[Federal Register Volume 61, Number 30 (Tuesday, February 13, 1996)]
[Rules and Regulations]
[Pages 5520-5523]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-3061]



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OFFICE OF MANAGEMENT AND BUDGET

Office of Federal Procurement Policy

48 CFR Part 9904


Cost Accounting Standards Board; Treatment of Gains or Losses 
Subsequent to Mergers or Business Combinations by Government 
Contractors; Increase in Minimum Acquisition Cost Criterion for 
Capitalization of Tangible Capital Assets

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

ACTION: Final rule.

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SUMMARY: The Office of Federal Procurement Policy, Cost Accounting 
Standards Board (CASB), hereby amends the Cost Accounting Standards 
(CAS) relating to the treatment of gains or losses attributable to 
tangible capital assets subsequent to mergers or business combinations 
by government contractors, and relating to the minimum acquisition cost 
criterion for capitalization of tangible capital assets by raising the 
prescribed criterion from $1,500 to $5,000.
    To resolve the problems that have been identified in this area, the 
Board hereby amends CAS 9904.404, ``Capitalization of Tangible Assets'' 
and CAS 9904.409, ``Depreciation of Tangible Capital Assets''. These 
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 final rule. This final rule 
addresses the Board's proposal to amend CAS 9904.404 and CAS 9904.409 
to deal with the issue of gains and losses subsequent to a merger or 
business combination.

EFFECTIVE DATE: This rule is effective April 15, 1996.

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. Sec. 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 final rule is step four in the four step process.

B. Background

Prior Promulgations

    The issues addressed in this proposal were first identified by 
commenters in response to the Board's request for agenda topics in 
November 1990. Subsequently, two Staff Discussion Papers (SDPs) were 
issued.
    The first SDP, dated August 26, 1991 and titled ``Recognition and 
Pricing of Changing Capital Asset Values Resulting from Mergers and 
Business Combination by Government Contractors,'' (56 FR 42079) raised 
broad 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 the 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 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, 
entitled ``Treatment of Gains or Losses Subsequent to Mergers or 
Business Combinations by Government Contractors,'' was issued on 
November 4, 1993 (58 FR 58882). On the basis of comments received in 
response to that SDP, an Advance Notice of Proposed Rulemaking (ANPRM) 
was developed and published in the Federal Register on May 24, 1994 (59 
FR 26774). The responses to the ANPRM were of significant assistance to 
the Board in developing a Notice of Proposed Rulemaking (NPRM). The 
NPRM was published in the Federal Register on March 8, 1995 (60 FR 
12725).

Public Comments

    Ten sets of public comments were received in response to the NPRM 
from government contractors, professional and industrial associations, 
law firms and Federal agencies.
    The views expressed by the various parties were, in essence, 
consistent with the views expressed by the same parties earlier when 
the ANPRM was published. The basic no step-up, no step-down approach 
was supported by the Government commenters and it was generally opposed 
by other commenters although some of these other 

[[Page 5521]]
commenters did not explicitly express their views on this basic issue.
    Besides expressing their views on the proposed approach outlined in 
the NPRM and the Board's arguments supporting this chosen approach, 
many commenters offered editorial as well as more substantive detailed 
comments on the various specific provisions of the document.
    These comments are discussed below in greater detail, under Section 
E., Public Comments. The Board and the CASB staff express their 
appreciation for the generally constructive and thoughtful responses 
provided by the commenters.

Benefits

    After consideration of all the comments received in response to the 
NPRM, the Board continues to believe that amendments to CAS 9904.404, 
``Capitalization of Tangible Assets,'' and CAS 9904.409, ``Depreciation 
of Tangible Capital Assets,'' as set forth in the ANPRM and essentially 
restated in the NPRM, and this final rule, will significantly improve 
and clarify the implementation of CAS and related procurement 
regulations in accounting for tangible capital assets after completion 
of a merger or business combination. In particular, the Board continues 
to believe that the proposal embodied in this final rule will clarify 
the current ambiguities in this area and thus should lead to reductions 
in negotiations and litigation. This point is of particular 
significance in the current economic and budgetary environment where 
the need to realize economies in the defense budget can be expected to 
lead to mergers, business combinations and restructurings among 
contractors. It is also anticipated that increasing the capitalization 
criterion for tangible capital assets in CAS 9904.404 from $1,500 to 
$5,000, will significantly reduce record keeping burden in many 
instances. The Board believes that the potential benefit to the audit, 
negotiation, and general contract administration processes accruing 
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 capitalization criterion for tangible capital assets in 
subsection 9904.404-40(b)(1) is increased from $1,500 to $5,000.
    b. The current subsection 9904.404-50(d) is deleted and is replaced 
by an amended section that prescribes:
    (1) That for contract costing purposes, tangible capital assets 
following a business combination shall retain their net book value 
recognized during the most recent cost accounting period prior to the 
business combination provided that the assets generated either 
depreciation expense or cost of money charges that were allocated 
during the period either as direct or indirect costs to Federal 
government contracts and subcontracts negotiated on the basis of cost.
    (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 during the most recent cost accounting period prior to the 
business combination did not generate either depreciation expense or 
cost of money charges that were allocated either as direct or indirect 
costs to Federal government contracts negotiated on the basis of cost.
    c. 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 9904.409 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 rulemaking, because this rule imposes 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 rule on contractors and subcontractors 
is expected to be minor. As a result, the Board has determined that 
this final rule 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 final rule 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 final rule does not require a 
regulatory flexibility analysis under the Regulatory Flexibility Act of 
1980.

E. Public Comments

    This final rule was developed after consideration of the public 
comments received in response to the Board's NPRM published on March 8, 
1995 (60 FR 12725). 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: Several commenters indicated that the final rule should 
make it clear that this revised rule is to be applied on a prospective 
basis only. One commenter suggested that the language in 9904.404-63 
and 9904.409-63 be supplemented to reflect the requirements of 
paragraph (a)(3) of the contract clause at 9903.201-4(a) which requires 
the receipt of a new CAS-covered contract for a new CAS requirement to 
be applicable.
    Response: Sections 9904.404-63 and 9904.409-63 have been 
supplemented to make it clear that these revisions are to be applied 
prospectively.
    Comment: Several commenters stressed once more that they believe 
there is a conflict between the CAS allocability provisions and the 
Federal Acquisition Regulation (FAR) allowability provisions in this 
area. It was suggested again, as in earlier comments, that the OFPP 
Administrator should address this issue.
    Response: The Board is aware that there is an appearance of 
conflict between the provisions of CAS 9904.404 and FAR 31.205-52. As 
stated in the proposed rulemakings, the OFPP Administrator will 
determine whether any changes may be necessary in the FAR cost 
principles to make them fully compatible with amended CAS 9904.404 and 
9904.409.
    Comment: One commenter pointed out the apparent inconsistency in 
the language between sections 9904.404-50(d) (1) and (2) when 
describing the scope of the two paragraphs. In one paragraph the 
reference is to costs charged to ``Federal Government contracts'', 
while in the other, the reference is to ``Federal Government contracts 
subject to CAS''. In addition, another commenter pointed out that these 
references did not make clear whether contractors subject to modified 
CAS coverage are affected by this amendment.
    Response: In order to make clear that the amendment applies to 
those tangible capital assets that were charged to Federal government 
contracts and subcontracts negotiated on the basis of cost before the 
business combination, the phrase ``subject to CAS'' has been 

[[Page 5522]]
eliminated. This should make it clear that this revised rule applies to 
tangible capital assets that generated costs allocated to Federal 
government contracts and subcontracts negotiated on the basis of cost, 
where such costs were allocated to contracts and subcontracts by the 
seller during the most recent cost accounting period prior to the 
business combination.
    Comment: Several suggestions were received dealing with different 
aspects of materiality in applying this revision. First, several 
contractors and industry associations suggested that specific 
materiality criteria be introduced, such as total dollar value of 
assets acquired or the percentage of commercial or competitively 
awarded fixed-priced contracts in relation to total sales. One 
Government commenter suggested that the coverage of the amendment 
should be extended also to those tangible capital assets that generated 
relevant costs chargeable to CAS-covered contracts ``anytime during the 
three accounting periods prior to the business combination''.
    Response: The Board does not believe that the introduction of 
additional materiality criteria is advisable at this time. By its very 
nature, under full CAS coverage, the amended Standard's requirements 
apply to major contractors that perform significant amounts of CAS-
covered work.
    CAS 9904.404-50(d) has been revised to clearly state that the costs 
of tangible capital assets acquired from a seller (whether CAS-covered 
or non-CAS covered) which generated depreciation expense or cost of 
money charges that were allocated to Federal government contracts or 
subcontracts shall not be written up by the buyer. The primary issue is 
whether or not a material amount of asset costs have been charged to 
Federal government contracts and subcontracts that were negotiated on 
the basis of cost, where such costs were allocated to contracts and 
subcontracts during the most recent cost accounting period prior to the 
acquisition date, not the amount of CAS-covered effort performed by the 
seller.
    Comment: One commenter suggested that the acquisition cost 
criterion in section 9904.404 be raised from $1,500 to $5,000.
    Response: The Board accepts this suggestion and therefore section 
9904.404-40(b)(1) is modified to increase the minimum acquisition cost 
criterion from $1,500 to $5,000.
    Comment: One Government commenter expressed the view that the 
provisions of the amendment should also be extended to non-CAS-covered 
contractors: ``The proposed rule does not provide uniformity or 
consistency since it provides for different treatment for acquired 
assets of CAS-covered from non-CAS-covered contractors''.
    Response: CAS 9904.404-50(d) has been revised to clearly establish 
that the acquired tangible capital asset valuations shall be determined 
in a consistent manner. As revised, application of the prescribed 
techniques in 9904.404-50(d)(1) and 9904.404-50(d)(2) is dependant upon 
whether or not the acquired assets were previously utilized in the 
performance of either CAS-covered and/or non-CAS covered Federal 
contracts that were negotiated on the basis of cost.
    Comment: Several commenters expressed their disagreement with the 
abandonment of GAAP principles in this revision to CAS 9904.404. The 
view was expressed that the CASB should deviate from GAAP only in 
exceptional cases and, in the view of these commenters, such an 
approach is not warranted in the present case.
    Response: The Board has pointed out in its Statement of Objectives, 
Policies and Concepts that it will make every reasonable effort to 
avoid conflict or disagreement with other bodies having similar 
responsibilities. However, it also pointed out that the nature of the 
Board's authority and its mission is such that it must retain and 
exercise full responsibility for meeting its objectives.
    As stated in previous discussions, the Board adopted the ``no step-
up, no step-down'' approach after extensive consideration of the 
possible alternative approaches. In particular, the issues associated 
with the recognition, allocation and recovery of the gain or loss 
subsequent to a merger or business combination were extensively 
explored in a Staff Discussion Paper (SDP) entitled ``Treatment of 
Gains or Losses Subsequent to Mergers or Business Combinations by 
Government Contractors.'' It was only after careful consideration of 
the responses to the SDP that the Board decided to proceed with the 
``no step-up, no step-down'' approach thereby establishing a cost 
accounting practice that diverges from the corresponding practice 
recognized for GAAP purposes.
    Comment: Several commenters pointed out that since this issue has 
been under review by the CAS Board, there have been significant changes 
in the statutes and regulations covering mergers and business 
combinations by Government contractors. The Government, in order to 
encourage contractors to consolidate, has recognized ``external 
restructuring'' which allows, in certain circumstances, contractors' 
restructuring costs to be charged to Government contracts to the extent 
that the restructuring results in savings that exceed the costs. The 
commenters argued that the same rationale should be applied to 
increased deprecation associated with the revaluation of a purchased 
company's assets if the business combination is regarded as an 
``external restructuring'', and, that it would be inequitable for the 
Government to benefit from all of the savings resulting from 
restructuring, while it is unwilling to recognize all of the costs 
needed to implement such restructuring.
    Response: In issuing this revision, the Board does not intend to 
encourage or discourage contractors to consolidate or restructure their 
operations. Rather, the Board's intent, in accordance with its stated 
objectives, in promulgating this revision, is to increase the degree of 
uniformity and consistency in like circumstances in the cost accounting 
practices that are used by Government contractors to record tangible 
capital asset values subsequent to mergers or business combinations. 
The Board believes that this action will result in cost allocations 
that are fair and equitable.
    Comment: Several commenters offered editorial comments to the 
proposed revisions.
    Response: All of these comments were considered and, as a result, 
the essence of several of these comments were incorporated in the final 
rule.

List of Subjects in 48 CFR Part 9904

    Cost accounting standards, Government procurement.
Richard C. Loeb,
Executive Secretary, Cost Accounting Standards Board.

    For the reasons set forth in this preamble, chapter 99 of title 48 
of the Code of Federal Regulations is amended as set forth below:
    1. The authority citation for part 9904 continues to read as 
follows:

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

PART 9904--COST ACCOUNTING STANDARDS


9904.404  Capitalization of tangible assets.

    2. Section 9904.404-40 is amended by revising paragraph (b)(1) to 
read as follows:


9904.404-40  Fundamental requirement.

* * * * *
    (b) * * *
    (1) The contractor's policy shall designate a minimum service life 
criterion, which shall not exceed 2 years, but which may be a shorter 

[[Page 5523]]
period. The policy shall also designate a minimum acquisition cost 
criterion which shall not exceed $5,000, but which may be a smaller 
amount.
* * * * *
    3. Section 9904.404-50 is amended by revising paragraph (d) to read 
as follows:


9904.404-50  Techniques for application.

* * * * *
    (d) The capitalized values of tangible capital assets acquired in a 
business combination, accounted for under the ``purchase method'' of 
accounting, shall be assigned to these assets as follows:
    (1) All the tangible capital assets of the acquired company that 
during the most recent cost accounting period prior to a business 
combination generated either depreciation expense or cost of money 
charges that were allocated to Federal government contracts or 
subcontracts negotiated on the basis of cost, shall be capitalized by 
the buyer at the net book value(s) of the asset(s) as reported by the 
seller at the time of the transaction.
    (2) All the tangible capital asset(s) of the acquired company that 
during the most recent cost accounting period prior to a business 
combination did not generate either depreciation expense or cost of 
money charges that were allocated to Federal government contracts or 
subcontracts negotiated on the basis of cost, shall be assigned a 
portion of the cost of the acquired company not to exceed their fair 
value(s) at the date of acquisition. When 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.
* * * * *
    4. Section 9904.404-63 is revised to read as follows:


9904.404-63  Effective date.

    (a) This Standard is effective April 15, 1996.
    (b) This Standard shall be applied beginning with the contractor's 
next full cost accounting period beginning after the receipt of a 
contract or subcontract to which this Standard is applicable.
    (c) Contractors with prior CAS-covered contracts with full coverage 
shall continue to follow Standard 9904.404 in effect prior to April 15, 
1996, until this Standard, effective April 15, 1996, becomes applicable 
after the receipt of a contract or subcontract to which this revised 
Standard applies.
    5. Section 9904.409-50 is amended by adding a new paragraph (j)(5) 
to read as follows:


9904.409-50  Techniques for application.

* * * * *
    (j) * * *
    (5) The provisions of this subsection 9904.409-50(j) do not apply 
to business combinations. The carrying values of tangible capital 
assets acquired subsequent to a business combination shall be 
established in accordance with the provisions of subsection 9904.404-
50(d).
* * * * *
    6. Section 9904.409-63 is revised to read as follows:


9904.409-63  Effective date.

    (a) This Standard is effective April 15, 1996.
    (b) This Standard shall be applied beginning with the contractor's 
next full cost accounting period beginning after the receipt of a 
contract or subcontract to which this Standard is applicable.
    (c) Contractors with prior CAS-covered contracts with full coverage 
shall continue to follow Standard 9904.409 in effect prior to April 15, 
1996, until this Standard, effective April 15, 1996, becomes applicable 
after the receipt of a contract or subcontract to which this revised 
Standard applies.

[FR Doc. 96-3061 Filed 2-12-96; 8:45 am]
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