[Federal Register Volume 70, Number 189 (Friday, September 30, 2005)]
[Rules and Regulations]
[Pages 57463-57467]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-19476]


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DEPARTMENT OF DEFENSE

GENERAL SERVICES ADMINISTRATION

NATIONAL AERONAUTICS AND SPACE ADMINISTRATION

48 CFR Part 31

[FAC 2005-06; FAR Case 2004-006; Item IX]
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: Final rule.

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SUMMARY: The Civilian Agency Acquisition Council and the Defense 
Acquisition Regulations Council (Councils) have agreed on a final rule 
amending the Federal Acquisition Regulation (FAR) by revising language 
regarding accounting for unallowable costs. The final rule adds 
language which provides specific criteria on the use of statistical 
sampling as a method to identify unallowable costs, including the 
applicability of penalties for failure to exclude certain projected 
unallowable costs. The final rule also revises the language regarding 
advance agreements by adding statistical sampling methods as an example 
for which advance agreements between the

[[Page 57464]]

contracting officers and contractors may be appropriate.

DATES: Effective Date: October 31, 2005.

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. Jeremy Olson at (202) 501-3221. 
Please cite FAC 2005-06, FAR case 2004-006.

SUPPLEMENTARY INFORMATION:

A. Background

    DoD, GSA, and NASA published a proposed FAR rule for public comment 
in the Federal Register at 68 FR 28108, May 22, 2003, under FAR case 
2002-006. The proposed rule related to FAR 31.201-6, Accounting for 
unallowable costs, and to FAR 31.204, Application of principles and 
procedures. No public comments were received on the proposed rule 
relating to FAR 31.204, and the Councils decided that the FAR 31.204 
proposed rule should be converted to a final rule with no changes to 
the proposed rule. Public comments were received on the proposed rule 
relating to FAR 31.201-6, and the Councils decided to make substantive 
changes to the proposed rule and published a second proposed rule under 
separate FAR case 2004-006 in the Federal Register at 69 FR 58014, 
September 28, 2004, with a request for comments by November 29, 2004.
    Five respondents submitted public comments in response to the 
second proposed FAR rule. A discussion of these public comments is 
provided below. The Councils considered all comments and concluded that 
the proposed rule should be converted to a final rule, with changes to 
the proposed rule to address the concerns raised in the public 
comments. Differences between the second proposed rule and the final 
rule are discussed in Comments 1, 2, and 3, below.

Public Comments

Application of statistical sampling, FAR 31.201-6(c)(2).

    Comment 1: One respondent recommends clarifying paragraph (c)(2) to 
make it clear that this paragraph refers to contractors, not the 
Government. The respondent therefore recommends revising the first 
sentence to read as follows:
    ``Statistical sampling is an acceptable practice for contractors 
to follow in accounting for and presenting unallowable costs 
provided the following criteria are met.''
    Councils' response: Concur. The Councils believe that the proposed 
change will enhance the clarity of the rule and emphasize that it is 
the contractor's ultimate responsibility for complying with the 
accounting and presentation of unallowable costs as prescribed in 
paragraph (c)(1). Therefore, the respondent's proposed language is 
added to FAR 31.201-6(c)(2). While it is the intent of the Councils to 
specifically state that statistical sampling is an acceptable method 
for contractors to comply with the identification and segregation 
requirements of this rule, this language in no way binds or limits the 
Government from performing their responsibilities in fulfilling the 
requirements for establishing indirect cost rates in accordance with 
FAR Subpart 42.7, Indirect Cost Rates.

Application of penalties, FAR 31.201-6(c)(3).

    Comment 2:Three respondents recommend that the proposed paragraph 
(c)(3) be revised. One respondent believes that the proposed paragraph 
(c)(3) will cause more confusion than it is intended to preclude. This 
respondent states that the penalty provisions of FAR 42.709 can be 
invoked in statistical sampling by using a simpler paragraph that reads 
as follows:
    ``For any cost in the selected sample that is subject to the 
penalty provisions at FAR 42.709, the amount projected to the 
sampling universe from that sampled cost is also subject to the same 
penalty provisions.''
    The second respondent believes that the proposed paragraph (c)(3) 
should be simplified to improve clarity and eliminate redundant text 
from FAR 42.709. This respondent believes that the penalty provisions 
in FAR 42.709 can be applied when sampling is used with a simpler, more 
concise paragraph that reads as follows:
    ``Any unallowable indirect costs that are not excluded from the 
universe, either as part of the projection of sample results or 
separate review of transactions, are subject to the penalty 
provisions at FAR 42.709.''
    The third respondent believes that the proposed paragraph (c)(3) is 
rather confusing and subject to misinterpretation. This respondent 
therefore recommends that the paragraph be revised to read as follows:
    ``For any cost in the selected sample that is subject to the 
penalty provisions at FAR 42.709, the associated projected amount to 
the sampling universe derived from that sampled item is also subject 
to the same penalty provisions.''
    This respondent states that if the proposed language is retained, 
the Councils need to address the following:
    (a) The wording in (c)(3)(i) ``excluded from any final indirect 
rate proposal'' is technically incorrect. The amounts are not 
``excluded'' from the ``proposal'', as the proposal would include 
gross, withdrawn, and claimed/recoverable costs. The respondent 
therefore recommends that this would need to be revised to read ``The 
following amounts must be excluded from any proposed final indirect 
rates or....''
    (b) Proposed paragraph (c)(3)(i)(B) is not clear as to what is 
meant by ``determined to be unallowable.'' This could relate to 
paragraph (b) of this cost principle or it could relate to FAR 42.709-
3(b) or something else.
    (c) Proposed paragraph (c)(3)(iii) appears redundant and 
unnecessary. Paragraph (c)(3)(iii) provides ``...are subject to the 
penalties provisions at FAR 42.709.'' By virtue of this reference that 
includes contract applicability language at 42.709-6, it does not 
appear necessary to provide another paragraph with the same type of 
contract applicability language.
    Councils' response: Concur. The Councils agree that the proposed 
language was potentially confusing. The Councils therefore recommend 
simplifying the language at FAR 31.201-6(c)(3) to read as follows:
    ``For any indirect cost in the selected sample that is subject 
to the penalty provisions at FAR 42.709, the amount projected to the 
sampling universe from that sampled cost is also subject to the same 
penalty provisions.''
    The Councils note that the intent of the subject language in both 
the proposed rule and the final rule is the same.

Advance agreements, FAR 31.201-6(c)(4) and FAR 31.109.

    Comment 3: Two respondents assert that paragraph (c)(4) is written 
in such a way as to suggest there is a requirement for an advance 
agreement. One respondent does not believe the potentially prescriptive 
language at paragraph (c)(4) is consistent with the examples of costs 
at FAR 31.109(h). Therefore, this respondent recommends eliminating 
this paragraph. The respondent further notes that if it is determined 
that the advance agreement reference must remain, the following text 
would be more acceptable to the contracting parties:
    ``An advance agreement (see 31.109) with respect to compliance 
with subparagraph (c)(3) of this subsection may be useful and 
desirable.''
    The second respondent believes it would be more appropriate and 
consistent with the verbiage used in other cost principles to simply 
reference FAR 31.109, such as is done in FAR 31.205-37. This respondent 
therefore recommends that the language at FAR 31.109(h) include 
sampling for

[[Page 57465]]

unallowable costs as another example of items that may require an 
advance agreement, and that paragraph (c)(4) be revised to read as 
follows:
    ``See 31.109 regarding advance agreements.''
    Councils' response: Partially concur. The Councils do not believe 
the proposed language requires an advance agreement. The proposed 
language states that use of statistical sampling should be the subject 
of an advance agreement. While the Councils believe that the advance 
agreement language should remain in FAR 31.201-6, the Councils do agree 
that it would be helpful to add sampling to FAR 31.109 as an example of 
the type of item for which an advance agreement may be appropriate, and 
therefore have added ``statistical sampling methods'' to FAR 31.109(a) 
and 31.109(h)(17).
    Comment 4: One respondent asserts that if the proposed rule is 
enacted, the rule should require an advance agreement that specifies 
what an adequate sampling plan entails. As such, this respondent 
recommends that paragraph (c)(4) require an advance agreement that 
documents the objective of the sample, the population, the measures, 
the sampling parameters, the confidence level, the precision, the 
sampling design, and the decision rule.
    Councils' response: Nonconcur. The Councils believe the comments 
submitted in response to the proposed rule and the second proposed rule 
demonstrate that it is preferable to provide general criteria rather 
than specific requirements. The use of specific requirements reduce the 
flexibility of the contracting parties to apply sampling in a manner 
that maximizes its efficient use while continuing to protect the 
Government interests. The Councils believe that the requirements for 
the sample to be a reasonable representation of the sampling universe, 
to permit audit verification, and to apply penalties to any projected 
amounts provides adequate protection for the Government without unduly 
restricting the effective use of proper statistical sampling 
techniques.
    In addition, the Councils do not believe an advance agreement 
should be required. However, the Councils believe it is important that 
the rule clearly state that it is the contractor's responsibility to 
prove compliance with the sampling criteria in FAR 31.201-6(c) when no 
advance agreement exists. When a contractor elects to use statistical 
sampling without entering into an advance agreement, the contractor is 
at risk that the Government will find the sampling plan in 
noncompliance with FAR 31.201-6(c), and the Government will perform 
their own sampling or even possibly a 100 percent review of the costs 
at issue. In those cases where the contracting officer or contracting 
officer's representative challenges the contractor's sampling methods, 
and no advance agreement exists, the burden of proof should be on the 
contractor to establish that the sampling methods comply with the FAR 
requirements. The final rule at paragraph (c)(5) has been revised to 
include this provision. To mitigate the potential for disputes 
regarding the acceptability of sampling methods, it is generally 
advisable for the contractor and the Government to enter into an 
advance agreement. Since the advance agreement has a significant impact 
on the accounting for unallowable costs, the final rule at paragraph 
(c)(4) requires that the contracting officer request auditor input 
prior to entering into such agreements.

Directly associated costs, FAR 31.201-6(e).

    Comment 5: One respondent believes that FAR 31.201-6(e) violates 
CAS 405 (Accounting for Unallowable Costs) and is subject to legal 
challenge by any Government contractor to which a procuring or 
administering agency might seek to apply it. This respondent believes 
that the proposed rule sends a message to the contracting community 
that contracting agencies follow CAS only where it suits them to do so, 
and may disregard CAS where it does not suit their interests. This 
respondent asserts that paragraph (e) ``...departs from the CAS 405 
definition and substitutes a `materiality' test for the `but for' test 
and further extends the materiality test to encompass even more factors 
that are unrelated to the CAS definition. While a suitable materiality 
test could itself be reconcilable with the CAS `but for' test, the FAR 
has gone well beyond this point to encompass additional factors that 
directly contradict the CAS 405 definition.'' The respondent states 
that the FAR could be revised to comply with CAS 405. The respondent 
asserts that ``a point clearly comes at which a particular cost becomes 
so significant that common sense tells us the `but for' test is 
satisfied. Thus, a test seeking to establish that point using the term 
`materiality' would be a valid implementation of CAS 405.'' The 
respondent therefore recommends that the FAR specify ``a sensible 
materiality test and delete the other two current criteria of FAR 
31.201-6(e).'' The respondent further noted that it has submitted 
copies of its comments to the CAS Board and suggested that the Board 
``review the conflict between CAS and FAR in the identification and 
allocation of directly associated cost and take what steps it may 
consider appropriate to defend its exclusive jurisdiction in this 
area.''
    Councils' response: Nonconcur. The Councils do not believe the 
language at paragraph (e) conflicts with CAS 405. The current language 
at FAR 31.201-6(e)(2), which has been in the FAR for over twenty years, 
has not been ruled to conflict with CAS 405 by any Court or by the CAS 
Board. The Councils believe this is important language, because it 
provides contracting personnel and contractors with specific 
information on when to treat salaries and expenses as directly 
associated costs. As such, the Councils believe this language should be 
retained.

Sampling for large dollar transactions, FAR 31.201(c)(2)(ii).

    Comment 6: One respondent believes that the proposed requirement at 
FAR 31.201-6(c)(2)(ii) that ``all large dollar and high risk 
transactions are separately reviewed for unallowable costs and excluded 
from the sampling process'' is overly restrictive. This respondent 
notes that its past experience has shown that sampling for unallowable 
costs is most efficient and effective for high volume accounts with low 
dollar, low risk transactions. Therefore, the respondent believes that 
for a given universe, there is often no need or benefit to set aside 
transactions for 100 percent review. The respondent notes that 
identification of any transactions requiring 100 percent review and the 
establishment of sampling strata or clusters as necessary are all 
inherent requirements of developing a sampling plan that provides a 
``reasonable representation of the sampling universe,'' as required by 
FAR 31.201-6(c)(2)(i). The respondent therefore recommends that the 
language in paragraph (c)(2)(ii) be deleted.
    Councils' response: Nonconcur. The Councils agree with the 
respondent that a reasonable representation of the sampling universe 
would require elimination of items that due to their nature and/or 
dollar amount are not reasonably similar to the other items in the 
universe. However, the Councils also believe this is an important area 
that requires clear language to assure that all parties understand that 
large dollar and high risk items must be removed from the sampling 
universe. Therefore, paragraph (c)(2)(ii) has been retained.

Use of statistical sampling, General.

    Comment 7: A respondent believes that the use of statistical 
sampling will

[[Page 57466]]

result in confusion, inconsistencies, and disputes. The respondent 
believes that statistical sampling should not replace accounting 
policies and procedures for properly identifying and segregating 
unallowable costs. The respondent states that unallowable costs should 
be appropriately identified and excluded when they are initially 
incurred and recorded. The respondent asserts that this internal 
control assures that unallowable costs are accounted for and excluded 
from a contractor's submission. The respondent states that allowing 
statistical sampling for identifying unallowable costs weakens this key 
internal control. The respondent further notes that if sampling is to 
be permitted, the Government and the contractor must develop the 
expertise in statistical sampling to ensure sampling plans are adequate 
and executed properly.
    Councils' response: Nonconcur. The Councils note that CAS 405 
(Accounting for Unallowable Costs) already permits sampling. As such, 
it would be a conflict with the CAS to state that sampling is not 
permitted for CAS-covered contracts. While the FAR could add a specific 
provision stating that statistical sampling is not permitted for non-
CAS covered contracts, the Councils do not believe this would be a 
prudent business action. The Councils believe that the use of 
statistical sampling should apply to all contracts covered by FAR Part 
31, Contract Cost Principles and Procedures. The purpose of the 
proposed rule is to provide some general structure to the process. 
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). A properly executed sampling plan 
should approximate the total unallowable costs from the sample 
universe. Internal controls and procedures established to meet the 
sampling objectives and evaluation of the sample selections should 
still be a key component of this process. The Councils are also 
concerned that it would be oxymoronic to argue that statistical 
sampling is not acceptable for segregating unallowable costs but is 
acceptable for verifying the validity of that segregation. As to the 
expertise that needs to be developed, the Councils again note that 
statistical sampling is already permitted by CAS, and is often used in 
both industry and the Government for many different types of 
applications. Thus, the Councils believe the necessary expertise for 
applying statistical sampling already exists within both the Government 
and the contractor community.
    Comment 8: One respondent believes that the FAR should include 
guidance similar to that issued by the IRS in Revenue Procedure 2004-
29. This respondent states that this Revenue Procedure establishes 
guidelines for using statistical sampling methods for meals and 
entertainment expenses. The respondent notes that this Revenue 
Procedure covered the sampling plan standards, the methods and 
attributes to be used with a sampling plan, the sampling documentation 
standards, and the technical formulas. In addition, the procedure 
specified a 95 percent one-sided confidence level.
    Councils' response: Nonconcur. The Councils believe that such 
prescriptive language is not necessary. The Councils believe that it is 
preferable to provide for more general requirements regarding 
acceptable statistical methods than to provide a detailed listing of 
what must be present for each and every situation.
    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.

B. Regulatory Flexibility Act

    The Department of Defense, the General Services Administration, and 
the National Aeronautics and Space Administration certify that this 
final rule will not 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 principle discussed in this rule.

C. Paperwork Reduction Act

    The Paperwork Reduction Act does not apply because the 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 22, 2005.
Julia B. Wise,
Director, Contract Policy Division.

0
Therefore, DoD, GSA, and NASA amend 48 CFR part 31 as set forth below:

PART 31-CONTRACT COST PRINCIPLES AND PROCEDURES

0
1. The authority citation for 48 CFR part 31 continues to read as 
follows:

    Authority: 40 U.S.C. 121(c); 10 U.S.C. chapter 137; and 42 
U.S.C. 2473(c).
0
2. Amend section 31.109 by--
0
a. Removing the period from the end of the third sentence of paragraph 
(a) and adding ``and on statistical sampling methodologies at 31.201-
6(c).'' in its place; and
0
b. Removing from the introductory text of paragraph (h) the words ``of 
costs''; removing from paragraph (h)(15) the last word ``and''; 
removing the period from the end of paragraph (h)(16) and adding ``; 
and'' in its place; and adding paragraph (h)(17) to read as follows:


31.109   Advance agreements.

* * * * *
    (h) * * *
    (17) Statistical sampling methods (see 31.201-6(c)(4).
0
3. Amend section 31.201-6 by--
0
a. Removing from the second sentence of paragraph (a) and the first 
sentence of paragraph (b) the word ``which'' each time it appears (3 
times) and adding the word ``that'' in its place;
0
b. Revising paragraph (c);
0
c. Removing from the first sentence of paragraph (d) the word ``which'' 
the first time it appears and adding ``that'' in its place; and
0
d. Removing from the end of paragraph (e)(1)(ii) the word ``or'' and 
adding the word ``and'' in its place; and revising paragraph (e)(3) to 
read 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 contractors 
to follow in accounting for and presenting unallowable costs provided 
the criteria in paragraphs (c)(1)(i), (c)(1)(ii), and (c)(1)(iii) of 
this subsection are met:
    (i) The statistical sampling results in an unbiased sample that is 
a reasonable representation of the sampling universe.
    (ii) Any large dollar value or high risk transaction is separately 
reviewed for unallowable costs and excluded from the sampling process.
    (iii) The statistical sampling permits audit verification.
    (3) For any indirect cost in the selected sample that is subject to 
the

[[Page 57467]]

penalty provisions at 42.709, the amount projected to the sampling 
universe from that sampled cost is also subject to the same penalty 
provisions.
    (4) Use of statistical sampling methods for identifying and 
segregating unallowable costs should be the subject of an advance 
agreement under the provisions of 31.109 between the contractor and the 
cognizant administrative contracting officer or Federal official. The 
advance agreement should specify the basic characteristics of the 
sampling process. The cognizant administrative contracting officer or 
Federal official shall request input from the cognizant auditor before 
entering into any such agreements.
    (5) In the absence of an advance agreement, if an initial review of 
the facts results in a challenge of the statistical sampling methods by 
the contracting officer or the contracting officer's representative, 
the burden of proof shall be on the contractor to establish that such a 
method meets the criteria in paragraph (c)(2) of this subsection.
* * * * *
    (e)(1) * * *
    (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. 05-19476 Filed 9-29-05; 8:45 am]
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