This blog is a departure from past blogs in that it is not based on a seminar question but deals with unallowable cost as it relates to dependent health care.  This was prompted by a letter from the Pricing Director of the Defense Procurement and Policy (DPAP) to the Defense Contract Audit Agency (DCAA), dated February 12, 2012. DPAP is supporting DCAA’s previously unsupported contention that certain dependent health care costs are specifically unallowable costs.  The Defense Federal Acquisition Regulations Supplement (DFARS) are currently silent on this subject. An apparently small change, however, one that could have significant contractor impact.

Let’s first take a look at the Federal Acquisition Regulation (FAR) as it currently reads pertaining to “Fringe Benefits”. Currently, FAR 31.205-6, (m), Compensation for Personal Services governs:

(m) Fringe benefits.

(1) Fringe benefits are allowances and services provided by the contractor to its employees as compensation in addition to regular wages and salaries. Fringe benefits include, but are not limited to, the cost of vacations, sick leave, holidays, military leave, employee insurance, and supplemental unemployment benefit plans. Except as provided otherwise in Subpart 31.2, the costs of fringe benefits are allowable to the extent that they are reasonable and are required by law, employer-employee agreement, or an established policy of the contractor. (bold added)

To assist the reader, below is the cited portion of Subpart 31.2:

31.201-2 — Determining Allowability.

(a) A cost is allowable only when the cost complies with all of the following requirements:

(1) Reasonableness.

(2) Allocability.

(3) Standards promulgated by the CAS Board, if applicable; otherwise, generally accepted accounting principles and practices appropriate to the circumstances.

(4) Terms of the contract.

(5) Any limitations set forth in this subpart.

Since August 2009, DCAA’s avenue to question dependent health care cost rested principally on the “reasonableness” criteria of FAR 31.201-2.  The bolded part of FAR 31.205-6 (m) does not say the costs are expressly unallowable such as 31.205-51 — Costs of Alcoholic Beverages.  The absence of a “black and white” standard permits Contracting Officers some latitude in dealing with a contractor cost claim.  Keeping track of the dependent status for every employee can be an administrative burden. In some cases, simple screening of the dependent’s age can be used to segregate unallowable costs.  My concern is the life event changes that must be reported by the employee, for example, the marriage of a dependent.  Is the contractor responsible for an unreported change? This change to the DFARS would create that situation by making these costs specifically unallowable for contracts subject to the supplement.

DCAA buttresses it’s unallowable cost argument by citing Cost Accounting Standard (CAS) 405, Accounting for Unallowable Costs.  This argument loses its weight when CAS 405 is more closely examined:

9904.405-40 Fundamental requirement.

(a) Costs expressly unallowable or mutually agreed to be unallowable, including costs mutually agreed to be unallowable directly associated costs, shall be identified and excluded from any billing, claim, or proposal applicable to a Government contract.

In its current regulatory state, DCAA cannot invoke the need for penalty application per FAR 42-709 because unallowable dependent health care costs are not “expressly unallowable”.  Unencumbered by the FAR, the August 4, 2009 DCAA guidance would have the contractor cited for violation of CAS 405 and require cost impact presentations for all contracts open or closed and for Incurred Cost Claims, settled or not.

Defense Contract Management Agency (DCMA) supported DCAA in their September 24, 2010 community guidance and noted the cost as “expressly unallowable”.  Again, neither FAR nor CAS supports that position as cited above.  Remarkably, this position is contrary to ABCSA decision:

“In June 2002, the Armed Services Board of Contract Appeals (ASBCA) discussed the concept of “expressly” unallowable costs in the appeal of General Dynamics (ASBCA No. 49372). Although the decision subsequently was reversed (on other grounds) on appeal, the Court’s opinion stands as the most lucid discussion of the topic. The Court opined—

We do not believe the determination of ‘express unallowability’ can turn solely on whether the contractor made a ‘good faith effort’ to comply with the particular cost principle involved, although subjective good faith is important. We think Congress intended the standard to be an objective one. The FAR and CAS definitions of ‘expressly unallowable’ point to the need to examine the particular principle involved in light of the surrounding circumstances. Moreover, since Congress adopted the ‘expressly unallowable’ standard to make it clear that a penalty should not be assessed where there were reasonable differences of opinion about the allowability of costs, we think the Government must show that it was unreasonable under all the circumstances for a person in the contractor’s position to conclude that the costs were allowable. The scope of the inquiry will vary with the clarity and complexity of the particular cost principle and the circumstances involved. Under 10 U.S.C. § 2324(e)(1)(F), for example, the ‘costs of alcoholic beverages’ are unallowable and may leave little room for debate, short of a discussion of alcohol levels. On the other hand, the analysis required under 10 U.S.C. § 2324(k) is far more complicated and the answer not necessarily obvious, particularly when a settlement agreement must be consulted. See also 10 U.S.C. § 2324(e)(1)(N), now (e)(1)(O). [Emphasis added.]”

Where are we left?  This ABCSA holding may be of little comfort to the contractor.  My own experience includes instances where both DCAA and DCMA personnel ignored what appears to be precedent. The best defense against a finding/penalty assessment is to strengthen internal controls in this area.

  1. Are your employees queried more often than the annual open enrollment period as to status changes?
  2. Is failure to report a family status change handled in your employee discipline procedure?
  3. Does Human Resources communicate changes immediately to Accounting or other administrators?
  4. Does Human Resources randomly check employees compared to previous statements? For example, does an employee claim additional dependents over previous years but did not report a family status change?
  5. How’s your record keeping?  What if DCAA asked to see the records?
  6. Could you document the above steps or something similar?

This is not final yet, so keep checking websites and other advisory services that might alert you.

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