One important reason contractors want to create joint ventures and SBUs is to have the opportunity to allocate either more or less costs to the entity. Whether the new entity is or is not a “segment” of the co-venturers often determines what costs can be allocated. For example, a segment will receive both direct costs (e.g. interorganizational transfers for goods or services) and indirect charges such as indirect service center costs based on usage (e.g. occupancy, data processing) and residual home office costs.  If the joint venture is not considered a segment, it would not qualify for such home office allocations.

Are joint ventures and SBUs segments?  For joint ventures, the CAS definition of “segment” is broad enough to give contractors a great deal of flexibility to make their own determinations that will help them meet their cost allocation needs. The definition of a “segment” (CAS 403-30(a)) includes a joint venture where an organization exercises control. But since most joint ventures consist of joint control, the definition does not clearly apply. On the other hand, if a “segment” determination is desirable, another section of the CAS (403-50(e)) provides a broader definition that allows a home office allocation where control is absent but performs certain functions to justify a home office allocation.

An SBU is more clearly a “segment” since it is typically a subdivision of an organization controlled by a home office. However, when an SBU is essentially a “paper entity” without its own employees, assets or liabilities and no direct responsibility for contract performance (e.g. all work is subcontracted out to other organizations), then it is unlikely a segment.

If the entity is a segment, the co-venturers/parent entities have flexibility in allocating indirect costs to joint ventures and SBUs by either following their established practices for indirect cost allocation or adopting a “special allocation.”  For example, an organization may track or estimate the costs of services provided by the home office to the joint venture and remove those costs from the pool and allocate them to the segment. Further flexibility is allowed when the entity has unequal ownership, providing the minority contractor the option of allocating its residual home office costs the joint venture or electing not to do so.

Practically, it should be noted that special allocations need advanced approval by the CO which often encounters delay for pricing proposals.  Contractors might price the proposal using the special allocation method assuming approval before contract award and if later not approved, the contractor must revert to its established practice resulting in more cost being allocated than planned. Alternatively, the contractor may price the new work using its established practices and to avoid potential defective pricing allegations, will divulge the intent to adopt a special allocation.

 

• Allocation of IR&D & B&P Costs

When IR&D & B&P costs are incurred before the entity is created, two choices exist: (1) Since no segment exists, the co-venturer/parent is justified in taking the position that IR&D costs should be allocated in the normal manner to other segments with no allocation to the new joint venture/SBU segment. CAS 420.50(e)(2) justifies this position (2) If the segment is established during the same cost accounting period, it can allocate the costs to all segments including the new one.  This second alternative runs the risk of not recovering these costs if contract award is not during the same cost accounting period.

CAS 420 dictates that IR&D & B&P costs accumulated at the home office will be allocated to its segments in two steps: first, direct assigning those costs to a specific segment when the costs can be identified with it and then allocating the remaining amount to all other segments in the same way it allocates its residual home office costs. Sometimes when an entity supports only one contract or product line, it may be that ongoing IR&D or B&P costs do not benefit those limited items as much as other segments or at all.  When this occurs, they will likely be required (or may be entitled) to seek a special allocation that will allow less home office IR&D/B&P costs to be allocated to the joint venture.

If a joint venture/SBU segment incurs or is assigned IR&D/B&P costs without yet receiving a contract, then it could be accumulating these costs with no vehicle for recovering them. Opportunities for recovery are limited because FAR 31.205-18 and CAS 420.40(f) as well as GAAP usually require current-year expensing. An exception is allowed for deferred IR&D recovery of current expenses but only if it developed a specific product, at its own risk, in anticipation of recovering development costs in the sale of the product and, in addition (1) the total amount of IR&D costs are identifiable (2) the proration of costs are reasonable (3) the contractor had no other government business or if it did, it chose to not allocate IR&D costs to government contracts (except for prorating specific costs) and (4) no costs of current IR&D programs are allocated to government work.

 

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