B-152462, JAN. 15, 1964

B-152462, JAN. 15, 1964

TO THE SECRETARY OF THE ARMY:

REFERENCE IS MADE TO LETTER OF SEPTEMBER 9, 1963, FROM DEPUTY ASSISTANT SECRETARY OF THE ARMY (INSTALLATIONS AND LOGISTICS), LOGISTICS, OFFICE OF THE ASSISTANT SECRETARY, REQUESTING OUR DECISION AS TO THE PROPRIETY OF INCLUDING THE ENTIRE AMOUNT OF THE INDIRECT EXPENSE APPLICABLE TO CONTRACTOR'S INDEPENDENT RESEARCH AND DEVELOPMENT PROGRAM IN THE FINAL NEGOTIATED OVERHEAD RATE FOR THE CONTRACTOR'S FISCAL YEAR 1960 IN DETERMINING THE REIMBURSABLE COSTS UNDER ITS GOVERNMENT RESEARCH CONTRACTS.

DURING ITS FISCAL YEAR ENDED OCTOBER 31, 1960, THE CONTRACTOR, CONTINENTAL AVIATION AND ENGINEERING CORPORATION, DETROIT RESEARCH DIVISION, WAS ENGAGED IN (1) ENGINEERING RESEARCH AND DEVELOPMENT UNDER COST-PLUS-FIXED-FEE DEFENSE CONTRACTS AND (2) A GENERAL RESEARCH AND DEVELOPMENT PROGRAM WHICH WAS INDEPENDENT OF AND NOT RELATED TO ANY GOVERNMENT OR COMMERCIAL CONTRACTS OR REQUIREMENTS. NO PART OF THE DIRECTS COSTS OF THE CONTRACTOR'S RESEARCH AND DEVELOPMENT PROGRAM HAVE BEEN CHARGED TO THE GOVERNMENT CONTRACTS, BUT ALL OF THE INDIRECT COSTS FOR ITS FISCAL YEAR 1960 HAVE BEEN CHARGED TO THE GOVERNMENT CONTRACTS. THE ARMY AUDIT AGENCY ESTIMATES THAT $252,800 OF THE INDIRECT COSTS SHOULD HAVE BEEN ALLOCATED TO THE CONTRACTOR'S INDEPENDENT RESEARCH AND DEVELOPMENT PROGRAM. THE OPERATIONS INVOLVED PERTAIN ONLY TO THE CONTRACTOR'S RESEARCH DIVISION, THAT IS, RESEARCH AND DEVELOPMENT IS THE SOLE "PRODUCT" OF THE CONTRACTOR. ALL INDIRECT COSTS ARE ACCUMULATED IN THREE MAJOR POOLS--- (1) DESIGN ENGINEERING DEPARTMENT BURDEN, (2) RESEARCH MANUFACTURING DEPARTMENT BURDEN AND (3) GENERAL AND ADMINISTRATIVE EXPENSES.

THE QUESTION IN ISSUE IS THE APPROPRIATENESS OF ALLOCATING 100 PERCENT OF THESE COSTS TO GOVERNMENT PROJECTS AND NONE TO THE CONTRACTOR'S OWN PROJECTS. THE CONTRACTOR CONCEDES THAT UNDER THE "OLD SECTION XV" OF THE ARMED SERVICES PROCUREMENT REGULATION (ASPR), I.E., PARAGRAPHS 15-204/S) AND 15-205/J), COSTS OF ITS INDEPENDENT RESEARCH PROJECTS ARE NOT ALLOWABLE AS COSTS UNDER GOVERNMENT CONTRACTS. THE CONTRACTOR URGES, HOWEVER, THAT THESE PROVISIONS SHOULD BE INTERPRETED AS APPLYING ONLY TO PRIME OR DIRECT COSTS ON THE GROUND THAT UNDER THE "NEW SECTION XV," I.E., 15-205.35/F), INDIRECT COSTS RELATING TO ITS INDEPENDENT RESEARCH PROJECTS MAY BE ALLOWABLE UNDER CERTAIN CIRCUMSTANCES. IN AN EFFORT TO JUSTIFY THIS POSITION THE CONTRACTOR CONTENDS THAT ITS INDEPENDENT RESEARCH PROJECT EXPENSE IS INDIRECT IN CHARACTER AND SHOULD NOT BECOME A PART OF THE BASE ON WHICH ADDITIONAL BURDEN IS APPLIED.

UNDER THE TERMS OF CONTRACT NO. DA-20-018-ORD-22905, WHICH WE UNDERSTAND ARE REPRESENTATIVE OF THE OTHER CONTRACTS,"ARTICLE VIII - ALLOWABLE COST, FIXED FEE, AND PAYMENT," PROVIDES IN PART THAT IN DETERMINING THE ALLOWABLE INDIRECT COSTS---

"C. ALLOWABILITY OF COSTS AND ACCEPTABILITY OF COST ALLOCATION METHODS SHALL BE DETERMINED IN ACCORDANCE WITH ASPR, SECTION XV, PART 2, IN EFFECT PRIOR TO ASPR REVISION 50 DATED 2 NOVEMBER 1959 UNTIL 31 OCTOBER 1960, AND THEREAFTER IN ACCORDANCE WITH ASPR, SECTION XV, PART 2, AS REVISED BY REVISION NO. 50 DATED 2 NOVEMBER 1959.'

FOLLOWING ARE PERTINENT PROVISIONS OF SECTION XV, PART 2, PRIOR TO REVISION NO. 50 DATED NOVEMBER 2, 1959, INCORPORATED INTO THE CONTRACTS FOR APPLICATION TO THE CONTRACTOR'S FISCAL YEAR 1960:

"15-201 GENERAL BASIS FOR DETERMINATION OF COSTS. (A) THE TOTAL COST OF A COST-REIMBURSEMENT TYPE CONTRACT IS THE SUM OF THE ALLOWABLE DIRECT COSTS INCIDENT TO THE PERFORMANCE OF THE CONTRACT, PLUS THE PROPERLY ALLOCABLE PORTION OF ALLOWABLE INDIRECT COSTS, LESS APPLICABLE INCOME AND OTHER CREDITS. THE TESTS USED IN DETERMINING THE ALLOWABILITY OF COSTS ALSO INCLUDE (I) REASONABLENESS, (II) APPLICATION OF GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND PRACTICES, AND (III) ANY LIMITATIONS AS TO TYPES OR AMOUNTS OF COST ITEMS SET FORTH IN THIS PART 2 OF SECTION XV OR OTHERWISE INCLUDED IN THE CONTRACT. FAILURE TO MENTION ANY ITEM OF COST IN THIS PART IS NOT INTENDED TO IMPLY THAT IT IS EITHER ALLOWABLE OR NOT ALLOWABLE. THE USE OF NORMAL OR STANDARD COSTS (WITH APPROPRIATE ADJUSTMENTS FOR VARIANCES, UNALLOWABLE COSTS AND THE OTHER PROVISIONS OF THIS PART) IS ACCEPTABLE IN DETERMINING AMOUNTS OF PROVISIONAL OR INTERIM PAYMENTS, BUT FINAL ALLOWABLE COSTS MUST REPRESENT ACTUAL COSTS. INCOME AND OTHER CREDITS ARISING OUT OF OPERATIONS UNDER THE CONTRACT, WHERE THE RELATED COST WAS REIMBURSED OR ACCEPTED AS AN ALLOWABLE COST, WILL BE CREDITED TO THE GOVERNMENT.

"15-204 EXAMPLES OF ITEMS OF ALLOWABLE COSTS. SUBJECT TO THE REQUIREMENTS OF ASPR 15-201 WITH RESPECT TO THE GENERAL BASIS FOR DETERMINING ALLOWABILITY OF COSTS, AND IRRESPECTIVE OF WHETHER THE PARTICULAR COSTS ARE TREATED BY THE CONTRACTOR AS DIRECT OR INDIRECT, THE FOLLOWING ITEMS OF COSTS ARE CONSIDERED ALLOWABLE WITHIN THE LIMITATIONS INDICATED:

"/S) RESEARCH AND DEVELOPMENT SPECIFICALLY APPLICABLE TO THE SUPPLIES OR SERVICES COVERED BY THE CONTRACT;

"15-205 EXAMPLES OF ITEMS OF UNALLOWABLE COSTS. IRRESPECTIVE OF WHETHER THE PARTICULAR COSTS ARE TREATED BY THE CONTRACTOR AS DIRECT OR INDIRECT, THE FOLLOWING ITEMS OF COST ARE CONSIDERED UNALLOWABLE, EXCEPT AS INDICATED:

"/J) GENERAL RESEARCH, UNLESS SPECIFICALLY PROVIDED FOR ELSEWHERE IN THE CONTRACT; "

AS INDICATED IN ASPR 15-201, QUOTED ABOVE, IN DETERMINING ITEMS OF COST CHARGEABLE TO GOVERNMENT CONTRACTS "FINAL ALLOWABLE COSTS MUST REPRESENT ACTUAL COSTS.' PRIOR TO REVISION NO. 50 ONLY SUCH RESEARCH AND DEVELOPMENT COSTS AS WERE SPECIFICALLY APPLICABLE TO PERFORMANCE OF THE GOVERNMENT CONTRACT WERE ALLOWABLE, AND NEITHER DIRECT NOR INDIRECT COSTS OF ANY OTHER RESEARCH AND DEVELOPMENT BY THE CONTRACTOR WERE ALLOWABLE. PURSUANT TO REVISION NO. 50 PROVISION WAS MADE WHEREBY, UNDER APPROPRIATE CIRCUMSTANCES, INDEPENDENT RESEARCH AND DEVELOPMENT COSTS MAY BE ALLOWABLE AS INDIRECT COSTS INCLUDING THEREIN THE ABSORPTION OF AN APPROPRIATE SHARE OF INDIRECT AND ADMINISTRATIVE COSTS, SUBJECT TO GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND PRACTICES AS WELL AS THE PRACTICES OF THE CONTRACTOR AND ANY OTHER PERTINENT CONSIDERATIONS. REVISION NO. 50, OF COURSE, IS NOT APPLICABLE TO THE CONTRACTOR'S FISCAL YEAR 1960 HERE INVOLVED.

IT IS FUNDAMENTAL THAT THE COSTS OF ANY PRODUCT OR PROJECT INCLUDE DIRECT COSTS AS WELL AS INDIRECT COSTS GENERATED BY THAT PRODUCT OR PROJECT, AND THERE IS NOTHING IN PART 2, SECTION XV OF ASPR, EITHER PRIOR OR SUBSEQUENT TO REVISION NO. 50, WHICH WOULD EVEN SUGGEST A DEPARTURE FROM THIS BASIC PRINCIPLE. ON THE CONTRARY, THIS PART REQUIRES IN ESSENCE THAT ALLOWABLE COSTS MUST MEET THE TESTS OF REASONABLENESS AND THE APPLICATION OF GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND PRACTICES APPLICABLE TO THE PARTICULAR CIRCUMSTANCES. MANIFESTLY, THE VARIOUS SUBPROVISIONS OF PART 2 MUST BE INTERPRETED IN A MANNER CONSISTENT WITH THE PRESCRIBED BASIC REQUIREMENTS. APPLYING THE GOVERNING PRINCIPLES AND TESTS TO THE CIRCUMSTANCES OF THIS CASE IT IS WHOLLY UNREASONABLE, IN OUR OPINION, FOR THE CONTRACTOR TO MAINTAIN THAT ITS COSTS FOR INDEPENDENT RESEARCH AND DEVELOPMENT PROJECTS DO NOT INCLUDE THE OVERHEAD AND INDIRECT EXPENSES GENERATED BY THOSE PROJECTS. CLEARLY SUCH INTERPRETATION OR PRACTICE WOULD PERMIT, IN EFFECT, THE CHARGING TO THE GOVERNMENT OF COSTS NOT INCIDENT AND NECESSARY OR ATTRIBUTABLE IN ANY WAY TO THE PERFORMANCE OF THE GOVERNMENT WORK IN DIRECT CONTRAVENTION OF THE INTENT AND PURPOSE, AS WELL AS THE EXPRESS TERMS, OF THE CONTRACTS.

WE DO NOT FEEL IT IS NECESSARY, TO COMMENT FURTHER ON THE JUSTIFICATION ADVANCED BY THE CONTRACTOR SINCE WE BELIEVE FOR THE FOREGOING REASONS THAT NO INTERPRETATION OF THE APPLICABLE PROVISIONS OF ASPR OR UNIVERSALLY ACCEPTED ACCOUNTING PRINCIPLES MAY REASONABLY BE CONSTRUED TO JUSTIFY THE INEQUITABLE ALLOCATION OF COSTS URGED BY THE CONTRACTOR. IT IS THEREFORE SUGGESTED THAT APPROPRIATE ACTION BE TAKEN BY YOUR DEPARTMENT TO RECOVER THE EXCESS COSTS CHARGED TO THE GOVERNMENT BY THE CONTRACTOR UNDER THESE CONTRACTS.