[Federal Register Volume 69, Number 187 (Tuesday, September 28, 2004)]
[Proposed Rules]
[Pages 58013-58016]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-21640]

[[Page 58013]]


Part II

Department of Defense

General Services Administration

National Aeronautics and Space Administration


48 CFR Part 31

Federal Acquisition Regulation; Accounting for Unallowable Costs; 
Proposed Rule

Federal Register / Vol. 69, No. 187 / Tuesday, September 28, 2004 / 
Proposed Rules

[[Page 58014]]





48 CFR Part 31

[FAR Case 2004-006]
RIN 9000-AK06

Federal Acquisition Regulation; Accounting for Unallowable Costs

AGENCIES: Department of Defense (DoD), General Services Administration 
(GSA), and National Aeronautics and Space Administration (NASA).

ACTION: Proposed rule.


SUMMARY: The Civilian Agency Acquisition Council and the Defense 
Acquisition Regulations Council (Councils) are proposing to amend the 
Federal Acquisition Regulation (FAR) by revising language regarding 
accounting for unallowable costs.

DATES: Interested parties should submit comments in writing on or 
before November 29, 2004 to be considered in the formulation of a final 

ADDRESSES: Submit comments identified by FAR case 2004-006 by any of 
the following methods:
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     Agency Web Site: http://www.acqnet.gov/far/ProposedRules/proposed.htm. Click on the FAR case number to submit comments.
     E-mail: [email protected]. Include FAR case 2004-
006 in the subject line of the message.
     Fax: 202-501-4067.
     Mail: General Services Administration, Regulatory 
Secretariat (V), 1800 F Street, NW, Room 4035, ATTN: Laurie Duarte, 
Washington, DC 20405.
    Instructions: Please submit comments only and cite FAR case 2004-
006 in all correspondence related to this case. All comments received 
will be posted without change to http://www.acqnet.gov/far/ProposedRules/proposed.htm, including any personal information 

FOR FURTHER INFORMATION CONTACT: The FAR Secretariat at (202) 501-4755 
for information pertaining to status or publication schedules. For 
clarification of content, contact Mr. Richard C. Loeb, at (202) 208-
3810. Please cite FAR case 2004-006.


A. Background

    The DoD Director of Defense Procurement and Acquisition Policy 
(DPAP) established a special interagency Ad Hoc Committee to perform a 
comprehensive review of policies and procedures in FAR Part 31, 
Contract Cost Principles and Procedures, relating to cost measurement, 
assignment, and allocation. DPAP announced a series of public meetings 
in the Federal Register notice (66 FR 13712) on March 7, 2001 (with a 
``correction to notice'' published in the Federal Register (66 FR 
16186) on March 23, 2001). Public meetings were held on April 19, 2001, 
May 10-11, 2001, and June 12, 2001. Attendees at the public meetings 
included representatives from industry, Government, and other 
interested parties who provided views on potential areas for revision 
in FAR Part 31. The Ad Hoc Committee reviewed the cost principles and 
procedures and the input obtained during the public meetings; 
identified potential changes to the FAR; and submitted several reports, 
including draft proposed rules for consideration by the Councils.
    The Councils reviewed the Ad Hoc Committee's reports and draft 
proposed rules related to FAR 31.204, Application of principles and 
procedures, and FAR 31.201-6, Accounting for unallowable costs. On May 
22, 2003, a proposed rule was published for public comment in the 
Federal Register (68 FR 28108) under FAR case 2002-006. No public 
comments were received on the proposed rule relating to FAR 31.204. The 
Councils concluded that the FAR 31.204 proposed rule should be 
converted to a final rule, with no changes to the proposed rule. The 
final rule version of 2002-006 was published in the Federal Register in 
Federal Acquisition Circular 2001-24 (69 FR 34224 on June 18, 2004).
    As a result of the public comments received under FAR case 2002-
006, the Councils also decided to make substantive changes to FAR 
31.201-6 and to publish the proposed revisions under this separate 
proposed rule 2004-006. The Councils' recommended changes include 
adding paragraphs (iii) through (vi) to subsection 31.201-6(c)(2) to 
provide specific criteria on the use of sampling as a method to 
identify unallowable costs, including the applicability of penalties 
for failure to exclude certain projected unallowable costs.
    This is not a significant regulatory action and, therefore, was not 
subject to review under Section 6(b) of Executive Order 12866, 
Regulatory Planning and Review, dated September 30, 1993. This rule is 
not a major rule under 5 U.S.C. 804.
    In response to the proposed FAR rule published under FAR Case 2002-
006 in the Federal Register (68 FR 28108) on May 22, 2003, nine 
respondents submitted comments on FAR 31.201-6. The Councils considered 
all comments and concluded that, since the changes result in a rule 
that differs significantly from the proposed rule, it should be 
published as a proposed rule under a new FAR Case 2004-006. Differences 
between the proposed rule under FAR Case 2002-006 and this proposed 
rule are discussed in Comments 3, 4, and 7, below.

Public Comments

    FAR 31.201-6(c)(1)

    1. Comment: Requirement to segregate unallowable costs. One 
respondent recommends removal of FAR 31.201-6(c)(1) from the proposed 
rule (which is also contained in the current FAR language). The 
respondent believes that non-CAS covered contractors should not be 
subject to CAS requirements because of their adherence to the FAR cost 
principles. The respondent also contends that incorporating such 
requirements into the FAR by reference results in lowering thresholds 
for CAS application and is contrary to DoD progressive initiatives such 
as the DoD Panel on Measurement, Assignment, and Allocability 
Provisions of FAR Part 31, and by the DFARS Transformation Project.
    Another respondent believes that retaining the requirement, for all 
contracts subject to FAR Part 31 (CAS and non-CAS covered), to comply 
with the provisions of CAS 405 (Accounting for Unallowable Costs) 
results in more clearly understood and easily applied criteria for 
accounting for unallowable costs. This respondent also believes that 
such requirements create a more level playing field between all 
    Councils' response: The Councils agree that the provision should be 
retained. Prior to the implementation of CAS 405, significant amounts 
of unallowable costs were often included in proposals and billings 
which necessitated significant use of Government resources to find such 
costs. The Councils believe this would occur again if the requirement 
was removed. In addition, unallowable costs must be segregated to 
comply with the statutory penalties provisions; thus, this provision 
serves to implement those statutory requirements.

    FAR 31.201-6(c)(2)

[[Page 58015]]

    2. Comment: Use of statistical sampling. The respondent believes 
that numerous disagreements may result from the proposed language. The 
respondent supports the use of statistical sampling to project 
unallowable costs in connection with discrete pools where the number of 
differing cost elements is limited. However, the respondent 
concurrently objects to the general application of statistical sampling 
for the purposes of projecting unallowable costs in connection with a 
universe of diverse cost elements subject to a significant number of 
cost principles.
    Councils' response: Nonconcur. The Councils recognize the 
respondent's concern about the potential limitations of statistical 
sampling. However, the Councils note that contractors are not required 
to use statistical sampling, i.e., it is an optional technique for 
segregating unallowable costs.
    FAR 31.201-6(c)(2)(iii), (iv), and (v)
    3. Comment: Statistical sampling verification versus segregation. 
The respondent disagrees with the proposed amendment to FAR 31.201-
6(c)(2). The respondent believes that the use of statistical sampling 
should not replace accounting policies and procedures for identifying 
and segregating unallowable costs when the costs are initially incurred 
and recorded. The respondent asserts that initial identification of 
unallowable costs is necessary to meet the requirements of 10 U.S.C. 
2324, which provides penalties against a contractor if expressly 
unallowable costs are included in its claims to the Government. 
Therefore, the respondent recommends adding the following language:
    ``Statistical sampling is an acceptable practice for verifying 
that a contractor's accounting practices and procedures for 
segregating and presenting unallowable costs are operating as 
    Councils' response: Concur in part. The Councils do not believe 
that sampling is precluded by 10 U.S.C. 2324. The Councils note that 
there is no requirement in 10 U.S.C. 2324 to specifically segregate 
every item of unallowable cost. Statistical sampling, when properly 
applied, is acceptable for both segregating unallowable costs and 
verifying that such costs have been properly segregated (either by 
specific identification or using appropriate sampling techniques). 
However, the Councils recognize that the sampling must appropriately 
consider the requirements of 10 U.S.C. 2324 related to the application 
of penalties on unallowable costs. To avoid potential disputes in this 
area, a new paragraph (c)(3) has been added at 31.201-6 to explicitly 
include these appropriate considerations.

    FAR 31.201-6(c)(2)(vi)

    4. Comment: Statistical sampling advance agreements. A respondent 
states that up-front coordination and agreement between the contractor 
and the auditor regarding the sampling plan (e.g., sampling method, 
expense accounts, stratification, precision, confidence, and 
projection) is essential in order to avoid subsequent disputes over the 
adequacy of the sampling plan used by the contractor. The respondent 
asserts that such disputes, as well as differing interpretations of 
statistical terms and methodologies, could delay a timely settlement of 
the contractor's incurred cost submissions and adversely impact the 
contract close-out process. The respondent proposes adding the 
following language to FAR 31.201-6(c):
    (3) Use of statistical sampling methods for identifying and 
segregating unallowable costs should be the subject of an advance 
agreement under the provisions of FAR 31.109.
    Councils' response: Concur. The Councils believe it will streamline 
the review process and avoid potential disputes if the parties agree 
up-front on the sampling plan. The Councils have added the respondent's 
proposed language as well as an additional sentence on advance 
agreements at new paragraph (c)(4) of 31.201-6.

    FAR 31.201-6(e)(1)

    5. Comment: Materiality threshold applied to directly associated 
unallowable costs. The respondent recommends the Council adopt the ``30 
percent rule'' that was contained in 1976 DoD guidance issued by the 
then Assistant Secretary of Defense (Installations and Logistics) Mr. 
Dale Babione. The respondent states that this guidance instructed DoD 
personnel how to interpret the materiality threshold applied to 
directly associated unallowable costs. The respondent further states 
that this 1976 guidance established a threshold of 30 percent of total 
time, over which salary costs are determined to be unallowable and 
under which further evaluation is required. The respondent asserts that 
many contractors and contracting officers have successfully implemented 
this guidance over the past 25 years.
    Councils' response: Nonconcur. The Councils believe that a decision 
on materiality should be made by the contracting officer on a case-by-
case basis after consideration of the three factors listed at 31.201-
6(e)(1): the actual dollar amount, the cumulative effect of all 
directly associated costs in a cost pool, and the ultimate effect on 
the cost of Government contracts.
    The Councils believe that materiality should not be determined 
based solely on a percentage. For example, 25 percent may have a 
material impact to the Government for a company in which every employee 
spends 25 percent of their time on directly associated unallowable 
costs. Conversely, the impact to the Government may be immaterial if 
the Government participation in the indirect cost base is small, even 
if an employee is spending more than 30 percent of his/her time on 
directly associated unallowable costs. Using a similar analysis, 50 
percent may have a material impact to the Government if the total 
amount involved is large and/or the Government has a large share of the 
allocation base. Conversely, 50 percent may have an immaterial impact 
to the Government if the total amount involved is small and/or the 
Government share of the allocation base is small.

    FAR 31.201-6(e)(2)

    6. Comment: Definition of directly associated cost. Two respondents 
contend that CAS 405 (Accounting for Unallowable Costs) does not 
distinguish among types of directly associated costs. They assert that 
CAS 405 prescribes a general rule of cost recognition, measurement and 
allocation, which applies to all types of cost, without distinction. 
They further state that CAS 405 prescribes the following ``but for'' 
test: Directly associated cost means any cost which is generated solely 
as a result of the incurrence of another cost, and which would not have 
been incurred had the other cost not been incurred. The respondents 
contend that FAR 31.201-6(e) abandons this ``but for'' test and 
substitutes a materiality test for recognizing and measuring the 
``salary expenses of employees who participate in activities that 
generate unallowable costs.'' Accordingly, the respondents believe it 
is confusing as to whether salaries and expenses are governed by the 
``but for'' test or by a new ``materiality'' test. Therefore, one 
respondent recommends amending FAR 31.201-6(e) so that it complies with 
CAS 405 in the application of the ``but for'' test and delete the 
``materiality'' test. As an alternative, the other respondent 
recommends that FAR 31.201-6(e) be amended to establish a rebuttable 
presumption that material amounts of time devoted to unallowable 
activities would, in the normal course of business, influence the 
employee's compensation. Under the respondent's proposal, contractors 
could rebut the presumption by showing that, in any

[[Page 58016]]

individual situation, compensation would not have been affected. For 
example, under the respondent's revision, compensation would not be 
affected in the unusual situation of a natural disaster requiring 
salaried personnel to devote material amounts of effort to unallowable 
charitable activities during a particular accounting period.
    Councils' response: Nonconcur. The Councils note that the current 
language at FAR 31.201-6(e)(2) is not a ``new'' materiality test. This 
language, which was promulgated over twenty years ago, provides 
contracting personnel and contractors with specific information on when 
to treat salaries and expenses as directly associated costs. The 
Councils believe this language should be retained. They also believe 
that the respondent's proposed alternative language would potentially 
cause significant increases in the number of disputes due to arguments 
regarding when compensation is and is not affected by unallowable 
    7. Comment: Illustration. The respondent states that it does not 
object to the inclusion of an illustration in FAR 31.201-6(e)(2), but 
if an illustration is to be included, it prefers the one included in 
CAS 405-60(e). The respondent contends that use of a CAS illustration 
will avoid potential conflicts in determining materiality.
    Councils' response: Nonconcur. The proposed language at FAR 31.201-
6(e)(2) is not an illustration, but is instead criteria for determining 
how to treat salary expenses of employees that participate in 
activities that generate unallowable costs. The Councils believe it is 
not appropriate for FAR Part 31 to include illustrations such as those 
contained in CAS because they would be inconsistent with the overall 
structure of the FAR, which does not include such illustrations in any 
other part.
    FAR 31.201-6(e)(3)
    8. Comment: Incorrect reference. Two respondents noted that the 
reference in 31.201-6(e)(3) is incorrect. The reference should be to 
paragraphs (e)(1) and (e)(2) of that subsection, rather than (f)(1) and 
    Councils' response: Concur. There is no paragraph (f)(1) or (f)(2) 
in FAR 31.201-6. The typographical errors have been corrected in 
paragraphs (e)(2), and (e)(3).

B. Regulatory Flexibility Act

    The Councils do not expect this proposed rule to have a significant 
economic impact on a substantial number of small entities within the 
meaning of the Regulatory Flexibility Act, 5 U.S.C. 601, et seq., 
because most contracts awarded to small entities use simplified 
acquisition procedures or are awarded on a competitive, fixed-price 
basis, and do not require application of the cost principles and 
procedures discussed in this rule. An Initial Regulatory Flexibility 
Analysis has, therefore, not been performed. We invite comments from 
small businesses and other interested parties. The Councils will 
consider comments from small entities concerning the affected FAR Part 
in accordance with 5 U.S.C. 610. Interested parties must submit such 
comments separately and should cite 5 U.S.C. 601, et seq. (FAR case 
2004-006), in correspondence.

C. Paperwork Reduction Act

    The Paperwork Reduction Act does not apply because the proposed 
changes to the FAR do not impose information collection requirements 
that require the approval of the Office of Management and Budget under 
44 U.S.C. 3501, et seq.

List of Subjects in 48 CFR Part 31

    Government procurement.

    Dated:September 20, 2004
Director,Contract Policy Division.
    Therefore, DoD, GSA, and NASA propose amending 48 CFR part 31 as 
set forth below:


    1. The authority citation for 48 CFR part 31 is revised to read as 

    Authority: 40 U.S.C. 121(c); 10 U.S.C. chapter 137; and 42 
U.S.C. 2473(c).
    2. Amend section 31.201-6 by--
    a. Amending paragraphs (a) and (b) by removing ``which'' and adding 
``that'' in its place each time it appears;
    b. Revising paragraph (c);
    c. Revising the first sentence in paragraph (d);
    d. Amending paragraph (e)(1)(ii) by removing ``or'' and adding 
``and'' in its place; and
    e. Revising paragraph (e)(3).
    The revised text reads as follows:

31.201-6  Accounting for unallowable costs.

* * * * *
    (c)(1) The practices for accounting for and presentation of 
unallowable costs must be those described in 48 CFR 9904.405, 
Accounting for Unallowable Costs.
    (2) Statistical sampling is an acceptable practice for accounting 
for and presenting unallowable costs provided the following criteria 
are met:
    (i) The statistical sampling results in an unbiased sample that is 
a reasonable representation of the sampling universe.
    (ii) All large dollar value and high risk transactions are 
separately reviewed for unallowable costs and excluded from the 
sampling process.
    (iii) The statistical sampling permits audit verification.
    (3) For the purposes of applying the penalty provisions at FAR 
42.709, when statistical sampling is used for accounting for and 
presenting unallowable costs--
    (i) The following amounts must be excluded from any final indirect 
rate proposal or final statement of costs incurred or estimated to be 
incurred under a fixed-price incentive contract submitted to the 
    (A) The amounts projected to the sampling universe for any 
expressly unallowable costs in the sample.
    (B) The amounts projected to the sampling universe for any costs in 
the sample determined to be unallowable for the contractor before 
proposal submission.
    (ii) Any amounts that are not excluded in accordance with paragraph 
(c)(3)(i) of this subsection are subject to the penalties provisions at 
FAR 42.709.
    (iii) The provisions of paragraph c)(3)(ii) of this subsection do 
not apply to the following:
    (A) Contracts that are $500,000 or less.
    (B) Fixed-price contracts without cost incentives.
    (C) Firm-fixed-price contracts for the purchase of commercial 
    (4) Use of statistical sampling methods for identifying and 
segregating unallowable costs should be the subject of an advance 
agreement under the provisions of FAR 31.109. The advance agreement 
should specify the basic characteristics of the sampling process.
    (d) If a directly associated cost is included in a cost pool that 
is allocated over a base that includes the unallowable cost with which 
it is associated, the directly associated cost shall remain in the cost 
pool. * * *
    (e) * * *
    (3) When a selected item of cost under 31.205 provides that 
directly associated costs be unallowable, such directly associated 
costs are unallowable only if determined to be material in amount in 
accordance with the criteria provided in paragraphs (e)(1) and (e)(2) 
of this subsection, except in those situations where allowance of any 
of the directly associated costs involved would be considered to be 
contrary to public policy.
[FR Doc. 04-21640 Filed 9-27-04; 8:45 am]