ‘a liability or expense.’”)

Citing to a case involving a petition for damages under the Vaccine Act, Judge O’Connell quoted the following—

[i]n ordinary usage, ... to ‘incur’ expenses means to pay or become liable for them. In one common usage, a person becomes liable for yet-to-arise expenses at the time of undertaking an obligation to pay those expenses if and when they arise. See Liability, Black’s Law Dictionary (10th ed. 2014) (defining liability as the state ‘of being legally obligated or accountable,’ through civil or criminal penalties).

Judge O’Connell also wrote—

In UMC Electronics Co. v. United States, 43 Fed. Cl. 776 (1999), aff’d 249 F.3d 1337 (Fed. Cir. 2001), the Court of Federal Claims considered the meaning of actual costs in the context of fraud counterclaims filed by the government. In that case, the contractor represented that its claim was based on actual costs. The court found, however, that the claim was based on purchase orders to subcontractors so that it sought, for example, payment for materials that the contractor never received and for which it never received invoices. Relying on the FAR 31.001 definition of ‘actual costs’ discussed above, the court held that a cost is incurred ‘when a person becomes legally bound to pay.’ The court recognized that at some future date the contractor might become liable for some of the unbilled costs, but rejected the contention that such a future cost could be considered an actual cost.

These decisions illustrate the fact intensive nature of determining when costs are incurred. Collectively, they demonstrate that a future expense must be more than merely likely or probable to be an incurred cost. …

It is undisputed that more than nine years after execution of the first note, Mr. Wadley has not demanded payment, and that the notes require Mr. Wadley to make a demand before payment is due. Even if the Board were to assume that there is a ‘near-certain future prospect’ that Mr. Wadley will demand payment, he has refrained from doing so. CMI’s liability to pay has not attached because Mr. Wadley has not taken the action necessary to trigger CMI’s obligation. Or, to use the Court of Federal Claims’ formulation, CMI is not legally bound to pay until Mr. Wadley demands payment. Accordingly, for purposes of FAR 31.001 and 52.216-7(d)(2)(ii), the Board holds that the consulting costs at issue are not incurred costs but are best described as ‘forecasted costs.’ Thus, the contracting officer correctly determined that these costs are not allowable.

In this case, the Board found that CMI had not incurred costs and it was not permitted to claim those costs as allowable expenses for government contract accounting purposes—even though it had (we assume) accrued them as liabilities on its balance sheet.

Whether or not one agrees with this decision, it is striking that no discussion of accrual accounting requirements under GAAP was made. There was no discussion of the validity of accrual accounting entries with respect to what costs have been “incurred” for government contract accounting purposes.

We noted that CMI was represented by the company’s CEO and not by a law firm well-versed in government contract disputes. Did the choice of representation affect the outcome? We couldn’t say.

However, we will venture the opinion that this case continues the worrisome trend of judges and lawyers trying to parse accounting concepts without the benefit of the opinions of actual accountants in the courtroom. In this case, we think the additional input would have been beneficial to the Board.


Global Fraud Resolution

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With not much happening in terms of regulatory changes or DCAA audit guidance updates—and with nothing happening at the CAS Board—we have scaled back the frequency of blog articles. When we do post, it is likely to be about a Department of Justice settlement. Even then, we try to restrict those articles to something that may be informative, something that may impart a lesson learned to our readers.

Today, as we wind up 2021, we have another DoJ settlement and (hopefully) another lesson for our readers.

On December 22, 2012, the Department of Justice announced that it had reached a “global resolution” of both civil and criminal matters with the contractor, Balfour Beatty Communities, LLC (BBC), an entity that was described as “one of the largest providers of privatized military housing to the U.S. Armed Forces.” (BBC operated 55 military housing communities for three different services, according to the DoJ press release.) The resolution involved BBC pleading guilty to one count of major fraud against the United States (18 U.S.C. § 1031)(a)(1)). In addition, BBC agreed to pay “over $33.6 million in criminal fines and over $31.8 million in restitution to the U.S. military, serve three years of probation, and engage an independent compliance monitor for a period of three years.”

But wait. There’s more. “Separately, BBC also entered into a False Claims Act settlement with the United States to resolve its civil liability for $35.2 million. The amounts paid under the civil settlement will be credited against the amounts owed under BBC’s criminal plea.”

So basically, almost $66 million. Not a small settlement, not at all.

What had BBC done to warrant such a significant payment?

According to the press release, BBC employees falsely claimed that the company had met contractual performance objectives in order to obtain quarterly (or semi-annual) performance incentive fees. The relevant contractual objectives related to timely performance of maintenance services and resident satisfaction with BBC’s management. “BBC employees altered or manipulated data in property management software and destroyed and falsified resident comment cards to falsely inflate these metrics and, ultimately, to fraudulently induce the service branches to pay performance incentive fees which BBC had not earned.”

In addition, “the military service branches were provided an inaccurate assessment of the state of BBC’s military housing communities and were unable to assess, and potentially correct, BBC’s performance.”

The size of the fine was affected by a number of factors, “including the nature and seriousness of the offense, the pervasiveness of the misconduct among BBC’s employees and at multiple military installations, and the state of BBC’s compliance program and the progress of its remediation, including the fact that BBC’s compliance program and internal controls [had] not been fully implemented or tested to demonstrate that they would prevent and detect similar misconduct in the future.”

Finally, the announcement stated that two BBC employees had been individually charged with offenses related to the scheme, and both had pleaded guilty earlier this year.

What lessons can be learned from this?

First, many contractors have award-fee contracts or incentive-fee contracts that require a contractor’s self-assessment. Other contracts make the self-assessment optional. In either case, contractors must be clear that their self-assessments are legal documents, subject (at a minimum) to the False Statements Act. And, as this case clearly shows, false statements (or documents) may lead to allegations of violations of the False Claims Act (or the Major Fraud Act). Therefore, contractors must take care to ensure that their self-assessments are factually correct to the best of their ability. There is a natural, human, tendency to puffery in such things—but that tendency must be tempered with the knowledge that an intent to deceive could have catastrophic consequences for the company that far exceed the award or incentive fees earned. Those consequences could (and, in this case, did) extend to individual employees.

Second, note that, once again, a contractor was heavily fined for an inadequate compliance program and associated internal controls. Contractors who have accepted contracts that contain FAR clause 52.213-13 (“Contractor Code of Business Ethics and Conduct”) are urged to read it closely and to take its requirements seriously. The money you save by implementing a robust compliance program and associated internal controls may be sufficient to repay your investment, several times over.

Link to DoJ’s charges is here.

Link to BBC’s plea agreement is right here.

This is likely the last 2021 blog article. We wish for you peace and prosperity in 2022!


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Effective January 1, 2019, Nick Sanders has been named as Editor of two reference books published by LexisNexis. The first book is Matthew Bender’s Accounting for Government Contracts: The Federal Acquisition Regulation. The second book is Matthew Bender’s Accounting for Government Contracts: The Cost Accounting Standards. Nick replaces Darrell Oyer, who has edited those books for many years.