Master the Essentials of Government Contract Accounting

The Truth in Negotiations Act (TINA), originally enacted in 1962 as Public Law 87-653, was recently renamed the Truthful Cost or Pricing Data Act.  TINA is a disclosure rule that aims to level the playing field between the government and contractors during negotiations by requiring contractors to share pricing data, like similar pricing for comparable work, or actual cost data.  This ensures the government has adequate information to negotiate a fair and reasonable price, particularly in situations like sole-source awards where competitive bids are absent. 

Here are some key things to know about TINA:

• Applicability: TINA applies to contract actions exceeding $2 million and modifications to negotiated contracts where the change value exceeds the threshold.
• Exceptions: Exceptions exist for situations with adequate price competition, commercial products and services, prices set by law, and waivers.
• Disclosure Requirements: Contractors must submit or identify cost or pricing data in writing, certifying it is current, accurate, and complete.  This data encompasses factual information (not judgments) that prudent buyers and sellers would reasonably expect to significantly influence price negotiations. 
• Contractor Responsibility: It is the contractor’s responsibility to comply with TINA, not the government’s to extract the data. [1, 13] This includes disclosing any data, regardless of whether it was used in the proposal. 
• Data Other Than Certified Cost or Pricing Data: This encompasses judgments and supporting information used to explain the estimating process, such as judgmental factors, mathematical estimates, projections from factual data, and contingency identification. 
• TINA Sweep: This is a process, ideally integrated into the contractor’s estimating system, to ensure the most current, accurate, and complete data is disclosed to the government.  It involves a review of inputs like indirect rates, labor agreements, material discounts, and commodity indexes to identify changes that might require disclosure. 

Failure to disclose current, accurate, and complete data may result in contract price adjustments and potential legal repercussions.  The Defense Contract Audit Agency (DCAA) plays a crucial role in auditing for defective pricing and assessing compliance with TINA requirements.  Contractors can mitigate the risk of defective pricing claims by:

• Documenting and seeking commercial item exemptions, especially for subcontracts. 
• Including indemnification agreements with subcontractors. 

Contractors should be well-versed in TINA requirements and maintain a robust estimating system with clear procedures for data disclosure to ensure compliance and avoid potential penalties.

Cost allowability is a key concept in government contracting, particularly for cost-reimbursement contracts where the government reimburses the contractor for allowable costs incurred in performing the contract. The Federal Acquisition Regulation (FAR) Part 31 outlines the principles and procedures for determining cost allowability. 

The FAR states that a cost is allowable only when it meets all of the following criteria:

• Reasonable: The cost must be reasonable in nature and amount, not exceeding what a prudent person would incur in a competitive business environment.  This is often referred to as the “newspaper test” meaning that if a cost would raise eyebrows if publicized, it’s probably not reasonable. 
• Allocable: The cost must be assignable or chargeable to one or more cost objectives, such as a specific contract, based on the benefits received or an equitable relationship. 
• Compliant with CAS or GAAP: The cost must be compliant with the Cost Accounting Standards (CAS) if applicable. If CAS does not apply, the cost must be consistent with Generally Accepted Accounting Principles (GAAP).
• Compliant with Contract Terms: The cost must adhere to the specific terms and conditions of the contract, including any limitations on allowable costs. 
• Within Limitations in FAR 31.2: The cost must fall within the limitations outlined in FAR Subpart 31.2, which provides specific guidance on the allowability of selected cost elements. 

The FAR explicitly lists various costs as unallowable, such as alcohol, entertainment expenses not directly tied to the contract, and certain types of advertising. 

Consequences of Non-Compliance

If a contractor claims unallowable costs, the government can:

• Disallow the Costs: The government can refuse to reimburse the contractor for any unallowable costs included in billings or proposals. 
• Demand Repayment: If the government has already paid for unallowable costs, it can demand repayment from the contractor, potentially with interest. 
• Impose Penalties: In cases of expressly unallowable costs (those specifically identified as unallowable in the cost principles), the government can impose penalties equal to the amount of the disallowed cost, effectively doubling the financial impact on the contractor.

Therefore, contractors must have systems and procedures in place to:

• Accurately identify and segregate unallowable costs. 
• Maintain adequate documentation to support the allowability of claimed costs. 

Government auditors, such as the Defense Contract Audit Agency (DCAA), may review contractor records to verify cost allowability. Contractors should be prepared to respond to audit inquiries and provide supporting documentation. 

A direct cost is any cost that can be specifically identified with a particular final cost objective. Direct costs are not limited to items that are incorporated into the end product as material or labor.  Costs identified specifically with a contract are direct costs of that contract. All costs identified specifically with other final cost objectives of the contractor are direct costs of those cost objectives.  For example, if a company purchases materials specifically for one contract and it can be identified solely with that contract, then it should be treated as a direct cost.  However, there are some circumstances where a contractor could reasonably treat material purchased for a contract as an indirect cost. 

A few examples of direct costs include:

• Direct Labor: When an employee identifies the actual hours they worked on one specific contract. 
• Direct Materials: The cost of hardware and supplies that can be identified, through a specific purchase order, inventory cost system, or other identification system, to a single contract. 
• Direct Subcontracts: Arrangements awarded with a third party firm to provide support under a prime contract agreement. 
• Direct Travel: Costs of hotels, meals, transportation, etc. that are associated with a single contract. 

The CASB Disclosure Statement Part II identifies three direct cost categories: labor, material, and other direct costs. It is important to note that the government does not dictate whether a particular cost is charged as direct or indirect.  The contractor has the prerogative to identify what costs will be treated as direct and what costs will be treated as indirect.  However, the company must be able to meet direct/indirect regulatory definitions and ensure that costs are treated consistently as direct or indirect in like circumstances.  Costs incurred for the same purpose in similar circumstances must also be a direct cost.  Insignificant direct costs can be treated as indirect costs. 

An indirect cost is any cost that is not directly identified with a single final cost objective, but is identified with two or more final cost objectives or with at least one intermediate cost objective . In other words, indirect costs are those that cannot be traced to a specific contract or project.

Indirect costs include:

• Overhead: Costs associated with running the business, such as rent, utilities, and administrative salaries.
• General and Administrative (G&A) expenses: Costs incurred for the overall management and administration of the business, such as executive salaries, legal fees, and marketing expenses.
• Other indirect expenses: Costs that benefit multiple contracts or projects, such as depreciation on equipment used for multiple projects and the cost of a company-wide travel management service.

It is important to note that the government does not dictate whether a particular cost is direct or indirect. The contractor has the responsibility to determine how costs are classified, as long as they are consistent with regulatory definitions and are treated consistently in like circumstances. For example, an RFP should not state “all travel will be an indirect cost,” but it can state, “all direct travel costs on this contract are unallowable” or “direct travel costs shall not exceed $XXX.”

Indirect costs are typically allocated to contracts using a predetermined rate based on an allocation base that has a causal or beneficial relationship to the pooled costs. Examples of allocation bases include:

• Total cost input (TCI)
• Value-added cost input
• Direct labor hours or dollars
• Square footage
• Headcount

The contractor must establish indirect cost pools and allocation bases in a way that results in an equitable distribution of indirect costs to all final cost objectives, including both government and commercial contracts.

The Cost Principles, as outlined in the Federal Acquisition Regulation (FAR) Part 31, establish the boundaries for allowable costs that can be negotiated or claimed under government contracts. They serve as a guide for determining which costs the government is willing to pay for and which are considered unallowable. The key principles are:

• Reasonableness – Costs must reflect prudent business decisions and not exceed what a prudent person would incur in a competitive environment.
• Allocable – Costs must be directly attributable to the contract or benefit it in a way that allows for reasonable apportionment.
• Compliance with Accounting Standards – Costs must adhere to the Cost Accounting Standards (CAS), if applicable, or Generally Accepted Accounting Principles (GAAP).
• Compliance with Contract Terms – Costs must comply with any specific allowability limitations outlined in the contract.
• Compliance with Cost Principle Limitations – Costs must adhere to the limitations outlined in FAR 31.205, which identifies specific unallowable costs.

The allowability of a cost is determined based on whether it is necessary for contract performance or is created as a result of doing business with the government. The FAR outlines 46 specific cost principles that provide guidelines for determining the allowability of various cost categories. These principles cover a wide range of expenses, including but not limited to:

• Employee compensation
• Depreciation
• Independent research and development (IR&D)
• Bid and proposal (B&P) costs
• Insurance
• Material costs
• Business organization costs
• Professional services
• Recruitment costs
• Taxes
• Travel expenses
• Legal proceeding costs
• Rental Costs

Contractors must be familiar with these cost principles and ensure their incurred costs align with the allowability requirements. Failure to comply can result in:

• Audits – The government may initiate audits to scrutinize cost allowability
• Cost Disallowance – The government has the authority to disallow costs that are deemed unallowable, and may demand repayment plus interest for previously paid unallowable costs.
• Penalties – In cases where expressly unallowable costs are charged, the government may seek penalties equal to the amount of the disallowed costs.

The Cost Principles are essential for maintaining transparency and fairness in government contracting, ensuring that taxpayer dollars are spent responsibly and that contractors are reimbursed for legitimate and necessary expenses.