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Panoptic Enterprises' FEDERAL CONTRACTS DISPATCH

DATE: September 12, 2002

SUBJECT: Department of Defense; Extension of Class Deviation Regarding Paragraph (c) of FAR 31.203, Indirect Costs

SOURCE: Department of Defense Memorandum, dated September 9, 2002

AGENCIES: Department of Defense (DOD)

ACTION: Extension of Federal Acquisition Regulation (FAR) Class Deviation

SYNOPSIS: On September 9, 2002, Director of Defense Procurement Deidre A. Lee issued a memorandum to the directors of defense agencies, the services' deputies for acquisition, and the Defense Logistics Agency's executive director for procurement management, extending through September 30, 2005, the DOD FAR class deviation that directs all DOD contracting activities to deviate from paragraph (c) of FAR 31.203, Indirect Costs, when costs disallowed under FAR 31.205-52, Asset Valuations Resulting from Business Combinations, are required to be included in the indirect cost base.

EDITOR'S NOTE: The original FAR class deviation was issued September 29, 1999, and was to expire September 30, 2002.

The Cost Accounting Standards are in Chapter 99 of Title 48 of the Code of Federal Regulations. The Cost Accounting Standards are available at http://www.arnet.gov/far/97/html/appendix.html.

EFFECTIVE DATES: This FAR class deviation is extended from September 30, 2002, to September 30, 2005.

FOR MORE INFORMATION CONTACT: David Capitano, 703-602-4245, or by e-mail: david.capitano@osd.mil.

SUPPLEMENTAL INFORMATION: Cost Accounting Standard (CAS) 404, Capitalization of Tangible Assets (Title 48 of the Code of Federal Regulations, Section 9904.404), is used to measure, assign, and allocate the costs of tangible capital assets acquired in a business combination under the purchase method of accounting on the basis of the assets' fair market value. Often, this resulted in an increase in the value of the assets over the pre-business combination book value. This increase is commonly called the "step-up amount." However, in 1996, the Cost Accounting Standards Board (CASB) issued a rule that prohibits an asset from being depreciated twice: first by the original owner of the asset, and then by a second owner that acquires the asset through a merger or other business combination. This is called the "no step-up, no step-down" rule, and it reflects the policy that the government should not be placed in a worse position because of a change in business ownership than it would have been had the change not taken place. Subsequently, FAR 31.205-52 was amended to reflect the "no step-up, no step-down" rule. (EDITOR'S NOTE: In the introduction to its 1996 rule, the CASB stated that it recognized the "no step-up, no step-down" rule diverged from "generally accepted accounting practices," but it believed the rule would clarify ambiguities, reduce litigation, and improve the audit, negotiation, and contract administration processes.)

While the purpose of FAR 31.205-52 is to assure that the amount of depreciation of tangible assets and amortization of intangible assets the government pays is not increased as a result of a business combination, CAS 405, Accounting for Unallowable Costs, requires that indirect expenses be allocated to the entire fair market value, including any step-up amounts (see 48 CFR 9904.405-40(e)). This requirement is reflected in FAR 31.203(c), which states, "once an appropriate base for distributing indirect costs has been accepted, it shall not be fragmented by removing individual elements. All items properly included in an indirect cost base should bear a pro rata share of indirect costs irrespective of their acceptance as government contract costs." This means the step-up amounts and the proportional amount of the indirect costs associated with those step-up amounts are unallowable.

In a memorandum dated September 29, 1999, then Director of Defense Procurement Eleanor Spector wrote, "in this situation, contractors should not be penalized by having their indirect cost recovery reduced. Therefore, I am authorizing a deviation from FAR 31.203(c). The deviation relates only to the application of FAR 31.203(c) to costs disallowed under FAR 31.205-52. Thus, when costs disallowed under FAR 31.205-52 are required to be included in the indirect cost base, the indirect expenses proportionate to those disallowed costs will not be disallowed on the basis of FAR 31.203(c)." This FAR class deviation is being extended until September 30, 2005, by current Director of Defense Procurement Deidre A. Lee.

The deviation applies to all future contracts and to indirect rates applicable to open cost-reimbursement contracts for which final indirect rates had not been established as of September 29, 1999 (the date of the Spector memorandum). Also, the deviation applies to any other situations requiring the settlement of indirect costs before contract prices are established, provided the final indirect cost rates had not been established by September 29, 1999.

FOR FURTHER INFORMATION CONTACT: Panoptic Enterprises at 703-451-5953 or by e-mail to Panoptic@FedGovContracts.com.

Copyright 2002 by Panoptic Enterprises. All Rights Reserved.

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