# Cost Accounting Standards Board; Treatment of Gains or Losses Subsequent to Mergers or Business Combinations by Government Contractors

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URL: https://www.frixlaw.com/law-library/documents/fr%3A94-12594

## Record

- **Collection:** Federal Register
- **Document type:** Uncategorized Document
- **Published:** May 24, 1994

## Text

OFFICE OF MANAGEMENT AND BUDGET
48 CFR Part 9904

Cost Accounting Standards Board; Treatment of Gains or Losses
Subsequent to Mergers or Business Combinations by Government
Contractors

AGENCY: Cost Accounting Standards Board, Office of Federal Procurement
Policy, OMB.

ACTION: Advance notice of proposed rulemaking (ANPRM).

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SUMMARY: The Office of Federal Procurement Policy, Cost Accounting
Standards Board (CASB), proposes to amend the Cost Accounting Standards
relating to treatment of gains or losses attributable to tangible
capital assets subsequent to mergers or business combinations by
government contractors.
To resolve the problems that have been identified in this area, the
Board proposes to amend CAS 404, ``Capitalization of Tangible Assets''
and CAS 409, ``Depreciation of Tangible Capital Assets''. The proposed
amendments are based on an approach involving a ``no step-up, no step-
down'' of asset bases and no recognition of gain or loss on a transfer
of assets following a business combination by contractors subject to
CAS.
Section 26(g)(1) of the Office of Federal Procurement Policy Act
requires that the Board, prior to the promulgation of any new or
revised Cost Accounting Standard, publish a report and an ANPRM. This
ANPRM addresses the Board's proposal to amend CAS 404 and CAS 409 to
deal with the issue of gains and losses subsequent to a merger or
business combination.

DATES: Comments should be received by July 25, 1994.

ADDRESSES: Comments should be addressed to Dr. Rein Abel, Director of
Research, Cost Accounting Standards Board, Office of Federal
Procurement Policy, 725 17th Street, NW., room 9001, Washington, DC
20503: Attn: CASB Docket No. 91-06(2).

FOR FURTHER INFORMATION CONTACT:
Dr. Rein Abel, Director of Research, Cost Accounting Standards Board
(telephone 202-395-3254).

SUPPLEMENTARY INFORMATION:

A. Regulatory Process

The Cost Accounting Standards Board's rules and regulations are
codified at 48 CFR chapter 99. Section 26(g)(1) of the Office of
Federal Procurement Policy Act, 41 U.S.C. 422(g)(1), requires that the
Board, prior to the establishment of any new or revised Cost Accounting
Standard, complete a prescribed rulemaking process. This process
consists of the following four steps:
1. Consult with interested persons concerning the advantages,
disadvantages and improvements anticipated in the pricing and
administration of government contracts as a result of a proposed
Standard.
2. Promulgate an Advance Notice of Proposed Rulemaking.
3. Promulgate a Notice of Proposed Rulemaking.
4. Promulgate a Final Rule.
This proposal is step two in the four step process.

B. Background and Report

Prior Promulgations

The issues addressed in this proposal were first identified by
commenters in response to the Board's request for suggested agenda
topics in November 1990. Subsequently two Staff Discussion Papers (SDP)
were issued.
The first, dated August 26, 1991 and titled ``Recognition and
Pricing of Changing Asset Values Resulting from Mergers and Business
Combination by Government Contractors,'' raised some broader issues
such as the scope of the proposed project, the basis for any Government
claim to gains or losses resulting from a business combination and the
likely economic consequences of a policy that would prohibit
revaluation of assets following a merger.
The responses to this SDP were used by the Board as basis for
discussing the basic issues involved in this case. As a result of this
discussion, the Board decided to issue a second SDP dealing with a
series of questions mostly concerning the specific procedures needed to
deal effectively with the recognition, allocation and recovery of the
gain or loss subsequent to a merger or business combination. The second
SDP, titled ``Treatment of Gains or Losses Subsequent to Mergers or
Business Combinations by Government Contractors,'' was issued on
November 4, 1993. The responses to this SDP were of significant
assistance to the Board in developing the current ANPRM.

Public Comments

Fifteen sets of public comments were received. Three of these were
from government agencies, five from government contractors, four from
trade and professional associations and three from individuals and
other commenters. The comments were most useful to the Board in its
decision-making process and, represented a wide spectrum of views on
the various issues that were raised. The SDP included a series of
questions dealing with the measurement of the gain or loss subsequent
to a merger or business combination, its allocation between the
government and the contractor and the possible methods of recovery that
the government could employ in trying to recover its share of a gain or
loss. In many instances, the responses to these questions indicated
that the commenters believed that a comprehensive and equitable process
of allocating gains or losses between the Government and contractors
would entail use of complex and cumbersome procedures that would add
significantly to the implementation cost of any Standard that would
sanction revaluation of tangible capital assets subsequent to a merger
or business combination. The comments that were received are discussed
below in greater detail, under Section E., Public Comments. The Board
and the CASB staff express their appreciation for the thoughtful and
generally constructive responses provided by the commenters.

Benefits

After consideration of all the comments received, the Board
believes that amendments to CAS 404, Capitalization of Tangible Assets,
and CAS 409, Depreciation of Tangible Capital Assets, as set forth in
this ANPRM will significantly improve and clarify the implementation of
CAS and related procurement regulations in accounting for tangible
capital assets after a merger or business combination. In particular,
the Board believes that a clean-cut resolution of this issue, as
proposed in the ANPRM, will clarify the ambiguities that currently
exist in this area and thus should lead at least to some reduction in
the present confrontational negotiations and litigation in this area.
This point is of particular significance in the current economic and
budgetary environment where further reductions in the defense budget
can be expected to lead to further mergers and business combinations
among defense contractors. The Board believes that potential benefits
to the audit, negotiations, and general contract administration
processes occurring from the added clarity and uniformity in the
measurement of the cost of depreciation and cost of money subsequent to
a business combination will be substantial and will greatly outweigh
any added costs.

Summary of Proposed Amendments

A brief description of the proposed amendments follows:
a. The current subsection 9904.404-50(d) is deleted and is replaced
by an amended section that prescribes:
(1) that for Federal Government contract costing purposes tangible
capital assets after a business combination shall retain their net book
value recognized prior to the business combination provided that the
assets had previously generated costs that were chargeable to Federal
Government contracts subject to CAS.
(2) That the cost of tangible capital assets shall be restated
after the business combination at a figure not to exceed the fair value
at the date of the acquisition pursuant to a business combination where
the assets prior to the business combination did not generate costs
that were chargeable to Federal Government contracts subject to CAS.
b. A new subparagraph 9904.409-50(j)(5), is added to current
subsection 9904.409-50(j). The purpose of this new subparagraph is to
make it clear that the CAS 409 provisions dealing with the recapture of
gains and losses on disposition of tangible capital assets should not
apply when assets are transferred subsequent to a business combination.

C. Paperwork Reduction Act

The Paperwork Reduction Act, Public Law 96-511, does not apply to
this proposal, and any associated rulemaking, because this proposal
would impose no paperwork burden on offerors, affected contractors and
subcontractors, or members of the public which require the approval of
OMB under 44 U.S.C. 3501, et seq.

D. Executive Order 12866 and the Regulatory Flexibility Act

The economic impact of this proposal on contractors and
subcontractors is expected to be minor. As a result, the Chairman has
determined that this ANPRM will not result in the promulgation of a
``major rule'' under the provisions of Executive Order 12866, and that
a regulatory impact analysis will not be required. Furthermore, this
proposal will not have a significant effect on a substantial number of
small entities because small businesses are exempt from the application
of the Cost Accounting Standards. Therefore, this proposed rule does
not require a regulatory flexibility analysis under the Regulatory
Flexibility Act of 1980.

E. Public Comments

This ANPRM was developed taking into account the comments received
to the issue raised in the Staff Discussion Paper made available for
public comment on November 4, 1993. The comments have provided valuable
input to the Board's rulemaking process. The comments received and the
action taken by the Board are summarized in the paragraphs that follow:
Comment: In response to a question on the relationship between CAS
and Generally Accepted Accounting Principles (GAAP) most commenters
agreed that the Board should utilize GAAP to the greatest practical
extent, but nevertheless, the Board clearly has the authority to depart
from GAAP when deemed necessary to meet the Board's objectives.
Response: The Board is in agreement with the comment.
Comment: In response to a question as to the level of aggregation
of individual asset values that might be used as a basis for
establishing ``fair values'' for tangible capital assets, a number of
comments pointed out that the current definitions of ``asset
accountability unit'' in 9904.404-30(a)(1) would be an adequate basis
for determining the detail required. They also pointed out that asset
groupings are already adequately covered in 9904.409-50(d) and in the
relevant illustrations 9904.409-60(a) (2) and (3).
Response: The Board is in agreement with this comment.
Comment: A great variety of comments were received in response to a
question as to whether the current 9904.409-50(j)(1) cap on government
recovery in the form of accumulated depreciation, should be also
applied to gains and losses recognized subsequent to a revaluation of
assets pursuant to a business combination. About half of the commenters
believe that the current cap should be also applied to gains related to
assets acquired in the course of a business combination. A significant
number of other commenters believe, however, that no such cap should be
applied in these circumstances. One commenter advocated a modified cap
that would recognize the element of inflation in the gain. Another
commenter stressed that the Government should share not only any gains,
but also in any losses that may emerge.
Response: The Board has considered the merits of a cap adjusted for
inflation. However, the actual calculations to establish such a
modified cap seem to require establishment of a fairly complex and
possibly cumbersome procedure.
The Board agrees with the commenter who stated that the Government
should participate in losses as well as in gains.
Comment: On the question as to whether the cap should be modified
to take into account cost of money paid in the past, the views of
commenters were clearly divided. The government commenters believed
that there should be some accounting for past cost of money payments
whereas all the other commenters did not think that any modification in
the cap was warranted. However, most commenters recognized, that any
attempt to modify the cap for cost of money would be complex and
extremely difficult to compute in practice.
Response: The Board agrees that any adequate process that could be
developed to modify the current cap on government recovery for the past
payments of cost of money would be complex and difficult to compute.
Comment: With respect to the conceptual argument as to who, the
contractor or the Government should retain the ``gain'' due to
inflation, there was no clear-cut agreement. In general, the government
commenters stated that the government was entitled to any gain
attributable to inflation on account of past cost of money payments.
The industry commenters generally disagreed, although on a conceptual
plane there were one or two exceptions.
One industry commenter pointed out, once again, that if the
Government wishes to share in the gain, it should be also willing to
share in the losses.
One commenter stated that there should be no attempt to try to
implement inflation accounting on a piecemeal basis. If it is to be
done, then asset bases should also be revalued.
However, the overwhelming majority of the commenters indicated that
whatever the arguments regarding the merit of recognizing inflationary
gains, in practice the procedures needed to implement such inflationary
adjustments would be so cumbersome and complex as to render the whole
system unworkable.
Response: The Board agrees with the commenters who state that the
calculation of any inflationary adjustment would be a cumbersome and
complex procedure.
Comment: When responding to the request in the SDP for suggestions
regarding basis for allocation of gains or losses between government
and contractors, virtually all of the commenters recognized the
construction of an index or some other factor to reflect the historical
usage of assets on CAS-covered work as contrasted with other work would
be impractical and the costs involved would clearly exceed any possible
benefits.
Three comments suggested that, in any event, it would be contrary
to the current CAS provisions to try to allocate the gain or loss on
the basis of historical usage. They point out that current CAS 409,
415, and 416, in effect, use the current activity as the base for
allocating adjustments related to the past cost measurements. Thus,
these commenters maintain that a charge against the current period
costs is all that is required.
Three other commenters suggested that it may be possible to use a
form of advance agreement that would establish, in conjunction with
incurred cost settlements or submission, the ratio of CAS/non-CAS work
at the indirect cost pool level.
It was also pointed out that no attempts at allocation should be
undertaken when the contractor is essentially all CAS covered or all
non-CAS covered, e.g., 85% or more in either category.
Response: The Board agrees with the commenters that it would be
difficult to develop an equitable and reliable, as well as, economical
basis for establishing the past usage of assets in CAS work as
contrasted with non-CAS work.
Comment: Most commenters indicated that gains or losses
attributable to misestimating of the residual value of assets
transferred in a business combination should not be treated differently
from other gains or losses attributable to assets transferred.
Several commenters pointed out, that in any event, it would be
difficult, if not impossible, to determine the amount of ``misestimated
residual value.''
Some commenters also expressed a belief that the question raised is
based on a false premise. Residual value is a concept based on
historical cost and enters into the process of determining depreciation
costs (an allocation process), whereas gains or losses based on fair
values subsequent to a business combination are derived from current
values (valuation process). Therefore, residual value should not be
compared to disposition value.
Nevertheless, a few commenters recognized the significant
discrepancy between the original residual value and the fair value
established subsequent to a business combination, may indicate a
misestimation in the residual value which could be interpreted as a CAS
non-compliance.
Response: The Board appreciates the input of comments who responded
to this issue. It notes the comments that indicate that it may be
difficult to separate the consequences of misestimates in residual
values from changes in fair values when assets are transferred in the
course of a business combination.
Comment: Practically all the commenters recognized that subsequent
to a business combination the government may have a clear-cut claim
against the seller.
A number of industry comments expressed the belief that the
government has a valid claim only to the extent that there have been
erroneous estimates of depreciation in the past.
A significant number of comments did recognize, however, that
subsequent to a business combination the relationship between the
government and the seller may dissolve. In those cases, it was
suggested that appropriate notation agreements should be negotiated
with the buyer. The government comments, in particular, stressed that
if the claim cannot be successfully pursued against the seller, then
there must be alternative ways of pursuing the claim, such as
proceeding against the buyer or trying to collect from the proceeds of
the acquisition.
Response: The Board notes the comment that the government may have
difficulties in pursing to claim against the original owner of the
assets if subsequent to a business combination there is no longer a
business relationship between the government and the seller.
Comment: The commenters on the whole, did not support the notion
that the government should recover its share of gain or loss subsequent
to asset revaluation from the buyer. Some comments pointed out that
such a gain or loss recovery is a contract administration issue and not
an accounting matter. It was also suggested that the matter might be
best dealt with at the time when novation and advance agreements are
negotiated between the government and the contractor.
Repsonse: The Board has taken note of the comments received on this
topic.
Comment: The last issue raised in the SDP concerned the
advisability of retaining the original asset base subsequent to the
business combination in view of the complex and costly procedures that
would have to be developed to share any gain or loss, attributable to
asset revaluation, between the government and the contractor.
There was a clear divergence of views on this topic between the
government commenters and other comments. All the government responses
indicated that assets should be not revalued subsequent to a business
combination. All the other comments expressed the views that such a
revaluation should be carried out and recognized for government
contract costing purposes. One industry comment did point out, however,
that the assets should not be revaluated if the business combination
takes the form of acquisition of shares rather than assets.
Several commenters pointed out that in any event the apparent
conflict between CAS and the Federal Acquisition Regulation (FAR)
should be eliminated. It was also pointed out that the government
should be consisted in its application of cost accounting practices in
this area. It should either allow revaluation of assets subsequent to
business combinations and then deal with the resulting gain and loss
issues, or adopt practices based on not revaluing assets and limiting
depreciation and gains and losses to historical costs without regard to
business combinations.
Response: The Board agrees with the commenters who stated or
inferred that in case of asset revaluations subsequent to a business
combination the procedures involved to develop an adequate and
equitable method to share the gain or loss between the government and
the contractor would be complex and costly. At the same time, the Board
does not agree with those commenters who maintain that the government
is not entitled to any share in the gain or loss subsequent to asset
revaluation because such a gain or loss can only accrue to a party that
bears the risk of ownership, i.e., the contractor. The Board believes
that in a business environment where cost-based pricing prevails, which
includes an allowance for cost of money, and long-term contractual
relationshps are the norm, the buyer, i.e., the government, has a sound
claim to the benefits that may emerge as the tangible capital asset
values increase in response to the interaction of various market
forces. Conversely, the Board also believes that if the government is
entitled to the benefits that may emerge as the asset values increase,
it should also be prepared to bear the additional costs when the asset
values are decreasing.
Therefore, the Board has concluded that in light of the complexity
of the procedures that are needed to deal with the revaluation of
assets and the subsequent sharing of ensuing gains and losses, the most
acceptable course to follow in pursuit of its objectives is to retain
the original asset acquisition cost as a base for calculating contract
costs after a business combination or merger has taken place.

List of Subjects in 48 CFR Part 9904

Cost accounting standards, Government procurement.
Steven Kelman,
Administrator for Federal Procurement Policy, and Chairman, Cost
Accounting Standards Board.
Accordingly, it is proposed to amend 48 CFR part 9904 as follows:

PART 9904--COST ACCOUNTING STANDARDS

1. The authority citation for part 9904 continues to read as
follows:

Authority: Public Law 100-679, 102 Stat. 4056, 41. U.S.C.
Sec. 422.

9904.404 [Amended]

2. Section 9904.50 is proposed to be amended by revising paragraph
(d) to read as follows:

9904.404-50 Techniques for application.

* * * * *
(d) Under the ``purchase method'' of accounting for business
combinations, tangible capital assets acquired shall be assigned
acquisition costs for Federal Government contract costing purposes as
follows:
(1) Where the assets prior to the business combination generated
costs that were chargeable to Federal Government contracts subject to
CAS, the assigned acquisition cost of tangible capital assets after the
business combination shall be their net book value, recognized for
Federal Government contract costing purposes, immediately prior to
entering into the business combination.
(2) Where the assets prior to business combinations did not
generate costs that were chargeable to Federal Government contracts
subject to CAS, the assigned acquisition costs of tangible capital
assets after the business combinations shall be a portion of the cost
of the acquired company, not to exceed their fair value at date of
acquisition. Where the fair value of identifiable acquired assets less
liabilities assumed exceeds the purchase price of the acquired company
in an acquisition under the ``purchase method,'' the value otherwise
assignable to tangible capital assets shall be reduced by a
proportionate part of the excess.
* * * * *

9904.409 [Amended]

3. Section 9904.409-50 is proposed to be amended by adding a new
paragraph (j)(5) to read as follows:

9904.409-50 Techniques for application.

* * * * *
(j) * * *
(5) The provisions of 9904.409-50(j) do not apply to tangible
capital assets transfers resulting from a business combination. The
carrying values of those assets subsequent to such a business
combination shall be established in accordance with the provisions of
9904.404-50(d).
* * * * *
[FR Doc. 94-12594 Filed 5-23-94; 8:45 am]
BILLING CODE 3110-01-M

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A94-12594. Public record. Not legal advice.