Understanding Unallowable Cost so You Don t Pay the Price

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1 Understanding Unallowable Cost so You Don t Pay the Price

2 Identification and Definition of Unallowable Costs per CAS and FAR An unallowable cost is one that: Under the provisions of any pertinent law, regulation, or contract, cannot be included in prices, cost reimbursements, or settlements under a Government contract which it is allocable. An expressly unallowable cost is one that: Under a particular item or type of cost which under the express provisions or an applicable law, regulation, or contract, is specifically named and stated to be unallowable.

3 OMB Super Circular When the Cost Accounting Standards (CAS) are applicable to the contract, they take precedence over the requirements of this Part except for Subpart F Audit Requirements of this Part when they are in conflict Costs that are made unallowable under 10 U.S.C. 2324(e) and 41 U.S.C. 4304(a) as described in the FAR subpart 31.2 and subpart are always unallowable

4 Accounting Treatment of Unallowable Costs CAS Accounting for Unallowable Costs Identification of costs specifically described as unallowable Cost accounting treatment for unallowable costs to promote consistent application Does not govern allowability

5 Statutes and Expressly Unallowable Costs FAR , Certification of Final Indirect Costs, requires a contractor to certify the indirect rate proposal does not include any costs which are expressly unallowable.

6 Enter Company Name Here Enter Company Location Here Certificate of Final Indirect Costs Fiscal Year End - mm/dd/yyyy This is to certify that I have reviewed this proposal to establish final indirect cost rates and to the best of my knowledge and belief: 1. All costs included in the proposal (identify proposal and date] to establish final indirect cost rates for (identify period covered by rate) are allowable in accordance with the cost principles of the Federal Acquisition Regulation (FAR) and its supplements applicable to the contracts to which the final indirect cost rates will apply; and 2. This proposal does not include any costs which are expressly unallowable under applicable cost principles of the FAR or its supplements. Firm: Signature: Name of Certifying Official: Title: Date of Execution:

7 Statutes and Expressly Unallowable Costs FAR and , Indirect Cost Rate Certification and Penalties on Unallowable Costs, make reference to the penalty provisions within FAR which incorporates 10 U.S.C 2324 Allowable costs under defense contracts (Armed Forces) 41 U.S.C 4303 Effect of submission of unallowable costs (Public Contracts) 10 U.S.C 2324 and 41 U.S.C 4303 prescribe penalties for submission of unallowable costs in final indirect cost rate proposals: Applies to all contracts in excess of $700,000 with FAR , Penalties for Unallowable Costs. Doesn t apply to fixed-price contracts without cost incentives or firm-fixedprice contracts for the purchase of commercial items.

8 Statutes and Expressly Unallowable Costs Both 10 U.S.C 2324 and 41 U.S.C 4303 identify costs not allowable under a covered contract: 17 categories of costs are identified as not allowable. Categories in both statutes are the same; only compensation differs in content. Statutes don t make reference to any specific cost principle within FAR , Selected Costs. To add confusion, the 46 areas of costs within FAR can be categorized as: Allowable Unallowable Allowable or Unallowable with exceptions or limitations

9 Penalties for Expressly Unallowable Costs An expressly unallowable indirect cost under a cost principle in the FAR, or an executive agency supplement to the FAR is subject to a penalty that is equal to: The amount of the disallowed costs allocated to contracts for which an indirect cost proposal has been submitted; plus Interest on the paid portion of the disallowance First-level penalty If the indirect cost has previously been determined to be unallowable before the submission of such proposal, the penalty assessed should be: An amount equal to two times the amount of the disallowed cost Interest on the paid portion of the disallowance Second-level penalty

10 Penalties for Directly Associated Costs Directly associated cost means any cost which is generated solely as a result of the incurrence of another cost, and which would not have been incurred had the other cost not been incurred. Generally, costs directly associated with expressly unallowable costs are not to be included in the computation of any penalty assessment. Exception when the directly associated costs meets any of the criteria: A DCAA Form 1 or advisory memorandum, Notice of Contract Costs Suspended and/or Disapproved, or any similar notice which the contractor elected not to appeal and was not withdrawn by the cognizant Government agency. A contracting officer final decision which was not appealed. A prior executive agency Board of Contract Appeals or court decision involving the contractor, which upheld the cost disallowance. A determination or agreement of unallowability under FAR

11 Directly Associated Costs-Court Case Raytheon Co., ASBCA Nos et al. (June 2015) Expressly unallowable costs are narrowly defined Direct and unmistakable terms No violation of CAS 405 Not subject to penalty

12 Sampling and Expressly Unallowable Costs Key items to consider within FAR , Accounting for Unallowable Costs: Indirect costs tested to be unallowable in sample are projected to the universe as total questioned costs. For indirect costs tested to be unallowable and subject to the penalty provisions at , the amount projected to the sampling universe from that sampled cost is also subject to the same penalty provisions.

13 DCAA Guidance DCAA CAM Chapter 6 Incurred Cost Audit Procedures Adequate point of entry or interim screening to identify and segregate expressly unallowable costs, including costs that are mutually agreedto-be unallowable, for most of its accounts CAM Chapter 6 provides examples of costs declared expressly unallowable DCAA CAM Chapter 7 Selected Areas of Cost Discusses items of cost and accounting methods requiring special attention. Follows the guidelines of FAR Part 31 and the penalty provisions in FAR and include language specific to those called expressly unallowable within the selected areas of cost.

14 DCAA Guidance MRD 14-PAC-021 Provides listing of cost principles from FAR 31that meet definition of expressly unallowable costs MRD 14-PAC-022 Stated in direct terms that costs are unallowable Identifies specific cost or type of cost in way that leaves little room for interpretation

15 Notable Case Law Addressing Expressly Unallowable Costs General Dynamics Corp., ASBCA, No The board noted Congress adopted an "expressly unallowable" standard for assessing penalties pursuant to 10 U.S.C 2324 to make clear a penalty should not be assessed where reasonable differences of opinion existed with respect to the allowability of costs. Because the costs were the subject of serious and reasonable disagreement between the parties, and in light of analyzed statues, regulations, and the parties settlement agreement, the contractor s position with respect to the allowability of the costs was sound. [T]he Government must show that it was unreasonable under all the circumstances for a person in the contractor s position to conclude that the costs were allowable

16 Notable Case Law Addressing Expressly Unallowable Costs Fiber Materials, Inc., ASBCA, No A board of contract appeals overturned the assessment of penalties imposed for including disallowed costs in indirect cost rates because some costs were allowable and the disallowed costs were either sufficiently colorable to preclude penalties or under $10,000. Incorporated General Dynamics Corp., ASBCA ruling citing the adoption of the expressly unallowable standard by Congress The Government must show that it was unreasonable under all the circumstances for a person in the contractor's position to conclude that the costs were allowable. The scope of the inquiry will vary with the clarity and complexity of the particular cost principle and the circumstances involved. Emerson Elec. Co., ASBCA, No With regard to CAS 405, the CAS Board clearly intended the word expressly in the phrase expressly unallowable cost to be understood in the broad dictionary sense, rather than as a term of art having some special, subtle meaning. According to the CAS Board, the unallowability of a cost item must be expressed in either direct or unmistakable terms Incorporated the phrase clear beyond cavil to describe how a particular cost is expressly unallowable

17 Ways to Avoid and Eliminate Unallowable Costs Know when contracts are awarded and understand the terms/clauses contained within those contracts. Develop sound internal controls to identify and exclude unallowable costs from submissions. Train employees to understand, identify and properly record unallowable costs. Develop and utilize sampling techniques, when appropriate, to identify and/or scrub for unallowable costs. Use capabilities within the accounting system (i.e., accounts, cost centers, project codes, business activities) to segregate unallowable costs

18 Contact Information Noah Leiden, CPA Partner (703) Drew Lewis, CPA Manager (703) Baker Tilly Government Contractor Advisory Services

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