[Federal Register Volume 60, Number 45 (Wednesday, March 8, 1995)]
[Proposed Rules]
[Pages 12725-12728]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-5566]



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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

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

action: Notice of proposed rulemaking.

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summary: The Office of Federal Procurement Policy, Cost Accounting 
Standards Board (CASB), proposes to amend the Cost Accounting Standards 
(CAS) 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 9904.404, ``Capitalization of Tangible 
Assets'' and CAS 9904.409, ``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 Notice of Proposed 
Rulemaking (NPRM). This NPRM 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.

dates: Comments should be received by May 8, 1995.

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. 91-06N.

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 [[Page 12726]] 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 proposal is step three 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 suggested agenda 
topics in November 1990. Subsequently two Staff Discussion Papers 
(SDPs) were issued.
    The first, 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 to 
the SDP, an Advance Notice of Proposed Rulemaking (ANPRM) was developed 
and published in the Federal Register on August 24, 1994 (59 FR 26774). 
The responses to the ANPRM were of significant assistance to the Board 
in developing this NPRM.

Public Comments

    Fourteen sets of public comments were received from government 
contractors, professional and industrial associations, Federal 
agencies, and accounting and consulting firms.
    All three Government commenters supported the basic approach and 
format incorporated in the ANPRM. All the other commenters, with one 
exception, were clearly opposed to the basic approach adopted in the 
ANPRM., i.e., the no step-up, no step-down approach. One industry 
commenter, although critical of the ANPRM, did not reject its basic 
approach out of hand and reserved his most critical comments to the 
current FAR provision that, in effect, sanctions the use of 
``historical cost or fair value, whichever is lower'' principle in 
cases of mergers or business combinations.
    Irrespective of their support or opposition to the basic approach 
incorporated in the ANPRM, a number of commenters offered additional, 
detailed comments on the various specific provisions of the document. 
Some of these comments were clearly editorial while others were more 
substantive in nature.
    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 
ANPRM, 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 this NPRM, 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 NPRM 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 further reductions in the 
defense budget can be expected to lead to additional mergers and 
business combinations among defense contractors. 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 current subsection 9904.404-50(d) is deleted and is replaced 
by an amended section that prescribes:
    (1) That for Federal contract costing purposes tangible capital 
assets following 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 charged either as 
direct or indirect costs 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 charged either as direct or indirect costs to Federal 
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 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 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 Board 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 [[Page 12727]] 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 NPRM was developed after consideration of the public comments 
received in response to the Board's ANPRM published on May 24, 1994 (59 
FR 26774). 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: Most non-Government commenters disagreed with the Board's 
proposed ``no step-up, no step-down'' approach. They opposed the 
exception from generally accepted accounting principles (GAAP) and 
expressed the opinion that the proposed approach does not represent 
sound accounting. They also pointed out that the proposed approach 
would lead to inconsistencies in the accounting practices applied in 
cases of CAS-covered contracts as contrasted with non-CAS-covered 
contracts. In general, the alternative approaches suggested involved 
either continuation of the ``status quo'', combined with proposals to 
rescind FAR 31.205-52, or suggestions to explore ways to insure that 
the government participates, when appropriate, in gains and losses 
recognized from assets involved in mergers or business combinations.
    Response: 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 this SDP that the 
Board decided to proceed with the ``no step-up, no step-down'' 
approach.
    The Board cannot agree with the suggestions that the status quo 
should be, in essence, maintained. The issues addressed in this 
proposal were first identified as significant issues by commenters in 
responses to the Board's request for suggested agenda topics in 
November 1990. Furthermore, the FAR 31.205-52 provisions, which are 
part of the current regulatory environment in this area, have been 
generally recognized as leading to inequitable consequences from the 
perspective of contractors. One commenter stated: ``* * * the FAR 
provision not only suffers from implementation and transition problems, 
but as written is patently unfair by using historical costs when the 
purchase method indicates increased asset values and using the purchase 
cost when it is lower than the historical values. This allows the 
government to choose the method of accounting which is most cost 
beneficial to it.'' Given these circumstance, the Board cannot agree 
that ``no action'' is the proper course to follow in this instance.
    Comment: Several commenters discussed the need to solve the 
apparent conflict between the CAS allocability provisions and the 
Federal Acquisition Regulation (FAR) allowability provisions in this 
area. In particular, it was suggested the OFPP Administrator address 
any continuing conflict between the Cost Accounting Standards and FAR 
31.205-52 pursuant to the authority conferred on the Administrator by 
41 U.S.C. 422(j)(3).
    Response: The Board is aware of the apparent conflict between the 
provisions of CAS 9904.404 and FAR 31.205-52. Once the proposed 
amendment to CAS has been promulgated, the OFPP Administrator will 
determine whether any changes may be necessary in the FAR cost 
principles to make them fully compatible with the amended CAS 9904.404 
and 9904.409.
    Comment: Several commenters stated that the proposed amendment is 
unfair to contractors as it would prevent them from recouping their 
investments through future contract prices. In particular, the contrast 
was drawn between the acquisition of individual assets through purchase 
and the acquisition of assets as part of a business combination. In one 
case, the GAAP rules regarding acquisition cost would be followed, 
whereas in the other, the new CAS rule would mandate adherence to 
historical cost.
    Response: It is the intent of the Board to apply the proposed 
amendments to CAS 9904.404 and 9904.409 on a prospective basis only. 
Therefore, any assets acquired in business combinations that have been 
concluded prior to the promulgation of these amendments will not be 
affected by the proposed changes in CAS. As to business combination 
taking place after the promulgation of the amendments, it is assumed 
that the parties involved will take into account, while negotiating the 
merger agreement, that any future depreciation chargeable to Government 
contracts and corresponding cash flow projections, will be based on the 
historical costs of the tangible capital assets being transferred in 
the course of the merger.
    As to the treatment of purchased assets in contrast to assets 
acquired through a business combination, it should be pointed out that 
in cases of individual tangible capital assets acquired from a CAS-
covered contractor, any gain or loss from such a sale would be subject 
to recapture by the Government in accordance with the provisions of CAS 
9904.409-50(j). It is precisely because the Board concluded that such a 
recapture would be impractical in cases of business combinations that 
it decided to proceed with the ``no step-up, no step-down'' approach in 
the proposed amendments.
    Comment: One commenter argued that any Government claim to a share 
in a gain resulting from changes in asset values due to price level 
changes cannot be justified on the basis of payment of cost of money as 
a government contract cost. The commenter argued that cost of money was 
introduced as an offset to profit and therefore should not have an 
impact on cost measurement.
    Response: At the time the CASB separately recognized cost of money 
in CAS 9904.414 as an imputed contract cost, it clearly acknowledged 
that prior to the promulgation of that Standard, this cost element had 
been a ``consideration in determining contract profit compensation.'' 
However, this acknowledgement did not imply that the Board regarded 
cost of money as being part of, or having the characteristics of 
profit. It clearly recognized pre-CAS 9904.414 cost of money as an 
element of cost that implicitly was recognized as part of profit. CAS 
9904.414 merely turned an implicitly recognized cost into an explicitly 
recognized cost.
    Comment: Several commenters suggested that some type of materiality 
or significance criterion should be introduced to deal with those 
instances where the acquired entity has allocated only immaterial 
amounts of assets costs to CAS-covered contracts prior to the business 
combination or where such allocations were not made during the cost 
accounting period immediately preceding the business combination 
although they may have been made in the course of earlier periods.
    Response: CAS 9904.404 and 9904.409 apply only in the case of full 
CAS coverage. Therefore, after the recent changes in the applicability 
criteria, the threshold for full CAS coverage has been increased to $25 
million in contract awards during a cost accounting period. It is hard 
to conceive [[Page 12728]] of circumstances where such an amount in 
contract awards would result, on a consistent basis, in insignificant 
depreciation and/or cost of money charges.
    Comment: Some commenters believed that the term ``generated costs 
chargeable'' was too ambiguous.
    Response: The word ``chargeable'' has been replaced by ``charged 
either as direct cost or as indirect cost''.
    Comment: Several commenters were concerned about the perceived 
potential recordkeeping burden including massive studies and protracted 
audits.
    Response: When CAS has been applied continuously, the proposed 
amendments do not create any need for new or additional data regarding 
tangible capital assets. The only requirement is that records regarding 
the net book values that were maintained prior to the business 
combination should be retained and kept up to date after the business 
combination.
    It is only when the contractor believes that the historical costs 
used for CAS purposes do not represent the fair value to be used for 
financial reporting purposes that the creation of additional records 
(or at least additional entries on existing records) becomes necessary.
    Comment: One commenter stated that an adequate definition of 
``business combination'' is required.
    Response: ``Business combination'' and ``purchase method'' are 
financial accounting terms that are already used in the current version 
of CAS 9904.404. CAS uses these terms in a derivative sense, i.e., it 
prescribes certain courses of action when events so described have been 
recognized for financial reporting purposes. The CASB is not an 
originator of these terms.
    Comment: One commenter suggested that issues dealt with in the 
proposed amendment also apply to intangible assets and that these 
should also be addressed in this proposal.
    Response: The proposed amendments are necessarily a part of CAS 
9904.404 and 9904.409. Since the application of these two Standards is 
limited to tangible capital assets, the proposed amendment is not a 
suitable vehicle for extending the coverage to intangible assets. A 
separate project on intangible assets would be necessary for such a 
purpose.
    Comment: One commenter in particular offered extensive editorial 
comments on the proposed amendments.
    Response: Most of these editorial comments were accepted.

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 proposed to be 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 9904.404-50 is proposed to be amended by revising 
paragraph (d) to read as follows:


9904.404-50  Techniques for application.

* * * * *
    (d) For Federal Government contract costing purposes, acquisition 
costs of tangible capital assets acquired in a business combination and 
accounted for under the ``purchase method'' of accounting shall be 
assigned to these assets as follows:
    (1) Tangible capital assets that generated costs charged either as 
direct costs or as indirect costs to Federal Government contracts prior 
to a business combination shall retain the same net book value(s) 
subsequent to a business combination as if the business combination had 
not taken place.
    (2) Where acquired tangible capital asset(s) did not generate costs 
that were charged to Federal contracts subject to CAS at the time of 
the business combination, the asset(s) 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.
* * * * *
    3. Section 9904.404-63 is proposed to be amended by designating the 
existing paragraph as (a) and by adding a new paragraph (b) to read as 
follows:


9904.404-63  Effective date.

    (a) * * *
    (b) The effective date of 9904.404-50(d) is [30 days after date of 
publication of the final rule in the Federal Register].
    4. 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 this subsection 9904.409-50(j) do not apply 
to business combinations. The carrying values of tangible capital 
assets subsequent to a business combination shall be established in 
accordance with the provisions of 9904.404-50(d).
* * * * *
    6. Section 9904.409-63 is proposed to be amended by designating the 
existing paragraph as (a) and by adding a new paragraph (b) to read as 
follows:


9904.409-63  Effective date.

    (a) * * *
    (b) The effective date of 9904.409-50(j)(5), is [30 days after date 
of publication of the final rule in the Federal Register].

[FR Doc. 95-5566 Filed 3-7-95; 8:45 am]
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