Cost Accounting Standards Board; Notice

OFFICE OF MANAGEMENT AND BUDGET

Office of Federal Procurement Policy

Cost Accounting Standards Board; Notice

AGENCY: Cost Accounting Standards Board, Officer of Federal Procurement

Policy, OMB.

ACTION: None.

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SUMMARY: The Cost Accounting Standards Board (CASB) hereby extends an

invitation for interested parties to provide comments on the following

letter sent to organizations that responded to the Staff Discussion

Paper (61 FR 49533, 9/20/96) on the treatment of the costs under

government contracts for post-retirement benefit (PRB) plans. While a

consensus emerged on many of the issues, the topics relating to the

validity (compellability) of the post-retirement benefit obligation as

a prerequisite for use of accrual accounting and the need, if any, to

substantiate accruals by funding, engendered forceful, diverse, and

often irreconcilable arguments. To promote a fuller dialogue and

understanding of the issues before the Board, the Board is asking

individuals to consider and comment on the opposing viewpoints

discussed in the letter and to possibly expand on their own comments,

if any.

DATES: Comments must be in writing, including an electronic copy of

your comments in WordPerfect 6.1 or ASCII format, and must be received

by March 15, 1999.

ADDRESSES: Comments should be addressed to the Cost Accounting

Standards Board, Office of Federal Procurement Policy, 725 17th Street,

NW, Room 9013, Washington, D.C. 20503. Attn: CASB Docket No. 96-02.

FOR FURTHER INFORMATION CONTACT: Rein Abel, Director of Research, Cost

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Accounting Standards Board (telephone: 202-395-3254).

Richard C. Loeb,

Executive Secretary; Cost Accounting Standards Board.

Executive Office of the President, Office of Management and Budget,

Washington, D.C. 20503

January 12, 1999.

Cost Accounting Standards Board

Subject: Costs of Post-Retirement Benefit Plans, CASB Docket No. 96-02.

To Members of the Government contracting community:

Your organization responded to the Staff Discussion Paper (61 Fed.

Reg. 49533; 9/20/96) of the treatment of the costs under government

contracts for post-retirement benefit (PRB) plans. While a consensus

emerged on many of the issues, the topics relating to the validity

(compellability) of the post-retirement benefit obligation as a

prerequisite for accrual accounting (Topic C) and the need, if any, to

substantiate accruals by funding (Topic G) engendered forceful,

diverse, and often irreconcilable arguments. To promote a fuller

dialogue and understanding of the issues before the Board, is asking

you to consider and comment on the opposing viewpoints discussed in

this letter and to possibly expand on your own comments. The Board

intends to widely distribute this letter and to invite other interested

parties to also provide comments on these topics.

The Board is considering the adoption of Financial Accounting

Standards Board Statement 106 (SFAS 106), ``Employer's Accounting for

Postretirement Benefits Other Than Pensions,'' as the basis for the

measurement of post-retirement benefit costs and assignment of those

costs to cost accounting periods. Under SFAS 106, it is the

``substantive plan'' that creates a liability warranting its

recognition for financial statement purposes. However, corporations

often downplay the firmness of this liability in the footnotes to their

financial statements. For instance, General Motors (GM) repetitively

included reservations about the nature of these liabilities in its

Financial Statements, e.g., Note 5 of GM's 1993 Financial Statement

stated:

The Corporation has disclosed in the financial statements

certain amounts associated with estimated future post retirement

benefits other than pensions and characterized such amounts as

`accumulated post retirement benefit obligations', `liabilities', or

`obligations.' Notwithstanding the recording of such amounts and the

use of these terms, the Corporation does not admit or otherwise

acknowledge that such amounts or existing post retirement benefit

plans of the Corporation (other than pensions) represent legally

enforceable liabilities of the Corporation.

The perception, particularly among Government commenters, the any

PRB liability recognized in the financial statements might be a

``soft'' liability has led to proposals that funding should be used as

a tool in validating these liabilities.

Requiring Funding To Substantiate the Post-Retirement Benefit Cost

Accrual

In Standards previously promulgated by the CAS Board dealing with

pension and insurance costs, the applicable Standards required that

pension and retiree insurance costs be funded. Therefore, it could be

argued that to maintain consistency with the promulgations of the

original CAS Board and amendments promulgated by the current Board, the

Board will have to consider funding as a prerequisite for the use of

accrual accounting for the costs of post-retirement benefit costs.

Industry representatives have pointed out the difference between

the basis for the funding requirements in the pension Standards and the

basis for a potential funding requirement under the post-retirement

benefits case. The Aerospace Industries Association made the point as

follows:

Public policy, as articulated in the tax code, has long

encouraged pension plan sponsors to fund their programs at an

adequate level. While industry does not agree that funding has any

place in the Cost Accounting Standards, the addition of a funding

requirement in the recent changes to CAS 412, as well as explicit

recognition of tax deductible limits, did not create tension between

public policies as expressed in the Internal Revenue Code and the

Cost Accounting Standards.

In contrast, however, Congress has intentionally discouraged

prefunding of post-retirement medical benefits. It would be

inconsistent for the Cost Accounting Standards Board to in essence

force contractors to fund these post-retirement benefit costs.

In general, industry commenters argued against any funding

requirement. The following comments made by General Electric capture

the essence of the industry arguments:

The CASB and staff need to recognize that funding, per se, does

not prove or disprove the validity of the PRB liability. The Staff

Discussion Paper appears to have a bias toward funding. Although

funding may be an important business consideration, the Board needs

to first address the appropriate accounting method absent the

``funding'' issue. There are many reasons for funding or not funding

a PRB liability but these reasons generally deal with cash flow

consequences and income tax considerations. The Board needs to focus

on the proper method of measuring, assigning and allocating PRB

costs based on the existence of the liability rather than on the

existence of funding. Funding is an allowability issue which is

already addressed in FAR 31.205-6(o).

Boeing also expressed the belief that funding does not necessarily

substantiate the liability, but suggested that more restrictive

measures of the accrual or cash accounting be used where the

contractual rights to a benefit are lacking. Boeing commented that:

The Government's concern is that accrual accounting will result

in reimbursing a contractor for costs the contractor has not

expended. This concern should not structure proper accounting. The

accounting must be based upon the likelihood that the contractor

will liquidate the liability. If the likelihood is in some doubt or

remote then the costs should be recognized on more limited accrual

basis, i.e., terminal funding or those vested, or if not appropriate

on a cash basis. Otherwise the costs must be recognized on an

accrual basis over the period of time the benefit is earned.

The American Bar Association (ABA) noted, for financial accounting

purposes, the threshold for recognition is met by a probability that an

obligation exists. But rather than suggesting the use of more

restrictive accounting or actuarial methods, the American Bar

Association (ABA) indicated there are situations when the funding of

the annual accrual can serve a legitimate purpose. The ABA wrote:

* * * Certainly, the FASB considered this issue and determined

that some estimate of future expenditures was preferable to no

estimate at all.

* * * * *

Require funding of PRB costs only if payment cannot be

compelled, or if research discloses a significant incidence of

contractors, defaulting on PRB obligations. The Discussion Paper

asks whether funding should be required to ``substantiate'' accrued

PRB costs. We believe that a valid accrual does not need to be

``substantiated'' through funding for accounting purposes. This

principle applies to pension costs as well as to PRBs. Funding

requirements are, at bottom, a matter of procurement policy and not

a cost accounting.

We do, however, agree that contractors should not be permitted

to accrue costs without funding them in cases where the payment

cannot be compelled. In such cases, no valid liability has been

incurred unless the liability is funded. Additionally, if

circumstances indicate that a contractor is likely to default on its

PRB obligations, accrual without funding should not be allowed.

The National Defense Industrial Association also acknowledged that

funding could be one means to

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substantiate (validate) the obligation when it commented.

If it can be determined that there is a valid obligation to pay,

determining an annual estimate of the cost of that liability is

feasible. Once an obligation to pay is established, there are two

limitations the CASB needs to establish. The first is delineating

the methods for arriving at a reasonable estimate of the cost of the

liability. The second task is to provide for subsequent period

adjustments as circumstances change. It is clear that funding

validates a liability. It is also clear that funding does not match

cost with products. It is also clear that the use of funding (or any

other cash payment) as a determinant of cost incurrence decreases

uniformity and consistency in accounting.

On the other hand, the comments from the Office of the Under

Secretary of Defense for Acquisition and Technology (OUSD) articulate

the concern of some members of the Government procurement community

that any potential risk that the liability may not be liquidated is

unacceptable. The OUSD unequivocally stated:

Yes, funding is necessary to substantiate accrual of costs. The

level of funding necessary is 100 percent of the maximum amount of

possible funding in accordance with the contractor's funding

vehicle. Permitting funding at less than 100 percent of the cost

accrual results in a potential risk that the liabilities for which

the Government has paid its fair share might never be liquidated. A

100 percent funding requirement assures the Government that the

money will be available when the liability must be paid. If there

are valid reasons to accrue the liabilities, the accruals should be

fully funded. Permitting less than 100 percent funding effectively

results in the Government providing a long-term interest free loan

to contractors. Permitting funding at less than 100 percent of the

cost accrual would require that earnings on the unfunded amounts be

imputed each year to preclude increased costs to the Government

resulting from lost earnings on the unfunded amounts.

CAS Board Concerns Currently Under Consideration:

The CAS Board's concern is that SFAS 106 recognition of the

obligation for the ``substantive plan'' is inappropriate for Government

contract cost accounting. In fact, the Board is concerned that the mere

existence of a written description of the plan does not ensure that

there is a contractual and enforceable, that is, compellable,

obligation to pay the promised benefit.

The Board is particularly concerned about he eventual settlement of

(i.e., disbursement for) the liability accrued for post-retirement

benefit costs. Under SFAS 106, there is an intentional and notable lack

of this concern in that there is no control over (i) an entity's having

accrued post-retirement benefit costs for any number of years under its

extant substantive post-retirement benefit plan, (ii) then subsequently

abrogating the plan in whole or in part, and (iii) recognizing a

``gain'' on the reversal of the prior accruals. Indeed, pre- and post-

SFAS 106, there have been instances of companies taking just such

actions. Comparing the case of post-retirement benefit costs to that of

pensions this respect is even more instructive in that pensions have

funding (and vesting) requirements imposed by other authorities (e.g.,

the Internal Revenue Code, the Employee Retirement Income Security Act)

which bolster the notion that the cost accrued for pensions will lead

to an actual disbursement in the future. Despite this collateral

support for pension accrual, the Board included a funding requirement

in its rules for both qualified and nonqualified pension plans. As it

deliberates on the issue of post-retirement benefit costs, a natural

extension of its funding requirement for pension costs would be to

incorporate a similar requirement for post-retirement benefit costs.

Request for Additional Comments and Rationale

To ensure all facts of this issue are fully considered from all

perspectives, the Board would like interested parties that oppose or

question the establishment of a funding requirement to suggest

alternatives to funding which would provide similar or equivalent

support for the compellability of the post-retirement benefit

obligation as that which is provided by a funding requirement. In

addition, if you believe that accrual of post-retirement benefit costs

solely in accordance with SFAS 106 criteria, without any further

validation of the ensuing liability, is an adequate method for

recognizing PRD costs for contract costing purposes, then the Board

request that you provide arguments for accepting the ``substantive

plan'' as the basis for contract cost measurement.

Conversely, for those that believe that there is no realistic

alternative to a funding requirement, the Board asks that you set forth

the arguments in favor of funding.

Submission of Comments

Comments regarding this request should be addressed to the Cost

Accounting Standards Board, Office of Federal Procurement Policy, 725

17th Street, N.W., Room 9001, Washington, D.C. 20503, Attn: CASB Docket

No. 96-02. It is requested that your comments be provided no later than

March 15, 1999 in order to receive full consideration. Please include

an electronic copy of your comments in Word Perfect 6.1 or ASCII

format.

For further information, please contact Rein Abel, Director of

Research, Cost Accounting Standards Board (telephone: 202-395-3254).

Sincerely,

Richard C. Lomb,

Executive Secretary.

[FR Dos. 99-3955 Filed 2-17-99; 8:45 am]

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