58014 Federal Register / Vol. 69, No. 187 / Tuesday, September 28, 2004 / Proposed Rules 

DEPARTMENT OF DEFENSE

GENERAL SERVICES 

ADMINISTRATION

NATIONAL AERONAUTICS AND 

SPACE ADMINISTRATION

48 CFR Part 31

[FAR Case 2004–006]

RIN 9000–AK06

Federal Acquisition Regulation; 

Accounting for Unallowable Costs

AGENCIES: Department of Defense (DoD), 

General Services Administration (GSA), 

and National Aeronautics and Space 

Administration (NASA).

ACTION: Proposed rule.

SUMMARY: The Civilian Agency 

Acquisition Council and the Defense 

Acquisition Regulations Council 

(Councils) are proposing to amend the 

Federal Acquisition Regulation (FAR) 

by revising language regarding 

accounting for unallowable costs.

DATES: Interested parties should submit 

comments in writing on or before 

November 29, 2004 to be considered in 

the formulation of a final rule.

ADDRESSES: Submit comments 

identified by FAR case 2004–006 by any 

of the following methods:

• Federal eRulemaking Portal: http://

www.regulations.gov. Follow the 

instructions for submitting comments.

• Agency Web Site: http://

www.acqnet.gov/far/ProposedRules/

proposed.htm. Click on the FAR case 

number to submit comments.

• E-mail: farcase.2004–006@gsa.gov. 

Include FAR case 2004–006 in the 

subject line of the message.

• Fax: 202–501–4067.

• Mail: General Services 

Administration, Regulatory Secretariat 

(V), 1800 F Street, NW, Room 4035, 

ATTN: Laurie Duarte, Washington, DC 

20405.

Instructions: Please submit comments 

only and cite FAR case 2004–006 in all 

correspondence related to this case. All 

comments received will be posted 

without change to http://

www.acqnet.gov/far/ProposedRules/

proposed.htm, including any personal 

information provided.

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. Richard C. Loeb, 

at (202) 208–3810. Please cite FAR case 

2004–006.

SUPPLEMENTARY INFORMATION:

A. Background

The DoD Director of Defense 

Procurement and Acquisition Policy 

(DPAP) established a special 

interagency Ad Hoc Committee to 

perform a comprehensive review of 

policies and procedures in FAR Part 31, 

Contract Cost Principles and 

Procedures, relating to cost 

measurement, assignment, and 

allocation. DPAP announced a series of 

public meetings in the Federal Register

notice (66 FR 13712) on March 7, 2001 

(with a ‘‘correction to notice’’ published 

in the Federal Register (66 FR 16186) on 

March 23, 2001). Public meetings were 

held on April 19, 2001, May 10–11, 

2001, and June 12, 2001. Attendees at 

the public meetings included 

representatives from industry, 

Government, and other interested 

parties who provided views on potential 

areas for revision in FAR Part 31. The 

Ad Hoc Committee reviewed the cost 

principles and procedures and the input 

obtained during the public meetings; 

identified potential changes to the FAR; 

and submitted several reports, including 

draft proposed rules for consideration 

by the Councils.

The Councils reviewed the Ad Hoc 

Committee’s reports and draft proposed 

rules related to FAR 31.204, Application 

of principles and procedures, and FAR 

31.201–6, Accounting for unallowable 

costs. On May 22, 2003, a proposed rule 

was published for public comment in 

the Federal Register (68 FR 28108) 

under FAR case 2002–006. No public 

comments were received on the 

proposed rule relating to FAR 31.204. 

The Councils concluded that the FAR 

31.204 proposed rule should be 

converted to a final rule, with no 

changes to the proposed rule. The final 

rule version of 2002–006 was published 

in the Federal Register in Federal 

Acquisition Circular 2001–24 (69 FR 

34224 on June 18, 2004).

As a result of the public comments 

received under FAR case 2002–006, the 

Councils also decided to make 

substantive changes to FAR 31.201–6 

and to publish the proposed revisions 

under this separate proposed rule 2004–

006. The Councils’ recommended 

changes include adding paragraphs (iii) 

through (vi) to subsection 31.201–6(c)(2) 

to provide specific criteria on the use of 

sampling as a method to identify 

unallowable costs, including the 

applicability of penalties for failure to 

exclude certain projected unallowable 

costs.

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.

In response to the proposed FAR rule 

published under FAR Case 2002–006 in 

the Federal Register (68 FR 28108) on 

May 22, 2003, nine respondents 

submitted comments on FAR 31.201–6. 

The Councils considered all comments 

and concluded that, since the changes 

result in a rule that differs significantly 

from the proposed rule, it should be 

published as a proposed rule under a 

new FAR Case 2004–006. Differences 

between the proposed rule under FAR 

Case 2002–006 and this proposed rule 

are discussed in Comments 3, 4, and 7, 

below.

Public Comments

FAR 31.201–6(c)(1)

1. Comment: Requirement to segregate 

unallowable costs. One respondent 

recommends removal of FAR 31.201–

6(c)(1) from the proposed rule (which is 

also contained in the current FAR 

language). The respondent believes that 

non-CAS covered contractors should not 

be subject to CAS requirements because 

of their adherence to the FAR cost 

principles. The respondent also 

contends that incorporating such 

requirements into the FAR by reference 

results in lowering thresholds for CAS 

application and is contrary to DoD 

progressive initiatives such as the DoD 

Panel on Measurement, Assignment, 

and Allocability Provisions of FAR Part 

31, and by the DFARS Transformation 

Project.

Another respondent believes that 

retaining the requirement, for all 

contracts subject to FAR Part 31 (CAS 

and non-CAS covered), to comply with 

the provisions of CAS 405 (Accounting 

for Unallowable Costs) results in more 

clearly understood and easily applied 

criteria for accounting for unallowable 

costs. This respondent also believes that 

such requirements create a more level 

playing field between all contractors.

Councils’ response: The Councils 

agree that the provision should be 

retained. Prior to the implementation of 

CAS 405, significant amounts of 

unallowable costs were often included 

in proposals and billings which 

necessitated significant use of 

Government resources to find such 

costs. The Councils believe this would 

occur again if the requirement was 

removed. In addition, unallowable costs 

must be segregated to comply with the 

statutory penalties provisions; thus, this 

provision serves to implement those 

statutory requirements.

FAR 31.201–6(c)(2)

Federal Register / Vol. 69, No. 187 / Tuesday, September 28, 2004 / Proposed Rules 58015

2. Comment: Use of statistical 

sampling. The respondent believes that 

numerous disagreements may result 

from the proposed language. The 

respondent supports the use of 

statistical sampling to project 

unallowable costs in connection with 

discrete pools where the number of 

differing cost elements is limited. 

However, the respondent concurrently 

objects to the general application of 

statistical sampling for the purposes of 

projecting unallowable costs in 

connection with a universe of diverse 

cost elements subject to a significant 

number of cost principles.

Councils’ response: Nonconcur. The 

Councils recognize the respondent’s 

concern about the potential limitations 

of statistical sampling. However, the 

Councils note that contractors are not 

required to use statistical sampling, i.e., 

it is an optional technique for 

segregating unallowable costs.

FAR 31.201–6(c)(2)(iii), (iv), and (v)

3. Comment: Statistical sampling 

verification versus segregation. The 

respondent disagrees with the proposed 

amendment to FAR 31.201–6(c)(2). The 

respondent believes that the use of 

statistical sampling should not replace 

accounting policies and procedures for 

identifying and segregating unallowable 

costs when the costs are initially 

incurred and recorded. The respondent 

asserts that initial identification of 

unallowable costs is necessary to meet 

the requirements of 10 U.S.C. 2324, 

which provides penalties against a 

contractor if expressly unallowable 

costs are included in its claims to the 

Government. Therefore, the respondent 

recommends adding the following 

language:

‘‘Statistical sampling is an acceptable 

practice for verifying that a contractor’s 

accounting practices and procedures for 

segregating and presenting unallowable costs 

are operating as intended.’’

Councils’ response: Concur in part. 

The Councils do not believe that 

sampling is precluded by 10 U.S.C. 

2324. The Councils note that there is no 

requirement in 10 U.S.C. 2324 to 

specifically segregate every item of 

unallowable cost. Statistical sampling, 

when properly applied, is acceptable for 

both segregating unallowable costs and 

verifying that such costs have been 

properly segregated (either by specific 

identification or using appropriate 

sampling techniques). However, the 

Councils recognize that the sampling 

must appropriately consider the 

requirements of 10 U.S.C. 2324 related 

to the application of penalties on 

unallowable costs. To avoid potential 

disputes in this area, a new paragraph 

(c)(3) has been added at 31.201–6 to 

explicitly include these appropriate 

considerations.

FAR 31.201–6(c)(2)(vi)

4. Comment: Statistical sampling 

advance agreements. A respondent 

states that up-front coordination and 

agreement between the contractor and 

the auditor regarding the sampling plan 

(e.g., sampling method, expense 

accounts, stratification, precision, 

confidence, and projection) is essential 

in order to avoid subsequent disputes 

over the adequacy of the sampling plan 

used by the contractor. The respondent 

asserts that such disputes, as well as 

differing interpretations of statistical 

terms and methodologies, could delay a 

timely settlement of the contractor’s 

incurred cost submissions and adversely 

impact the contract close-out process. 

The respondent proposes adding the 

following language to FAR 31.201–6(c):

(3) Use of statistical sampling 

methods for identifying and segregating 

unallowable costs should be the subject 

of an advance agreement under the 

provisions of FAR 31.109.

Councils’ response: Concur. The 

Councils believe it will streamline the 

review process and avoid potential 

disputes if the parties agree up-front on 

the sampling plan. The Councils have 

added the respondent’s proposed 

language as well as an additional 

sentence on advance agreements at new 

paragraph (c)(4) of 31.201–6.

FAR 31.201–6(e)(1)

5. Comment: Materiality threshold 

applied to directly associated 

unallowable costs. The respondent 

recommends the Council adopt the ‘‘30 

percent rule’’ that was contained in 

1976 DoD guidance issued by the then 

Assistant Secretary of Defense 

(Installations and Logistics) Mr. Dale 

Babione. The respondent states that this 

guidance instructed DoD personnel how 

to interpret the materiality threshold 

applied to directly associated 

unallowable costs. The respondent 

further states that this 1976 guidance 

established a threshold of 30 percent of 

total time, over which salary costs are 

determined to be unallowable and 

under which further evaluation is 

required. The respondent asserts that 

many contractors and contracting 

officers have successfully implemented 

this guidance over the past 25 years.

Councils’ response: Nonconcur. The 

Councils believe that a decision on 

materiality should be made by the 

contracting officer on a case-by-case 

basis after consideration of the three 

factors listed at 31.201–6(e)(1): the 

actual dollar amount, the cumulative 

effect of all directly associated costs in 

a cost pool, and the ultimate effect on 

the cost of Government contracts.

The Councils believe that materiality 

should not be determined based solely 

on a percentage. For example, 25 

percent may have a material impact to 

the Government for a company in which 

every employee spends 25 percent of 

their time on directly associated 

unallowable costs. Conversely, the 

impact to the Government may be 

immaterial if the Government 

participation in the indirect cost base is 

small, even if an employee is spending 

more than 30 percent of his/her time on 

directly associated unallowable costs. 

Using a similar analysis, 50 percent may 

have a material impact to the 

Government if the total amount 

involved is large and/or the Government 

has a large share of the allocation base. 

Conversely, 50 percent may have an 

immaterial impact to the Government if 

the total amount involved is small and/

or the Government share of the 

allocation base is small.

FAR 31.201–6(e)(2)

6. Comment: Definition of directly 

associated cost. Two respondents 

contend that CAS 405 (Accounting for 

Unallowable Costs) does not distinguish 

among types of directly associated costs. 

They assert that CAS 405 prescribes a 

general rule of cost recognition, 

measurement and allocation, which 

applies to all types of cost, without 

distinction. They further state that CAS 

405 prescribes the following ‘‘but for’’

test: Directly associated cost means any 

cost which is generated solely as a result 

of the incurrence of another cost, and 

which would not have been incurred 

had the other cost not been incurred. 

The respondents contend that FAR 

31.201–6(e) abandons this ‘‘but for’’ test 

and substitutes a materiality test for 

recognizing and measuring the ‘‘salary 

expenses of employees who participate 

in activities that generate unallowable 

costs.’’ Accordingly, the respondents 

believe it is confusing as to whether 

salaries and expenses are governed by 

the ‘‘but for’’ test or by a new 

‘‘materiality’’ test. Therefore, one 

respondent recommends amending FAR 

31.201–6(e) so that it complies with 

CAS 405 in the application of the ‘‘but 

for’’ test and delete the ‘‘materiality’’

test. As an alternative, the other 

respondent recommends that FAR 

31.201–6(e) be amended to establish a 

rebuttable presumption that material 

amounts of time devoted to unallowable 

activities would, in the normal course of 

business, influence the employee’s 

compensation. Under the respondent’s 

proposal, contractors could rebut the 

presumption by showing that, in any 

58016 Federal Register / Vol. 69, No. 187 / Tuesday, September 28, 2004 / Proposed Rules 

individual situation, compensation 

would not have been affected. For 

example, under the respondent’s 

revision, compensation would not be 

affected in the unusual situation of a 

natural disaster requiring salaried 

personnel to devote material amounts of 

effort to unallowable charitable 

activities during a particular accounting 

period.

Councils’ response: Nonconcur. The 

Councils note that the current language 

at FAR 31.201–6(e)(2) is not a ‘‘new’’

materiality test. This language, which 

was promulgated over twenty years ago, 

provides contracting personnel and 

contractors with specific information on 

when to treat salaries and expenses as 

directly associated costs. The Councils 

believe this language should be 

retained. They also believe that the 

respondent’s proposed alternative 

language would potentially cause 

significant increases in the number of 

disputes due to arguments regarding 

when compensation is and is not 

affected by unallowable activities.

7. Comment: Illustration. The 

respondent states that it does not object 

to the inclusion of an illustration in 

FAR 31.201–6(e)(2), but if an illustration 

is to be included, it prefers the one 

included in CAS 405–60(e). The 

respondent contends that use of a CAS 

illustration will avoid potential conflicts 

in determining materiality.

Councils’ response: Nonconcur. The 

proposed language at FAR 31.201–

6(e)(2) is not an illustration, but is 

instead criteria for determining how to 

treat salary expenses of employees that 

participate in activities that generate 

unallowable costs. The Councils believe 

it is not appropriate for FAR Part 31 to 

include illustrations such as those 

contained in CAS because they would 

be inconsistent with the overall 

structure of the FAR, which does not 

include such illustrations in any other 

part.

FAR 31.201–6(e)(3)

8. Comment: Incorrect reference. Two 

respondents noted that the reference in 

31.201–6(e)(3) is incorrect. The 

reference should be to paragraphs (e)(1) 

and (e)(2) of that subsection, rather than 

(f)(1) and (f)(2).

Councils’ response: Concur. There is 

no paragraph (f)(1) or (f)(2) in FAR 

31.201–6. The typographical errors have 

been corrected in paragraphs (e)(2), and 

(e)(3).

B. Regulatory Flexibility Act

The Councils do not expect this 

proposed rule to 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 principles and procedures 

discussed in this rule. An Initial 

Regulatory Flexibility Analysis has, 

therefore, not been performed. We invite 

comments from small businesses and 

other interested parties. The Councils 

will consider comments from small 

entities concerning the affected FAR 

Part in accordance with 5 U.S.C. 610. 

Interested parties must submit such 

comments separately and should cite 5 

U.S.C. 601, et seq. (FAR case 2004–006), 

in correspondence.

C. Paperwork Reduction Act

The Paperwork Reduction Act does 

not apply because the proposed 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 Part 31

Government procurement.

Dated:September 20, 2004

LAURA AULETTA,

Director,Contract Policy Division.

Therefore, DoD, GSA, and NASA 

propose amending 48 CFR part 31 as set 

forth below:

PART 31–CONTRACT COST 

PRINCIPLES AND PROCEDURES

1. The authority citation for 48 CFR 

part 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 31.201–6 by—

a. Amending paragraphs (a) and (b) by 

removing ‘‘which’’ and adding ‘‘that’’ in 

its place each time it appears;

b. Revising paragraph (c);

c. Revising the first sentence in 

paragraph (d);

d. Amending paragraph (e)(1)(ii) by 

removing ‘‘or’’ and adding ‘‘and’’ in its 

place; and

e. Revising paragraph (e)(3).

The revised text reads as follows:

31.201–6 Accounting for unallowable 

costs.

* * * * *

(c)(1) The practices for accounting for 

and presentation of unallowable costs 

must be those described in 48 CFR 

9904.405, Accounting for Unallowable 

Costs.

(2) Statistical sampling is an 

acceptable practice for accounting for 

and presenting unallowable costs 

provided the following criteria are met:

(i) The statistical sampling results in 

an unbiased sample that is a reasonable 

representation of the sampling universe.

(ii) All large dollar value and high risk 

transactions are separately reviewed for 

unallowable costs and excluded from 

the sampling process.

(iii) The statistical sampling permits 

audit verification.

(3) For the purposes of applying the 

penalty provisions at FAR 42.709, when 

statistical sampling is used for 

accounting for and presenting 

unallowable costs—

(i) The following amounts must be 

excluded from any final indirect rate 

proposal or final statement of costs 

incurred or estimated to be incurred 

under a fixed-price incentive contract 

submitted to the Government:

(A) The amounts projected to the 

sampling universe for any expressly 

unallowable costs in the sample.

(B) The amounts projected to the 

sampling universe for any costs in the 

sample determined to be unallowable 

for the contractor before proposal 

submission.

(ii) Any amounts that are not 

excluded in accordance with paragraph 

(c)(3)(i) of this subsection are subject to 

the penalties provisions at FAR 42.709.

(iii) The provisions of paragraph 

c)(3)(ii) of this subsection do not apply 

to the following:

(A) Contracts that are $500,000 or 

less.

(B) Fixed-price contracts without cost 

incentives.

(C) Firm-fixed-price contracts for the 

purchase of commercial items.

(4) Use of statistical sampling 

methods for identifying and segregating 

unallowable costs should be the subject 

of an advance agreement under the 

provisions of FAR 31.109. The advance 

agreement should specify the basic 

characteristics of the sampling process.

(d) If a directly associated cost is 

included in a cost pool that is allocated 

over a base that includes the 

unallowable cost with which it is 

associated, the directly associated cost 

shall remain in the cost pool.***

(e) * * *

(3) When a selected item of cost under 

31.205 provides that directly associated 

costs be unallowable, such directly 

associated costs are unallowable only if 

determined to be material in amount in 

accordance with the criteria provided in 

paragraphs (e)(1) and (e)(2) of this 

subsection, except in those situations 

where allowance of any of the directly 

associated costs involved would be 

considered to be contrary to public 

policy.

[FR Doc. 04–21640 Filed 9–27–04; 8:45 am]

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