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Cost Accounting Standards - Federal Govt Contracts (US)

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					 National Defense Industrial Association

Cross Border Cost, Accounting and Pricing
             Considerations
   Associated with Federal Government
               Contracts

            Mary Karen Wills, Partner
             Beers & Cutler PLLC
                  March 2006
                  Topics

 Contracting Considerations
 Pricing Considerations
 Cost Issues
 Cost Accounting Standards Considerations
 Government Audit Considerations




                      2
Contracting Considerations
              Contract Considerations
   Contracting method will dictate many cross border
    issues
    – Commercial item contract
    – Negotiated contract
    – Specific contract type, e.g. cost type, fixed-price, T&M
   Contracting agency and associated regulations will
    also dictate cross border issues
    – United States government agency
    – Foreign government agency
   Our Focus will be primarily on contracts with United
    States government
                                  4
        Commercial Item Acquisition
 Commercial item contracts more prevalent
 Negotiated commercial item contracts provide for
  government access and right to examine records
  related to contract – information other than cost or
  pricing data
 Most Favored Customer Clause Compliance deserves
  consideration – often included in agreements
 Consider how foreign contractors can or will support
  comparable pricing data for discounts and pricing
  history—accuracy, completeness and verifiability
 Anticipate unique clauses for inclusion
                          5
            Negotiated Procurement

 If contract exceeds $550,000, the Truth in Negotiation
  Act applies unless an exemption is met. No special
  exemptions for foreign concerns.
 Contractors required to submit current, accurate and
  complete cost and/or price information.
 Responsibility for subcontractor cost or pricing data
  could raise issues with foreign companies and ability to
  substantiate with cost or pricing data. Also consider
  prime’s responsibility for reviewing cost or pricing data,
  and how this will be accomplished.
 Consider how to accomplish “assist audits” overseas.

                            6
    Options for Structuring Foreign Work

 Contract/subcontract with a separate foreign
  company
 Contract/subcontract with an existing foreign
  related party entity
    – Subsidiary
    – Division
    – Branch
 Set-up a new related party foreign entity
 Joint Ventures and teaming arrangements
 Strategic alliances
                       7
    Options for Structuring Foreign Work

 Tax issues may be important in driving
  selection of entity
 Consider obtaining in-country local knowledge
 Many companies outsource accounting and tax
  functions in-country, especially payroll




                      8
Pricing Considerations
    Incremental Costs To Include in Cost
          Estimates or Bid Prices
   Many contracts with foreign concerns result in
    significant incremental costs over domestic concerns.
    Consider:
    – International transportation/shipping – impact can often be as
      high as sales price. Not typically included in domestic bids.
    – Insurance – multiple handling points and differing risks warrant
      consideration
    – Taxes – employee and employer, VAT, local, income taxes
    – Export licenses, permits and legal fees
    – Employee Wage Differentials
    – Foreign currency translation costs
    – Letter of credit/financing costs
                                 10
         Employee Compensation Costs
 Expatriates or local hires?
 Country specific rules and agreements:
    – Residency
    – Requirement to pay personal income tax in country and United
      States
    – Credit available to United States tax ($80,000 exclusion)
      (United States, Germany, Italy, United Kingdom)
   Compensation differentials often include:
    –   Cost of living increases
    –   Housing
    –   Relocation
    –   Tax gross up
    –   Travel in country and to US
    –   Education expenses
                                  11
        Employee Compensation Costs

   FAR 31.205-6 Compensation explicitly covers
    allowability for additional income tax resulting
    from foreign assignments

   FAR 31.205-6 also includes limits on
    severance payments to foreign national
    performing on contracts outside the US.
    Amounts deemed allowable up to amounts
    typically paid in U.S. Other provisions also
    included.

                          12
    Consider Incremental Costs in Pricing
                  Contract
 Contract type may dictate need for inclusion of
  special clauses to ensure adequate recovery of
  additional costs due to cross-border issues.
 Cost-type contract, consider clauses detailing
  types of costs considered to be reimbursable
 Fixed-price contract, consider EPA clause or
  other clause to mitigate foreign currency
  exchange risk
 Ensure bids include adequate estimates for
  incremental costs
                       13
             Payment Considerations
   Complexities can arise in relation to obtaining
    payments. Consider currency to be used? What
    exchange rate applies? How payment will be secured?
   Clarify payment method in contract, if unusual – eg,
    advance payments, negotiated payment schedule
   Consider ability of foreign entity to timely submit
    progress payment support
   Consider working capital requirements related to
    progress payments
   Consider how to structure payment terms with foreign
    payors, often letters of credit need to be established by
    US companies.
                             14
Cost Matters
                     Cost Matters
   Certain costing issues arise in connection with dealing
    with related party foreign concerns, e.g. joint venture,
    subsidiaries, branches, etc.
   These costing issues often arise as entities fulfill
    contractual obligations using multiple entities of the
    organization, e.g. borrowed labor, intercompany
    purchase of products, maximizing existing capabilities.
   These issues create a need for supportable transfer
    pricing methodologies between related party entities.



                             16
           Transfer Pricing Example
 Entity A provides IT services, installs hardware and
  performs training. Entity is located in Houston, TX
 Entity B is a subsidiary located in India that provides
  call center services to government and commercial
  entities.
 Entity C produces computer hardware in China only for
  sale to US Government.
 All three entities are collaborating on a US Government
  contract. How will costing and pricing be performed for
  all entities?

                           17
              Transfer Pricing Issues
   Related party entities typically establish transfer pricing
    policies, that is pricing policies for products or services
    sales between segments or geographic locations
   Transfer pricing includes how the price is determined,
    e.g. base cost, indirects, G&A and profit to be applied
    between related party entities
   These transfer pricing policies should be established
    and should ensure consistency of pricing methods
   Need to consider whether transfer pricing policies have
    already been established in CASB Disclosure
    Statements or GAAP accounting and how they will be
    adhered to and comply with FAR and CAS.
                              18
               Transfer Pricing

 Often transfer pricing is determined based on
  trying to minimize taxes. Typically required to
  be arm’s length. Arm’s length definition varies
  by country and is often subjective.
 Many times, transfer pricing includes a profit
  element.
 Contractors can use differing transfer pricing
  methodologies for contract costing purposes
  than are used for tax or reporting purposes.


                        19
          FAR 31.205-26 Material Costs
   FAR 31.205-(e) Allowance for all materials, supplies and services
    that are sold or transferred between any divisions, subdivisions,
    subsidiaries, or affiliates of the contractor under a common control
    shall be on the basis of cost incurred in accordance with this
    subpart. However, allowance may be at price when —

    (1) It is the established practice of the transferring organization to
    price interorganizational transfers at other than cost for
    commercial work of the contractor or any division, subsidiary or
    affiliate of the contractor under a common control; and

    (2) The item being transferred qualifies for an exception under
    15.403-1(b) and the contracting officer has not determined the
    price to be unreasonable


                                    20
    Transfer Pricing for Internal Services

 Companies often look to other parts of a
  consolidated entity to provide not only contract
  or end product items, but also internal services,
  like accounting, HR, legal, IT.
 Transfer pricing policies, or written MOUs
  should be developed that detail how these cost
  transfers will be determined.
 These must also be consistently adhered to
  and used for cost buildup purposes, where so
  required.

                        21
       Cost Allowability Considerations

   Federal Acquisition Regulations – FAR Part 31
    cost principles do not cover all costs
    associated with foreign contracts
    – GAAP (Generally Accepted Accounting Principles)
      provides guidance on accounting treatment where
      FAR is silent
    – International Accounting Standards may differ from
      US GAAP
    – Examples, foreign currency translation costs


                           22
    Foreign Currency Cost Considerations
   Denomination of Contract in local currency or dollars
    – Highly inflationary economy? Cumulative inflation of approx
      100% over 3 year period
    – Stability of local currency?
    – Ability to hedge exchange risk. Assess historic exchange rate
      risk and economic data for future.
   Contract Type – contractor assumes foreign currency
    risk in fixed-price contract. Consider including EPA or
    other adjustment clause to mitigate risk. (Elter S.A.
    case, ASBCA No. 52441, 01-1 BCA)


                                23
    Foreign Currency Cost Considerations
   Foreign Currency Translation Costs typically treated as
    allowable costs

    – No mention in FAR Part 31 cost principles
    – GAAP – Statement of Financial Accounting Standard No. 52
      (SFAS 52)
    – Exchange gains and losses recorded under GAAP represent
      allowable costs
    – GE Case – Government originally disallowed a portion of
      depreciation charges on spare parts order. re translation of
      depreciation expense “in converting into dollars the
      depreciation cost of a contractor’s foreign affiliate whose local
      economy is highly inflationary, historic exchange rates must be
      used.
                                 24
Cost Accounting Considerations
      Cost Accounting Standards (CAS)
   Foreign contractors and subcontractors are subject to
    the same CAS and Disclosure Statement requirements
    applicable to domestic firms.
   However, in lieu of filing a CASB DS-1 Disclosure
    Statement, a foreign concern may, with CAS Board
    approval, use a form prescribed by an agency of its
    government.
   The CAS Board has approved alternative forms for
    contractors from Canada, Federal Republic of
    Germany and the UK.


                            26
    Cost Accounting Standards Coverage

 If contract value exceeds $50 million or $50
  million of CAS covered contracts in last fiscal
  year, full CAS Coverage (19 Standards apply)
 If contract value exceeds $7.5 million, modified
  CAS coverage (4 Standards apply)
 Disclosure Statement required at full CAS
  Coverage (consider Home Offices and
  Segments)
 Must consistently follow disclosed practices

                       27
               CAS Considerations

   CAS provides an exemption for:
    – Contracts and subcontracts executed and
      performed entirely outside the U.S., its territories
      and possessions (may go away?)
    – Contracts and subcontracts with foreign
      governments or their agents and instrumentalities
    – Contracts and subcontracts awarded to foreign
      concerns (except CAS 401 and 402)
    – Subcontracts under the NATO PHM Ship program
      to be performed outside the US by a foreign
      concern

                            28
      UK CAS Disclosure Statement
            Considerations
 UK contractors are allowed to substitute the
  UK QMAC “Questionnaire on Method of
  Allocation of Costs” and recent Supplemental
  QMAC for the DS-1.
 QMAC consists of 9 schedules detailing
  general accounting system disclosures, along
  with bases for recovery of indirect expenses,
  and detailed supporting schedules.


                       29
           CAS Considerations

 Note that when a subcontract is awarded under
  a CAS-covered prime contract or higher-tier
  subcontract, CAS coverage of the subcontract
  is determined in the same manner as it is
  determined for the prime contract.
 Ensure that prime contract is CAS covered
  before assuming subcontracts are subject to
  CAS!


                      30
        Government Audit Considerations

 DCAA presence limited overseas
 Foreign audit agencies experience and
  capabilities differ
 Consider
    –   How to affect assist audits on foreign companies
    –   Financial capability assessments
    –   Indirect rate agreements
    –   Forward pricing agreements


                             31
                Tips for Consideration

   Include contract clauses regarding treatment of unique
    costs as allowable and reimbursable, or determine the
    basis will be used to determine allowability
   Consider impact of potential contract termination and
    how termination recovery will be determined, including
    cost differentials
   Anticipate incremental costs to maximum extent at time
    of proposal preparation or contract negotiation
    – Put cost differentials in bids
       • Employee compensation
       • Taxes

                                 32

				
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