A rule that prevents disallowance under DOD contracts of indirect expenses allocable to an asset step-up resulting from a business combination will continue in effect until Sept. 30, 2008 according to a memo issued by the acting director of the DOD Office of Procurement and Acquisition Policy Dominick Cipicchio.  The rules takes the form of a class deviation from requirements of FAR 31.203(c) when costs disallowed under FAR 31.205-52 are required to be included in the contractors indirect cost base.  

The original class deviation in 1999 explained that prior to April 1996, the cost accounting standards measured, assigned and allocated the costs of tangible capital assets acquired in a business combination under the purchase method of accounting on the basis of fair market value.  This usually resulted in an increase in the value of the assets over the pre-business combination book value (i.e. fair market value usually exceeds net cost basis) which is referred to as step-up amount.  FAR 31.205-52 disallows costs stemming from this step-up amount.  When assets that are valued at fair market value (including step-up amounts) and the resulting costs like depreciation of assets or amortization of intangible assets are included as part of the base for allocating indirect costs FAR 31.203(c) renders unallowable that share of the indirect expenses that are allocable to the disallowed step-up amount.  The class deviation stated the purpose of FAR 31.205-52 was to assure that depreciation or amortization of any step-up amount of assets were not increased as a result of the business combination but here “contractors should not be penalized by having their indirect cost recovery reduced.”  “Thus when costs disallowed under 31.205-52 are required to be included in the indirect cost base the indirect expenses proportionate to those disallowed costs will not be disallowed on the basis of FAR 31.203(c).”  The updated class deviation applies to all future contracts as well as indirect rates applicable to all open cost reimbursement contracts or any other situations requiring that indirect costs be settled before contract prices are established.

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