[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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