Director of Defense Procurement Deidre Lee extended until September 30, 2005 a class deviation which prevents the disallowance of indirect expenses allocable to asset step-ups resulting from a business combination. The waiver was originally authorized in 1999 and states all DOD contracting activities must deviate from the requirements of FAR 31.203(c) when costs disallowed under FAR 31.205-52 are required to be included in the indirect cost base.
Prior to 1996, contractors measured the costs of all assets acquired in a business combination under the purchase method of accounting on the basis of fair market value (FMV). This usually resulted in an increase in the value of assets over their pre-business combination book value. The FMV value is referred to as the step-up amount. FAR 31.205-52 was initiated to disallow the step-up amount because it often led to increased costs (e.g. higher depreciation, higher cost of money) assigned to government contracts due to the business combination. When assets valued at FMV are included as part of the base for allocating indirect costs, CAS requires that all costs be part of the base including any step-up amount. FAR 31.203(c) makes unallowable the share of indirect costs allocated to this disallowed step-up amount, which results in the contractor being penalized because their otherwise allowable indirect costs are reduced. The deviation from FAR 31.203(c) is intended to not penalize the contractor simply because they engaged in a business combination which the government recognizes often results in savings.
The deviation applies to all future contracts as well as to indirect rates applicable to open cost reimbursement contracts and other contacts requiring indirect costs be settled before the contract price is established. The authorizing memo for the extension is at “www. Acq.osd.mil/dp/”.
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