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CAS COVERAGE
Perplexed  Posted on Friday, July 11, 2003 - 05:04 pm:

I hope this is not too simple a question but it's been bugging me, wonder if one can help.

A small business has been awarded a contract that under most circumstance (value) would be CAS covered. Being a small business at the time of award, of course, triggers the exemption. The contract is a multi-year incrementally funded CP. My question is, if this small business is bought by a large business that does have CAS covered contracts, does the small business's original contract still enjoy the exemption or does become subject to CAS coverage, also?

Thanks


edwardo  Posted on Saturday, July 12, 2003 - 09:48 am:

You wouldn't be asking if you didin't have some hunch that this sm will be bought by a Large. It depends on the buying company. Novation and name change agreements asume all in place liabilities, contracts, proceeds, etc....if they exercise the novation, they woul most likely be held to CAS due to the new acct. system


Lone Wolf  Posted on Saturday, July 12, 2003 - 11:36 am:

I'm not sure I agree with Eduardo. The applicability of CAS to a contract is determined at the time the basic contract is awarded; once awarded, a contract's CAS status does not change regardless of later events. See 59 Fed Reg 55746.

For example, not only would a $450,000 award to a large business be exempt, a later within-scope modification adding another $450,000 of work -- bringing the total value of the contract to $900,000 -- would not trigger CAS coverage, either for the added work or for the overall contract. The result would be the same if the value of the mod were $600,000. As I recall, there is an "Ask the Professor" Q&A making this same point.

Here's some more support for the rule that a contract's CAS status is determined at time of award and is not changed by later events: consider the case of a contractor who receives an award subject to modified CAS but later in that same accounting period receives a $50M+ non-exempt award, triggering full coverage. The CAS regs make clear that full coverage applies only to the $50M+ plus award and any later awards received in that same cost accounting period. The earlier-received award that was subject to modified covereage at the date of award stays subject to modified coverage, even after receipt of the $50M+ award. 9903.201-2(b)(2), (b)(3). Contractors thus can have some contracts subject to full coverage and other contracts subject to modified coverage at the same point in time. 9903.304.

Finally, the CAS regs address full CAS coverage in terms of "awards." A contractor who acquires a contract via novation does not receive an "award," so an express criterion for full coverage in the regs is not met.

I do agree with Eduardo that a large company that acquires a smaller one might agree in a novation agreement to administer certain novated awards under full CAS coverage, but this result would arise from contract, not from regulation. I can't imagine a large business agreeing to such a provision in a novation agreement, and I don't think I've ever seen the Govt demand such a provision.


John Ford  Posted on Saturday, July 12, 2003 - 12:54 pm:

I am in general agreement with LW in regard to the original question. However, I have to disagree that the type of CAS coverage is always determined at the time of award. Specifically, if a small business were to acquire a segment of a large business subject to CAS coverage and have those contracts novated to the small business, the contracts would lose their CAS coverage upon the novation. That is because the CAS rules exempt contracts "with" small businesses from CAS coverage, not just contracts "awarded" to small businesses.


Vern Edwards  Posted on Sunday, July 13, 2003 - 02:11 pm:

The specific question cannot be answered on the basis of the information provided; however, I'll take a stab at providing a general answer.

A business unit must comply with CAS when it has a CAS-covered contract. (The definition of business unit is in FAR § 2.101.) As a business unit, the small business was exempt from CAS.

Now a large business unit with CAS-covered contracts has "bought" the small business. In my opinion, if as a result of the purchase the small business has became a part of the large business unit that has CAS-covered contracts, then it will have to comply with CAS because it is part of a business unit that must comply with CAS, even though its contract was originally exempt from CAS and even if it did not include the CAS clause. However, I think that if, despite the purchase, the small business has remained a separate business unit, then it will not have to comply with CAS even though its new ownership means that it is no longer a small business under SBA regulations.

So I think that the answer to the specific question depends on the effect that the purchase had on the organizational status of the former small business, whether it was merged into the large business unit or remained a distinct business unit. The change in its size status, in and of itself, should not bring CAS into effect on the contract, even if the contract included the CAS clause. I'm pretty sure this is correct, but I'm not absolutely sure.


John Ford 

Posted on Sunday, July 13, 2003 - 03:57 pm:  

I want to respond to Vern's post by stating that to the best of my knowledge we are all giving our opinions here because there is no case on point to dispose of this issue. Further, I am not sure what the answer should be. However, I would like to receive more reasoning from Vern regarding the first situation described in his post as most of his posts are well reasoned, even if I disagree with him from time to time.

For simplicity sake, here is the fact situation. A large business Government contractor buys a small business Government contractor and merges the small business into the large business. The small business disappears and all we are left with is a contract that was awarded to a small business now being performed by a large business. Because the contract orginally was with a small business, it was not subject to CAS. It is now being performed by a large business that has CAS covered contracts. The contract does not contain any CAS clause. If the contract now becomes subject to CAS coverage, under what theory are the appropriate CAS clauses incorporated into the contract so that they become enforceable against the large business? Would the answer be different if a novation were required or if the contract were transferred by operation of law?


perplexed.  Posted on Monday, July 14, 2003 - 09:23 am:   

After reading Vern's post, I should add that this purchase was done as a stock purchase as opposed to an asset purchase. In this case I understand that a novation is not applicable. Secondly, the former small business is a wholly owned subsidiary of the large company.

Because of this, I tend to believe that the orginal contract would maintain CAS exemption.

Thanks for all your inputs.


Vern Edwards  Posted on Monday, July 14, 2003 - 08:20 pm:

John:

I wrestled with the issue that you are raising, and its a good one. Here is how I reasoned it out:

I did not say that the previously exempt contract would become CAS-covered following the purchase of the small business by the large business. I said: "In my opinion, if as a result of the purchase the small business has became a part of the large business unit that has CAS-covered contracts, then it will have to comply with CAS because it is part of a business unit that must comply with CAS, even though its contract was originally exempt from CAS and even if it did not include the CAS clause."

I probably could have made my point more clearly than I did. I don't think a business unit can keep two sets of books -- one for CAS-covered contracts and one for non-CAS-covered contracts. Am I wrong? Thus, as a practical matter, once a business unit agrees to comply with CAS under any contract, it must comply with CAS with respect to all its accounting for government contracts, even its non-CAS-covered contracts. At least, this is what I have been told.

Can a business unit keep two sets of books, one for CAS-covered contracts and another for non-CAS-covered contracts? I honestly don't know, but I think not. Am I wrong?

I think that if a contractor with both CAS-covered and non-CAS-covered contracts violates a cost accounting standard the government cannot come after it for breach under its non-CAS-covered contracts, because it did not promise to comply with CAS under those contracts. The government must come after it under the CAS-covered contracts.

I don't know what the right answer is; I'm just trying to think it through based on what I do know. What do you think?


John Ford Posted on Monday, July 14, 2003 - 10:05 pm:  

Vern, as a practical matter you are correct when you say that a contractor cannot keep two sets of books, one for CAS covered contracts and one for non CAS covered contracts. However, this is a matter of convenience not of CAS compliance or the CAS clauses in the FAR. Thus, from a theoretical perspective, a contractor can keep two sets of books. In fact, perhaps we should add that it can keep three or four sets of books. One for it its CAS covered contracts, one for its non-CAS covered contracts which are subject to the cost principles, one for cost accumulation and management on its sealed bid contracts and one for its commercial items.

The issue I am concerned with is the question of whether the contracts with the former small business would become CAS covered as a matter of compliance with the CASB's regulations although those contracts would not have any CAS clause in them. In this regard, the CASB's regulations on applicability of the CAS state that "negotiated contracts not exempt in accordance [with the regulations] shall be subject to CAS." No exemption in the regulations covers this situation. Thus, it would seem that the former small businesses contracts would become subject to CAS when they are taken over by the large business. However, to me it seems that the CASB did not have transfers of contracts in mind when it wrote the regulations as they seem to address a contract's CAS status being determined at the time of award. As I said earlier, I don't know what the answer is to this question.


Vern Edwards  Posted on Tuesday, July 15, 2003 - 11:11 am:

John:

I barely passed accounting in business school, so let me ask: Wouldn't keeping two sets of books -- one for CAS-covered contracts and one for exempt contracts -- make it hard for a business unit to comply with CAS under its covered contracts? Think of CAS 410 and 418. Could a business unit allocate indirect costs one way under its covered contracts and differently under its exempt contracts and still comply?

Also, I don't think that a change in a business unit's size status affects CAS coverage of its pre-existing contracts, except as a practical matter, as we have discussed.

Vern


AnonYmus  Posted on Tuesday, July 15, 2003 - 12:19 pm:

Vern,

Yes. Contractors must keep several sets of books: (1) as per GAAP for financial reporting, (2) as per IRS code for tax accounting and reporting, (3) as per FAR Part 31 for those cost-based contracts subject to that subsection but otherwise exempt from CAS, and (4) as per CAS for CAS-covered contracts. And we wonder why contractors' indirect rates are so high??

Anyway, y'all might want to check out the CAS requirements at 48 CFR 9903.201-2 (Types of CAS Coverage). Here is a pertinent quotes --

"(b)(3) A contract awarded with modified CAS coverage shall remain subject to such coverage throughout its life regardless of changes in the business unit's CAS status during subsequent cost accounting periods."

From that specific rule I deduce (or is it infer?) to a general rule that a contract's CAS coverage status (i.e., Exempt, Modified or Full) is determined once at contract award and does not change throughout the life of the contract regardless of what happens to the business unit.

A topic for more general discussion might be what it means to be CAS-covered. A contract might be exempt from CAS, but subject to the half-dozen CAS brought into the Part 31 cost principles because allowability is determined by virtue of compliance with a particular Standard.

If a contract is exempt from CAS, then it seems to be that the real advantage a contractor has is that a contracting officer cannot assess a CAS non-compliance with respect to that contract. Also, when a contractor initiates a change in cost accounting practice, that CAS-exempt contract would not be included as an "affected contract" for purposes of the cost impact analysis.

You make a very cogent point, Vern, in that cost accounting practices do not, as a rule, vary by contract. Cost accounting practices exist at the business unit (or segment) level and must be applied consistently to all contracts, though billing practices might vary widely. The remedy found in CAS for a failure to consistently apply those practices, however, will only be applied to CAS-covered contracts.

So to answer the initial question, although the contract remains exempt from CAS, we would expect the cost accounting practices applied to the contract to be compliant with the Standards to which the acquiring entity was subject.


John Ford  Posted on Tuesday, July 15, 2003 - 05:37 pm:

AnonYmous, I cannot agree with your statement that a contract retains its original CAS status throughout the life of the contract. Specifically, I refer back to the hypothetical I raised in my first post to this thread. If a small business obtains a business unit, along with its CAS covered contracts, it is my contention that those contracts are no longer CAS covered. One of the specific exemptions from CAS coverage relates to contracts "with" small businesses. Thus, it is my contention that all contracts "with" small businesses are exempt from CAS coverage not just those that are awarded to small businesses. This result furthers the policy reason for exempting small businesses from CAS coverage in the first instance. To require a small business to comply with the CAS would be contrary to the reason they are exempt, i.e., to prevent small businesses from having to incur the expense and effort that CAS compliance requires.


 

 

 

 

 

AnonYmus Posted on Tuesday, July 15, 2003 - 11:53 pm:

Well John, you and I are just going to have to disagree on this one. (Though I'll throw you some hope at the end of this post ...)

Under your reasoning, Lockheed Martin or Boeing could have a fully CAS-covered contract but move performance to, let's say, Warsaw. That contract would then be available for the exemption at 9903.201-1(b)(15) -- "Contracts ... to be executed and performed entirely outside the United States..." Granted, we can dispute the meaning of the term "executed" but a contract can be executed anywhere (especially in the digital age) so I contend that would be a quibble. All it would take is simply to move performance OCONUS and that would be it -- the contract would now be exempt from CAS.

Basically, my point is that if it were really that simple, we would see a mass migration of CAS-covered contract performance to Zimbabwe or Timbuktu or wherever (anyplace but the USA). Since we don't see that happening, there must be some reason why not ...

Moving on, let's note DOD's CAS Working Group Item 76-2, which says in part: "With respect to contract modifications the general rule is that any modifications made to a contract pursuant to the terms and conditions of the contract will not affect the status of the contract with respect to CAS application. That is, if CAS was applicable to the original contract, it will be applicable to the modification; if CAS was not applicable to the original contract, it will not apply to the modification.”

So DOD guidance is that, generally, an exempt contract does not become CAS-covered because it was modified with additive changes to a value that is now over the CAS threshold. Let's take it a step further and agree that a CAS-covered contract cannot become exempt from CAS simply by enough deductive changes to drop it under the CAS threshold. In other words, you can't take a $10 million CAS-covered contract and make it subject to the exemption at 9903.201-1(b)(2) ["Negotiated contracts .. not in excess of $500,000."] simply by processing $9.9 million of deductive changes or issuing a partial TforC. That makes sense, right?

So, in summary, a modified CAS-covered contract EXPLICITLY cannot "change its stripes" no matter what happens to the business unit; a change of performance location won't affect a contract's CAS coverage; and subsequent modifications won't (as a general rule) affect the contract's CAS status.

Are we seeing a pattern here? I contend the pattern leads inextricably to the conclusion that a contract's CAS status is determined at award (or perhaps at negotiation of price) and doesn't change no matter what.

Now here's the ray of hope I promised you ...

it comes from the original CAS Board's prefatory comments, at Preamble F, dated 12/24/1974. In discussing CAS applicability the Board said:

"Retroactivity. Several commentators requested that the Board modify its proposal so as to provide retroactive exemption to existing contracts where the circumstances are such that these existing contracts would have been exempt if awarded after the effective date of the proposed regulation.

The Board has no authority to modify existing contractual agreements between the government procurement agencies and their contractors. However, the Board sees nothing inconsistent with its regulations or with Pub. L. 91-379 in modification by the procurement agencies of contracts in this category, assuming of course that the Government receives adequate consideration for deletion of the CAS requirements."

So, in theory, it would be possible to negotiate away CAS coverage in the hypothetical circumstances you have created... assuming the small business could offer adequate consideration. I maintain that this is not particularly likely, however. Perhaps some current 1102's might like to add something about whether they would consider something along this line given your hypothetical.

Great question -- good discussion.

Regards

Vern Edwards Posted on Wednesday, July 16, 2003 - 11:32 pm:

John:

What if a large business becomes a small business (it happens). Do you believe that its CAS-covered contracts would then become exempt?

John Ford Posted on Friday, July 18, 2003 - 11:13 am:

Vern, in this case, I do not think the contracts would become exempt. There are several factual distinctions between this situation and the one where a small business obtains the business line of a large business with CAS covered contracts. First, there is no transfer of the contracts from one contractor to another. Second, the large business (presumably) had an accounting system that was designed to accommodate the CAS. Thus, there would be no need for the contractor to change its accounting system. This leads to the final factor that distinguishes the two situations and that is the policy underlying the small business exemption, i.e., not to impose the burden of establishing and maintaining a CAS compliant accounting system. In your hypothetical, the contractors accounting system would already be set up for the CAS. While it may have to incur some marginal costs to continue with that system until its CAS covered contracts expire, I do not think this is a sufficient basis for applying the exemption in this case.
I think this discussion demonstrates a need for the CASB to clarify how the exemptions are to apply in a dynamic instead of static environment.

AnonYmus Posted on Friday, July 18, 2003 - 02:52 pm:

My favorite (unanswered) CAS coverage question is whether a contract is exempt from CAS when it is performed entirely on an Indian Reservation.

John, you're right that there is a lot of ambiguity remaining in CAS. I don't want the current CAS Board, however, to tackle anything else right now. In my view, ressurecting the CAS Board under OFPP has been an unmitigated disaster for both industry and government.

Right now the CAS Board is down to one staffer, is missing an Executive Director, and has a Chairperson who, apparently, couldn't care less about dealing with cost accounting issues. Not a recipe for success...

John Ford Posted on Friday, July 18, 2003 - 03:39 pm:  

Anon, my big gripe with the CASB is that it is separate from the FAR Council. The CASB rights accounting rules to be applied in a government procurement context, yet its members do not have general procurement experience nor do they right the rules with an appreciation of procurement policies. The CASB should be subordinate to the FAR Council who could reject proposes rules or Standards if they do not promote sound procurement policies or conflict with other national interests such as military readiness.

AnonYmus Posted on Friday, July 18, 2003 - 04:28 pm:

John, we should move this debate to another thread because we're moving off-topic.

What makes you think the FAR Council has any appreciation of good, accurate, cost accounting policies? In fact, what makes you think that the FAR Council is concerned with sound procurement policies? Have you seen recent proposed rules (e.g., FAR Case 2002-008, Proposed Revisions to FAR Part 30, DOD Guidance on Changes to Cost Accounting Practice, etc.)?

Regards

Lone Wolf Posted on Friday, July 18, 2003 - 04:34 pm:   

John -

I agree that the distinctions you identify in your post of 7/18 (11:13 am) are legitimate distinctions, but I'm not sure you're being consistent here. If you are in favor of reading the small business exemption (exempting contracts "with" small businesses) literally in order to reach the result that a fully-CAS-covered contract awarded to a large business loses its CAS status where it is novated to a small business, why don't you want to read the same provision just as literally when responding to Vern's hypo? In both cases, after the relevant event has occurred (the novation in the first hypo, the change in size status in the second hypo) the contract is no longer "with" a "small business."

I think the better analysis is: a contract that is exempt when it is awarded stays exempt throughout its life. A contract can only be subject to CAS if it meets the threshold requirements at the time it is "awarded." A contract subject to CAS at the time of award can lose its CAS status if it is novated to a small business, because, as you correctly note, the exemption language focuses on who the contract is "with," not to whom it was "awarded." To me, this interpretation is both equitable and consistent with the CAS rules.

I do agree, however, that this issue, like others relating to CAS, needs regulatory clarification.

My big CAS gripe: the way far too many Part 31 cost principles incorporate CAS standards by reference (e.g., 31.205-6 incorporating CAS 412 and 413). What a nightmare!

 

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