Cost Accounting Standards Pension Harmonization Rule CAS harmonization Next steps for government contractors On December 27, 2011, the Cost Accounting Standards Board (CASB) issued the long- awaited final pension harmonization rule titled Cost Accounting Standards: Cost Accounting Standards 412 and 413 Cost Accounting Standards Pension Harmonization Rule 76 Fed. Reg. 81295 (the final rule). The final rule achieves CASB's responsibility to satisfy a provision in the Pension Protection Act of 2006 (PPA), which required the CASB to harmonize CAS pension costs with the minimum required pension contributions under the Employee Retirement Income Security Act of 1974 (ERISA), as amended. This article provides an overview of the final rule with a focus on: Transition dates Disclosure requirements New proposal pricing Contract price adjustments Additionally, this article highlights actions that government contractors, who maintain defined benefit pension plans, should take to ensure compliance with the final rule.
A brief history of the Pension Protection Act of 2006 Passed in 2006, the PPA was the most comprehensive reform to the nation's pension laws since the passage of ERISA. The PPA was designed to enhance ERISA and address identified weaknesses such as: Sponsors of underfunded plans were not required to make additional contributions as long as their plans were at least 90% funded. The interest rates used to calculate current pension plan liabilities and the asset values used to calculate minimum funding requirements were different, leading to an inaccurate measurement of plan liabilities and plan assets. Some sponsors of underfunded plans were able to avoid making contributions to their plans for several years because they had made deposits in previous years greater than the required minimum contribution. The PPA resulted in changes to the minimum funding requirements for, and the tax deductibility of, contributions to defined benefit pension plans. However, the minimum funding requirements set forth in the PPA create regulatory inconsistencies between the pension costs using the PPA formula and pension costs under CAS. As a result, the PPA contained a provision requiring CASB to harmonize CAS with PPA. 1 1 Pension Protection Act of 2006, Public Law 109-280, Section 106, Part D CAS pension harmonization final rule CAS 412 requires contractors to measure the actuarial accrued liability and normal cost based on a long-term or "going concern" approach. It is concerned with consistency in the assignment and recovery of costs over the long term. The actuarial calculations follow accrual accounting practices using a long-term approach to valuing future asset returns and future salary increases. On the other hand, the PPA uses a short-term or "settlement" approach to value pension plan assets and liabilities. The primary goal of the PPA was to ensure that defined benefit plans were adequately funded based on current obligations. The PPA actuarial valuation method uses a short-term approach to valuing future asset returns and does not consider future salary increases. The final rule implements the PPA requirements with the addition of 9904.412-50(b)(7). Other minor technical corrections are part of the final rule. The final rule requires contractors to compare pension costs based on PPA with pension costs based on CAS. Under PPA, pension costs equal the sum of the minimum actuarial liability plus the minimum normal cost measured on a settlement basis (PPA method). Under CAS, pension costs equal the sum of the actuarial accrued liability plus normal cost measured on a going concern basis (CAS method). Pension cost Is determined using the greater of the PPA method or the CAS method If the costs calculated under the CAS method exceed the costs calculated under the PPA method, then the CAS method is used for contract costs. If the costs calculated under the PPA method exceeds the CAS method, then the PPA method is used for contract costs (subject to a five-year transition period). The CAS Board chose a fiveyear transition period to approximate a typical contracting cycle. The five-year transition period begins with the contractor's first cost accounting period that starts after June 30, 2012. The final rule reduces the amortization period for actuarial gains and losses from 15 years to 1o years. The acceleration in the recognition of gains and losses should help contractors reduce the delay in cost recognition. The final rule does not affect gains or losses recognized in prior years, which will continue to be amortized over 15 years. Key requirements of the final rule 1. Important dates: effective date, applicability date, and transition period The final rule is effective as of February 27, 2012 (the effective date). When a new contract, subject to CAS 412 and 413, is awarded after February 27, 2012, the new requirements become applicable on the first day of the cost accounting period starting after June Government Contracting 2
30, 2012 (the applicability date). The final rule provides that the applicability date can never be before July 1, 2012, in order to eliminate a portion of the equitable adjustments for contractors that report on a calendar year basis. The final rule establishes a transition period to phase in the difference between the PPA method and the CAS method. The transition period is the five-year period beginning with a contractor's first cost accounting period that starts after June 30, 2012 (the implementation date). The implementation date is independent of the applicability date but will likely be the same for most large contractors. 2 Contractors that receive a contract subject to CAS 412 and 413 during the transition period are subject to the following limitations on the difference between the PPA method and the CAS method :3 Transition period by cost accounting period The following example presents how a contractor would implement the transition period: 2 9904.412-64.1(a). 3 9904.412-64.1(b)(3) Percentage of difference recognized 1 0% 2 25% 3 50% 4 75% 5 100% A contractor has a calendar year cost accounting period with an implementation date and applicability date of January 1, 2013. If in 2013 (year 1 of the transition period) the pension cost measured using the PPA method was $1,500 and the pension cost measured using the CAS method was $1,000, the 2013 pension expense would equal $1,000 ((($1,500 less $1,000) * 0%) + $1,000))). If in 2014 (year 2 of the transition period) the pension cost measured using the PPA method was $2,000 and the pension cost measured using the CAS method was $1,500, the 2014 pension expense would equal $1,125 ((($2,000 less $1,500) * 25%) + $1,000))). Since the applicability date is independent of the implementation date, a delay in the applicability date to January 1, 2014, would not change the 2014 pension cost of $1,125. The effect of the fixed five-year transition period ensures that the impact of the change in the cost accounting practice will be recognized for all contractors by the end of calendar year 2017. Example Contractor A, calendar year-end CAS-covered contract awarded on April 15, 2012 Effective CAS Contract Award 2/27/2012 4/15/2012 Applicability and Implementation 1/1/2013 For contractors with a calendar year cost accounting period that receive a contract subject to CAS 412 and 413 on or after the effective date, the applicability date and the implementation date will be January 1, 2013. Example Contractor B, September 30 year-end: CAS-covered contract awarded on July 9, 2012 Effective CAS Contract Award 2/27/2012 7/09/2012 For contracts subject to CAS 412 and 413 awarded on or after the effective date but before the start of a contractor's next cost accounting period, so long as the cost accounting period starts after June 30, 2012, the applicability date and the implementation date will be the first day of the contractor's next cost accounting period. Example Contractor C, fiscal year-end: Applicability and Implementation 10/1/2012 CAS covered contract awarded on March 15, 2013 Effective Implementation 2/27/2012 1/1/2013 CAS Contract Award 3/15/2013 Applicability 4/1/2013 A contractor's transition period implementation date and applicability date will differ if the contractor receives a contract subject to CAS 412 and 413 after the start of its next cost accounting period which also begins after June 30, 2012. If a contractor incurs pension cost as a home office expense, the receipt of a new contract subject to CAS 412 and 413 on or after the effective date will apply the final rule to all existing contracts across the contractor's segments. If pension costs are incurred as a segment expense, segments may have different applicability dates depending on when the contractor receives a contract subject to CAS 412 and 413. Government Contracting 3
2. Disclosure requirements Contractors should evaluate their current disclosed accounting practices for defined benefit pension costs to determine the changes required to comply with the final rule. Contractors will need to elect and disclose the actuarial assumptions, including the specific settlement rates that will be used when calculating pension cost using the PPA method. Contractors' interest assumptions must reflect the best estimate of the rate that the pension benefits could effectively be settled at today. Contractors may select interest rate assumptions based on the current rate of return on investmentgrade fixed income investments that are in the top three quality levels available. Alternatively, contractors may elect to use the investment-grade corporate bond rates that are used to determine the minimum contribution required by ERISA and published by the Secretary of the Treasury; election of this rate is considered a safe harbor. Any change to the contractor's cost accounting practices that must be made in order to stay in compliance with final rule is required change under FAR 52.230-6. In accordance with the notification requirements set forth in FAR 52.230-6(b), contractors shall submit a description of the change to the Cognizant Federal Agency Official (CFAO) no less than 60 days prior to implementing the change (i.e., no less than 60 days prior to the start of the contractor's cost accounting period in which the revised CAS 412 and 413 will become applicable). 3. Proposal pricing Contractors should update their forward pricing rates to incorporate the effect of the final rule on future years. Prior to the final rule, contractors were prohibited from including increased pension costs resulting from the PPA in contract prices or forward pricing rate (FPR) based on guidance provided by the Defense Procurement and Acquisition Policy Director. 4 Because contractors will be able to seek an equitable adjustment only on contracts that were priced in accordance with the existing CAS 412 and 413 standard and awarded before February 27, 2012, contractors should have adjusted their FPRs no later than February 27, 2012. The revised FPRs should be used to price proposals that are awarded after February 27, 2012. Contractors may be required to adjust proposed contract pricing for proposals that were submitted prior to the effective date, but will be awarded after that date. Forward pricing rates should be updated no later than February 27, 2012 When contractors propose on CAS covered contracts that will be subject to the final rule, contractors should follow FAR 52.230-7 by preparing "the price proposal using the changed practices for the period of performance for which the practice will be used" and "submit a description of the changed cost accounting practice to the contracting officer and CFAO as pricing support for the proposal." 5 4. Contract price adjustment The final rule allows contractors to submit a request for equitable adjustment (REA) in order to recover any increased costs on contracts awarded before February 27, 2012. The final rule does not contain specific guidance regarding preparing and submitting the REA. Therefore, the normal rules for required CAS changes should be followed pursuant to FAR 52.230-6(b) and FAR 52.243-4. In order to calculate the increase or decrease in cost accumulations as a result of this cost accounting change, contractors should compile a complete and accurate listing of CAS-covered contracts and subcontracts affected by the change. The contract listing should include, but may not limited to, contract number, contract type, awarding agency, original award amount, and backlog by contract. Only contracts awarded prior to February 27, 2012, are eligible for an equitable adjustment Additionally, contractors should ensure that any significant but undefinitized contract actions (e.g., modifications, change orders, requests for equitable adjustment) have been considered in its cost impact study. 4 Defense Procurement and Acquisition Policy Director, Shay Assad, memorandum to military services and defense agencies, December 22, 2006. 5 FAR 52.230-7 Government Contracting 4
What this means for you As a result of the final rule, contractors that have defined benefit pension plans should: 1. Evaluate their current disclosed practices for accounting for defined benefit pension plans to ensure that these practices comply with the final rule. Contractors should make necessary disclosures related to the actuarial assumptions used to measure the PPA pension costs. This disclosure must be made regardless of whether the contractor elects to use the PPA safe harbor option or not. 2. Determine the applicability date of the CAS pension harmonization rule and implementation date for the transition period. 3. Update and negotiate their forward pricing rate agreements to ensure rates are consistent with the final rule and allow for recovery of increased costs. Contractors should have updated their forward pricing rates no later than February 27, 2012. All contracts that are awarded after the implementation date should be priced in accordance with the final rule. Contractors may have to update their forward pricing rates prior to February 27, 2012, if they are proposing on a contract affected by the new rule, but for which the contract will not be awarded until after the effective date. 4. Begin preparing the cost impact and request for equitable adjustment associated with the required change. Government Contracting 5
A special acknowledgment to the author of this piece: Suzanne Roske (703) 918-1503 suzanne.f.roske@us.pwc.com To have a deeper conversation about how this subject may affect your business, please contact: James Bucrek (312) 298-3907 james.bucrek@us.pwc.com John May (617) 530-5340 john.m.may@us.pwc.com James Thomas (703) 918-3050 james.w.thomas@us.pwc.com Philip Treccagnoli (646) 471-8191 philip.d.treccagnoli@us.pwc.com 2012 PricewaterhouseCoopers LLP. All rights reserved. refers to the United States member firm, and may sometimes refer to the network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details.
2012 PricewaterhouseCoopers LLP. All rights reserved. refers to the United States member firm, and may sometimes refer to the network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.