What happens when a contract clause makes unallowable indirect costs required to be allocated by Cost Accounting Standards (CAS)? Let’s find out, courtesy of this recent audit report by KPMG LLP, courtesy of the DOE Inspector General.

In 2007, Savannah River Nuclear Services (SRNS) received a Management and Operating (M&O) contract from the Department of Energy (DOE) to manage and operate the Savannah River Site. SRNS was a joint venture whose members included Fluor Federal Services, Inc. (FFS), Newport News Nuclear (NNN), and Honeywell International. FFS was the majority owner of the SRNS joint venture.

CAS 403 required Fluor to allocate Home Office expenses to both FFS and SRNS, since those two entities met the CAS 403-30 definition of a “segment”. Unfortunately, the M&O contract contained a special “Section H” clause – H-20 – which stated, “Home office expenses, whether direct or indirect, relating to activities of the Contractor are unallowable, except as otherwise specifically provided in the Contract or specifically agreed to in writing by the Contracting Officer consistent with DEAR 970.3102-3-70."

The Home Offices expenses allocated by Fluor to SRNS were not charged to the M&O contract. We assume they were written off against profit. On the other hand, Home Office expenses allocated to FFS were received in the FFSI G&A expense pool and included in allowable G&A expenses allocated to FFS cost objectives.

The inclusion of Fluor Home Office expenses in FFS indirect cost rates would not normally be a problem, except when FFSI employees charged to the SRNS M&O contract on a “labor loaned” basis.

The DOE IG hired KPMG LLP to perform an audit on the loaned labor costs from FFSI to SRNS. (DCAA auditors take note! Historically, that would have been DCAA and not KPMG performing such audit work.) KPMG found—

In accordance with the Loaned Employee Agreement and Cost Transfer Agreement between SRNS and FFS, employees loaned to SRNS by FFS under the corporate reachback arrangement were billed at actual cost plus applicable FFS burdens (fringe benefits and G&A costs). The fully burdened costs including travel expenses for the employees under the corporate reachback arrangement were billed to SRNS and charged to the M&O contract.

KPMG confirmed that Fluor’s Home Office expenses were included as allowable costs in the G&A rates applied to labor loaned from FFS to SRNS. KPMG estimated that $1,256,481 in Home Office expenses had been billed to SRNS between 2008 and 2012, plus an additional $36,763 in related Facilities Capital Cost of Money (COM) allocations.

For its part, SRNS argued that the indirect cost burdens applied to loaned labor were fully allowable. As KPGM wrote—

SRNS management stated that the H-20 clause within M&O contract DE-AC09-08SR22470 and DEAR 970.3102-3-70 applies only to the DOE contractor, SRNS, and therefore, the fully burdened FFS corporate reachback costs (which include home office allocations from Fluor Corporation and Fluor Government Group Headquarters via the FFS G&A rate) charged by SRNS to the M&O contract were appropriate, because the FFS G&A costs are attributable to FFS and not SRNS.

The SRNS management response was printed, in full, in the KPMG audit report. It is a masterly discourse on why the DOE M&O contract clause is not applicable to labor loaned from FFS to SRNS. Unfortunately, it did not persuade the DOD IG nor did it persuade the cognizant DOE Contracting Officer—who “initiated action.to disallow the $1,256,481 in home office expenses” that KPMG had identified.

We’ll have to see whether Fluor pays up, negotiates a smaller settlement, or takes this issue to Court. In the meantime, the DOD IG gets an opportunity to tout some questioned costs, courtesy of KPMG LLP.