FAR 31.201-6(a) and CAS 9904.405-30(a) both define directly associated cost as “any cost which is generated solely as a result of incurring another cost, and which would not have been incurred had the other cost not been incurred.” FAR 31.201-6(a) restates the definition replacing the word “which” with the word “that.” Still a consistent view of what directly associated cost means.
The Clash of DoD and the CAS Board with Directly Associated Cost
In the 1970s, DoD and the CAS board were at odds over directly associated cost prior to the CAS 405 enactment. An article in Public Contract Law Journal, Vol. 31, No. 3 (Spring 2002), pp. 479-512; titled “CAS 405 and Directly Associated Labor Costs: An Historic Clash Between DoD and the CAS Board” published by the American Bar Association provides an excellent overview of this Government family squabble. It is hard to believe that DoD and the CAS Board would be at odds when the two groups had a self-professed CAS expert in common. The Director of DCAA is on the CAS Board and reports to the Comptroller, a secretary-level position within DoD. Apparently, bringing groups together is not a DCAA skill set, even back in the 1970s.
We are not going to rehash the Government’s dirty laundry from the 1970s and into the 1980s. However, it does appear that DoD had given into the CAS Board. In 1975, the then Deputy Secretary of Defense for Procurement, Dale Babione, issued a letter to the Chairman of the ASPR committee (ASPR is a predecessor to the FAR). (Paraphrasing) Mr. Babione did not want DoD taking a position or issuing a regulation that would conflict with the CAS Board. The CAS Board’s position on directly associated cost is based on the “but for” test, which aligns well with the definition of a directly associated cost being one that is generated solely as a result of incurring an unallowable cost/activity and would not have been incurred had the unallowable cost/activity not been incurred.
The “But For” Test for Directly Associated Cost
Simply stated, a contractor employee that travels to attend an unallowable sporting event (i.e., entertainment activity) would have the cost of the event tickets and travel cost disallowed. FAR 31.205-14, Entertainment costs, makes the cost of the tickets to a sporting event unallowable plus any additional directly associated cost. Seeing as the travel cost would not have been incurred but for the employee’s attendance at the unallowable event, the travel cost would be an unallowable directly associated cost. The next question is, should any amount of the employee’s salary/compensation be treated as unallowable directly associated cost. Using the CAS Board’s “but for” test and assuming this is the one of only a handful of unallowable activities the employee engages in during the year, no salary/compensation would be treated as unallowable directly associated cost. (Effectively Illustration (e) in CAS 9904.405-60)
Apparently not satisfied with where the CAS Board came down, in 1982, the DAR Committee (successor to the ASPR Committee), apparently pushed by the Air Force, promulgated substantially the same materiality requirements set forth in FAR 31.201-6(e) today. Now that you have a little of the back story, we can discuss the current requirements around directly associated cost.
Directly Associated Cost WITHIN Indirect Cost Pool
If a direct cost is determined to be unallowable, then only other direct costs that are potentially directly associated need to be identified. Both FAR 31.201-6(d) and CAS 9904.405-40(e) provide that any directly associated cost included in an indirect cost pool that is allocated over the base including the unallowable direct cost, the directly associated cost remains in the indirect cost pool as the unallowable direct cost will attract their allocable share of costs based on the application of the indirect rate.
The Materiality of Directly Associated Costs
Now that’s not so bad – the fun begins when you need to identify directly associated costs related to unallowable indirect cost. FAR 31.201-6(d) goes on to require if an indirect cost is determined to be unallowable, you must purge all directly associated costs from remaining indirect expenses, if material in amount. FAR 31.205-6(e)(1) provides guidance on how to determine if a directly associated cost is material. Materiality consideration should be based on:
- 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.
It goes on in FAR 31.205-6(e)(2) to require special treatment of salary cost. For employees who participate in unallowable activities, their salary shall be treated as directly associated cost based on the time spent on the unallowable activity, if the cost is material. It does provide an exception for when the salary cost is itself, unallowable. So, the salary cost is an unallowable directly associated cost unless it is unallowable for some other reason. Now that’s not confusing in anyway – Right. Besides the materiality considerations above, it adds one more consideration. Is the time spent on the unallowable activity compared to the total time spent on allowable activity material? It does add that time spent outside normal working hours should not be considered except when it is evident it is so frequent that such times are considered a part of the employee’s regular duties. In today’s 24-7 work environment, when would this not be the case?
While it appears clear that FAR 31.201-6(e)(1) and (2) have effectively eliminated the CAS but for test, replacing it with a Government compliance test that requires all directly associated costs be identified, and then things boil down to arguing over materiality. Recent experience with DCAA auditors has shown that materiality is not their strong suit.
And Now Public Policy?
Now for FAR 31.201-6(e)(3), it starts out well by reinforcing that even if a specific cost principle under FAR 31.205 states directly associated costs be unallowable, the directly associated costs are unallowable only if material. That could be helpful if the next part did not cut the legs out from under the first part. It then provides an exception to the requirement for materiality, in cases where allowance of any directly associated cost would be contrary to public policy. It is hard to think of a cost principle that an auditor is not likely to say is public policy or at least driven by an underlying public policy.
Do not think that just because working through the subjectivity of determining what cost is directly associated and is that cost also material, limits the application of penalties to the directly associated cost determined to be material. In the Raytheon Case (ASBCA, 17-1 BCA ¶36,724 Raytheon Company, Armed Services Board of Contract Appeals, (Apr. 17, 2017)), the Board found, in the case of lobbying activities, that “[u]nder FAR 31.201-6(a), ‘[w]hen an unallowable cost is incurred, its directly associated costs are also unallowable.’ Thus, material salary expenses of employees who engage in activities that generate unallowable lobbying costs are named and stated to be unallowable under the combination of FAR 31.201-6(a) and FAR 31.201-6(e)(2). Therefore, those salary costs are expressly unallowable as defined in FAR 31.001 and subject to penalty under FAR 42.709-1(a)(1).”
One Best Practice—Address Unallowable Cost Policy
All that said – the best advice is when there is a risk of potentially directly associated cost to deal with, identify them upfront, and make your case on materiality and any public policy implications or lack thereof. Having a section in your unallowable cost policies and procedures that highlights unallowable activities that increase the risk of potential directly associated cost requiring the up-front identification and analysis of materiality and related public policy concerns is a best practice.
Redstone GCI assists contractors throughout the U.S. and internationally with understanding the Government’s expectations and developing accounting policies and procedures that comply with these requirements.
John is a Director with Redstone Government Consulting, Inc. providing government contract consulting services to our clients primarily related to the DFARS business systems, CAS Disclosure Statements, and DCAA/DCMA compliance preparation, advisory, and defense. Prior to joining Redstone Government Consulting, John served in a number of capacities with DCAA/DCMA for more than 30 years. Upon his retirement, he was based in Texas as an SES-level Corporate Audit Director for DCAA, managing a staff of 300 auditors at one of the largest DOD programs. Professional Experience John began his career in the late 80s working in the Clearwater, FL audit office and over the next three decades he progressed through a number of positions within both DCAA and DCMA with career highlights as DCAA Program Manager at Ft. Belvoir, Chief of Technical Programs Division, Deputy Assistant Director-Policy, Director of the DCMA Cost and Pricing Center, the SES-level Lockheed Martin Corporate Audit Director, and Director of Integrity and Quality Assurance. John’s three decades of experience in performing and leading DCAA auditors and DCMA reviewers provides a wealth of expertise to our clients. John’s role, not only in the performance of audits, but also in the development of audit policy affords him unique insights into the defense of audit findings and the linkage of audit program steps to the underlying regulatory framework. He is an expert in FAR, DFARS, and other agency acquisition regulation, as well as a subject matter expert in the Cost Accounting Standards having reviewed and provided audit feedback on many of the largest and most complex cost accounting practices during his tenure with the DCAA. John’s tenure with DCAA and DCMA came at a critical time during each agency’s history where a number of changes were occurring such as the response to the ICS backlog, development of audit approaches to the DFARS Business Systems and implementation of new audit initiatives as a result of Congressional oversight through the NDAA process. John’s leadership at the DCMA Cost & Pricing center saw oversight of all major DOD pricing actions, leadership of should cost review teams, the Commercial Pricing group and many other areas of strategic value to our clients. His involvement in these and other Agency initiatives is of great value to our clients due to his in depth understanding of DCAA and DCMA’s internal policy directives. Education John holds a Master of Business Administration and a B.A. in Accounting from the University of South Florida. Certifications Certified Information Systems Auditor State of Alabama Certified Public Accountant