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LACCD Contractors Overview of Federal Acquisition Regulation (FAR) Part 31 Contract Cost Principles and Procedures

LACCD Contractors Overview of Federal Acquisition Regulation (FAR) Part 31 Contract Cost Principles and Procedures. Presenter: James J. Check, CPA Managing Director, Kroll Government Contractor Advisory Services jcheck@kroll.com 703-796-2870.

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LACCD Contractors Overview of Federal Acquisition Regulation (FAR) Part 31 Contract Cost Principles and Procedures

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  1. LACCD Contractors Overview of Federal Acquisition Regulation (FAR) Part 31 Contract Cost Principles and Procedures

  2. Presenter: James J. Check, CPA Managing Director, Kroll Government Contractor Advisory Services jcheck@kroll.com 703-796-2870

  3. Government Contractor Advisory Services provided by Kroll • Contract Cost Accounting and Pricing • Claims Pricing and Support • Regulatory Compliance Reviews • Special Investigations • Financial Accounting and Reporting Consultation • Process and Control Assessments • Commercial Pricing and GSA Multiple Award Schedule Contracting • Expert Testimony

  4. Agenda • Applicability of FAR Part 31 • Cost Allowability / Allocability • Direct / Indirect Costs • Selected Cost Principles • Indirect Rates

  5. Applicability of FAR Part 31 • Fixed-price contracts • Applicable subparts of FAR Subpart 31 used when cost analysis is performed or a specific contract clause requires the determination or negotiation of costs • Cost-type contracts • In general, applicable principles and procedures in FAR Subpart 31.2 should be used for cost-reimbursement contracts to: • Determine reimbursable costs • Negotiate indirect cost rates • Settle costs of cost-reimbursement terminated contracts • Other price revisions or contract modifications Ref: FAR 31.102, 31.103 and 31.105

  6. Composition of Total Cost • Total cost of a contract includes: • Standard costs properly adjusted for applicable variances • Direct costs • Indirect costs allocable to the contact • Allocable cost of money pursuant to FAR 31.205-10 • Allocable credits deducted • Allowable costs are limited to those defined under FAR Part 31 • “In ascertaining what constitutes a cost, any generally accepted method of determining or estimating costs that is equitable and is consistently applied may be used.” Ref: FAR 31.201-1

  7. Allowability vs. Allocability • Costs are allowable to the extent they are reasonable, allocable and determined to be allowable under FAR 31.201 “Composition of Total Cost”, FAR 31.201-2 “Determining Allowability”, FAR 31.201-3 “Determining Reasonableness” and as specifically determined under FAR 31.205 “Selected Costs”. • “Allowability” refers to whether or not the Government will pay for a particular cost incurred in connection with government contracts. • “Allocability” refers to how costs are assigned to a contractor’s work; all costs are either directly allocable or indirectly allocable to a particular cost objective.

  8. Determining Allowability • Characteristic of a cost that permits its inclusion in a contract, and depends on … • Reasonableness • Allocability • CAS, GAAP, appropriate under circumstances • Terms of the contract • Any FAR Subpart 31.2 limitations Ref: FAR 31.201-2

  9. Determining Reasonableness • Recognized as ordinary and necessary • Accepted sound business practices, arm’s length bargaining, and Federal and State laws and regulations • Contractor’s responsibilities to the Government, other customers, owners of the business, employees, the public at large • Significant deviations from contractor’s established practices Ref: FAR 31.201-3

  10. Determining Allocability • Cost is incurred specifically for the contract • Benefits both the contract and other work-distributed in reasonable proportion to the benefits received • Cost is necessary to the overall operation of the business • Although no direct relationship to any particular cost objective can be shown Ref: FAR 31.201-4

  11. Credits • Applicable portion shall be credited to the Government as a cost reduction or cash refund • Income • Rebate • Allowance • Other credit Ref: FAR 31.201-5

  12. Advance Agreements • Advance agreements on the treatment of special or unusual costs, including statistical sampling methodologies at 31.201-6(c) are preferred but not required nor affect the reasonableness, allocability or the allowability under the specific cost principles in FAR Subparts 31.2, 31.3, 31.6 and 31.7 • Advance agreements may be negotiated either before or during a contract but should be negotiated before incurrence of the costs involved. • An agreement cannot contradict the treatment of costs as set out in FAR Part 31 Ref: FAR 31.109

  13. Direct vs. Indirect Cost • Direct cost: Related to a particular cost objective and can be traced to it in an economically feasible way. • Defined as “any cost that is identified specifically with a particular final cost objective.” (FAR 2.101) • Direct Labor • Direct Materials • Other Direct Costs • Indirect cost: Costs remaining to be allocated after direct costs have been determined and charged directly to the contract or other work. • Defined as: “any cost not directly identified with a single, final cost objective, but identified with two or more final cost objectives or with at least one intermediate cost objective.” (FAR 2.101) • Allocated to the cost objective. Ref: FAR 2.101, 31.202 and 31.203

  14. Direct vs. Indirect Cost (cont.) Direct Costs – FAR 31.202 • The contractor is responsible for defining the types of costs that it will account for as direct costs • Costs normally defined as direct costs • Material and subcontract costs • Manufacturing direct labor and direct project performance labor for service firms • Costs defined as direct costs by some companies, yet as indirect by others: • Manufacturing engineering labor • Project management labor • Quality Assurance • Defining what is accounted for as a direct cost involves balancing the accuracy of the cost accounting and the administrative burden/cost

  15. Direct vs. Indirect Cost (cont.) Indirect Costs – FAR 31.203 • Indirect costs are normally allocated to the products or projects that benefit from these costs • Usually grouped into common pools and charged to benefiting objectives through an allocation or indirect cost rate • The allocation base attempts to allocate indirect costs to the product or project based on the relative benefit received

  16. Accounting for Indirect Costs • Allocation of Indirect Costs – Understanding the Balancing Act • The best form of cost accounting must reflect a cost-benefit analysis: • The required level of accuracy of the cost accounting approach • The cost and complexity of achieving the various levels of accuracy • The materiality of the cost to the total cost of the product or service • Written policy • Policy defines what is a direct or an indirect cost • Policy must be applied consistently

  17. Accounting for Indirect Costs (cont.) • Homogeneity • Accumulate indirect costs in homogeneous pools • Indirect costs are homogeneous if the activity they represent has the same (or similar) casual or beneficial relationship to the final cost objective • Allocation in reasonable proportion to causal or beneficial relationship • Costs in an indirect cost pool shall be allocated to a cost objective based on an appropriate measure of resource consumption

  18. Accounting for Unallowable Costs • Expressly unallowable: mutually agreed cost, directly associated cost • Exclude from billing, claim or proposal • When an unallowable cost is incurred, • Directly associated costs are unallowable • Costs specifically designated as unallowable • Written decision of the contracting officer • FAR 31.201-6 (c)(1) reads: “The practices for accounting for and the presentation of unallowable costs must be those described in [CAS 405], Accounting for Unallowable Costs.” • Statistical sampling may be acceptable • Unbiased sample, reasonable representation of the sampling universe • High dollar or high risk transaction separately reviewed • Statistical sampling permits audit verification Ref: FAR 31.201-6

  19. Accounting for Unallowable Costs (cont.) • Penalties for unallowable indirect costs for contracts over $650,000: • Amount of the disallowed costs allocated to contracts • Penalty is two times the amount if the indirect cost is determined unallowable before proposal submission • Interest on the paid portion of the disallowance • Additional administrative, civil, and criminal penalties • Not necessary for unallowable costs to have been paid to the contractor in order to assess a penalty • All costs allocated to a CAS contract must comply with CAS 405 including: • Home office costs • Service center costs • Costs charged from other segments • G&A departments Ref: FAR 42.709

  20. Categorization of Selected Costs • Expressly unallowable • Generally allowable if reasonable and allocable • Generally allowable to % or $ thresholds specified • Allowable or unallowable based on purpose of expenditure

  21. Expressly Unallowable Costs Cost Principle Exceptions/Other Reference Bad Debts Contributions or donations Entertainment costs Fines and penalties Interest & other financial costs Losses on other contracts Goodwill Executive lobbying costs Costs of alcoholic beverages None Community service activities (FAR 31.205-1(e)(3)) None When required by the contract (FAR 31.205-15) Interest on tax penalties caused by the Gov't. (FAR 31.205-41(a)(3)) None None None None

  22. Construction and architect-engineer contracts • Generally, follows the cost principles detailed in FAR 31.2 • Specifically noted in paragraph (d): • Advance agreements as set in FAR 31.109 are preferred to set expectations between the contractor and the government • Actual cost data for ownership and operation cost of equipment should be used, if available. If not: • Use predetermined schedules of construction equipment use rates • Maintenance and repairs to rental equipment is unallowable • Costs incurred at the job site incident to performing the work are allowable as direct or indirect costs Ref: FAR 31.105

  23. Selected Cost Principles • Costs Reviewed: • 31.205-1: Public Relations & Advertising Costs • 31.205-6: Compensation for Personal Services • 31.205-7: Contingencies • 31.205-10: Cost of Money • 31.205-13: Employee Morale, Health & Welfare • 31.205-14: Entertainment Costs • 31.205-17: Idle Facilities & Idle Capacity Costs • 31.205-18: IR&D and B&P Costs • 31.205-20: Interest & Other Financial Costs • 31.205-22: Lobbying & Political Activity Costs • 31.205-25: Manufacturing & Production Engineering Costs • 31.205-26: Material Costs • 31.205-32: Precontract Costs • 31.205-33: Professional & Consultant Service Costs • 31.205-34: Recruitment Costs • 31.205-35: Relocation Costs • 31.205-36: Rental Costs • 31.205-38: Selling Costs • 31.205-40: Special Tooling & Special Test Equipment Costs • 31.205-43: Trade, Business, Technical & Professional Activity Costs • 31.205-46: Travel Costs • 31.205-47: Costs Related to Legal & Other Proceedings • 31.205-52: Asset Valuations from Business Combinations

  24. Public Relations & Advertising (FAR 31.205-1) • Generally UNALLOWABLE except the following areas: • Specific job recruiting • Acquiring scarce items or disposing of scrap • Costs required by contract • Responding to inquiries on company policies and activities • Communication with public, press, stockholders, etc. • Liaison with media re: matter of public concern • Other minor areas (community service drives, plant tours, etc.) • Costs to Promote Aerospace Exports (PL 100-202) • UNALLOWABLE costs include: • Models, gifts, souvenirs • Entertainment • Hospitality suites for entertainment • Alcoholic beverages

  25. Compensation For Personal Services (FAR 31.205-6) • Compensation is generally ALLOWABLE if reasonable and includes: • Salaries and wages • Fringe benefits • Bonus and incentive compensation • Stock options • Pension plans • Deferred compensation • Severance pay • Compensation incidental to business acquisitions

  26. Compensation For Personal Services (FAR 31.205-6) (cont.) • Compensation must be reasonable • Tests of reasonableness include: • Firms of the same size • Firms in the same industry • Firms in the same geographic area • Firms which engage in non-Government work • Costs for comparable services from outside sources • Closely held business scrutinized for distribution of profits to owners • When challenged - offsets considered between allowable elements of compensation package within same job grade or level • The Office of Management and Budget (OMB) annually sets maximum allowable median compensation amounts for all senior executives. For fiscal 2008, this is set at $612,196.

  27. Compensation For Personal Services (FAR 31.205-6) (cont.) • Must be based on an established plan, policy or employer/employee agreement • When paid in stock: • Valued at fair market value on measurement date • May be deferred: • Based on current or future services • Based on production, cost reduction or efficient performance Bonuses, Incentive Pay & Stock Options

  28. Compensation For Personal Services (FAR 31.205-6) (cont.) • For involuntary termination • ALLOWABLE if required by: • Law • Employer-employee agreement • Established policy • Circumstances of the particular employment • Normal turnover allocable to ALL contractor’s work • Accruals for abnormal or mass severance pay are NOT allowed but actual payments are judged on a case by case basis Severance Pay (Dismissal Pay)

  29. Contingencies (FAR 31.205-7) • Historical costing • Generally UNALLOWABLE • May be ALLOWABLE in some cases (e.g., terminations) to recognize minor unsettled factors • Future costing • Includable in cost estimates if conditions are known and foreseeable (e.g., cost of rejects/defective work) • Must exclude if not measurable (e.g., outcome of pending litigation) • Should be separately disclosed for negotiation purposes

  30. Cost of Money (FAR 31.205-10) • Generally ALLOWABLE provided it is measured, assigned, and allocated to contracts, or measured and added to the cost of capital assets under construction. • Actual interest cost in lieu of the calculated imputed cost of money is UNALLOWABLE. • ALLOWABLE imputed cost determined by applying a cost-of-money rate to facilities capital under construction or employed in contract performance. • Cost-of-money rate is based on interest rates specified by the Secretary of the Treasury under Public Law 92-41. • Cost-of-money need not be entered on contractor’s books of account - memorandum records should be utilized. • Must be specifically identified or proposed in cost proposal.

  31. Employee Morale, Health & Welfare (FAR 31.205-13) • Activities designed to improve working conditions, employer-employee relations, employee morale and performance • ALLOWABLE costs can include: • House publications; health clinics and wellness/fitness centers • Company-sponsored sports teams; employee counseling services • Certain food and dormitory services losses; award dinners, compensation or recognition awards • UNALLOWABLE costs include gifts to employees, tickets to sports events, greens fees, membership dues and most recreation costs

  32. Entertainment Costs (FAR 31.205-14) • Entertainment includes: • Amusement • Diversions • Social activities • Any other directly associated costs: • Tickets to shows or sports events • Meals • Lodging • Rentals • Transportation • Gratuities • Membership in social, dining, or country clubs or other organizations having the same purposes • Entertainment Costs are expressly UNALLOWABLE. These costs are NOTALLOWABLE under any other cost principle.

  33. Idle Facilities & Idle Capacity Costs (FAR 31.205-17) • Costs of idle facilities or idle capacity include: • Maintenance • Repair • Housing • Rent • Other related costs: • Property taxes • Insurance • Depreciation • "Facilities" means plant or any portion thereof (including land integral to the operation), equipment, individually or collectively, or any other tangible capital asset, wherever located, and whether owned or leased by the contractor. • "Idle capacity" means the unused capacity of partially used facilities. • "Idle facilities" means completely unused facilities that are excess to the contractor's current needs.

  34. Idle Facilities & Idle Capacity Costs (FAR 31.205-17) (cont.) • Costs of idle facilities are UNALLOWABLE unlessthe facilities: • Are necessary to meet fluctuations in workload • Were necessary when acquired and are now idle because of changes in: • Requirements • Production economies • Reorganization • Termination • Other causes which could not have been reasonably foreseen • Costs of idle facilities are ALLOWABLE for a reasonable period, ordinarily not to exceed 1 year • Costs of idle capacity are ALLOWABLE provided the capacity is necessary or was originally reasonable and is not subject to reduction or elimination by subletting, renting, or sale, in accordance with sound business, economics, or security practices. • Note: Any costs to be paid directly by the Government for idle facilities or idle capacity reserved for defense mobilization production shall be the subject of a separate agreement.

  35. IR&D and B&P Costs (FAR 31.205-18) • Independent research & development (“IR&D”) costs include: • Basic research • Applied research • Development • Systems and other concept formulation studies • Bid & proposal (“B&P”) costs are the costs incurred in preparing, submitting, and supporting bids and proposals on potential contracts • IR&D and B&P costs are generally ALLOWABLE if allocable and reasonable • Exceptions include: • Deferred IR&D costs • Cooperative arrangements

  36. Interest & Other Financial Costs (FAR 31.205-20) • The following interest & other financial costs are UNALLOWABLE: • Interest on borrowings • Bond discounts • Costs of financing and refinancing capital • Legal and professional fees paid in connection with preparing prospectuses • Costs of preparing and issuing stock rights • Exception: interest assessed by State or local taxing authorities under the conditions specified in the FAR is ALLOWABLE.

  37. Lobbying & Political Activity Costs (FAR 31.205-22) • Costs associated with the following lobbying activities are UNALLOWABLE: • Attempts to influence elections through contributions, endorsements or publicity • Attempts to influence Federal or state legislation through publicity, propaganda or liaison activities • The following activities are exceptions to above rules: • Presenting technical and factual information on a topic directly related to performance of contract • Any activity specifically authorized by statute to be undertaken with funds from contract • Lobbying to directly reduce contract costs

  38. Manufacturing & Production Engineering Costs (FAR 31.205-25) • ALLOWABLE costs of manufacturing and production engineering include: • 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 • Developing and deploying pilot production lines • Improving current production functions • Material and manufacturing producibility analysis for production suitability and to optimize manufacturing processes, methods, and techniques • Costs NOT included in this cost principle are the following: • Basic and applied research effort related to new technology, materials, systems, processes, methods, equipment, tools and techniques • Development effort for manufacturing or production materials, systems, processes, methods, equipment, tools, and techniques intended for sale • Where manufacturing or production development costs are capitalized or required to be capitalized under the contractor's capitalization policies

  39. Material Costs (FAR 31.205-26) • Material Costs are ALLOWABLE subject to the following requirements: • Costs adjusted for credits (e.g., trade discounts, rebates, refunds) • Reasonable Inventory adjustments • Interorganizational transfers -- at actual cost or price -- using the following limitations: • Meets FAR 15.403-1(b) exemption • Established practice of price transfer • Contracting officer determines reasonable

  40. Precontract Costs (FAR 31.205-32) • Incurred before effective date of contract • Pursuant to the negotiation • Activity is necessary to comply with proposed delivery schedule • Precontract costs are ALLOWABLE to the extent that they would have been ALLOWABLE if incurred after the date of the contract

  41. Professional & Consultant Service Costs (FAR 31.205-33) • Costs are ALLOWABLE except for: • Services to improperly obtain information or data • Services to improperly influence the selection of sources for contract awards • Services resulting in violation of any statute or regulation prohibiting improper business practices • Services which are not consistent with the scope of the services contracted • Services associated with defense or prosecution of claims against the Government • Services connected with patent infringement litigation (unless provided for in contract)

  42. Professional & Consultant Service Costs (FAR 31.205-33) (cont.) • The following should also be considered in determining allowability of service costs: • Nature of service rendered in relation to that required • Necessity of contracting for service • Past pattern of acquiring services • Impact of Government contracts on contractor’s business • Whether services can be performed more economically by employment rather than contracting • The qualifications of the individual rendering the service and adequacy of the contractual agreement for the service • Adequate support of work performed • Details of agreement • Invoices supporting time spent and nature of services provided • Work product

  43. Recruitment Costs (FAR 31.205-34) • ALLOWABLE costs include: • Help-wanted advertising • Employment offices • Educational testing programs • Travel costs for employees to recruit personnel • Employment agency fees - not in excess of standard commercial rates • UNALLOWABLE costs include: • Advertising which does not describe specific positions or is not relevant to recruitment

  44. Relocation Costs (FAR 31.205-35) • Certain costs ALLOWABLE with certain limitations: • Travel for family and effects • Closing costs on disposition of old home • House hunting costs not to exceed 60 days for employee and 45 days for spouse/dependants, etc. • Certain costs UNALLOWABLE: • Loss on sale • Costs related to purchasing a new home • Continuing mortgage principal payments on old residence being sold, etc. • *Note: If the relocated employee resigns within 12 months, the contractor must credit or refund the relocation costs to the Government.

  45. Rental Costs (FAR 31.205-36) The following costs are ALLOWABLE: • Rental costs under operating lease if rates are reasonable considering: • Rental costs of comparable property • Market conditions in the area • Type, life expectancy, condition and value of property rented • Alternatives available • Rental costs under sale and leaseback arrangement - cost of ownership • Related party rent - cost of ownership

  46. Selling Costs (FAR 31.205-38) • Direct selling costs are ALLOWABLE if reasonable. • Direct selling efforts are those acts or actions to induce particular customers to purchase particular products or services of the contractor. • The costs of direct selling efforts incurred in connection with a significant effort to promote export sales of products normally sold to the U.S. government are allowable. • Costs UNALLOWABLE under another cost principle are NOTALLOWABLE as selling costs

  47. Special Tooling & Special Test Equipment Costs(FAR 31.205-40) • The cost of special tooling and special test equipment used in performing one or more Government contracts is ALLOWABLE and shall be allocated to the specific Government contract or contracts for which acquired, except that the cost of: • Items acquired by the contractor before the effective date of the contract (or replacement of such items); and • Items which the contract schedule specifically excludes, shall be ALLOWABLE only as depreciation or amortization

  48. Trade, Business, Technical & Professional Activity Costs(FAR 31.205-43) • The following types of costs are ALLOWABLE: • Memberships in trade, business, technical, & professional organizations • Subscriptions to trade, business, professional, or other technical periodicals • 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, costs of: • Organizing, setting up, and sponsoring the meetings, conventions, symposia, etc.; • Attendance by contractor employees, including travel costs; and • 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 individual's attendance is essential to achieve the purpose of the conference, meeting, convention, symposium, etc.

  49. Travel Costs (FAR 31.205-46) • Generally ALLOWABLE if reasonable (meet Federal Travel Regulation per diems) • Advance agreements must be obtained for costs above federal rates • General travel expenses are ALLOWABLE as an indirect cost - contract travel is a direct charge • Costs of contractor owned or leased aircraft are limited to standard airfare - must be fully documented and justified

  50. Costs Related to Legal & Other Proceedings(FAR 31.205-47) • Costs incurred in connection with any proceeding brought by Federal, state, local or foreign government for failure to comply with laws or regulations are UNALLOWABLE if: • The proceeding results in a criminal conviction • The contractor if found liable • The contractor is debarred or suspended • A contract is voided, rescinded, or terminated for default • Disposition by consent or compromise if the proceeding could have resulted in any of the above.

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