Achieving a more equitable outcome?

Introduction

The Defense Contract Audit Agency (DCAA) recently issued a Memorandum for Regional Directors (MRD) titled “Revised Audit Guidance on the Cost Impact Calculations for a Unilateral Cost Accounting Practice Change.” The DCAA made this change in audit guidance to reflect certain Armed Services Board of Contract Appeals (ASBCA) decisions and the application of the board’s decisions to the range of unilateral Cost Accounting Practice (CAP) change scenarios. The DCAA also wanted to highlight the importance of understanding the nature of the unilateral CAP change and how it will affect future measurement, assignment and allocation impacting accumulation and reporting of cost on government contracts and subcontracts. The change in the guidance addresses the auditor’s calculation of the estimated increased cost to the government, in the aggregate, resulting from the CAP change and is intended to ensure that the calculation is more equitable.

Unilateral cost accounting practice changes

A unilateral change in cost accounting practices is a change to its disclosed cost accounting practices made by a contractor. The Federal Acquisition Regulation (FAR) allows a contractor to implement a unilateral CAP change; however, the government will not pay increased cost because of the CAP change. Therefore, it is critical for the auditor to estimate the cost impact to the government resulting from the contractor’s change in accounting practices. The key to estimating the effect of the change is the estimate to complete (ETC) for relevant associated contracts. The estimated impact to the government is calculated by comparing the ETC on affected Cost Accounting Standards (CAS)-covered contracts using the new cost accounting practice to the ETC using the old cost accounting practice. Increased costs, in the aggregate, represent the total amount owed to and to be recovered by the government resulting from the change.

A unilateral CAP change affects fixed price and flexibly priced contracts differently. On a flexibly priced contract, the increased or decreased costs allocated due to a unilateral CAP change are accumulated on the contract and the government actually pays for or receives the benefit of those changes. However, the price of a fixed price contract (the amount paid by the government) does not change absent a modification to the contract.

The audit team should evaluate the unilateral CAP change to understand the type of CAP change, the universe of all affected CAS-covered contracts and subcontracts, the movement of cost among contract groups and customers and all business units impacted by the unilateral CAP change. The contractor’s basis for the ETC amounts for the new cost accounting practice and the old cost accounting practice must be applied prospectively from the effective date of the change through the end of contract performance.

In the first scenario, an increased ETC on flexibly priced contracts and a decreased ETC on fixed price contracts, BOTH result in increased cost to the government. In this case, the cost impact to the government, in the aggregate, will generally be the greater of the two cost impact amounts. This is based upon the assumption that the unilateral CAP change resulted in the same costs being shifted from the affected fixed price contracts to the affected flexibly priced contracts. When this occurs, the auditors should only count the same costs as “increased costs” one time.

In the second scenario, with increased ETC on flexibly priced and increased ETC on fixed price, the result is increased cost to the government on flexibly priced and decreased cost on the fixed price contracts. When this situation occurs, the cost impact to the government, in the aggregate, will generally be the increased cost amount on the flexibly priced CAS-covered contracts. The increased costs on flexibly priced contracts will be realized by the government in the form of higher actual billings, while the fixed prices (cost to the government) on fixed price contracts remain the same. The MRD states that the contractor is not entitled to offset the “decreased costs” for the fixed price contracts against the actual increased costs that will be paid on flexibly priced contracts because the FAR says that the government will “not pay increased costs, including a profit enlarged beyond that in the contemplation of the parties to the contract when the contract costs, price or profit is negotiated, by reason of a contractor's failure … to follow consistently its cost accounting practices.”

When the unilateral CAP change results in decreased ETC on the flexibly priced CAS-covered contracts (decreased cost to the government) and decreased ETC on the fixed price CAS-covered contracts (increased costs to the government) as in scenario three, the cost impact to the government, in the aggregate, will generally be limited to the excess of the increased fixed price costs over the decreased flexibly priced contract cost. Under this scenario, fewer costs will be accumulated on both the fixed and flexibly priced CAS-covered contracts. The decreased costs on flexibly priced contracts will be realized in the form of fewer or smaller actual billings and therefore should be considered in the calculation of the increased cost in the aggregate. The decrease in cost accumulations on fixed price contracts represents an increased cost to the government, because had the new cost accounting practice been used to negotiate the fixed price contracts, the negotiated price would have been lower. The contractor is not entitled to additional profits because of a unilateral CAP change; therefore, these costs are also considered when estimating the increased cost to the government, in the aggregate.