[Federal Register Volume 59, Number 99 (Tuesday, May 24, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-12594]


[[Page Unknown]]

[Federal Register: May 24, 1994]


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OFFICE OF MANAGEMENT AND BUDGET
48 CFR Part 9904

 

Cost Accounting Standards Board; Treatment of Gains or Losses 
Subsequent to Mergers or Business Combinations by Government 
Contractors

AGENCY: Cost Accounting Standards Board, Office of Federal Procurement 
Policy, OMB.

ACTION: Advance notice of proposed rulemaking (ANPRM).

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SUMMARY: The Office of Federal Procurement Policy, Cost Accounting 
Standards Board (CASB), proposes to amend the Cost Accounting Standards 
relating to treatment of gains or losses attributable to tangible 
capital assets subsequent to mergers or business combinations by 
government contractors.
    To resolve the problems that have been identified in this area, the 
Board proposes to amend CAS 404, ``Capitalization of Tangible Assets'' 
and CAS 409, ``Depreciation of Tangible Capital Assets''. The proposed 
amendments are based on an approach involving a ``no step-up, no step-
down'' of asset bases and no recognition of gain or loss on a transfer 
of assets following a business combination by contractors subject to 
CAS.
    Section 26(g)(1) of the Office of Federal Procurement Policy Act 
requires that the Board, prior to the promulgation of any new or 
revised Cost Accounting Standard, publish a report and an ANPRM. This 
ANPRM addresses the Board's proposal to amend CAS 404 and CAS 409 to 
deal with the issue of gains and losses subsequent to a merger or 
business combination.

DATES: Comments should be received by July 25, 1994.

ADDRESSES: Comments should be addressed to Dr. Rein Abel, Director of 
Research, Cost Accounting Standards Board, Office of Federal 
Procurement Policy, 725 17th Street, NW., room 9001, Washington, DC 
20503: Attn: CASB Docket No. 91-06(2).

FOR FURTHER INFORMATION CONTACT:
Dr. Rein Abel, Director of Research, Cost Accounting Standards Board 
(telephone 202-395-3254).

SUPPLEMENTARY INFORMATION: 

A. Regulatory Process

    The Cost Accounting Standards Board's rules and regulations are 
codified at 48 CFR chapter 99. Section 26(g)(1) of the Office of 
Federal Procurement Policy Act, 41 U.S.C. 422(g)(1), requires that the 
Board, prior to the establishment of any new or revised Cost Accounting 
Standard, complete a prescribed rulemaking process. This process 
consists of the following four steps:
    1. Consult with interested persons concerning the advantages, 
disadvantages and improvements anticipated in the pricing and 
administration of government contracts as a result of a proposed 
Standard.
    2. Promulgate an Advance Notice of Proposed Rulemaking.
    3. Promulgate a Notice of Proposed Rulemaking.
    4. Promulgate a Final Rule.
    This proposal is step two in the four step process.

B. Background and Report

Prior Promulgations

    The issues addressed in this proposal were first identified by 
commenters in response to the Board's request for suggested agenda 
topics in November 1990. Subsequently two Staff Discussion Papers (SDP) 
were issued.
    The first, dated August 26, 1991 and titled ``Recognition and 
Pricing of Changing Asset Values Resulting from Mergers and Business 
Combination by Government Contractors,'' raised some broader issues 
such as the scope of the proposed project, the basis for any Government 
claim to gains or losses resulting from a business combination and the 
likely economic consequences of a policy that would prohibit 
revaluation of assets following a merger.
    The responses to this SDP were used by the Board as basis for 
discussing the basic issues involved in this case. As a result of this 
discussion, the Board decided to issue a second SDP dealing with a 
series of questions mostly concerning the specific procedures needed to 
deal effectively with the recognition, allocation and recovery of the 
gain or loss subsequent to a merger or business combination. The second 
SDP, titled ``Treatment of Gains or Losses Subsequent to Mergers or 
Business Combinations by Government Contractors,'' was issued on 
November 4, 1993. The responses to this SDP were of significant 
assistance to the Board in developing the current ANPRM.

Public Comments

    Fifteen sets of public comments were received. Three of these were 
from government agencies, five from government contractors, four from 
trade and professional associations and three from individuals and 
other commenters. The comments were most useful to the Board in its 
decision-making process and, represented a wide spectrum of views on 
the various issues that were raised. The SDP included a series of 
questions dealing with the measurement of the gain or loss subsequent 
to a merger or business combination, its allocation between the 
government and the contractor and the possible methods of recovery that 
the government could employ in trying to recover its share of a gain or 
loss. In many instances, the responses to these questions indicated 
that the commenters believed that a comprehensive and equitable process 
of allocating gains or losses between the Government and contractors 
would entail use of complex and cumbersome procedures that would add 
significantly to the implementation cost of any Standard that would 
sanction revaluation of tangible capital assets subsequent to a merger 
or business combination. The comments that were received are discussed 
below in greater detail, under Section E., Public Comments. The Board 
and the CASB staff express their appreciation for the thoughtful and 
generally constructive responses provided by the commenters.

Benefits

    After consideration of all the comments received, the Board 
believes that amendments to CAS 404, Capitalization of Tangible Assets, 
and CAS 409, Depreciation of Tangible Capital Assets, as set forth in 
this ANPRM will significantly improve and clarify the implementation of 
CAS and related procurement regulations in accounting for tangible 
capital assets after a merger or business combination. In particular, 
the Board believes that a clean-cut resolution of this issue, as 
proposed in the ANPRM, will clarify the ambiguities that currently 
exist in this area and thus should lead at least to some reduction in 
the present confrontational negotiations and litigation in this area. 
This point is of particular significance in the current economic and 
budgetary environment where further reductions in the defense budget 
can be expected to lead to further mergers and business combinations 
among defense contractors. The Board believes that potential benefits 
to the audit, negotiations, and general contract administration 
processes occurring from the added clarity and uniformity in the 
measurement of the cost of depreciation and cost of money subsequent to 
a business combination will be substantial and will greatly outweigh 
any added costs.

Summary of Proposed Amendments

    A brief description of the proposed amendments follows:
    a. The current subsection 9904.404-50(d) is deleted and is replaced 
by an amended section that prescribes:
    (1) that for Federal Government contract costing purposes tangible 
capital assets after a business combination shall retain their net book 
value recognized prior to the business combination provided that the 
assets had previously generated costs that were chargeable to Federal 
Government contracts subject to CAS.
    (2) That the cost of tangible capital assets shall be restated 
after the business combination at a figure not to exceed the fair value 
at the date of the acquisition pursuant to a business combination where 
the assets prior to the business combination did not generate costs 
that were chargeable to Federal Government contracts subject to CAS.
    b. A new subparagraph 9904.409-50(j)(5), is added to current 
subsection 9904.409-50(j). The purpose of this new subparagraph is to 
make it clear that the CAS 409 provisions dealing with the recapture of 
gains and losses on disposition of tangible capital assets should not 
apply when assets are transferred subsequent to a business combination.

C. Paperwork Reduction Act

    The Paperwork Reduction Act, Public Law 96-511, does not apply to 
this proposal, and any associated rulemaking, because this proposal 
would impose no paperwork burden on offerors, affected contractors and 
subcontractors, or members of the public which require the approval of 
OMB under 44 U.S.C. 3501, et seq.

D. Executive Order 12866 and the Regulatory Flexibility Act

    The economic impact of this proposal on contractors and 
subcontractors is expected to be minor. As a result, the Chairman has 
determined that this ANPRM will not result in the promulgation of a 
``major rule'' under the provisions of Executive Order 12866, and that 
a regulatory impact analysis will not be required. Furthermore, this 
proposal will not have a significant effect on a substantial number of 
small entities because small businesses are exempt from the application 
of the Cost Accounting Standards. Therefore, this proposed rule does 
not require a regulatory flexibility analysis under the Regulatory 
Flexibility Act of 1980.

E. Public Comments

    This ANPRM was developed taking into account the comments received 
to the issue raised in the Staff Discussion Paper made available for 
public comment on November 4, 1993. The comments have provided valuable 
input to the Board's rulemaking process. The comments received and the 
action taken by the Board are summarized in the paragraphs that follow:
    Comment: In response to a question on the relationship between CAS 
and Generally Accepted Accounting Principles (GAAP) most commenters 
agreed that the Board should utilize GAAP to the greatest practical 
extent, but nevertheless, the Board clearly has the authority to depart 
from GAAP when deemed necessary to meet the Board's objectives.
    Response: The Board is in agreement with the comment.
    Comment: In response to a question as to the level of aggregation 
of individual asset values that might be used as a basis for 
establishing ``fair values'' for tangible capital assets, a number of 
comments pointed out that the current definitions of ``asset 
accountability unit'' in 9904.404-30(a)(1) would be an adequate basis 
for determining the detail required. They also pointed out that asset 
groupings are already adequately covered in 9904.409-50(d) and in the 
relevant illustrations 9904.409-60(a) (2) and (3).
    Response: The Board is in agreement with this comment.
    Comment: A great variety of comments were received in response to a 
question as to whether the current 9904.409-50(j)(1) cap on government 
recovery in the form of accumulated depreciation, should be also 
applied to gains and losses recognized subsequent to a revaluation of 
assets pursuant to a business combination. About half of the commenters 
believe that the current cap should be also applied to gains related to 
assets acquired in the course of a business combination. A significant 
number of other commenters believe, however, that no such cap should be 
applied in these circumstances. One commenter advocated a modified cap 
that would recognize the element of inflation in the gain. Another 
commenter stressed that the Government should share not only any gains, 
but also in any losses that may emerge.
    Response: The Board has considered the merits of a cap adjusted for 
inflation. However, the actual calculations to establish such a 
modified cap seem to require establishment of a fairly complex and 
possibly cumbersome procedure.
    The Board agrees with the commenter who stated that the Government 
should participate in losses as well as in gains.
    Comment: On the question as to whether the cap should be modified 
to take into account cost of money paid in the past, the views of 
commenters were clearly divided. The government commenters believed 
that there should be some accounting for past cost of money payments 
whereas all the other commenters did not think that any modification in 
the cap was warranted. However, most commenters recognized, that any 
attempt to modify the cap for cost of money would be complex and 
extremely difficult to compute in practice.
    Response: The Board agrees that any adequate process that could be 
developed to modify the current cap on government recovery for the past 
payments of cost of money would be complex and difficult to compute.
    Comment: With respect to the conceptual argument as to who, the 
contractor or the Government should retain the ``gain'' due to 
inflation, there was no clear-cut agreement. In general, the government 
commenters stated that the government was entitled to any gain 
attributable to inflation on account of past cost of money payments. 
The industry commenters generally disagreed, although on a conceptual 
plane there were one or two exceptions.
    One industry commenter pointed out, once again, that if the 
Government wishes to share in the gain, it should be also willing to 
share in the losses.
    One commenter stated that there should be no attempt to try to 
implement inflation accounting on a piecemeal basis. If it is to be 
done, then asset bases should also be revalued.
    However, the overwhelming majority of the commenters indicated that 
whatever the arguments regarding the merit of recognizing inflationary 
gains, in practice the procedures needed to implement such inflationary 
adjustments would be so cumbersome and complex as to render the whole 
system unworkable.
    Response: The Board agrees with the commenters who state that the 
calculation of any inflationary adjustment would be a cumbersome and 
complex procedure.
    Comment: When responding to the request in the SDP for suggestions 
regarding basis for allocation of gains or losses between government 
and contractors, virtually all of the commenters recognized the 
construction of an index or some other factor to reflect the historical 
usage of assets on CAS-covered work as contrasted with other work would 
be impractical and the costs involved would clearly exceed any possible 
benefits.
    Three comments suggested that, in any event, it would be contrary 
to the current CAS provisions to try to allocate the gain or loss on 
the basis of historical usage. They point out that current CAS 409, 
415, and 416, in effect, use the current activity as the base for 
allocating adjustments related to the past cost measurements. Thus, 
these commenters maintain that a charge against the current period 
costs is all that is required.
    Three other commenters suggested that it may be possible to use a 
form of advance agreement that would establish, in conjunction with 
incurred cost settlements or submission, the ratio of CAS/non-CAS work 
at the indirect cost pool level.
    It was also pointed out that no attempts at allocation should be 
undertaken when the contractor is essentially all CAS covered or all 
non-CAS covered, e.g., 85% or more in either category.
    Response: The Board agrees with the commenters that it would be 
difficult to develop an equitable and reliable, as well as, economical 
basis for establishing the past usage of assets in CAS work as 
contrasted with non-CAS work.
    Comment: Most commenters indicated that gains or losses 
attributable to misestimating of the residual value of assets 
transferred in a business combination should not be treated differently 
from other gains or losses attributable to assets transferred.
    Several commenters pointed out, that in any event, it would be 
difficult, if not impossible, to determine the amount of ``misestimated 
residual value.''
    Some commenters also expressed a belief that the question raised is 
based on a false premise. Residual value is a concept based on 
historical cost and enters into the process of determining depreciation 
costs (an allocation process), whereas gains or losses based on fair 
values subsequent to a business combination are derived from current 
values (valuation process). Therefore, residual value should not be 
compared to disposition value.
    Nevertheless, a few commenters recognized the significant 
discrepancy between the original residual value and the fair value 
established subsequent to a business combination, may indicate a 
misestimation in the residual value which could be interpreted as a CAS 
non-compliance.
    Response: The Board appreciates the input of comments who responded 
to this issue. It notes the comments that indicate that it may be 
difficult to separate the consequences of misestimates in residual 
values from changes in fair values when assets are transferred in the 
course of a business combination.
    Comment: Practically all the commenters recognized that subsequent 
to a business combination the government may have a clear-cut claim 
against the seller.
    A number of industry comments expressed the belief that the 
government has a valid claim only to the extent that there have been 
erroneous estimates of depreciation in the past.
    A significant number of comments did recognize, however, that 
subsequent to a business combination the relationship between the 
government and the seller may dissolve. In those cases, it was 
suggested that appropriate notation agreements should be negotiated 
with the buyer. The government comments, in particular, stressed that 
if the claim cannot be successfully pursued against the seller, then 
there must be alternative ways of pursuing the claim, such as 
proceeding against the buyer or trying to collect from the proceeds of 
the acquisition.
    Response: The Board notes the comment that the government may have 
difficulties in pursing to claim against the original owner of the 
assets if subsequent to a business combination there is no longer a 
business relationship between the government and the seller.
    Comment: The commenters on the whole, did not support the notion 
that the government should recover its share of gain or loss subsequent 
to asset revaluation from the buyer. Some comments pointed out that 
such a gain or loss recovery is a contract administration issue and not 
an accounting matter. It was also suggested that the matter might be 
best dealt with at the time when novation and advance agreements are 
negotiated between the government and the contractor.
    Repsonse: The Board has taken note of the comments received on this 
topic.
    Comment: The last issue raised in the SDP concerned the 
advisability of retaining the original asset base subsequent to the 
business combination in view of the complex and costly procedures that 
would have to be developed to share any gain or loss, attributable to 
asset revaluation, between the government and the contractor.
    There was a clear divergence of views on this topic between the 
government commenters and other comments. All the government responses 
indicated that assets should be not revalued subsequent to a business 
combination. All the other comments expressed the views that such a 
revaluation should be carried out and recognized for government 
contract costing purposes. One industry comment did point out, however, 
that the assets should not be revaluated if the business combination 
takes the form of acquisition of shares rather than assets.
    Several commenters pointed out that in any event the apparent 
conflict between CAS and the Federal Acquisition Regulation (FAR) 
should be eliminated. It was also pointed out that the government 
should be consisted in its application of cost accounting practices in 
this area. It should either allow revaluation of assets subsequent to 
business combinations and then deal with the resulting gain and loss 
issues, or adopt practices based on not revaluing assets and limiting 
depreciation and gains and losses to historical costs without regard to 
business combinations.
    Response: The Board agrees with the commenters who stated or 
inferred that in case of asset revaluations subsequent to a business 
combination the procedures involved to develop an adequate and 
equitable method to share the gain or loss between the government and 
the contractor would be complex and costly. At the same time, the Board 
does not agree with those commenters who maintain that the government 
is not entitled to any share in the gain or loss subsequent to asset 
revaluation because such a gain or loss can only accrue to a party that 
bears the risk of ownership, i.e., the contractor. The Board believes 
that in a business environment where cost-based pricing prevails, which 
includes an allowance for cost of money, and long-term contractual 
relationshps are the norm, the buyer, i.e., the government, has a sound 
claim to the benefits that may emerge as the tangible capital asset 
values increase in response to the interaction of various market 
forces. Conversely, the Board also believes that if the government is 
entitled to the benefits that may emerge as the asset values increase, 
it should also be prepared to bear the additional costs when the asset 
values are decreasing.
    Therefore, the Board has concluded that in light of the complexity 
of the procedures that are needed to deal with the revaluation of 
assets and the subsequent sharing of ensuing gains and losses, the most 
acceptable course to follow in pursuit of its objectives is to retain 
the original asset acquisition cost as a base for calculating contract 
costs after a business combination or merger has taken place.

List of Subjects in 48 CFR Part 9904

    Cost accounting standards, Government procurement.
Steven Kelman,
Administrator for Federal Procurement Policy, and Chairman, Cost 
Accounting Standards Board.
    Accordingly, it is proposed to amend 48 CFR part 9904 as follows:

PART 9904--COST ACCOUNTING STANDARDS

    1. The authority citation for part 9904 continues to read as 
follows:

    Authority: Public Law 100-679, 102 Stat. 4056, 41. U.S.C. 
Sec. 422.


9904.404  [Amended]

    2. Section 9904.50 is proposed to be amended by revising paragraph 
(d) to read as follows:


9904.404-50  Techniques for application.

* * * * *
    (d) Under the ``purchase method'' of accounting for business 
combinations, tangible capital assets acquired shall be assigned 
acquisition costs for Federal Government contract costing purposes as 
follows:
    (1) Where the assets prior to the business combination generated 
costs that were chargeable to Federal Government contracts subject to 
CAS, the assigned acquisition cost of tangible capital assets after the 
business combination shall be their net book value, recognized for 
Federal Government contract costing purposes, immediately prior to 
entering into the business combination.
    (2) Where the assets prior to business combinations did not 
generate costs that were chargeable to Federal Government contracts 
subject to CAS, the assigned acquisition costs of tangible capital 
assets after the business combinations shall be a portion of the cost 
of the acquired company, not to exceed their fair value at date of 
acquisition. Where the fair value of identifiable acquired assets less 
liabilities assumed exceeds the purchase price of the acquired company 
in an acquisition under the ``purchase method,'' the value otherwise 
assignable to tangible capital assets shall be reduced by a 
proportionate part of the excess.
* * * * *


9904.409  [Amended]

    3. Section 9904.409-50 is proposed to be amended by adding a new 
paragraph (j)(5) to read as follows:


9904.409-50  Techniques for application.

* * * * *
    (j) * * *
    (5) The provisions of 9904.409-50(j) do not apply to tangible 
capital assets transfers resulting from a business combination. The 
carrying values of those assets subsequent to such a business 
combination shall be established in accordance with the provisions of 
9904.404-50(d).
* * * * *
[FR Doc. 94-12594 Filed 5-23-94; 8:45 am]
BILLING CODE 3110-01-M