[Federal Register: April 5, 2004 (Volume 69, Number 65)]
[Rules and Regulations]               
[Page 17764-17768]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]

[[Page 17764]]





48 CFR Parts 2 and 31

[FAC 2001-22; FAR Case 2001-034; Item II]
RIN 9000-AJ60

Federal Acquisition Regulation; General Provisions of the Cost 

AGENCIES: Department of Defense (DoD), General Services Administration 
(GSA), and National Aeronautics and Space Administration (NASA).

ACTION: Final rule.


SUMMARY: The Civilian Agency Acquisition Council and the Defense 
Acquisition Regulations Council (Councils) have agreed on a final rule 
amending the Federal Acquisition Regulation (FAR) to revise certain 
general provisions of the cost principles pertaining to Composition of 
total cost; Determining allowability; Direct costs; and Indirect costs. 
The rule revises the cost principles by improving clarity and 
structure, and removing unnecessary and duplicative language. The 
revisions are intended to revise Contract Cost Principles and 
Procedures in light of the evolution of Generally Accepted Accounting 
Principles (GAAP), the advent of Acquisition Reform, and experience 
gained from implementation of FAR Contract Cost Principles and 
Procedures. The final rule also adds the definition of ``direct cost'' 
and revises the definition of ``indirect cost'' to be consistent with 
the terminology used in the cost accounting standards (CAS).

DATES: Effective Date: May 5, 2004.

FOR FURTHER INFORMATION CONTACT: The FAR Secretariat at (202) 501-4755 
for information pertaining to status or publication schedules. For 
clarification of content, contact Mr. Edward Loeb, Policy Advisor, at 
(202) 501-0650. Please cite FAC 2001-22, FAR case 2001-034.


A. Background

    DoD, GSA, and NASA published a proposed rule in the Federal 
Register at 68 FR 5774, February 4, 2003, with request for comments. 
Four respondents submitted comments; a discussion of the comments is 
provided below. The Councils considered all comments and concluded that 
the proposed rule should be converted to a final rule, with changes to 
the proposed rule. Differences between the proposed rule and final rule 
are discussed in paragraphs 4, 5, 6, 7, and 8 below.

Public Comments

FAR 2.101--Definition of ``Indirect Cost''--Reference to CAS
    1. Comment: A respondent recommends that if the FAR is going to 
include CAS definitions, these definitions should be referenced rather 
than restated to eliminate redundancy and any inadvertent differences 
of interpretation when CAS is not directly quoted.
    Councils' Response: Nonconcur. The Councils believe it is better to 
include the definitions in the FAR rather than include a reference to 
another regulation to which a user may not have easy access. This is 
particularly important in this instance, since the term ``indirect 
cost'' is used in various parts of the FAR.
FAR 31 Cost Principles--Incorporating CAS Provisions
    2. Comment: A respondent recommends that FAR 31 make CAS standards 
applicable to FAR contracts, and then exclude certain standards and/or 
certain classes of contracts from FAR Part 31 application.
    Councils' Response: Nonconcur. The Councils believe it is not 
desirable to incorporate all of the CAS standards and then exclude 
certain ones. The Councils believe the current approach in FAR Part 31 
that adopts certain standards in specific sections of the FAR provides 
easier application than the suggested revision.
    3. Comment: A respondent asserts that the proposed rule 
incorporates substantial CAS provisions into the FAR cost principles. 
The respondent states that, by law, the CAS Board governs the 
measurement, assignment, and allocation of cost to cost objectives, and 
that FAR cost principles should be limited to matters of allowability. 
The respondent further states that if the FAR includes CAS concepts, 
the inclusion should be done using direct quotes or references.
    Councils' Response: Nonconcur. The Councils considered this 
proposal but believe that eliminating all CAS from FAR would create 
significant problems.
    It is the responsibility of the Councils, not the CAS Board, to 
promulgate rules for the measurement, assignment, and allocation of 
costs for non-CAS covered contracts. The CAS Board does not have 
jurisdiction over non-CAS covered contracts. For some costs, 
particularly deferred compensation including pension costs (CAS 412, 
413, and 415), cost of money (CAS 414/417), and self-insurance (CAS 
416), the Councils have chosen to use the same requirements for non-CAS 
covered contracts as the CAS Board has chosen to use for CAS-covered 
contracts. Furthermore, the Councils have chosen to use some of the 
same definitions and concepts as used in CAS, including the definitions 
of direct and indirect costs. To eliminate all CAS from the FAR would 
require removal of these key FAR Part 31 provisions.
    As for the incorporation of the CAS provisions into the FAR, the 
respondent did not specify any particular language that it believes has 
been paraphrased. Nevertheless, the Councils reviewed the proposed rule 
to see if any such paraphrasing existed, and found that the proposed 
rule does not paraphrase any CAS requirements.
FAR 31.106-2 and 31.203--Special Allocations
    4. Comment: A respondent recommends that the special allocation 
language include an illustration similar to those that are included in 
the CAS. The respondent notes that CAS 410.60(g) makes a point that 
contract costs that are outside the contractor's normal productive 
activity should be excluded from the G&A base. The respondent also 
recommends that the language at 31.106-2(b)(3) be revised to read 
``Exclude the related allocation base data for the facilities contract 
from the base used to allocate the pool.''
    Three other respondents recommend that FAR 31.106-2 be eliminated 
in its entirety. One respondent asserts that this topic is adequately 
addressed in CAS. If this suggestion is not adopted, the three 
respondents recommend that the proposed language not be promulgated and 
the existing language remain unchanged. Two respondents assert that the 
proposed rule adds language prescribing the use of certain accounting 
methods for special allocations for ``facilities contracts'' that will 
lead to disagreements as to accounting decisions. This includes 
requiring the contracting officer to enter into an advance agreement. 
To correct this, they recommend replacing ``shall'' with ``may'' at 
    Three respondents contend that the proposed rule ``flips'' the 
responsibility of accounting decisions from the contractor to the 
contracting officer by stating ``The Cognizant Federal Agency

[[Page 17765]]

is responsible for determining whether the conditions necessitating a 
special allocation exist and negotiating the terms of an advance 
agreement.'' Two respondents assert that this language takes the 
accounting decisions out of the hands of contractors, which is clearly 
against public policy. One respondent further asserts that it is the 
contractor's responsibility to determine if the conditions 
necessitating a special allocation exist. Another respondent asks what 
is the remedy if a contractor does not agree to a special allocation. 
One respondent recommends that the language be removed and replaced 
with ``Negotiate an advance agreement with the cognizant Federal agency 
in accordance with 31.109 criteria''.
    Two respondents note that the proposed language at 31.106-2(d) and 
(e) provides examples that are not all inclusive and could be 
misleading. One respondent believes that this will give rise to 
disputes because of differences in interpretation between the CAS and 
the FAR. The other respondent believes the conceptual framework for 
this language is already covered by 31.109 and thus it is not needed in 
this paragraph.
    Councils' Response: Concur in part. After reviewing the public 
comments and the background underlying this revision, the Councils 
believe it is preferable to not include the concept of special 
allocations in FAR Part 31. The Councils believe the current language 
is adequate and necessary to address this issue, since that language 
provides the contracting parties with the necessary flexibility to 
address those unique circumstances when a particular contract requires 
special treatment. As a result, the Councils agreed that the proposed 
rule for FAR 31.106-2 not be published (the only proposed change to 
this provision was for the special allocation). The Councils also 
agreed to delete the proposed language on special allocations at FAR 
31.203(f), and retain the current language at FAR 31.203(f) (renumbered 
as paragraph (h)).
FAR 31.201-1(a)--Standard Cost
    5. Comment: Two respondents assert that the language at 31.201-1(a) 
on ``standard cost'' is duplicated at the beginning and end of this 
paragraph. They further assert that standard costs are fully defined 
and dealt with in CAS 407, Use of Standard Costs for Direct Material 
and Direct Labor, and there is no need to paraphrase CAS language or to 
eliminate the reference to the CAS requirements.
    Councils' Response: Concur in part. The Councils agree that the 
phrase ``including standard costs properly adjusted for applicable 
variances'' is repeated at the beginning and end of the paragraph at 
FAR 31.201-1(a), and, therefore, they agreed to delete it from the end 
of the paragraph. However, the Councils do not believe the paragraph 
should completely delete the reference to standard costs. The reference 
is intended to assure that standard costs are included as part of the 
composition of total costs, provided they are properly adjusted to 
reflect applicable variances. Without this language, the cost 
principles could be misinterpreted as excluding standard costs from the 
determination of total cost.
FAR 31.201-2(a)--Determining Allowability
    6. Comment: Three respondents state that the proposed language 
constitutes a major change in determining allowability because it 
revises the language on determining allowability from ``factors to be 
considered'' to ``A cost is allowable only when all of the following 
requirements are met.'' Two respondents recommend that this language be 
    Two respondents assert that the proposed language is overly 
prescriptive, limits contracting officer discretion, and violates the 
guiding principles at FAR 1.102. One respondent asserts that such 
language does not ``encourage innovation, and local adaptation where 
uniformity is not essential,'' nor does it provide ``the authority to 
the maximum extent practicable and consistent with the law, to 
determine the application of rules, regulations, and policies on a 
specific contract.'' The respondent also believes this language is 
contrary to FAR 1.102-4(e), which states ``If a policy or procedure, or 
a particular strategy or practice, is in the best interest of the 
Government and is not specifically addressed in the FAR, nor prohibited 
by law (statutes or case law), Executive order or other regulation, 
Government members of the Team should not assume it is prohibited. 
Rather, absence of direction should be interpreted as permitting the 
Team to innovate and use sound business judgment that is otherwise 
consistent with the law and within the limits of their authority. 
Contracting Officers should take the lead in encouraging business 
process innovations and ensuring that business decisions are sound.''
    One respondent asserts that the proposed language would allow 
Government auditors to disregard CAS allocability requirements in 
seeking to prove that the Government was charged costs that were deemed 
unallocable on Government contracts. If this language is retained, the 
respondent recommends that the allocability requirements in 
subparagraphs (2) and (3) be deleted. The respondent also notes that 
all five criteria are not necessarily present in all cases (such as 
when there are no specific reimbursement requirements in the terms of 
the contract) and thus the language is not appropriate.
    Councils' Response: Nonconcur. The Councils believe the proposed 
language is consistent with established case law, i.e., a cost must 
meet all five factors to be allowable. In Celesco Industries (ASBCA 
Case Number 22402, 80-1 BCA, 14721, dated 1/31/80), the court stated:

``Of course, appellant's methods of allocation of indirect costs are 
required, pursuant to DAR 15-201.2, to be in accord with the 
generally accepted accounting principles.'' (Emphasis added.)

    In this case, the ASBCA clearly stated that application of 
Generally Accepted Accounting Principles is required under the cost 
principle (DAR 15-201.2 is the predecessor to the current 31.201-2 and 
included the same language).
    The argument that these are just ``considerations'' also fails when 
viewed in light of the ``factors'' listed at FAR 31.201-2. Included in 
this list are the Cost Accounting Standards (CAS) and the terms of the 
contract. These are not items that can simply be ``considered'' but not 
necessarily followed. The CAS, when applicable to a particular 
contract, is a statutory requirement that cannot be disregarded at the 
discretion of the contracting parties. In addition, the terms of the 
contract cannot just be considered; they must be adhered to. 
Furthermore, certain parts of FAR 31 implement statutory provisions 
that preclude reimbursement of certain costs, and as such, cannot be 
subjectively applied.
    It is also evident that the promulgators have, for many years, 
intended for these items to be requirements rather than just 
considerations. In particular, DFARS 2.402 states that the Director for 
Defense Procurement and Acquisition Policy is the approval authority 
for any individual or class deviation to FAR subpart 31.2. If the 
intention of 31.201-2 was to only consider the factors listed, the 
provision at DFARS 2.402 would not be necessary. The contracting 
officer would consider these factors (which includes the requirements 
of FAR subpart 31.2), and apply them at his/her discretion. Such an 
application would circumvent the requirement at DFARS 2.402. The 
specific approval authority for deviations at DFARS 2.402 exists 
because these are intended to be requirements, not just considerations.

[[Page 17766]]

    As to FAR 1.102, this provision provides direction to the 
contracting officer and other acquisition team members to use when the 
regulations do not address a particular situation. It does not direct 
that the regulations should not provide for specific allowability 
    In those rare situations where a particular cost does not meet the 
requirements of the five factors but is the type that the contracting 
activity wants to allow, a deviation should be requested in accordance 
with the FAR requirements.
    As for the argument that the five requirements may not always be 
present and therefore this provision is not appropriate, the Councils 
disagree. However, the Councils review of this comment disclosed that 
the proposed wording might have lead to some confusion. As a result, 
the proposed language at 31.201-2(a) has been revised.
FAR 31.203--Indirect Costs
    7. Comment: A respondent asserts that the proposed language 
includes direct quotes from CAS 402, Consistency in Allocating Costs 
Incurred for the Same Purpose, and other CAS language that should be 
eliminated in the spirit of DFARS transformation. The respondent states 
that a simple word count shows the word ``allocate'' in various forms 
twenty times. The respondent also states that cost allocation is the 
responsibility of the CAS Board, and sees no valid reason to replicate 
    Councils' Response: Concur in part. The proposed language is 
intended to apply to contractors that are not subject to the CAS 
allocation standards, i.e., full CAS coverage. For contracts not 
subject to full CAS-coverage, the Councils believe that some basic 
requirements are needed for determining the allocation of indirect 
costs to Government cost-based contracts; the absence of such 
requirements would result in significant disagreements and potential 
misallocations of costs to cost-based Government contracts. 
Accordingly, to provide clarity, the Councils added paragraph (a) to 
FAR 31.203.
FAR 31.203(b)--Final Cost Objectives
    8. Comment: A respondent recommends that FAR 31.203(a) (renumbered 
as paragraph (b)) be revised to add the words ``two or more'' before 
``final cost objectives.''
    Councils' Response: Concur. The Councils believe the revision will 
provide for increased consistency with the definition of indirect costs 
at 2.101.
FAR 31.203(d)--Revising FAR To Reflect Court Decisions
    9. Comment: A respondent asserts that while the FAR revises the 
language at 31.203(c) (renumbered as paragraph (d)) to reflect the 
outcome in a recent court case where the Government position was 
sustained, there is no FAR revision to reflect the outcome of another 
court case on changes in cost accounting practice where the Government 
position was not sustained. The respondent believes the Councils should 
treat both situations alike and not attempt to sway contracting 
officers in one direction or another by selectively adding the outcome 
of certain court cases.
    Councils' Response: Nonconcur. The language at 31.203(d) is not 
being modified to reflect the outcome of any court case. This paragraph 
revises the term ``distributing'' to ``allocating,'' to be consistent 
with the terminology used throughout FAR Part 31. The Councils also 
note that the respondent's referenced case on changes in cost 
accounting practice does not address any FAR requirements, i.e., the 
provisions at issue were solely in the CAS.
FAR 31.203(g)--Base Period for Allocating Indirect Costs
    10. Comment: A respondent recommends that CAS 406, Cost Accounting 
Period, be used in lieu of FAR 31.203(g). If FAR 31.203(g) is not 
replaced by CAS 406, the respondent recommends that the language at FAR 
31.203(g) replace the term ``base period'' with ``cost accounting 
periods'', to be consistent with the language in CAS 406.
    Councils' Response: Nonconcur. The Councils believe that the 
detailed requirements in CAS 406 are not necessary for non-CAS covered 
contracts. As for the ``base period,'' paragraph (g) defines the base 
period as ``the cost accounting period during which * * * '' Since the 
definition of a base period includes the cost accounting period, the 
Councils do not believe it is necessary to change the term ``base 
period'' to ``cost accounting period.''
    This is not a significant regulatory action and, therefore, was not 
subject to review under Section 6(b) of Executive Order 12866, 
Regulatory Planning and Review, dated September 30, 1993. This rule is 
not a major rule under 5 U.S.C. 804.

B. Regulatory Flexibility Act

    The Department of Defense, the General Services Administration, and 
the National Aeronautics and Space Administration certify that this 
final rule will not have a significant economic impact on a substantial 
number of small entities within the meaning of the Regulatory 
Flexibility Act, 5 U.S.C. 601, et seq., because most contracts awarded 
to small entities use simplified acquisition procedures or are awarded 
on a competitive, fixed-price basis, and do not require application of 
the cost principle discussed in this rule.

C. Paperwork Reduction Act

    The Paperwork Reduction Act (Pub. L. 104-13) does not apply because 
the changes to the FAR do not impose information collection 
requirements that require the approval of the Office of Management and 
Budget under 44 U.S.C. 3501, et seq.

List of Subjects in 48 CFR Parts 2 and 31

    Government procurement.

    Dated: March 26, 2004.
Laura Auletta,
Director, Acquisition Policy Division.

Therefore, DoD, GSA, and NASA amend 48 CFR parts 2 and 31 as set forth 
1. The authority citation for 48 CFR parts 2 and 31 is revised to read 
as follows:

    Authority: 40 U.S.C. 121(c); 10 U.S.C. chapter 137; and 42 
U.S.C. 2473(c).


2. Amend section 2.101 in paragraph (b) by adding, in alphabetical 
order, the definition ``Direct cost'' and by revising the definition 
``Indirect cost'' to read as follows:

2.101  Definitions.

* * * * *
    (b) * * *
* * * * *
    Direct cost means any cost that is identified specifically with a 
particular final cost objective. Direct costs are not limited to items 
that are incorporated in 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.
* * * * *
    Indirect cost means any cost not directly identified with a single 
final cost objective, but identified with two or more final cost 
objectives or with at least one intermediate cost objective.
* * * * *

[[Page 17767]]


31.109  [Amended]

3. Amend section 31.109(h)(13) by removing ``31.203(f)'' and adding 
``31.203(h)'' in its place.

31.201-1  [Amended]

4. Revise section 31.201-1 to read as follows:

31.201-1  Composition of total cost.

    (a) The total cost, including standard costs properly adjusted for 
applicable variances, of a contract is the sum of the direct and 
indirect costs allocable to the contract, incurred or to be incurred, 
plus any allocable cost of money pursuant to 31.205-10, less any 
allocable credits. In ascertaining what constitutes a cost, any 
generally accepted method of determining or estimating costs that is 
equitable and is consistently applied may be used.
    (b) While the total cost of a contract includes all costs properly 
allocable to the contract, the allowable costs to the Government are 
limited to those allocable costs which are allowable pursuant to Part 
31 and applicable agency supplements.

5. Amend section 31.201-2 by revising paragraphs (a), (c), and (d) to 
read as follows:

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.
* * * * *
    (c) When contractor accounting practices are inconsistent with this 
subpart 31.2, costs resulting from such inconsistent practices in 
excess of the amount that would have resulted from using practices 
consistent with this subpart are unallowable.
    (d) A contractor is responsible for accounting for costs 
appropriately and for maintaining records, including supporting 
documentation, adequate to demonstrate that costs claimed have been 
incurred, are allocable to the contract, and comply with applicable 
cost principles in this subpart and agency supplements. The contracting 
officer may disallow all or part of a claimed cost that is inadequately 

6. Revise section 31.202 to read as follows:

31.202  Direct costs.

    (a) No final cost objective shall have allocated to it as a direct 
cost any cost, if other costs incurred for the same purpose in like 
circumstances have been included in any indirect cost pool to be 
allocated to that or any other final cost objective. Direct costs of 
the contract shall be charged directly to the contract. All costs 
specifically identified with other final cost objectives of the 
contractor are direct costs of those cost objectives and are not to be 
charged to the contract directly or indirectly.
    (b) For reasons of practicality, the contractor may treat any 
direct cost of a minor dollar amount as an indirect cost if the 
accounting treatment--
    (1) Is consistently applied to all final cost objectives; and
    (2) Produces substantially the same results as treating the cost as 
a direct cost.
7. Revise section 31.203 to read as follows:

31.203  Indirect costs.

    (a) For contracts subject to full CAS coverage, allocation of 
indirect costs shall be based on the applicable provisions. For all 
other contracts, the applicable CAS provisions in paragraphs (b) 
through (h) of this section apply.
    (b) After direct costs have been determined and charged directly to 
the contract or other work, indirect costs are those remaining to be 
allocated to intermediate or two or more final cost objectives. No 
final cost objective shall have allocated to it as an indirect cost any 
cost, if other costs incurred for the same purpose, in like 
circumstances, have been included as a direct cost of that or any other 
final cost objective.
    (c) The contractor shall accumulate indirect costs by logical cost 
groupings with due consideration of the reasons for incurring such 
costs. The contractor shall determine each grouping so as to permit use 
of an allocation base that is common to all cost objectives to which 
the grouping is to be allocated. The base selected shall allocate the 
grouping on the basis of the benefits accruing to intermediate and 
final cost objectives. When substantially the same results can be 
achieved through less precise methods, the number and composition of 
cost groupings should be governed by practical considerations and 
should not unduly complicate the allocation.
    (d) Once an appropriate base for allocating indirect costs has been 
accepted, the contractor shall not fragment the base by removing 
individual elements. All items properly includable in an indirect cost 
base shall bear a pro rata share of indirect costs irrespective of 
their acceptance as Government contract costs. For example, when a cost 
input base is used for the allocation of G&A costs, the contractor 
shall include in the base all items that would properly be part of the 
cost input base, whether allowable or unallowable, and these items 
shall bear their pro rata share of G&A costs.
    (e) The method of allocating indirect costs may require revision 
when there is a significant change in the nature of the business, the 
extent of subcontracting, fixed-asset improvement programs, 
inventories, the volume of sales and production, manufacturing 
processes, the contractor's products, or other relevant circumstances.
    (f) Separate cost groupings for costs allocable to offsite 
locations may be necessary to permit equitable distribution of costs on 
the basis of the benefits accruing to the several cost objectives.
    (g) A base period for allocating indirect costs is the cost 
accounting period during which such costs are incurred and accumulated 
for allocation to work performed in that period.
    (1) For contracts subject to full or modified CAS coverage, the 
contractor shall follow the criteria and guidance in 48 CFR 9904.406 
for selecting the cost accounting periods to be used in allocating 
indirect costs.
    (2) For contracts other than those subject to paragraph (g)(1) of 
this section, the base period for allocating indirect costs shall be 
the contractor's fiscal year used for financial reporting purposes in 
accordance with generally accepted accounting principles. The fiscal 
year will normally be 12 months, but a different period may be 
appropriate (e.g., when a change in fiscal year occurs due to a 
business combination or other circumstances).
    (h) Special care should be exercised in applying the principles of 
paragraphs (c), (d), and (e) of this section when Government-owned 
contractor-operated (GOCO) plants are involved. The distribution of 
corporate, division or branch office G&A expenses to such plants 
operating with little or no dependence on corporate administrative 
activities may require more precise cost groupings, detailed accounts 
screening, and carefully developed distribution bases.

31.205-42  [Amended]

8. Amend section 31.205-42 in the second sentence of paragraph (h) by

[[Page 17768]]

removing ``31.203(c)'' and adding ``31.203(d)'' in its place.

[FR Doc. 04-7406 Filed 4-2-04; 8:45 am]