[Federal Register Volume 74, Number 236 (Thursday, December 10, 2009)]
[Rules and Regulations]
[Pages 65608-65612]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-28934]


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DEPARTMENT OF DEFENSE

GENERAL SERVICES ADMINISTRATION

NATIONAL AERONAUTICS AND SPACE ADMINISTRATION

48 CFR Part 31

[FAC 2005-38; FAR Case 2006-021; Item V; Docket 2009-0043, Sequence 1]
RIN 9000-AK84


Federal Acquisition Regulation; FAR Case 2006-021, Postretirement 
Benefits (PRB), FAS 106

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

ACTION: Final rule.

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SUMMARY: The Civilian Agency Acquisition Council and the Defense

[[Page 65609]]

Acquisition Regulations Council (Councils) are issuing a final rule 
amending the Federal Acquisition Regulation (FAR) to permit the 
contractor to measure accrued PRB costs using either the criteria in 
Internal Revenue Code (IRC) 419 or the criteria in Financial Accounting 
Standard (FAS) 106.

DATES: Effective Date: January 11, 2010.

FOR FURTHER INFORMATION CONTACT: For clarification of content, contact 
Mr. Edward N. Chambers, Procurement Analyst, at (202) 501-3221. For 
information pertaining to status or publication schedules, contact the 
Regulatory Secretariat at (202) 501-4755. Please cite FAC 2005-38, FAR 
case 2006-021.

SUPPLEMENTARY INFORMATION:

A. Background

    FAR 31.205-6(o) allows contractors to choose among three different 
accounting methods for PRB costs; pay-as-you-go (cash basis), terminal 
funding, and accrual basis.
    When the accrual basis is used, the FAR currently requires that 
costs must be measured based on the requirements of Financial 
Accounting Standard (FAS) 106.
    However, the tax-deductible amount that is contributed to the 
retiree benefit trust, which is part of a welfare benefit plan, is 
determined using Internal Revenue Code (IRC) (Title 26 of the United 
States Code) sections 419 and 419A, which has different measurement 
criteria than FAS 106. As a result, the FAS 106 amount can often exceed 
the costs measured under IRC sections 419 and 419A, and contractors 
that choose to accrue PRB costs for Government reimbursement face a 
dilemma: whether to fund the entire FAS 106 amount to obtain Government 
reimbursement of the costs, regardless of tax implications; or fund 
only the tax deductible amount and not be reimbursed for the entire FAS 
106 amount under their Government contracts.
    Consequently, DoD, GSA, and NASA published a proposed rule in the 
Federal Register at 72 FR 64185, November 15, 2007 to address this 
matter.
    The Councils are amending FAR 31.205-6(o) to alleviate this 
dilemma. This amendment would provide the contractor an option of 
measuring accrued PRB costs using criteria based on IRC sections 419 
and 419A rather than FAS 106, thereby permitting the contractor to fund 
the entire tax deductible amount without having a portion potentially 
disallowed because it did not meet the FAR's current measurement 
criteria. The Councils note that this amendment will not change the 
total measured PRB costs, i.e., the total measured PRB costs over the 
life of the PRB plan would be the same whether the contractor chose to 
apply the criteria in FAS 106 or IRC sections 419 and 419A.
    The Councils note that in this final rule the Government will not 
pay higher PRB costs, since the resulting difference from contractors 
previously funding the lower IRC amount rather than the full FAS amount 
will continue to be an unallowable cost. This final rule does permit 
contractors to electively switch to the IRC 419 accrual basis and avoid 
any current or future disallowances.

B. Public Comments

    Public comments were received from two industry associations and 
one contractor.
    The commenters made specific remarks but generally agreed with the 
purpose of the proposed rule.
    One commenter wrote that they:
    ``generally agree with the concept of revising FAR 31.205-6(o) to 
better align FAR allowability provisions for Postretirement Benefit 
(PRB) Plans accounted for on an accrual basis with payments made to 
benefit trusts for tax purposes. We see this as a positive step toward 
allowing appropriate flexibility and equity in measuring, assigning and 
allocating allowable PRB costs.''
    Another commented:
     ``We support the Councils' proposal to amend the Federal 
Acquisition Regulation 31.205-6(o) (``FAR'') to permit contractors to 
measure postretirement benefit (``PRB'') costs using either the 
criteria in Internal Revenue Code section 419 (``IRC'') or the criteria 
in the Statement of Financial Accounting Standards No. 106 (``FAS'').''
    Specific Comments:
    Comment 1: Two commenters objected to the 15 year minimum 
amortization period for PRB costs, stating:
     ``The proposed rule specifying that assignment of PRB costs be 
made over ``the working lives of employees or fifteen years, whichever 
is longer'' may not be appropriate. In our opinion, the proposed FAR 
requirement for costs measured in accordance with the deductibility 
measurement under the Internal Revenue Code (IRC) Section 419/419A has 
the potential for mismatching PRB costs with the underlying causal 
activity, that is, the labor of active employees covered by PRB plans. 
The IRC requires that the costs be assigned over the working lives of 
the employees, whereas the proposed rule would require that the costs 
be assigned over the working lives of employees or fifteen years, 
whichever is longer. We are concerned about extending the assignment of 
costs beyond the working lives of employees, as this would cause costs 
to be charged to contracts that are not getting the benefit of those 
employees' services.''
    Response: The Councils believe the language in the proposed rule is 
appropriate. Many PRB plans cover no or few active employees, as 
contractors have closed their PRB plans to new entrants. FAS 106 
requires that if a plan is comprised predominantly of inactive 
participants, then the cost should be spread over the future life 
expectancy of the inactive employees. FAR 31.205-6(o)(2)(ii) requires 
that if terminal funding is used then the liability must be spread over 
15 years. For contractors who elect to use the proposed alternative 
accrual accounting method, the Councils believe that the FAS 106 
requirement that plans predominantly comprised of inactive participants 
be spread over future periods should be maintained. For consistency, 
the proposed rule uses the same amortized recognition as required for 
terminally funded plans. The proposed rule adopted a simple ``greater-
of'' rule to avoid any disputes concerning when a plan is predominantly 
comprised of inactive employees.
    However, if the plan population comprises only inactive 
participants, the cost shall be spread over the average future life 
expectancy of the participants. This ensures that the accruals do not 
extend beyond the period when benefits are paid and the trust is 
dissolved. Therefore, the final rule revises FAR 31.205-
6(o)(2)(iii)(A)(2)(ii) to state: ``However, if the plan is comprised of 
inactive participants only, the cost shall be spread over the average 
future life expectancy of the participants.''
    Comment 2: The proposed rule does not address several issues of 
assignment of credits to a period that can arise when the accrual is 
based on FAS 106.
    Two commenters remarked as follows regarding contract credits that 
might arise:
    ``Measuring PRB costs in accordance with FAS 106 can result in 
credits being assigned to cost accounting periods. FAS 106 dictates 
these credits be immediately assigned to cost accounting periods. 
However, contractors have no ability to extract irrevocably funded PRB 
contributions from their trusts. * * *''
    Commenters were also concerned that the proposed rule does not 
address conflicts between the FAR and FAS 106

[[Page 65610]]

when there is a curtailment, settlement or payment of ``special 
termination benefits.'' As a commenter noted:
     ``In the event of a curtailment, settlement or payment of 
``special termination benefits'' (i.e., early retirement enhancements, 
FAS 106 mandates immediate recognition. This assignment of income was 
also one of the issues with FAS 106, which the failed promulgation of 
CAS 419 sought to moderate.''
    On the other hand, another commenter correctly noted that the 
proposed rule permits a contractor to elect to account for its PRB 
costs following the welfare benefit fund provisions of the IRC as an 
alternative to the current rule that limits accrual accounting to the 
provisions of FAS 106. The commenter discusses the advantages of having 
a choice as follows:
    ``Under existing FAR rules, contractors under accrual basis of 
accounting must use FAS 106 (so long as the transition obligation cost 
is amortized) for measuring PRB costs and fund this FAR expense to the 
PRB plan in order for the FAS expense to be considered an allowable 
cost.
    ``We believe this amendment will promote simplification of the 
funding of PRB plans by avoiding the dilemma of whether to fund the IRC 
limit or the FAS expense when there is conflict with each other. The 
contractor would not need to be worried about running afoul of tax 
rules or under-billing the contract.
    ``In addition, one advantage of permitting the PRB cost to be 
either FAS or IRC basis is that in the first year of a PRB funded plan, 
the amendment gives the contractor the flexibility to fund the larger 
of the two bases in order to lower PRB costs in the future as assets 
grow with investment returns. Done consistently under the same 
accounting basis, this approach would benefit the contract with lower 
PRB costs in the long run rather than limiting funding due the current 
dilemma of funding FAS or IRC.
    ``And finally, the amendment will promote an equitable measure of 
allowable PRB costs during the life of the PRB plan. Whether choosing 
FAS or IRC basis for funding, both methods would arrive at the same 
aggregate allowable cost over the life of the PRB plan.''
    Response: The Councils believe that the issues regarding credits, 
curtailments, and settlements do not need to be addressed in the 
proposed rule. No evidence has been presented that this issue has been 
a problem. Furthermore, these issues are outside the scope of this 
case. As noted in the background section of Federal Register notice:
    ``* * * This amendment would provide the contractor an option of 
measuring accrued PRB costs using criteria based on IRC 419 rather than 
FAS 106, thereby permitting the contractor to fund the entire tax 
deductible amount without having a portion disallowed because it did 
not meet the FAR's current measurement criteria. * * *''
    The proposed rule provides an alternative for measuring PRB costs 
on an accrual accounting basis. The proposed rule and Federal Register 
notice do not address the existing provisions which, first published as 
56 FR 29127 on June 25, 1991, adopted generally accepted accounting 
principles (FAS 106). The original rule was amended by 56 FR 41738 on 
August 22, 1991 to add a limitation only on the choice of recognizing 
the transition obligation.
    Comment 3: Commenters expressed a concern with the provision 
allowing use of a healthcare inflation assumption as follows:
    ``The proposed rule's specific authorization of the use of a 
healthcare inflation assumption for measurement of costs which would 
otherwise be in accordance with IRC Sections 419/419A creates a 
mismatch of FAR allowable costs and IRS deductibility limitations. If 
the intent of the rule was to better align funding with FAR 
requirements, we find this provision, while not detrimental, is 
inconsistent with the stated purpose of the proposed rule, which is to 
better align the FAR allowability rules with the IRC for those 
contractors that choose to use IRC 419/419a.''
    Response: The Councils believe that the proposed rule should be 
revised to clarify the intent of this language. Generally accepted 
accounting principles currently require the use of a healthcare 
inflation assumption. For consistency, the intent of the proposed rule 
was to require use of a health care assumption unless the IRC welfare 
benefit fund rules prohibited it. The Councils are revising the wording 
in the proposed rule to assure clarity on this issue. Thus, the final 
rule revises FAR 31.205-6(o)(2)(iii)(A)(2)(i) to state that the costs 
shall ``be measured using reasonable actuarial assumptions, which shall 
include a healthcare inflation assumption unless prohibited by the 
Internal Revenue Code provisions governing welfare benefit funds.''
    Comment 4: Finally, two commenters opined that the requirement that 
assets be restricted is unnecessary. One of the commenters wrote: ``Our 
recommended changes to the proposed rule are shown in Attachment I. It 
should be noted that we have also proposed the elimination of the last 
sentence in 31.205-6(o)(2)(iii)(B). We do not believe that this asset 
restriction language is necessary to protect the Government's 
interests.''
    Response: The Councils disagree with the commenter. The Councils 
believe that the Government must assure there is adequate protection of 
the assets. If the fund holding the PRB plan can be cancelled or 
diverted to other purposes, then deposits to the fund can not be 
recognized as incurred. Moreover, this language is consistent with the 
FAS 106 definition of ``plan assets,'' and with the IRC 419/419A 
criteria for tax-exempt funding.
    The Councils note that even if an appropriately restricted fund is 
used, once all obligations for benefits have been settled the remaining 
assets may revert to the contractor or else inure to the contractor's 
benefit if diverted to provide other employee benefits. However, the 
Councils believe that the Government's interests are protected by 
existing FAR 31.205-6(o)(5) which states:
     The Government shall receive an equitable share of any amount of 
previously funded PRB costs which revert or inure to the contractor. 
Such equitable share shall reflect the Government's previous 
participation in PRB costs through those contracts for which cost or 
pricing data were required or which were subject to Subpart 31.2.
    Comment 5: One commenter expressed its concern with how the 
transition between accounting methods would be accomplished, writing:
     ``However, we are not certain if this proposal addresses changes 
of accounting methods, particularly from FAS to IRC basis; whether such 
resulting costs will be fully allowed immediately or transitioned over 
a period of time. Under the concept that both methods should yield the 
same aggregate cost over time, an immediate change of accounting method 
may misalign this relationship, and thus, new transition rules may be 
designed to preserve the equality. If this occurs, we believe it would 
be advisable for the Councils to promulgate new transition rules--
preferably short-term ones in order to avoid prolonged complexity in 
cost calculations for many years, and incorporate them in FAR Part 
31.205-6(o).''
    This commenter further explained:
    ``FAS 106 allows either the immediate expensing or the amortization 
of the transition obligation. However, for Government contract costing 
purposes,

[[Page 65611]]

the transition obligation must be capitalized and subsequently 
amortized. The parenthetical clause ``so long as the transition 
obligation cost is amortized'' could be more clearly stated as 
``provided the transition obligation cost is amortized rather than 
expensed.''''
    The commenter also noted that actuaries and mathematicians have 
stated that both accrual accounting methods would result in the same 
aggregate costs over the life of the PRB plan when either method is 
applied to a separate PRB plan as of ``day one.'' But they then 
expressed their concern that changing the accounting method 
``midstream'' might cause misalignment of costs due to differences of 
timing arising from the two computational methodologies.
    Finally they expanded their written comment by observing that the 
rule will permit a change of accrual accounting method and that this 
transition will result in a higher or lower amount of PRB costs in 
subsequent years than would have resulted without a change in methods. 
The commenter explained they were asking if there will be a ``phase-in 
period'' when changing methods of accounting for PRB costs, i.e., would 
the change of costs be recognized in a single accounting period or 
amortized over future periods.
    Response: The Councils agree that the language in the proposed rule 
should be revised to address the transition issue.
    The Councils believe that the existing FAR 31.205-6(o)(2)(iii) 
provision regarding recognition of the FAS 106 Transition Obligation 
clearly articulates that the transition obligation cost is amortized 
rather than expensed.
    The comment does raise two issues. First, a paraphrase of the 
existing policy at FAR 31.205-6(o)(2)(iii)(A) follows:
    Accrued PRB costs shall be measured and assigned in accordance with 
generally accepted accounting principles, provided the portion of PRB 
costs attributable to the transition obligation assigned to the current 
year that is in excess of the amount assignable under the delayed 
recognition methodology described in paragraphs 112 and 113 of 
Financial Accounting Standards Board Statement 106 is unallowable. The 
transition obligation is defined in Statement 106, paragraph 110;
    The cost impact of the change in cost accounting practice is 
addressed by the Cost Accounting Standards, rather than the FAR, for 
those contracts covered by the CAS. Under the CAS this would be a 
unilateral change in cost accounting practice; as such, the Government 
would not pay any increased costs resulting from this change unless the 
contracting officer has determined it to be a desirable change. For 
those contracts not covered by the CAS, the FAR does not provide for 
price adjustments resulting from a change in cost accounting practice. 
The Councils do not believe this change is so unique as to require an 
alteration to this long-standing set of regulations regarding the 
treatment of changes in cost accounting practice. Thus, the language in 
the proposed rule has not been revised to address this issue.
    The second issue regards the treatment of the change in actuarial 
liability and normal cost and recognition of accruals assigned to prior 
periods. Language has been added at FAR 31.205-6(o)(2)(iii)(G) to 
require that the Government has an opportunity to review and approve 
how the change in accounting method will be implemented. The new 
provision at FAR 31.205-6(o)(2)(iii)(G) reads:
    (G) Comply with the following when changing from one accrual 
accounting method to another: the contractor shall--
    (1) Treat the change in the unfunded actuarial liability (unfunded 
accumulated postretirement benefit obligation) as a gain or loss; and
    (2) Present an analysis demonstrating that all costs assigned to 
prior periods have been accounted for in accordance with subparagraphs 
(D), (E), and (F) to ensure that no duplicate recovery of costs exists. 
Any duplicate recovery of costs due to the change from one method to 
another is unallowable. The analysis and new accrual accounting method 
may be a subject appropriate for an advance agreement in accordance 
with 31.109.
    It is clear that the final rule must address how the transition 
from one cost method to another is accomplished. As one commenter 
observed, at ``day one'' the cost of the PRB plan, on a present value 
basis, will be the same under any of the methods permitted by FAR 
31.205-6(o). However, after day one, this equivalence can only be 
maintained if there is a full accounting for costs assigned to prior 
periods, adjusted for interest, benefit payments, and administrative 
expenses. Only if prior funding and unfunded accrued costs are fully 
recognized will the costs assigned to future periods produce equivalent 
results, on a present value basis, over the life of the PRB plan. And 
to avoid any misunderstandings, the final rule at FAR 31.205-
6(o)(2)(iii)(D) makes it clear that any prior period unfunded accrual 
becomes and remains unallowable under either accrual accounting method. 
FAR 31.205-6(o)(2)(iii)(D) reads:
    (D) Eliminate from costs of current and future periods the 
accumulated value of any prior period costs that were unallowable in 
accordance with paragraph (3), adjusted for interest under 
paragraph(4).
    The assets do fully account for prior accrued costs that were 
funded and the accumulated value of unallowable costs fully account for 
any prior unfunded accruals. To the extent that prior contract costs 
were always based on accrual accounting, prior accruals can be 
recognized in the current value of the plan assets plus the accumulated 
value of prior unallowable costs, adjusted for interest cost due to 
delayed funding.
    And, finally, some contractors may have made deposits to voluntary 
employee benefit associations or other trusts in prior periods but used 
pay-as-you-go or terminal funding for contract costing purposes during 
those prior periods. To the extent that assets are attributable to 
costs that have never been recognized as Government contract cost, such 
assets must be excluded from the assets that have been accumulated by 
prior assigned costs. Otherwise, the contractor would be inequitably 
prevented from claiming a cost that has not yet been reimbursed.
    Therefore, to ensure that prior funded accrued costs are fully 
recognized, paragraph FAR 31.205-6(o)(2)(iii)(E) has been added to the 
final rule. This provision reads:
    (E) Calculate the unfunded actuarial liability (unfunded 
accumulated postretirement benefit obligation) using the market (fair) 
value of assets that have been accumulated by funding costs assigned to 
prior periods for contract accounting purposes.
    Likewise, FAR 31.205-6(o)(2)(iii)(F) specifies that assets 
accumulated by deposits that were not used to claim contract costs are 
identified as prepayment credits and excluded from the plan assets used 
to determine the unfunded actuarial liability. FAR 31.205-
6(o)(2)(iii)(F) reads:
     (F) Recognize as a prepayment credit the market (fair) value of 
assets that were accumulated by deposits or contributions that were not 
used to fund costs assigned to previous periods for contract accounting 
purposes.

C. Regulatory Planning and Review

    This is a significant regulatory action and, therefore, was subject 
to review under Section 6(b) of Executive Order 12866, Regulatory 
Planning and Review, dated September 30, 1933. This rule is not a major 
rule under 5 U.S.C. 804.

[[Page 65612]]

D. Regulatory Flexibility Act

    The Department of Defense, the General Services Administration, and 
the National Aeronautics and Space Administration certify that this 
final rule will not 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 small entities do 
not accrue PRB costs for Government contract costing purposes.

E. Paperwork Reduction Act

    The Paperwork Reduction Act does not apply because the 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. 
chapter 35, et seq.

List of Subjects in 48 CFR Part 31

    Government procurement.

    Dated: November 30, 2009.
Al Matera,
Director, Acquisition Policy Division.

0
Therefore, DoD, GSA, and NASA amend 48 CFR part 31 as set forth below:

PART 31--CONTRACT COST PRINCIPLES AND PROCEDURES

0
1. The authority citation for 48 CFR part 31 continues to read as 
follows:

    Authority:  40 U.S.C. 121(c); 10 U.S.C. chapter 137; and 42 
U.S.C. 2473(c).


0
2. Amend section 31.001 by adding, in alphabetical order, the 
definition ``welfare benefit fund'' to read as follows:


31.001  Definitions.

* * * * *
    Welfare benefit fund means a trust or organization which receives 
and accumulates assets to be used either for the payment of 
postretirement benefits, or for the purchase of such benefits, provided 
such accumulated assets form a part of a postretirement benefit plan.

0
3. Amend section 31.205-6 by revising paragraph (o)(2)(iii) to read as 
follows:


31.205-6  Compensation for personal services.

* * * * *
    (o) * * *
    (2) * * *
    (iii) Accrual basis. PRB costs are accrued during the working lives 
of employees. Accrued PRB costs shall comply with the following:
    (A) Be measured and assigned in accordance with one of the 
following two methods:
    (1) Generally accepted accounting principles, provided the portion 
of PRB costs attributable to the transition obligation assigned to the 
current year that is in excess of the amount assignable under the 
delayed recognition methodology described in paragraphs 112 and 113 of 
Financial Accounting Standards Board Statement 106 is unallowable. The 
transition obligation is defined in Statement 106, paragraph 110; or
    (2) Contributions to a welfare benefit fund determined in 
accordance with applicable Internal Revenue Code. Allowable PRB costs 
based on such contributions shall--
    (i) Be measured using reasonable actuarial assumptions, which shall 
include a healthcare inflation assumption unless prohibited by the 
Internal Revenue Code provisions governing welfare benefit funds;
    (ii) Be assigned to accounting periods on the basis of the average 
working lives of active employees covered by the PRB plan or a 15 year 
period, whichever period is longer. However, if the plan is comprised 
of inactive participants only, the cost shall be spread over the 
average future life expectancy of the participants; and
    (iii) Exclude Federal income taxes, whether incurred by the fund or 
the contractor (including any increase in PRB costs associated with 
such taxes), unless the fund holding the plan assets is tax-exempt 
under the provisions of 26 USC Sec.  501(c).
    (B) Be paid to an insurer or trustee to establish and maintain a 
fund or reserve for the sole purpose of providing PRB to retirees. The 
assets shall be segregated in the trust, or otherwise effectively 
restricted, so that they cannot be used by the employer for other 
purposes.
    (C) Be calculated in accordance with generally accepted actuarial 
principles and practices as promulgated by the Actuarial Standards 
Board.
    (D) Eliminate from costs of current and future periods the 
accumulated value of any prior period costs that were unallowable in 
accordance with paragraph (o)(3) of this section, adjusted for interest 
under paragraph (o)(4) of this section.
    (E) Calculate the unfunded actuarial liability (unfunded 
accumulated postretirement benefit obligation) using the market (fair) 
value of assets that have been accumulated by funding costs assigned to 
prior periods for contract accounting purposes.
    (F) Recognize as a prepayment credit the market (fair) value of 
assets that were accumulated by deposits or contributions that were not 
used to fund costs assigned to previous periods for contract accounting 
purposes.
    (G) Comply with the following when changing from one accrual 
accounting method to another: the contractor shall--
    (1) Treat the change in the unfunded actuarial liability (unfunded 
accumulated postretirement benefit obligation) as a gain or loss; and
    (2) Present an analysis demonstrating that all costs assigned to 
prior periods have been accounted for in accordance with paragraphs 
(o)(2)(iii)(D), (E), and (F) of this section to ensure that no 
duplicate recovery of costs exists. Any duplicate recovery of costs due 
to the change from one method to another is unallowable. The analysis 
and new accrual accounting method may be a subject appropriate for an 
advance agreement in accordance with 31.109.
* * * * *
[FR Doc. E9-28934 Filed 12-9-09; 8:45 am]
BILLING CODE 6820-EP-S