Our client and I met with DCAA several times and we responded in writing that the disputed costs were properly charged to the indirect cost pool and hence should be allocated to all contracts including federal cost type contracts and subcontracts. The reasons put forth are as follows:

1. Consistent with established practices and written policies and practices. Since the contractor has always charged costs related to third party lawsuits as indirect, it has an established practice. In addition, the contractor’s written policies and procedures identify specific costs that are considered direct (e.g. labor, materials, rental equipment) and the type of costs in dispute (e.g. indirect labor, consulting costs not used for a direct on-going job) are not included in this category. Though "consulting" costs are not specially identified as indirect costs, "professional services" are one of the categories identified as indirect and the type of effort in support of the lawsuits certainly qualifies.

2. Consistent with the contractor’s own definitions of direct versus direct cost. Though it is possible, with enough time and effort to identify any cost with a final cost objective, the contractor, like most others, recognizes such precision is not worth the effort. Instead, it limits direct charges to those costs that "add value" while charging remaining costs indirect. Hence, consulting and in-house labor are direct costs only when the costs are in direct support of contract performance.

3. Contractor’s practice is consistent with CAS 418. Though not CAS covered, CAS standards are instructive because they explicitly address the issue in question here – appropriate allocation of costs to government contracts. To ensure the contractor’s decisions are reasonable CAS 418 establishes two criteria: (1) the classification of whether a cost is direct or indirect must be made "pursuant to a written statement of accounting policies and practices for classifying costs as direct or indirect which shall be consistently applied" and (2) a cost is either direct, which is defined as any cost identified to a particular final cost objective, or it is indirect. The contractor is provided extensive flexibility in determining how to treat a cost and is instructed to make their decision applying the above definition reasonably and in a written statement of policies and procedures. The contractor’s written procedures distinguishing direct versus indirect costs and its prior consistent practices certainly meet the requirements of this standard.

4. Disputed costs are immaterial. CAS 418 allows immaterial direct costs to be charged indirectly. In the Preamble to CAS 418, a contractor should be required to make an accounting change only if the result has a "materially different cost impact on a government contract." In all years, the costs in question represent an immaterial amount of the total indirect costs (less than 2 percent) and hence there would be an immaterial impact on the government contracts

5 Case law provides it is reasonable to charge the disputed costs indirectly when incurred after physical performance. Our client does not argue the disputed costs must be charged indirect but only that it is reasonable to do so, which meets the criteria of CAS 418. There are several cases that hold essentially similar costs in dispute that are incurred after physical performance have no direct bearing on either performance or administration of the contract and thereby are indirect costs. In Singer Corp., the court ruled the professional fees incurred for the submission of a request for equitable adjustment (REA) after performance of a contract did not have a "sufficient nexus to the successful completion of the contract" to be allowed as a direct contract cost (The Singer Company, Lobrascope Div. V. United States. 568 F. 2d). In Gulf Contracting, professional fees expended for preparing an REA that were directly charged to the contract were ruled unallowable costs to the contract because only costs "related to performance or administration of an ongoing contract" can be considered direct and that expenses incurred after completion "bear no relation to performance or administration" (Gulf Contracting Inc., & Hughes Masonry Co., Inc. v United States).

6. The FMC case is not relevant. In the case DCAA cited for its position, the court ruled FMC should charge costs direct to a subcontract when that subcontract was still open and FMC’s disclosure statement stated professional services "are charged direct when specifically related to a contract task." In the FMC case, though the subcontract was physically complete it was still administratively open and the disclosed practices clearly stated the costs should be direct. In addition, the lawsuit itself was between the actual contracting parties intended to untangle their respective contract rights and not part of a third party lawsuit where the party had nothing to do with the original contract.

7. The costs in question are really indirect, period costs in the year it is incurred. Assignment of the cost is the means used to associate a cost to a specific fiscal year where they are assigned either to the year of incurrence or future years. In Stanwick Corp., ASBCA No 18083, the board ruled costs may never be assigned to years prior to when the cost was incurred. This is logical since even though occurrence of a prior event may give rise to the need for professional services, there is no means at the time to estimate and hence accrue the costs prior to when they were incurred. According to FASB No. 5 a cost exists either when there is a binding liability or the expenditure of cash, whichever occurs earlier. The costs in question cannot be assigned to an earlier period since it is impossible to know what the legal liability is or even if there will be one. Such "costs" in an earlier period would be unrecognizable contingencies and not costs. A cost assigned to a fiscal year may be a direct cost only if it is identifiable specifically with a final cost objective in existence during that year; in any other circumstance, it is an indirect cost.

8. The costs in question are similar to environmental remediation costs. Like the costs questioned here, environmental remediation costs are usually incurred long after the full performance of the contract that caused the contamination. Under DCAA’s own guidance (DCAA Policy Memorandum, October 12, 1992) environmental remediation costs caused in prior years will "generally be period costs" and should be allocated to "residual G&A costs." DCAA clearly recognizes these costs to be "period" costs to be expensed in the current fiscal year and that they should be allocated indirectly because there is no specific cost objective in that year that benefits from or exclusively caused the costs.

9. DCAA’s Position Violates Consistency Requirements. FAR 31.202 and 31.203, like their cost accounting standards counterparts at CAS 401, 402 and 418, essentially require contractors to distinguish between direct and indirect costs and once the decision is made, to treat the costs consistently. If DCAA’s position is followed, the consistency principle would be violated because (1) the contractor would select a single type of cost from its indirect cost pool and reassign it in a manner inconsistent with its disclosed written policies and historical accounting practices and (2) it would require direct cost treatment of the same cost that needs to be treated indirectly for pricing purposes. The inconsistent treatment for pricing and costing purposes occurs because for proposal purposes the costs can only be treated indirectly because there is no way to accurately estimate future third party suits for a given contract. Very few if any customers would ever reimburse a contractor directly for the possibility of future third party suits so recovery would need to be limited to estimates of indirect cost making charging those costs direct in violation of the consistency requirements of FAR.

10. CAS 410 requires allocation to all contracts. DCAA challenged the allocation of the questioned costs to government contracts even if it was appropriate to charge them indirectly. The questioned costs were incurred to defend the contractor from a corporate liability. Whether it is from a commercial, local or federal government contract, defense against third party suits that generated the costs benefit the company as a whole by protecting the company against potentially catastrophic damages and it is appropriate that government contracts share the burden. CAS 410-30(a)(6), Allocation of G&A costs, requires that an allowable expense that benefits the entire business should be allocated equitably to all of the business customers.

The above response was communicated to both DCAA and we requested it be included in the "Contractor Comments" portion of the DCAA final report. DCAA did not reverse their position and then we asked for a meeting with the cognizant administrative officer before a final audit report was issued to discuss this and other questioned costs. We asked the ACO to review our position paper. The ACO, along with his legal and price analysts at the meeting, rejected DCAA’s questioned costs. It must be said, in a spirit of cooperation, that other questioned costs were agreed to by my client in order to arrive at an overall settlement everyone could feel they benefited from.

{TAG_FORM_TITLE}