Cost Accounting Standards Board; Treatment of Gains or Losses Subsequent to Mergers or Business Combinations by Government Contractors; Increase in Minimum Acquisition Cost Criterion for Capitalization of Tangible Capital Assets

OFFICE OF MANAGEMENT AND BUDGET

Office of Federal Procurement Policy

48 CFR Part 9904

Cost Accounting Standards Board; Treatment of Gains or Losses

Subsequent to Mergers or Business Combinations by Government

Contractors; Increase in Minimum Acquisition Cost Criterion for

Capitalization of Tangible Capital Assets

AGENCY: Cost Accounting Standards Board, Office of Federal Procurement

Policy, OMB.

ACTION: Final rule.

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SUMMARY: The Office of Federal Procurement Policy, Cost Accounting

Standards Board (CASB), hereby amends the Cost Accounting Standards

(CAS) relating to the treatment of gains or losses attributable to

tangible capital assets subsequent to mergers or business combinations

by government contractors, and relating to the minimum acquisition cost

criterion for capitalization of tangible capital assets by raising the

prescribed criterion from $1,500 to $5,000.

To resolve the problems that have been identified in this area, the

Board hereby amends CAS 9904.404, ``Capitalization of Tangible Assets''

and CAS 9904.409, ``Depreciation of Tangible Capital Assets''. These

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 final rule. This final rule

addresses the Board's proposal to amend CAS 9904.404 and CAS 9904.409

to deal with the issue of gains and losses subsequent to a merger or

business combination.

EFFECTIVE DATE: This rule is effective April 15, 1996.

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. Sec. 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 final rule is step four in the four step process.

B. Background

Prior Promulgations

The issues addressed in this proposal were first identified by

commenters in response to the Board's request for agenda topics in

November 1990. Subsequently, two Staff Discussion Papers (SDPs) were

issued.

The first SDP, dated August 26, 1991 and titled ``Recognition and

Pricing of Changing Capital Asset Values Resulting from Mergers and

Business Combination by Government Contractors,'' (56 FR 42079) raised

broad 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 the 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 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,

entitled ``Treatment of Gains or Losses Subsequent to Mergers or

Business Combinations by Government Contractors,'' was issued on

November 4, 1993 (58 FR 58882). On the basis of comments received in

response to that SDP, an Advance Notice of Proposed Rulemaking (ANPRM)

was developed and published in the Federal Register on May 24, 1994 (59

FR 26774). The responses to the ANPRM were of significant assistance to

the Board in developing a Notice of Proposed Rulemaking (NPRM). The

NPRM was published in the Federal Register on March 8, 1995 (60 FR

12725).

Public Comments

Ten sets of public comments were received in response to the NPRM

from government contractors, professional and industrial associations,

law firms and Federal agencies.

The views expressed by the various parties were, in essence,

consistent with the views expressed by the same parties earlier when

the ANPRM was published. The basic no step-up, no step-down approach

was supported by the Government commenters and it was generally opposed

by other commenters although some of these other

[[Page 5521]]

commenters did not explicitly express their views on this basic issue.

Besides expressing their views on the proposed approach outlined in

the NPRM and the Board's arguments supporting this chosen approach,

many commenters offered editorial as well as more substantive detailed

comments on the various specific provisions of the document.

These comments are discussed below in greater detail, under Section

E., Public Comments. The Board and the CASB staff express their

appreciation for the generally constructive and thoughtful responses

provided by the commenters.

Benefits

After consideration of all the comments received in response to the

NPRM, the Board continues to believe that amendments to CAS 9904.404,

``Capitalization of Tangible Assets,'' and CAS 9904.409, ``Depreciation

of Tangible Capital Assets,'' as set forth in the ANPRM and essentially

restated in the NPRM, and this final rule, will significantly improve

and clarify the implementation of CAS and related procurement

regulations in accounting for tangible capital assets after completion

of a merger or business combination. In particular, the Board continues

to believe that the proposal embodied in this final rule will clarify

the current ambiguities in this area and thus should lead to reductions

in negotiations and litigation. This point is of particular

significance in the current economic and budgetary environment where

the need to realize economies in the defense budget can be expected to

lead to mergers, business combinations and restructurings among

contractors. It is also anticipated that increasing the capitalization

criterion for tangible capital assets in CAS 9904.404 from $1,500 to

$5,000, will significantly reduce record keeping burden in many

instances. The Board believes that the potential benefit to the audit,

negotiation, and general contract administration processes accruing

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 capitalization criterion for tangible capital assets in

subsection 9904.404-40(b)(1) is increased from $1,500 to $5,000.

b. The current subsection 9904.404-50(d) is deleted and is replaced

by an amended section that prescribes:

(1) That for contract costing purposes, tangible capital assets

following a business combination shall retain their net book value

recognized during the most recent cost accounting period prior to the

business combination provided that the assets generated either

depreciation expense or cost of money charges that were allocated

during the period either as direct or indirect costs to Federal

government contracts and subcontracts negotiated on the basis of cost.

(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 during the most recent cost accounting period prior to the

business combination did not generate either depreciation expense or

cost of money charges that were allocated either as direct or indirect

costs to Federal government contracts negotiated on the basis of cost.

c. 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 9904.409 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 rulemaking, because this rule imposes 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 rule on contractors and subcontractors

is expected to be minor. As a result, the Board has determined that

this final rule 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 final rule 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 final rule does not require a

regulatory flexibility analysis under the Regulatory Flexibility Act of

1980.

E. Public Comments

This final rule was developed after consideration of the public

comments received in response to the Board's NPRM published on March 8,

1995 (60 FR 12725). 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: Several commenters indicated that the final rule should

make it clear that this revised rule is to be applied on a prospective

basis only. One commenter suggested that the language in 9904.404-63

and 9904.409-63 be supplemented to reflect the requirements of

paragraph (a)(3) of the contract clause at 9903.201-4(a) which requires

the receipt of a new CAS-covered contract for a new CAS requirement to

be applicable.

Response: Sections 9904.404-63 and 9904.409-63 have been

supplemented to make it clear that these revisions are to be applied

prospectively.

Comment: Several commenters stressed once more that they believe

there is a conflict between the CAS allocability provisions and the

Federal Acquisition Regulation (FAR) allowability provisions in this

area. It was suggested again, as in earlier comments, that the OFPP

Administrator should address this issue.

Response: The Board is aware that there is an appearance of

conflict between the provisions of CAS 9904.404 and FAR 31.205-52. As

stated in the proposed rulemakings, the OFPP Administrator will

determine whether any changes may be necessary in the FAR cost

principles to make them fully compatible with amended CAS 9904.404 and

9904.409.

Comment: One commenter pointed out the apparent inconsistency in

the language between sections 9904.404-50(d) (1) and (2) when

describing the scope of the two paragraphs. In one paragraph the

reference is to costs charged to ``Federal Government contracts'',

while in the other, the reference is to ``Federal Government contracts

subject to CAS''. In addition, another commenter pointed out that these

references did not make clear whether contractors subject to modified

CAS coverage are affected by this amendment.

Response: In order to make clear that the amendment applies to

those tangible capital assets that were charged to Federal government

contracts and subcontracts negotiated on the basis of cost before the

business combination, the phrase ``subject to CAS'' has been

[[Page 5522]]

eliminated. This should make it clear that this revised rule applies to

tangible capital assets that generated costs allocated to Federal

government contracts and subcontracts negotiated on the basis of cost,

where such costs were allocated to contracts and subcontracts by the

seller during the most recent cost accounting period prior to the

business combination.

Comment: Several suggestions were received dealing with different

aspects of materiality in applying this revision. First, several

contractors and industry associations suggested that specific

materiality criteria be introduced, such as total dollar value of

assets acquired or the percentage of commercial or competitively

awarded fixed-priced contracts in relation to total sales. One

Government commenter suggested that the coverage of the amendment

should be extended also to those tangible capital assets that generated

relevant costs chargeable to CAS-covered contracts ``anytime during the

three accounting periods prior to the business combination''.

Response: The Board does not believe that the introduction of

additional materiality criteria is advisable at this time. By its very

nature, under full CAS coverage, the amended Standard's requirements

apply to major contractors that perform significant amounts of CAS-

covered work.

CAS 9904.404-50(d) has been revised to clearly state that the costs

of tangible capital assets acquired from a seller (whether CAS-covered

or non-CAS covered) which generated depreciation expense or cost of

money charges that were allocated to Federal government contracts or

subcontracts shall not be written up by the buyer. The primary issue is

whether or not a material amount of asset costs have been charged to

Federal government contracts and subcontracts that were negotiated on

the basis of cost, where such costs were allocated to contracts and

subcontracts during the most recent cost accounting period prior to the

acquisition date, not the amount of CAS-covered effort performed by the

seller.

Comment: One commenter suggested that the acquisition cost

criterion in section 9904.404 be raised from $1,500 to $5,000.

Response: The Board accepts this suggestion and therefore section

9904.404-40(b)(1) is modified to increase the minimum acquisition cost

criterion from $1,500 to $5,000.

Comment: One Government commenter expressed the view that the

provisions of the amendment should also be extended to non-CAS-covered

contractors: ``The proposed rule does not provide uniformity or

consistency since it provides for different treatment for acquired

assets of CAS-covered from non-CAS-covered contractors''.

Response: CAS 9904.404-50(d) has been revised to clearly establish

that the acquired tangible capital asset valuations shall be determined

in a consistent manner. As revised, application of the prescribed

techniques in 9904.404-50(d)(1) and 9904.404-50(d)(2) is dependant upon

whether or not the acquired assets were previously utilized in the

performance of either CAS-covered and/or non-CAS covered Federal

contracts that were negotiated on the basis of cost.

Comment: Several commenters expressed their disagreement with the

abandonment of GAAP principles in this revision to CAS 9904.404. The

view was expressed that the CASB should deviate from GAAP only in

exceptional cases and, in the view of these commenters, such an

approach is not warranted in the present case.

Response: The Board has pointed out in its Statement of Objectives,

Policies and Concepts that it will make every reasonable effort to

avoid conflict or disagreement with other bodies having similar

responsibilities. However, it also pointed out that the nature of the

Board's authority and its mission is such that it must retain and

exercise full responsibility for meeting its objectives.

As stated in previous discussions, the Board adopted the ``no step-

up, no step-down'' approach after extensive consideration of the

possible alternative approaches. In particular, the issues associated

with the recognition, allocation and recovery of the gain or loss

subsequent to a merger or business combination were extensively

explored in a Staff Discussion Paper (SDP) entitled ``Treatment of

Gains or Losses Subsequent to Mergers or Business Combinations by

Government Contractors.'' It was only after careful consideration of

the responses to the SDP that the Board decided to proceed with the

``no step-up, no step-down'' approach thereby establishing a cost

accounting practice that diverges from the corresponding practice

recognized for GAAP purposes.

Comment: Several commenters pointed out that since this issue has

been under review by the CAS Board, there have been significant changes

in the statutes and regulations covering mergers and business

combinations by Government contractors. The Government, in order to

encourage contractors to consolidate, has recognized ``external

restructuring'' which allows, in certain circumstances, contractors'

restructuring costs to be charged to Government contracts to the extent

that the restructuring results in savings that exceed the costs. The

commenters argued that the same rationale should be applied to

increased deprecation associated with the revaluation of a purchased

company's assets if the business combination is regarded as an

``external restructuring'', and, that it would be inequitable for the

Government to benefit from all of the savings resulting from

restructuring, while it is unwilling to recognize all of the costs

needed to implement such restructuring.

Response: In issuing this revision, the Board does not intend to

encourage or discourage contractors to consolidate or restructure their

operations. Rather, the Board's intent, in accordance with its stated

objectives, in promulgating this revision, is to increase the degree of

uniformity and consistency in like circumstances in the cost accounting

practices that are used by Government contractors to record tangible

capital asset values subsequent to mergers or business combinations.

The Board believes that this action will result in cost allocations

that are fair and equitable.

Comment: Several commenters offered editorial comments to the

proposed revisions.

Response: All of these comments were considered and, as a result,

the essence of several of these comments were incorporated in the final

rule.

List of Subjects in 48 CFR Part 9904

Cost accounting standards, Government procurement.

Richard C. Loeb,

Executive Secretary, Cost Accounting Standards Board.

For the reasons set forth in this preamble, chapter 99 of title 48

of the Code of Federal Regulations is amended as set forth below:

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

follows:

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

PART 9904--COST ACCOUNTING STANDARDS

9904.404 Capitalization of tangible assets.

2. Section 9904.404-40 is amended by revising paragraph (b)(1) to

read as follows:

9904.404-40 Fundamental requirement.

* * * * *

(b) * * *

(1) The contractor's policy shall designate a minimum service life

criterion, which shall not exceed 2 years, but which may be a shorter

[[Page 5523]]

period. The policy shall also designate a minimum acquisition cost

criterion which shall not exceed $5,000, but which may be a smaller

amount.

* * * * *

3. Section 9904.404-50 is amended by revising paragraph (d) to read

as follows:

9904.404-50 Techniques for application.

* * * * *

(d) The capitalized values of tangible capital assets acquired in a

business combination, accounted for under the ``purchase method'' of

accounting, shall be assigned to these assets as follows:

(1) All the tangible capital assets of the acquired company that

during the most recent cost accounting period prior to a business

combination generated either depreciation expense or cost of money

charges that were allocated to Federal government contracts or

subcontracts negotiated on the basis of cost, shall be capitalized by

the buyer at the net book value(s) of the asset(s) as reported by the

seller at the time of the transaction.

(2) All the tangible capital asset(s) of the acquired company that

during the most recent cost accounting period prior to a business

combination did not generate either depreciation expense or cost of

money charges that were allocated to Federal government contracts or

subcontracts negotiated on the basis of cost, shall be assigned a

portion of the cost of the acquired company not to exceed their fair

value(s) at the date of acquisition. When 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.

* * * * *

4. Section 9904.404-63 is revised to read as follows:

9904.404-63 Effective date.

(a) This Standard is effective April 15, 1996.

(b) This Standard shall be applied beginning with the contractor's

next full cost accounting period beginning after the receipt of a

contract or subcontract to which this Standard is applicable.

(c) Contractors with prior CAS-covered contracts with full coverage

shall continue to follow Standard 9904.404 in effect prior to April 15,

1996, until this Standard, effective April 15, 1996, becomes applicable

after the receipt of a contract or subcontract to which this revised

Standard applies.

5. Section 9904.409-50 is amended by adding a new paragraph (j)(5)

to read as follows:

9904.409-50 Techniques for application.

* * * * *

(j) * * *

(5) The provisions of this subsection 9904.409-50(j) do not apply

to business combinations. The carrying values of tangible capital

assets acquired subsequent to a business combination shall be

established in accordance with the provisions of subsection 9904.404-

50(d).

* * * * *

6. Section 9904.409-63 is revised to read as follows:

9904.409-63 Effective date.

(a) This Standard is effective April 15, 1996.

(b) This Standard shall be applied beginning with the contractor's

next full cost accounting period beginning after the receipt of a

contract or subcontract to which this Standard is applicable.

(c) Contractors with prior CAS-covered contracts with full coverage

shall continue to follow Standard 9904.409 in effect prior to April 15,

1996, until this Standard, effective April 15, 1996, becomes applicable

after the receipt of a contract or subcontract to which this revised

Standard applies.

[FR Doc. 96-3061 Filed 2-12-96; 8:45 am]

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