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Welcome to Apogee Consulting, Inc.

Commercial Items in a Cost-Plus Environment

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We have written several articles covering acquisitions of commercial items. This will be another! But if you are unfamiliar with commercial item contracting, please don’t start with this one. Instead, go to the site search feature (which is on the upper right corner of the home page), or else use the “Title Filter” on the top of the News Archive page, and search using the term “commercial”. You should see about four or five worthy starting points.

We have written several articles covering our concerns about the tendency of DCAA and DCMA to “push around” small businesses. This will be another! Again, there are three or four worthy articles that provide background and anecdotal evidence supporting our concerns in this area.

We have written a few articles covering the challenges faced by contractors seeking to properly value inter-organizational transfers (aka intercompany transfers, aka inter-divisional transfers, aka intracompany transactions, aka inter-company subcontracts—which we will simply acronymize as “IOTs”). This will be another! Here’s a link to a good starting point. In another brief article (posted in 2010), we noted that Bell Textron had resolved allegations of violations of the False Claims Act related to the pricing of its IOTs by agreeing to pay the U.S. Government some $16.6 million.

With all that as background, let’s assert a few opinions right off the bat.

  1. The Department of Defense has difficulty in dealing with commercial item determinations (CIDs). It has difficulty in accepting a contractor’s CID. It has difficulty accepting the lack of cost or pricing data that is part and parcel of commercial item contracting, since by definition the price is established by the marketplace. It has difficulty in accepting the profit inherent in commercial items. DoD COs, as a rule, just plain don’t like commercial items. (As Vern Edwards recently posted on the WIFCON forum: “Most of the problems with commercial item assertions have arisen in connection with DOD purchases of spare parts. … The main difficulty is COs who feel they must apply a ‘beyond a reasonable doubt’ standard when making their commerciality determinations in order to avoid criticism. This is yet another reason why DOD needs its own acquisition regulation, if for no other reason than to free everybody else from the insanity of its [own] processes.”) In an attempt to stop “the insanity” DoD has recently created six Commercial Item Centers of Excellence to “advise Procuring Contracting Officers (PCOs) in their determinations of commerciality."

  1. Congress is aware of DoD’s difficulties in this area. The 2017 National Defense Authorization Act contained an entire Subsection F, with multiple provisions intended to help DoD in its struggles with commercial items.

  1. DCAA has even more trouble dealing with commercial items than the COs do. They don’t like commercial items because there’s nothing to audit. About the only thing an auditor can do is to assert that a commercial item price is unreasonable—which is crazy if you think about it, because by definition the price paid in the free and open market is the essence of price reasonableness.

  1. We have seen (and written about) DCAA’s propensity for asserting that a contractor’s accounting system is inadequate when a contractor has the temerity to disagree with a DCAA position. It’s the biggest club DCAA has and, even if there are no payment withholds associated with the system inadequacy determination, the fact is that it is a body blow to the reputation and competitive position of a contractor. For a small business that is desperate for new contract awards, it may well be the action that puts that company out of business for good. The only defense to a DCAA attempt to run roughshod over a contractor is the “independent business judgment” of a CO; and that is a hit-or-miss proposition (at best). There seems to be no consequences to any Government party for a determination that a contractor’s accounting system is inadequate, even if it is later shown to have been a egregiously wrong determination without any rational basis whatsoever. That’s a shame, in our view.

Okay. At this point, you may well be asking, “where in the heck is this article going?” We have an answer: It’s going here.

“Here” is a link to an ASBCA decision, published 8 February 2017, in the appeal of A-T Solutions, Inc. (We are happy to report that the ASBCA website seems to have come back from the Error 403 land of the dead.) The decision was written by Judge O’Sullivan on behalf of the Board. ATS was represented by the firm Crowell & Moring, who said of the decision, “in rare litigation over the pricing of items transferred between a contractor’s commonly controlled subdivisions, C&M successfully appealed a Contracting Officer’s refusal to pay commercial prices for materials a contractor had transferred between its business units.”

As you can see from that one sentence summary, the Board’s decision involved commercial items, IOTs, and a CO’s decision that IOT’s valued at price, based on a CID, were unreasonable. What you didn’t see (but will!) is that ATS was a small business that was being unjustly pushed around by DCAA and, rather than stand up for the company, the cognizant CO simply rubber stamped the DCAA audit findings (which included a finding that the accounting system was inadequate because the company refused to agree that it’s commercial item IOTs should be valued at cost). Pretty much everything we recited above is found in this one decision.

You ready to dig into it? Good.

In 2009 ATS was awarded a contract to provide training for armed forces to help them defeat the threat of Improvised Explosive Devices (IEDs). The contract type was cost-plus-fixed-fee (CPFF). It was to be awarded on a competitive basis. (Four proposals were received.) ATS was the incumbent contractor, previously having been awarded a firm, fixed-price on a sole source basis as well as a follow-on firm, fixed-price contract on a competitive basis. It was the successful bidder once again, being the low bidder while receiving top technical scores

In the prior contracts, “ATS provided its training materials and equipment as commercial items and was paid for them at its catalog prices.” Its proposal for the cost-type contract was summarized by Judge O’Sullivan as follows:

ATS proposed to bill direct labor, consultants, and subcontractors at cost plus a fixed fee calculated at 9% of estimated cost. ATS proposed to bill travel at cost (no fee). ATS proposed to charge for its commercial item training materials and equipment at the catalog prices attached to the proposal … Finally, consumable items bought locally would be billed at incurred cost (no fee).

ATS’ proposed price was accepted by the government “without further negotiations,” based on the price analysis performed as well as the cost realism analysis, and the finding that its price was “realistic, fair and reasonable.”

Starting in October 2009, ATS began to invoice for training materials and equipment at its catalog prices. The invoices were paid “promptly and in full.” This all changed when, a few months later, DCAA showed up at the small business to conduct an audit of “contract costs.” As Judge O’Sullivan wrote, “Because DCAA did not accept ATS's position that it need not provide cost information for items that had been proposed and accepted at price, and the Army deferred to DCAA, ATS suspended its billing for the training materials and equipment in February of 2010 …” That was the first injustice done to ATS. DCAA’s position that it had magical access into commercial item costs, instead of simply accepting the catalog pricing as a given, led to a decision by ATS to forego a significant portion of its due cash flow—potentially crippling the small business. It would not be the last injustice.

Note that the Army “deferred to DCAA” instead of exercising independent business judgment as required. It would not be the last deferral and refusal to exercise independent business judgment.

The DCAA audit report was damning. It stated—

In our opinion, ATS' accounting system is inadequate for accumulating and billing costs under Government contracts. Our examination disclosed a significant deficiency that is considered to be a material weakness in the design or operation of the accounting system. We determined the contractor is not currently billing material at cost as required under a cost reimbursable contract. In our judgment, this deficiency could adversely affect the organization's ability to initiate, authorize, record, process, and/ or report costs in a manner that is consistent with applicable Government contract laws and regulations. As a result, we recommend you pursue suspension of a percentage of reimbursement of costs in accordance with DFARS 242.7502.

We determined ... the contractor is billing costs associated with its training aids at catalog price rather than at actual unit cost. During discussions with [the] chief financial officer, we determined the contractor is continuing a practice started under the original firm-fixed-price contract. However, the contractor's current contract, which began in late 2009, is cost-plus-fixed-fee. Cost reimbursable type contracts require materials to be tracked and billed at the base cost level, unless otherwise stated in the subject contract.

Let’s stop right there and review the bidding. ATS had established the commerciality of its training aids and that commerciality had been accepted by the government. ATS had established a cost accounting practice of transferring those items at price, rather than at cost, in its previous contracts. ATS had proposed those items at price and expressly called attention to its practice in its proposal, which had been accepted without further negotiation or discussion, because the price was obviously fair and reasonable.

Now DCAA was expressing the opinion that the CPFF contract type required ATS to change its established cost accounting practices. DCAA was expressing the opinion that ATS was required to account for costs in a manner different than it had proposed them. DCAA was expressing the opinion that government acceptance of the commerciality of the costs and acceptance of the resulting price somehow didn’t matter anymore.

We are at a loss to understand where in existing audit guidance those positions came from. We are fairly sure there’s nothing anywhere that would have supported those positions. We are confident that any reasonable supervisory or higher level review would have noted that the position(s) were untenable and based on nothing more than legal conclusions regarding how commercial item accounting was supposed to work. There is nothing in the quoted pieces, above, that support the notion that the audit report was compliant with Generally Accepted Government Audit Standards (GAGAS).

Yet DCAA issued that adverse audit report anyway.

In the spirit of fairness, we have to tell you that DCAA did have one piece of evidence. The auditors had a report from ATS’ Deltek CostPoint accounting system that showed the inter-organizational transfer at cost. However, had the auditors’ done a lick more of work, they would have seen that the report had been issued at the enterprise level—i.e., including consolidation and elimination of intercompany profit as required by Generally Accepted Accounting Principles (GAAP). But the auditors were satisfied that their single report—a report that they had wrongly interpreted—was sufficient evidence to support their legal theory. And no amount of protestation from ATS was going to change their minds. (Which is another GAGAS violation, but whatever.)

As noted, DCAA not only refused to listen to ATS’ arguments, it told ATS (and the contracting officer) that ATS “would have to prove it was capable of accumulating costs on the JATAC contract to prevent its accounting system from being found inadequate. … ATS thereafter, in order to avoid an adverse determination of inadequacy, submitted a ‘Corrective Action Plan’ to provisionally bill its products at fully burdened cost until the dispute could be resolved.” In other words, the price for disagreeing with DCAA’s legal theory was an inadequate accounting system. If this weren’t the government, we would be throwing around words like “extortion” and “bad faith” and “fraud in the inducement” but, of course, this is the government so Hanlon’s Razor applies. (Look up that reference.)

And where was the contracting officer in this Charlie Foxtrot? Nowhere to be found.

In March, 2014, ATS submitted a certified claim to the CO, asking for the $9.8 million that it had wrongfully withheld from the small business. It was denied. The CO—

... observed that using catalog pricing ‘to support a proposed estimated cost in a competitive acquisition’ was ‘appropriate’ but would not influence ‘how payments are actually disbursed on a CPFF contract.’ She also found the commerciality of the materials not relevant, since the government's requirement ‘as a whole’ was non-commercial. While commercial materials could be provided under the contract, she stated, ATS's accounting for the cost of materials must conform to the cost principles and procedures of FAR Part 31 and the terms of the cost-type contract.

The CO also agreed with DCAA that the IOTs of the commercial items had been made at cost, not price—as well as using “the misimpression” that “DCAA had ‘determined ATS's accounting system [to be] inadequate’ to meet the FAR requirement for billing at price” as additional justification for the denial.

Calling that a “misimpression” was a kindness on Judge O’Sullivan’s part. In our view, it betrays a complete misunderstanding of so many things that we think the CO should have her warrant pulled. First, DCAA does not get to make determinations of accounting system adequacy—that’s the CO’s job. The fact that she didn’t get that speaks volumes to her level of knowledge and expertise. Second, an accounting system is either adequate or it’s not. There’s no “adequate for this but not that” in this area. It was a fact that DCMA had found ATS’ accounting system to be adequate (because it had caved to DCAA’s legal position)—and that was all that mattered. The CO seemed to have forgotten that “adequate means adequate” in her haste to support her COFD.

As Judge O’Sullivan wrote for the Board, FAR 31.205-26(e) provides an exception to the normal requirement that IOTs must be based on cost. IOTs may be based on price “when (1) it ‘is the established practice of the transferring organization to price interorganizational transfers at other than cost for commercial work of the contractor or any division, subsidiary or affiliate of the contractor under a common control’; (2) the item being transferred qualifies for an exception to the requirement to submit cost or pricing data under FAR 15.403-l(b); and (3) the contracting officer has not determined the price to be unreasonable.” In this case, the government conceded that ATS met requirements (2) and (3) but argued that it didn’t meet the first requirement.

The government advanced two theories supporting its argument that ATS didn’t meet the first requirement. “First, because ATS's transfers of training materials … lacked ‘economic substance’ and therefore do not qualify as transfers within the meaning of the relevant cost principle. Second, because even if the transfers qualify as such under the cost principle, the transfers were at cost, not price.”

Judge O’Sullivan quickly disposed of the first “economic substance” theory, writing—

… the cost principle does not impose a requirement that the transfers in question have ‘economic substance,’ and the government's support for urging us to adopt such a test is thin: a bare citation to a section of a cost accounting treatise that purportedly lists examples of interorganizational transfers (neither the text of the treatise nor the context was supplied to the Board) and a citation to a Cost Accounting Standards regulation that addresses when transfers between affiliates will be deemed ‘subcontracts’ for purposes of CAS coverage. We decline the government's invitation to read an ‘economic substance’ requirement into the cost principle at issue. The government has failed to establish the existence of such a requirement or to suggest how a court or Board could tell if it had been met in a particular case.

(We note that Judge O’Sullivan could have also mentioned that the government’s reference to CAS was inapposite, since ATS was a small business and therefore exempt from CAS coverage.)

Judge O’Sullivan wrote further—

The fact that training materials never left the Logistics and Production division at anything other than price, and that there were valid business reasons for crediting that division with a sale at commercial price whether the transaction was external or internal, carries great weight. Additionally, we do not see how the accounts receivable amount for sales of training materials could be posted to the Training division account rather than the Logistics and Production account if there had not been a transfer of the materials. That the transfer may be essentially pass-through in nature does not prevent its recognition.

The government's argument that the transfers were recorded at cost rests on the proposition that any transfer between divisions would have had to take place before ATS sold the materials and issued the invoice, but since the first and only time the transaction is recorded at price is when the sale is made to the customer, ipso facto, if a prior transfer occurred at all, it must have occurred at cost. The government produced no evidence or law in support of this proposition. To the contrary, the United States Court of Appeals for the Federal Circuit has recognized in its United Technologies decision that more than one valid transaction may take place simultaneously, and ATS has produced credible evidence that such transfers were recorded by the transferring division at commercial catalog price.

(Emphasis added. Internal citations omitted.)

So there you have it.

Literally eight years after contract award, ATS was permitted to bill its commercial item IOTs in the way it had consistently accounted for them, in the way it had proposed them, and in the way that the government had accepted when it agreed on the contract price.

Our opinion of the government’s actions in this fiasco have not exactly been hidden. The role of a DCAA auditor to render an impartial and independent opinion has been called into question. The role of the DCAA supervisory auditor and higher-level reviewers, who allegedly ensure that the audit report complies with GAGAS, has been called into question. The role of the contracting officer, who is not supposed to defer to DCAA but, instead, to render an impartial decision using independent business judgment, has been called into question. Nobody on the government’s side has been covered with glory, in our view.

And what of ATS, that small business who kept on providing important training services to the warfighter while being denied a significant amount of cash flow it could have used to support its operations? That company who patiently pointed out DCAA’s errors until faced with a Draconian penalty for failing to cave in? In our view, that company seems to be the only entity in this story that did the right thing for the right reasons. In a perfect world, DCAA Director Bales and DCMA Director Lt. Gen. Masiello would proffer written apologies to ATS and subject their employees to disciplinary action.

But the world of government contracting is far from perfect, isn’t it?

Last Updated on Thursday, 16 March 2017 19:12

Accounting for IRAD Expenses

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Accounting for Independent Research & Development (IR&D or IRAD) expenses is hard to do. There’s a cost principle (31.205-18) that discusses the allowability of such costs, but that cost principle also discusses the allowability of Bids & Proposals (B&P) costs. IR&D and B&P expenses are treated similarly, but they are not the same. So the first thing to do is to parse out what parts of 31.205-18 apply to which expenses.

When you do that, you get a definition of the kinds of activities that qualify as IRAD expenses. But that’s not the end of the story, not by a long shot. At that point, the cost principle points you to CAS 420 and tells you that you need to comply with that Standard in order for your IRAD costs to be allowable. (This is a news flash to many small businesses that think they are exempt from CAS. If they have a cost-type contract that belief is (unfortunately) not true.)

IRAD expenses are “period” expenses, which means that in almost every circumstance they will be accounted for as “below the line” costs in the fiscal year in which they are incurred.

At its most fundamental level, proper IRAD accounting requires compliance with the requirements of both 31.205-18 and CAS 420. But that’s not the end of the story, not by a long shot. Because what about concurrent IRAD and contract work, where the end product of a successful IRAD project will be a technology that will be inserted into an active contract? You need to separate the two cost streams (direct contract work and IRAD work) for both financial reporting and government contract accounting purposes. That can get messy, to say the least.

You need to keep the costs separate because (as noted) IRAD expenses are period expenses, but direct contract costs are “costs of goods sold” or “costs of sales” which is something entirely different. Moreover, for government cost accounting purposes IRAD costs are recovered through the General & Administrative (G&A) expense rate whereas direct contract costs are recovered by charging them to the contract as incurred, dollar for dollar. It makes a difference; it makes a big difference.

And then you have manufacturing and production engineering costs, which are similar to IRAD costs but not IRAD. Take a look at the 31.205-25 cost principle (which almost nobody does because that’s one of those cost principles that you don’t need to know, until you really need to know it). That cost principle defines manufacturing and production engineering costs as (among other things) “developing and deploying new or improved materials, systems, processes, methods, equipment, tools and techniques that are or are expected to be used in producing products or services.” The development of new stuff sounds a lot like IRAD (that would be the “development” part of independent research and development), but in this case it’s not, because it’s manufacturing and production engineering costs. Generally speaking, such costs are charged to overhead, but there is also the possibility that they could be capitalized and amortized ratably over future years in accordance with the depreciation cost principle at 31.205-11. The key thing is that they are not subject to CAS 420 and they are not recovered through the G&A expense rate, so you need to keep them separate from IRAD expenses.

So now we have direct contract costs and we have overhead costs and we have G&A costs—and we could maybe have capital assets on the balance sheet—and the poor contractor is expected to keep all that straight and separate, even though the activities all kinda sorta look alike and may well be performed by the same people. It’s hard, surprisingly hard, to get this right. It’s easy to mistake one thing for another, especially if you are an engineer working on a complex development project that involves new tooling and new technology and some contract required stuff, and you have three or four charge numbers but you don’t have solid direction about which part of the complex development activity goes where. That situation can create inadvertent mischarging, which could be a problem if the mischarging is systemic and you have a large number of engineers putting the wrong hours to the wrong charge number, and the streams of costs, which are supposed to be kept separate, get crossed and you have direct costs in the IRAD costs or overhead costs in the IRAD costs. That’s a bad situation because, if that happens, from a financial reporting perspective you have screwed up your cost of sales and your period expenses.

But even worse than that is that, from a government contract cost accounting perspective, you have too many costs in your G&A expense pool and not enough costs in your G&A expense allocation base, which is a double-whammy that really jacks up the G&A expense rate higher than it should have been. (Mathematically you have increased the numerator while at the same time decreasing the denominator, which is really going to increase the resulting rate.)

Jacking-up your G&A expense rate is really bad news if you have been billing that jacked-up G&A expense rate to your government customers on cost-type contracts, and also using that jacked-up G&A expense rate in your cost proposals for firm, fixed-price contracts. In the former case you have billed more than you should have billed, and in the latter case you have bid more than you should have bid.

If the Government believes that you have jacked-up your G&A expense rate by failing to keep the separate activities separate and crossing the streams, and that your failure was large enough and systemic enough to warrant an allegation of “reckless disregard” or “deliberate ignorance” then you may well face charges that you violated the False Claims Act.

Which is very bad news indeed.

Which brings us to a recent Department of Justice press release, in which we learned that Sierra Nevada Corporation (SNC) recently paid $14.9 million to settle allegations that it violated the False Claims Act by “misclassifying certain direct contract costs and Manufacturing and Production Engineering costs as Independent Research and Development (IR&D) costs, and charging certain IR&D costs in the wrong cost accounting period.” According to the DOJ, "this improper characterization of costs artificially inflated General & Administrative overhead (sic) rates paid to SNC across its federal contracts and resulted in overcharging federal agencies.”

Okay, $14.9 million is a decent amount of money. But before you judge SNC, consider just how hard it is to get all this stuff correct. Consider how hard it is for that engineer in the lab to figure out which charge number goes with which part of their complex activities.

It is hard to do. Accounting for IRAD is a surprisingly difficult job.

But it (obviously) pays to take the necessary pains to get it right.


Last Updated on Sunday, 12 March 2017 19:40

T&M Subcontracts: What Can Go Wrong and How to Make it Right

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A recent ASBCA decision (No. 58081, 2 December 2016) in the appeal of Kellogg Brown & Root Services, Inc. (KBR) of a contracting officer’s final decision (COFD) disallowing $14.7 million in KBR’s claimed subcontractor costs shows the pitfalls of issuing time and materials (T&M) subcontracts. It also shows how to defeat certain government arguments attacking claimed costs related to those T&M subcontracts.

KBR was issued a cost-plus-award-fee (CPAF) ID/IQ contract that “required KBR to provide the supervision, equipment, materials, labor, travel, and all means necessary to provide an immediate response for civilian construction contract capability in response to natural disasters or similar events.” Under its contract, KBR responded to several huge natural disasters in the Southern United States, including Hurricane Katrina, Hurricane Ivan, Hurricane Rita, and other related efforts. As part of its efforts, KBR issued several T&M subcontracts.

We have written before that a prime contractor should think twice before issuing T&M subcontracts, because of all the administrative requirements that go into proper subcontractor management of that contract type. We recently wrote: “At this point, if a prime is going to be issuing a T&M subcontract, there had better be a compelling business reason. Because if there is no compelling business reason then it would seem to be a really bad idea.” In this case, though, KBR seemed to have a compelling business reason for use of that subcontract type. The scope of work was simply too fluid to use a firm, fixed-price, type and the size (and maturity) of the subcontractors tended to preclude use of a pure cost-reimbursement type.

We don’t like T&M subcontracts because DCAA likes to poke holes in them, particularly with respect to initial reasonableness of subcontract pricing and also with respect to whether the personnel performing the work properly fit into the labor categories in which they are being billed. In KBR’s case, DCAA initiated Form 1 disallowances and made other audit findings (many of which were sustained by the contracting officer) that proved our point. The disallowances were so large and pervasive that, in June 2009, the Navy customer simply stopped paying all KBR invoices and making the required award fee determinations to which KBR was entitled under the contract.

DCAA questioned (and disallowed) KBR’s subcontractor costs using the following rationales, many of which applied to the same subcontractor:

  • Subcontractor markup applied to hourly labor rates and equipment, because that created a prohibited cost-plus-percentage-of-cost subcontract type.

  • Subcontractor pricing was unreasonable.

  • Unreasonable and/or unallowable costs built-into subcontractors’ fixed hourly billing rates.

  • Subcontractors billing lower-tier subcontractor costs as material (with markup) instead of labor, which would have been via fixed hourly rates (without markup).

  • Unsupported third-tier subcontractor costs (certified payrolls were required to be submitted).

  • Subcontractor billed labor hours that did not match the subcontractors’ certified payroll records.

  • Subcontractor invoice math errors related to labor adjustments (the contract work moved from Davis-Bacon Act applicable to nothing to Davis-Bacon Act applicable to Service Contract Act applicable).

  • Subcontractor Other Direct Costs (ODCs) and associated markup, because reasons.

The ASBCA decision discusses those points and, in the main, refutes them. The vast majority of questioned (and disallowed) costs was found to have been properly billed by KBR. The decision did not discuss the fairness of simply not paying invoices for nearly eight years but, given the fact that the COFD was rejected in nearly all respects, we have to ask whether that reflected well on the Navy and its administrative team. The lesson here, for government folks, may be that ringing the alarm bell over a DCAA audit report is not always warranted. In fact, COs are required to be independent adjudicators of disputes between DCAA and contractors. (But we digress.)

The decision is worth going into because many of the points raised by DCAA (and sustained by the CO) in KBR’s contract are points that are frequently raised. Thus, the decision gives us all some ammunition we can use to refute those points the next time they are raised. We are not going to cover all issues raised and decided in the decision; instead, we are going to focus on the ones that seem to us to be the most important.

1. A T&M subcontract with additional markups (on either side of the T&M equation) is an illegal cost-plus-percentage-of-cost (CPPC) subcontract. No, it’s not. Citing to Urban Data Systems (699 F.2d 1147, Fed Circuit, 1983), Judge D'Alessandris, writing for the Board, found that “A contract is a cost-plus-a-percentage-of-cost contract when (1) payment is on a predetermined percentage rate; (2) the predetermined rate is applied to actual performance costs; (3) the contractor's entitlement is uncertain at the time of contracting; and ( 4) the contractor's entitlement increases directly with an increase in performance costs.” He found that the additional markup applied by KBR’s subcontractors to their T&M billings did not equate to a CPPC subcontract because the markups were not applied to actual costs; instead, they were applied to the fixed hourly billing rates. Thus, the second factor or prong of the four-part test was not satisfied. Even where a markup was applied to the reimbursable “M” side of the T&M contract, the contract was still not a CPPC type because it still had fixed hourly billing rates on the “T” side. This is a critical finding and readers need to remember it. Essentially, so long as any aspect of a subcontract is not billed at actual costs, it is very difficult to find that the subcontract is a CPPC type.

2. When the government asserts that subcontractor pricing is unreasonable, the burden of proof is on the contractor to prove it is reasonable. Well, not exactly. Citing to another KBR decision at the Federal Circuit level, Judge D’Alessandris quoted “"the standard for assessing reasonableness is flexible, allowing [the Board] to consider many fact-intensive and context-specific factors.'" Thus, even though the burden of proof was on KBR, its arguments as to why the pricing was reasonable were persuasive. For example, with respect to one subcontractor (Environment Chemical Corporation), DCAA alleged that KBR awarded the subcontract to the highest of three bidders without justification and that KBR did not solicit bids from qualified competitors that had lower rates. In the COFD, the CO determined that ECC’s labor rates were reasonable compared to its competitors but still questioned some of the claimed labor costs. According to the decision, “KBR … presented direct evidence that ECC' s bid of $68 per hour was the best value because the other two offerors did not submit fully burdened labor rates as requested by KBR, and also because the rates, when adjusted for the additional overhead items disclosed in the bids by the other offerors, were higher than ECC's rate or close to the ECC rate with other overhead items still not accounted for.” Thus, the rates were found to be reasonable. Period.

3. The government can question unallowable and/or unreasonable costs within the fixed hourly billing rate. No, they can’t. Back to ECC. The COFD asserted (based on the DCAA audit findings) that ECC’s fixed hourly billing rates contained unallowable and/or unallocable and unreasonable costs, including such items as an allocation of unallowable/unallocable “management airfare” and lodging costs that were already reflected in the hourly billing rates. Judge D’Alessandris disposed of those assertions, finding that the FAR cost principles did not apply to the fixed-price hourly billing rates. He wrote “FAR 31.205 pertains to the allowability of selected costs for cost-type contracts. FAR 3l.204(b)(1) provides that costs in that FAR part are allowable for cost-reimbursement, fixed-price incentive, and price redeterminable contracts. As ECC had a fixed-price, time-and-materials contract, these cost allowability provisions are inapplicable and we find for KBR with regard to the $0.15 per hour management airfare issue. … ECC submitted a fixed-price fully burdened bid, and the final decision does not question the fixed hourly rate. How ECC internally apportions that hourly rate is irrelevant to the Navy, as the Navy is reimbursing at a fixed hourly rate of $68 per hour.” (Emphasis added.)

4. Math errors in the reconciliations supporting subcontractor invoices, without further support, indicate unallowable costs. Wrong again. One subcontractor had to repropose its hourly billing rates as its efforts flipped in and out of Davis-Bacon Act and Service Contract Act coverage. There were other contract changes going on as well. KBR kept a spreadsheet of all the changes and, according to DCAA, it was rife with math errors. The COFD cited to DCAA’s audit finding without any further support. The decision states “On cross-examination, the DCAA auditor … testified that he had not attempted to seek more information from KBR regarding the calculations in the spreadsheet. He also conceded that if the explanations [provided by KBR about the changes] were correct, then there were no math errors in the spreadsheet. [He] further testified that if the rates used the in the spreadsheet were appropriate, there would be no basis for questioning BE&K's costs.” (Internal citation omitted.)

5. Failure to submit certified payrolls to support invoices results in unallowable subcontractor costs. Nope. That’s not correct either. KBR paid 75% of a subcontractor’s invoice but withheld 25% percent because the subcontractor failed to submit certified payrolls to establish compliance with Davis-Bacon Act requirements. Naturally, the COFD asserted that the 75% paid was unallowable because it was unreasonable for KBR to have paid the subcontractor anything at all. For its part KBR asserted that “it was unreasonable for the Navy to disallow the FSS invoice amount in its entirety, especially because KBR had already reduced the invoiced amount by 25%.” Key to KBR’s argument was that the work had been actually performed. Judge D’Alessandris wrote “The DCAA audit and the final decision denied payment based solely upon the failure to provide the certified payroll information, and the disallowance was not based on any finding that the payroll information provided, although not in the correct format, was inaccurate. Under these circumstances, we hold that the Navy improperly denied any payment of the invoice; however, there is a quantum issue to determine the appropriate amount of withholding. Here the contracting officer denied 100% of the amount invoiced, which already reflected a 25% discount from FSS' invoice. Pursuant to the Board's holding in Acme, the withholding must be a ‘reasonable’ amount. The reasonable amount is a quantum issue to be remanded to the parties.”

This decision is complex, with more than 250 separate findings of fact. We have attempted to summarize the aspects of the decision that we found potentially impactful to our readers. There were other aspects that we could have discussed but then this article would have approached the 56 page length of the decision! For those seeking more insight, we suggest you read the entire decision, once the ASBCA website returns to functionality.

Hat Tip to ERMan for sending us the decision via email. Much appreciated!

Last Updated on Saturday, 11 March 2017 17:28

“Lowest Available Airfare”—What Does That Even Mean?

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Cool dude ERMan writes with a question. He asks—

… the new airfares the airlines are coming up with called Economy Basic. Travelers purchase tickets that are cheaper than regular economy but the tickets don’t come with overhead bin use privileges and are only allowed one small carry-on that fits under the seat in front of you. How does this impact the lowest airfare available requirement of FAR 31.205-46? Is this new airfare class the new low benchmark? 

Premium_AirfareIn December, 2009, the FAR Councils—in their boundless wisdom—saw fit to issue a final rule revising the 31.205-46 cost principle “to ensure a consistent application of the limitation on allowable contractor airfare costs.” Like many similar cost principle revisions, the language was distorted and stretched and taken out of context by government auditors. (We’re looking at you, DCAA. See MRD 10-PAC-10 for an example of creating requirements where none exist in the regulation.) As a result, contractors and compliance practitioners collectively have scratched their heads regarding what the revisions actually meant and how they were to be implemented in practice.

For a rule that was intended solely “to ensure a consistent application,” the actual application has been anything but consistent.

Let’s quote from the promulgating comments of the final rule (link above)—

The travel cost principle at FAR 31.205-46(b) currently limits allowable contractor airfare costs to ‘the lowest customary standard, coach, or equivalent airfare offered during normal business hours.’ The Councils are aware that this limitation is being interpreted inconsistently, either as lowest coach fare available to the contractor or lowest coach fare available to the general public, and these inconsistent interpretations can lead to confusion regarding what costs are allowable.

The Councils believe that the reasonable standard to apply in determining the allowability of airfares is the lowest priced airfare available to the contractor. It is not prudent to allow the costs of the lowest priced airfares available to the general public when contractors have obtained lower priced airfares as a result of direct negotiation.

Furthermore, the Councils believe that the cost principle should be clarified to omit the term ‘standard’ from the description of the classes of allowable airfares since that term does not describe actual classes of airline service. The Councils further believe that the terms ‘coach, or equivalent,’ given the great variety of airfares often available, may result in cases where a ‘coach, or equivalent’ fare is not the lowest airfare available to contractors, and should thus be omitted.

(Emphasis added.)

Looking at the public comments and FAR Councils’ responses to those comments we see:

4. Comment: How will the Government determine the lowest priced coach class airfare available to the contractor versus the lowest priced coach class airfare available to the general public if the contractor does not have a negotiated airfare agreement with air travel providers and, therefore, only has available to it the same airfare that is available to the general public?

Response: In the situations described by this commenter, the lowest priced coach class airfare available to the contractor and the lowest priced coach class airfare available to the general public are the same. In this regard, the revision promulgated in this FAR case has no effect on the contractor. This amendment is intended to prohibit the contractor's practice where it has negotiated airfare agreements with travel providers and uses those agreements to purchase first class or business class seats but does not use the lowest priced airfare available under the agreements to determine the allowable cost baseline for the first class or business class seats, but instead determines the allowable cost based on the lowest airfare available to the general public instead of the lowest airfare available to the contractor under the agreements. This amendment will require the contractor to use the lowest airfare available to the contractor.

(Emphasis added.)

In response to another comment, the FAR Councils stated—

The amendment is not intended to guide contractors through the decision-making process of selecting the most economical airfare with the lowest net cost when multiple corporate airfare agreements are in place, as this is properly addressed in the contractor's policies and procedures that should be applied appropriately and reasonably in the circumstances of each travel mission and its associated scheduling requirements. In relying on the contractor's procedures to select the most economical airfare appropriate in the circumstances, this amendment only seeks to clarify for the contractor that it should use the lowest airfare available to the contractor that meets the schedule requirements of the trip rather than considering only airfare available to the general public for the same flight. This amendment makes explicit that the lowest of the two should be selected as the appropriate baseline.

(Emphasis added.)

Let’s summarize all that stuff above.

The contractor is not required to choose the lowest airfare available to it. The contractor is required to choose the “most economical airfare with the lowest net cost,” considering “the circumstances of each travel mission and its associated schedule requirements.” That is the requirement. That is the entirety of the requirement.

The purpose of the revision to the cost principle was to clarify that when calculating the amount of unallowable airfare associated with premium fares (business or first class) the baseline for the allowable fare was not the standard coach fare available to the general public but, instead, the actual fare available to the contractor when the contractor had negotiated fare discounts with certain airlines. Big contractors negotiate fare discounts based on their volume of travel and then they tell their employees to travel with the airline(s) that have the agreements in place. Small contractors have no opportunity to negotiate those volume-based fare discounts and thus were not affected by the rule revision. (Notwithstanding DCAA’s creation of allowability requirements where none in fact exist.)

As noted in the FAR Councils’ comments, quoted above, a savvy contractor will create travel policies and procedures (aka, “command media”) that establish the decision-tree to be used that will result in the “most economical airfare with the lowest net cost” considering “the circumstances of each travel mission and its associated schedule requirements.”

In the situation raised by ERMan, the question to be answered (for each contractor) is whether or not it is reasonable to have travelers book a fare that does not permit use of an overhead bin. For some trips—e.g., a day trip with no associated lodging—it may well be prudent and reasonable to book the lower fare. However, for most other travel it would not be prudent and reasonable to book that fare because the traveler would be carrying luggage that would need to be stowed in an overhead bin. The alternative—checking the luggage—might result in an additional fee or might result in a schedule delay as the traveler is forced to wait for the luggage to be retrieved. (There is also the risk of lost luggage.) All of these issues need to be addressed in the contractor’s decision-tree embedded in its travel-related command media.

To summarize, the imposition of the new airfare type creates a need for contractors to revisit their travel policies and procedures. There are some circumstances where it would be prudent to use the new, lower-cost fares; and there are many circumstances where it wouldn’t be prudent to use them. The trick is to delineate those different circumstances so that the travelers (and DCAA auditors) understand the contractor’s practices in this area.

Thanks ERMan for asking this question!

If you have questions of your own that might have wider applicability, feel free to email them in.


Last Updated on Monday, 06 March 2017 11:24

Seminars Versus Selling

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In our attempts to make sense of the FAR Part 31 Cost Principles, from time to time we discuss some aspect of cost allowability that seems to be a challenge for many folks.

Today we want to talk about the allowability issues associated with attendance at a technical seminar, symposium, or conference. These are not trade shows, though you could be forgiven for thinking so because, quite often, contractors set up booths in the foyer. And it’s a fact that almost every seminar or technical conference has sponsors: some sponsorships are differentiated by levels (e.g., gold, silver, bronze, etc.), which means that the highest level sponsors paid the most money and get the most favorable attention called to them. Other seminars are “hosted” which means that one contractor provides the facilities and the snacks & beverages.

Some employees attend these seminars or conferences in order to disseminate technical information; others attend to man the tradeshow booth. Others attend to mingle and network at the breaks. Some individuals do all of the above.

There is labor to deal with, and expenses, and seminar registration fees and seminar sponsorship fees. Where is the bright line for cost allowability determinations?

A couple of cost principle points will help us figure this out.

31.205-1 states (in part)—“Advertising media include but are not limited to conventions, exhibits, free goods, samples, magazines, newspapers, trade papers, direct mail, dealer cards, window displays, outdoor advertising, radio, and television. Public relations and advertising costs include the costs of media time and space, purchased services performed by outside organizations, as well as the applicable portion of salaries, travel, and fringe benefits of employees engaged in [these] functions and activities… The only allowable advertising costs are those that are—

(1) Specifically required by contract, or that arise from requirements of Government contracts, and that are exclusively for—(i) Acquiring scarce items for contract performance; or (ii) Disposing of scrap or surplus materials acquired for contract performance;

(2) Costs of activities to promote sales of products normally sold to the U.S. Government, including trade shows, which contain a significant effort to promote exports from the United States.”

(Emphasis added.)

Except as specifically noted as being allowable, all advertising costs are unallowable.

31.205-38 states (in part)—“’Selling’ is a generic term encompassing all efforts to market the contractor’s products or services … Selling activity includes the following broad categories:

(1) Advertising. … (2) Corporate image enhancement. … (3) Bid and proposal costs. … (4) Market planning. … Long-range market planning costs are subject to the allowability provisions of 31.205-12. Other market planning costs are allowable. .. (5) Direct selling. Direct selling efforts are those acts or actions to induce particular customers to purchase particular products or services of the contractor. Direct selling is characterized by person-to-person contact and includes such efforts as familiarizing a potential customer with the contractor’s products or services, conditions of sale, service capabilities, etc. It also includes negotiation, liaison between customer and contractor personnel, technical and consulting efforts, individual demonstrations, and any other efforts having as their purpose the application or adaptation of the contractor’s products or services for a particular customer’s use. The cost of direct selling efforts is allowable. [The costs of any selling efforts other than those addressed in this cost principle are unallowable.]”

(Emphasis added.)

Except for activities noted as being allowable, selling costs are unallowable. Generally, only “direct selling” expenses are allowable. More specifically, general schmoozing, networking, and corporate image enhancement efforts are not allowable.

31.205-43 states (in part)—“The following types of costs are allowable … When the principal purpose of a meeting, convention, conference, symposium, or seminar is the dissemination of trade, business, technical or professional information or the stimulation of production or improved productivity—

(1) Costs of organizing, setting up, and sponsoring the meetings, conventions, symposia, etc., including rental of meeting facilities, transportation, subsistence, and incidental costs;

(2) Costs of attendance by contractor employees, including travel costs … and

(3) Costs of attendance by individuals who are not employees of the contractor, provided—

(i) Such costs are not also reimbursed to the individual by the employing company or organization, and

(ii) The individuals attendance is essential to achieve the purpose of the conference, meeting, convention, symposium, etc.”

Okay. Now we’ve got the basic rules and we can apply them.

If you read the rules (and you did read them, right?) then it becomes apparent that we need to understand the purpose of the expenditure in order to make the proper cost allowability determination.

  • When the purpose is the dissemination of information, costs are allowable.

  • When the purpose is corporate image enhancement, costs are unallowable.

  • When the purpose is advertising, general marketing, networking, etc., the costs are unallowable. (Unless the efforts are to promote export of defense products.)

Those employees manning the trade show booth in the foyer? Unallowable time and expense. The employees there to network at the breaks? Unallowable time and expense. However, those employees attending the seminar or conference in order to learn something—that is 100% allowable.

What that means is that the employees who are attending for dual purposes will need to properly break-out their time and expenses between allowable and unallowable activities. Making the presentation? Likely allowable. Manning the booth afterwards? Almost certainly unallowable.

What about sponsorships?

As noted in the 205-43 cost principle, sponsorship is allowable where the purpose is a bona fide dissemination of technical information. However, where there is no dissemination of bona fide technical information—for example, where no employee is presenting and no employee is attending to learn—then the purpose of the sponsorship would be general image enhancement (general selling), and the costs would be unallowable.

Thus, the rule: bona fide training and technical information exchange are allowable, while general image enhancement and general selling are unallowable.

Remember, where costs are unallowable then all directly associated costs are also unallowable. These unallowable directly associated costs include travel-related expenses, as well as labor and allocated fringe benefits.

Last Updated on Tuesday, 28 February 2017 21:00

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In March 2009, Nick Sanders’ article “Surviving Government Audits: Have the Rules of Engagement Changed?” was published in Government Contract Costs, Pricing & Accounting Reports (4 No. 2 GCCPAR P. 11). Apogee Consulting, Inc. is proud to announce that Mr. Sanders’ article was selected for reprint and publication in Thomson West’s The New Landscape of Government Contracting.  Mr. Sanders, Apogee Consulting’s Principal Consultant, joins such distinguished contributors as Professors Steven Schooner and Christopher Yukins, Luis Victorino and John Chierachella, Joseph West and Karen Manos, Joseph Barsalona and Philip Koos and Richard Meene, and several others.  The text covers a lot of ground, ranging from the American Recovery and Reinvestment Act (ARRA) to Business Ethics and Corporate Compliance, and includes several articles on the False Claim Act and the Foreign Corrupt Practices Act.  In addition, the text includes the full text of many statutory and regulatory matters affecting Government contract compliance.


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