B-158138, MAR. 4, 1966

B-158138: Mar 4, 1966

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WHILE WE HAVE REVIEWED THE PROPOSED CHANGES. THERE ARE A NUMBER OF REVISIONS AND PROVISIONS. ON WHICH WE HAVE INSUFFICIENT INFORMATION OR AUDIT EXPERIENCE TO ENABLE US TO COMMENT. WE WILL OF COURSE ADVISE YOU OF OUR FINDINGS AND RECOMMENDATIONS. WE HAVE THE FOLLOWING COMMENTS TO OFFER. 1-15.205-12 EXCESS IDLE PLANT COSTS THE STATED PURPOSE OF THIS PROPOSED REVISION IS THE EXPANSION OF CRITERIA TO BETTER DEFINE THE ALLOWABILITY OF COSTS RELATING TO IDLE AND EXCESS FACILITIES. UNDER THE PROPOSED LANGUAGE WE BELIEVE IT WOULD BE POSSIBLE FOR THE CONTRACTOR TO CLAIM AND BE REIMBURSED FOR THE COST OF MAINTAINING IDLE FACILITIES WHICH HE COULD HAVE DISPOSED OF AT A NOMINAL LOSS OR MODERATE PROFIT.

B-158138, MAR. 4, 1966

TO ADMINISTRATOR, GENERAL SERVICES ADMINISTRATION:

BY LETTER DATED NOVEMBER 19, 1965, THE ASSISTANT GENERAL COUNSEL,REGULATIONS AND GENERAL LAW DIVISION, REQUESTED OUR REVIEW AND COMMENTS ON PROPOSED REVISIONS TO THE FEDERAL PROCUREMENT REGULATIONS PART 1-15, CONTRACT COST PRINCIPLES AND PROCEDURES.

WHILE WE HAVE REVIEWED THE PROPOSED CHANGES, THERE ARE A NUMBER OF REVISIONS AND PROVISIONS, SUCH AS THOSE IN 1-15.205-9 CONCERNING DEPRECIATION, ON WHICH WE HAVE INSUFFICIENT INFORMATION OR AUDIT EXPERIENCE TO ENABLE US TO COMMENT. IN THE EVENT OUR AUDIT WORK DISCLOSES A NEED FOR FURTHER REVISION, WE WILL OF COURSE ADVISE YOU OF OUR FINDINGS AND RECOMMENDATIONS. WE HAVE THE FOLLOWING COMMENTS TO OFFER.

1-15.205-12 EXCESS IDLE PLANT COSTS

THE STATED PURPOSE OF THIS PROPOSED REVISION IS THE EXPANSION OF CRITERIA TO BETTER DEFINE THE ALLOWABILITY OF COSTS RELATING TO IDLE AND EXCESS FACILITIES.

IN "BETTER DEFINING" THE ALLOWABILITY OF COSTS THE REVISION ALSO SUBSTANTIALLY LIBERALIZES THE POLICY FOR ALLOWING COSTS OF THIS NATURE. THE EXISTING COST PRINCIPLE RECOGNIZES ONLY THE COSTS OF MAINTAINING, REPAIRING AND HOUSING THOSE IDLE AND EXCESS FACILITIES REASONABLY NECESSARY FOR STANDBY PURPOSES AS ALLOWABLE COSTS, WHEREAS THE PROPOSED REVISION WOULD EXTEND THE ALLOWABILITY OF SUCH COSTS TO FACILITIES NOT DISPOSED OF FOR SOUND BUSINESS, ECONOMIC OR SECURITY REASONS. WE BELIEVE THIS LIBERALIZATION MAY NOT BE IN THE BEST INTERESTS OF THE GOVERNMENT.

UNDER THE PROPOSED LANGUAGE WE BELIEVE IT WOULD BE POSSIBLE FOR THE CONTRACTOR TO CLAIM AND BE REIMBURSED FOR THE COST OF MAINTAINING IDLE FACILITIES WHICH HE COULD HAVE DISPOSED OF AT A NOMINAL LOSS OR MODERATE PROFIT, BUT WHICH HE RETAINED BECAUSE HE FELT IT TO HIS ECONOMIC BENEFIT TO HOLD OUT FOR HIGHER SALES PRICES. THUS, HE COULD AFFORD TO MAINTAIN THE FACILITIES IN A GOOD STATE OF REPAIR WHILE WAITING FOR A MORE FAVORABLE SALES PRICE BECAUSE A CERTAIN PORTION OF THE COST OF SUCH MAINTENANCE PLUS TAXES, INSURANCE, HOUSING AND DEPRECIATION WOULD BE CHARGED TO A GOVERNMENT CONTRACT.

THE PROPOSED REVISION MIGHT ALSO BE CONSTRUED TO PERMIT CHARGING TO GOVERNMENT CONTRACTS THE COST OF MAINTAINING IDLE FACILITIES MADE IDLE BECAUSE OF AN ABNORMAL DECLINE IN SALES. A CONTRACTOR COULD TAKE THE POSITION IT WOULD BE SOUND BUSINESS TO RETAIN THE FACILITIES IN THE HOPES OF REGAINING HIS FORMER PRODUCTION BASE. WHILE THE LOSS OF PRODUCTION AT FULL PLANT CAPACITY MAY HAVE RESULTED FROM UNSOUND BUSINESS PRACTICES OR DECISIONS, IT MIGHT BE EFFECTIVELY ARGUED THAT IT WOULD BE A SOUND BUSINESS DECISION TO RETAIN THE FACILITIES UNTIL FULL PRODUCTION CAPACITY WAS REACHED AND MEANTIME THE GOVERNMENT WOULD BE CHARGED A CERTAIN PORTION OF THE COST OF MAINTAINING THE IDLE PLANT. WE DO NOT BELIEVE THE GOVERNMENT CONTRACTS SHOULD BEAR THE COSTS OF MAINTAINING FACILITIES DURING AN INDEFINITE PERIOD OF SLUMP IN BUSINESS.

ACCORDINGLY, WE SUGGEST A LIMITATION ON ALLOWABLE COSTS FOR MAINTAINING IDLE AND EXCESS FACILITIES TO PLANTS MADE IDLE BECAUSE OF UNAVOIDABLE OPERATING INTERRUPTIONS AND UNUSED CAPACITY NECESSARY TO MEET AVERAGE PRODUCTION OR SALES DEMANDS OVER AN EXTENDED PERIOD BECAUSE OF SEASONAL OR CYCLICAL VARIATIONS. WE BELIEVE THIS COULD BE SATISFACTORILY ACCOMPLISHED BY DELETING SUBPARAGRAPHS (A) (1) AND (A) (2), AND REVISING THE LAST PHRASE IN PARAGRAPH (A) TO READ: "EXCEPT TO THE EXTENT THAT THE CONTRACTOR DEMONSTRATES PERIODICALLY THAT SUCH IDLE AND EXCESS PLANT IS NECESSARY TO MAINTAIN NORMAL PLANT CAPACITY.'

1-15.205-22 MATERIAL COSTS

THE STATED PURPOSE OF THIS REVISION IS TO PROVIDE CLARIFICATION AND EXPANSION IN SUBSECTION (E) WITH RESPECT TO INTRACOMPANY TRANSFERS, AND TO REFERENCE THE CONCEPT OF "ADEQUATE COMPETITION" , ETC., AS A PRICE BASIS.

SUBSECTION (E) IN THE CURRENT FPR 1-15.205-22 DEALS ONLY WITH THE TREATMENT OF "CHARGES FOR MATERIALS, SERVICES AND SUPPLIES SOLD OR TRANSFERRED BETWEEN PLANTS, DIVISION, OR ORGANIZATIONS, UNDER A COMMON CONTROL.' THE REVISED SUBSECTION (E) EXTENDS ITS PROVISIONS TO OTHER THAN INTRACOMPANY TRANSFERS, I.E., TO MATERIALS AND SUPPLIES PRODUCED BY THE DIVISION HOLDING THE CONTRACT. AS WE INTERPRET THIS REVISION, IT WOULD PROVIDE FOR THE FIRST TIME THAT THE DIVISION HOLDING THE CONTRACT COULD CHARGE OFF-THE-SHELF ITEMS, FOR EXAMPLE, TO THE CONTRACT AT ITS REGULAR COMMERCIAL SALES PRICE RATHER THAN ITS COST TO MANUFACTURE. WE BELIEVE THIS WOULD BE UNDESIRABLE IN THAT IT COULD RESULT IN THE PAYMENT TO A CONTRACTOR OF A DOUBLE PROFIT--- PROFIT IN THE FORM OF A FEE COMPUTED ON ESTIMATED COSTS AND PROFIT WHICH IS BUILT INTO THE COMMERCIAL SALES PRICE OF CERTAIN SUPPLIES, PARTS OR COMPONENTS USED IN PRODUCTION OF THE END ITEM. THIS PROBLEM OF AVOIDING DUPLICATE PROFITS COULD BE TAKEN INTO CONSIDERATION IN ESTABLISHING A FEE IF THERE WAS AN ADVANCE AGREEMENT ON THE QUANTITY OF STANDARD COMMERCIAL ITEMS THAT WOULD BE USED IN PERFORMING THE CONTRACT. HOWEVER, THERE IS NO PROVISION IN FPR 1-3.8, "PRICE NEGOTIATIONS POLICIES AND TECHNIQUES," WHICH WOULD GIVE RECOGNITION TO THE SEPARATE TREATMENT OF MATERIAL REGULARLY MANUFACTURED FOR COMMERCIAL USE AS A FACTOR TO CONSIDER IN ESTABLISHING A FEE OR PROFIT. ACCORDINGLY, WE BELIEVE SUBSECTION (E) SHOULD BE RESTRICTED TOINTRACOMPANY TRANSFERS AS HERETOFORE.

THE PROPOSED 1-15.205-22/E) REVISION IS STATED IN LANGUAGE VIRTUALLY THE SAME AS THAT CONTAINED IN ASPR 15-205.22/E) ISSUED AS A PART OF REVISION 12 IN AUGUST 1965. THE NOTES AND FILING INSTRUCTIONS OF THAT REVISION STATED:

"MATERIAL COSTS-INTERDIVISION TRANSFERS. PARAGRAPH 15-205.22/E) IS REVISED TO INCORPORATE DEFINITIONS OF "ADEQUATE PRICE COMPETITION" AND "ESTABLISHED CATALOG OR MARKET PRICES OF COMMERCIAL ITEMS SOLD IN SUBSTANTIAL QUANTITIES TO THE GENERAL PUBLIC," AND OTHERWISE TO CLARIFY POLICY ON COST TREATMENT OF INTRACOMPANY TRANSFERS.'

(NOTE: THE EFFECTIVE DATE OF THIS REVISION HAS SINCE BEEN SUSPENDED INDEFINITELY. SEE DPC NO. 37.)

NOTING THAT THE ASPR COMMITTEE LIKEWISE MADE NO MENTION THAT THE SUBSECTION (E) WAS BEING BROADENED, TO COVER OTHER THAN INTRACOMPANY TRANSFERS WE INQUIRED OF AN OFFICIAL OF THE DEPARTMENT OF DEFENSE AS TO THE INTENT OF THE REVISION. WE WERE ADVISED THAT SUBSECTION (E) WAS INTENDED TO APPLY SOLELY TO INTRACOMPANY TRANSFERS.

AS TO THE TREATMENT OF INTRACOMPANY TRANSFERS OF MATERIAL, THE PROPOSED FPR REVISION WOULD REQUIRE, ACCORDING TO OUR INTERPRETATION, THAT ITEMS NOT REGULARLY MANUFACTURED BY THE TRANSFEROR (REFERRED TO AS "SELLER") OR REGULARLY MANUFACTURED BY THE TRANSFEROR BUT NOT AVAILABLE FROM OTHER SOURCES WOULD BE CHARGED TO THE CONTRACT ON THE BASIS OF COST INCURRED TO THE TRANSFEROR. THIS IS A SIGNIFICANT DEVIATION FROM THE EXISTING FPR WHICH PROVIDES THAT SUCH CHARGES ,ORDINARILY SHALL BE ALLOWABLE TO THE EXTENT OF THE LOWER OF COST TO THE TRANSFEROR OR CURRENT MARKET PRICE.' WE HAVE RECENTLY SUBMITTED A DRAFT REPORT TO THE DEPARTMENT OF DEFENSE IN WHICH IT IS DISCLOSED THAT DURING A PERIOD JANUARY 1960 THROUGH MARCH 1965 CHARGES TO GOVERNMENT COST AND INCENTIVE TYPE CONTRACTS FOR MATERIALS PROCURED BY THE CONTRACTOR ON A COST-REIMBURSEMENT BASIS FROM OTHER PLANTS AND DIVISIONS OF THE COMPANY EXCEEDED BY ABOUT $1.9 MILLION THE PRICES AT WHICH THOSE MATERIALS WERE AVAILABLE FROM INDEPENDENT SUPPLIERS. BELIEVE OUR FINDINGS DEMONSTRATE THAT THE "LOWER OF COST OR MARKET PRICE" CONCEPT SHOULD BE RETAINED, AND IF ANY REVISION IS MADE, PERHAPS THE COST PRINCIPLE SHOULD BE CLARIFIED TO SATISFACTORILY MEET THE CONTRACTOR'S ARGUMENT THAT A MARKET PRICE CANNOT PROPERLY BE ESTABLISHED BY MULTIPLE SUPPLIERS ALONE--- THAT A MARKET REQUIRES MULTIPLE BUYERS AS WELL AS MULTIPLE SELLERS AND THAT A MARKET PRICE CANNOT BE ESTABLISHED FOR ITEMS USED EXCLUSIVELY FOR THE GOVERNMENT BECAUSE THE GOVERNMENT IS THE SOLE BUYER OR USER. THIS MIGHT BE ACCOMPLISHED BY CHANGING THE EXISTING WORDS "CURRENT MARKET PRICE" TO "THE BEST AVAILABLE PRICE FROM SUPPLIERS NOT AFFILIATED WITH THE CONTRACTOR.'

FURTHERMORE, UPON SUSPENDING THE AFOREMENTIONED AUGUST 1965 REVISION OF ASPR 1-15.205-22/E) THE CHAIRMAN OF THE ASPR COMMITTEE CIRCULATED ANOTHER REVISION OF SUBSECTION (E) STATING THAT ITS PURPOSE IS TO CORRECT AN INCONSISTENCY BETWEEN THE AUGUST 1965 REVISION AND THE DEFINITION OF CATALOG PRICES IN ASPR 3-807. IF INCONSISTENCIES EXIST IN ASPR IT MAY BE THAT SIMILAR INCONSISTENCIES WILL EXIST IN FPR IF THE PROPOSED REVISION IS ADOPTED.

1-15.205-34 RENTAL COSTS (INCLUDING SALE AND LEASEBACK OF FACILITIES)

THE STATED PURPOSE OF THIS PROPOSED REVISION IS THAT IT PROVIDES ADDITIONAL CRITERIA TO BE USED IN EVALUATING THE REASONABLENESS OF RENTAL COSTS; DISCUSSES A TYPE OF LEASE WHICH AMOUNTS TO AN INSTALLMENT PURCHASE OF FACILITIES; AND SPECIFIES THAT ALLOWABLE RENTAL COSTS NEED NOT BE ADJUSTED BY ANY APPLICABLE INVESTMENT CREDIT.

WHILE THE PRINCIPLE STATED IN SUBSECTIONS (A) AND (B) APPEAR ACCEPTABLE, WE CONSIDER THE EXPLANATORY SECTIONS WHICH FOLLOW TO BE SOMEWHAT AMBIGUOUS AND DIFFICULT TO INTERPRET.

IN SUBPARAGRAPH (C), IT IS STATED THAT THE DETERMINATIONS AS TO THE APPROPRIATE METHOD OF ACQUIRING OR RETAINING THE USE OF PROPERTY SHALL BE BASED ON THE LEAST COST ESTIMATED FOR THE ANTICIPATED USEFUL LIFE OF THE PROPERTY TO THE CONTRACTOR BASED UPON A COMPARISON OF THE CUMULATIVE COSTS THAT WOULD BE ALLOWED THE CONTRACTOR IF HE OWNED THE PROPERTY WITH THE CUMULATIVE COSTS THAT WOULD BE ALLOWED UNDER ANY OF THE VARIOUS TYPES OF LEASING ARRANGEMENTS AVAILABLE. THE INTENT OF THE WORDS "CUMULATIVE COSTS THAT WOULD BE ALLOWED THE CONTRACTOR" IS NOT CLEAR. FOR EXAMPLE, IT DOES NOT STATE WHETHER THE DETERMINATION OF WHAT "WOULD BE ALLOWED" SHALL BE BASED UPON GOVERNMENT CONTRACTS EXISTING AT THE TIME OR BE BASED UPON THE ASSUMPTION THAT GOVERNMENT CONTRACTS WILL SHARE THE COSTS DURING THE ENTIRE USEFUL LIFE OF THE FACILITY TO BE ACQUIRED.

SUBSECTION (C) (I) (B) DEALS WITH WHEN "TECHNOLOGICAL LIFE" MAY BE USED TO JUSTIFY LEASING. TECHNOLOGICAL LIFE IS DEFINED AS "UTILITY BEFORE BECOMING OBSOLETE IN WHOLE OR IN PART.' THE FOUR CITED SITUATIONS WHICH MAY GIVE RISE TO THE NEED TO REPLACE EXISTING FACILITIES ARE SITUATIONS WHICH MAY BE CAUSED BY AN OBSOLESCENCE FACTOR OR MERELY THE ABSENCE OF ADEQUATE FACILITIES HAVING A LONG PHYSICAL LIFE. TO RELATE OBSOLESCENCE TO THE LATTER TENDS TO OBSCURE THE INTENDED USE OF ,TECHNOLOGICAL LIFE" AS A CRITERION FOR ANTICIPATING THE USEFUL LIFE OF THE PROPERTY. FURTHER, IT IS NOT CLEAR WHY THE CONSIDERATION APPLIES ONLY TO THE REPLACEMENT OF "EXISTING LEASED ILITIES.' AN INFORMAL DISCUSSION OF THIS POINT WITH A REPRESENTATIVE OF GENERAL SERVICES ADMINISTRATION ELICITED AN OPINION THAT THE WORD "LEASED" HAD BEEN INSERTED BY MISTAKE.

THE LAST SENTENCE OF SUBSECTION (C) (I) (B) APPEARS TO NULLIFY THE CONDITION CITED IN III AS BEING A VALID SITUATION IN WHICH "TECHNOLOGICAL LIFE" MAY BE USED. EXISTING FACILITIES MAY BE ABLE TO SATISFY FUTURE REQUIREMENTS, THOUGH NOT EFFICIENTLY.

OUR INTERPRETATION OF THE INTENDED MEANING OF SUBSECTION (C) (I) (B) IS THAT FACILITIES PROPOSED FOR LEASING MAY BE CONSIDERED AS "SHORTLIFE" FACILITIES WHEN PLANT EXPANSION OR REPLACEMENT IS NECESSARY TO PERFORM THE GOVERNMENT CONTRACT BUT NOT NECESSARY TO THE CONTRACTOR'S BUSINESS THEREAFTER. IF THIS BE THE INTENT, WE BELIEVE IT COULD BE STATED MORE CLEARLY. THIS IS WHERE THE PRINCIPLE SEEMS TO SUGGEST THAT THE WORDS "CUMULATIVE COST THAT WOULD BE ALLOWED" IS LIMITED TO COSTS WHICH WOULD BE ALLOWED ON EXISTING CONTRACTS AT THE TIME THE DETERMINATION OF ,LEAST COST" IS MADE. IF IT IS NOT THE INTENT, CLARIFICATION WOULD SEEM TO BE NEEDED.

FURTHER, IF OUR INTERPRETATION OF SUBSECTION (C) (I) (B) IS CORRECT, THEN WE BELIEVE THE PRINCIPLE CITED THEREIN IS NOT IN THE BEST INTERESTS OF THE GOVERNMENT. WHERE THE RENTAL COSTS THUS INCURRED ARE SIGNIFICANT, THE QUESTION OF INCURRING SUCH COSTS AS OPPOSED TO THE GOVERNMENT'S FURNISHING THE PROPERTY SHOULD BE CONSIDERED IN ADVANCE OF THE CONTRACT AWARD. THE COSTS ARE NOT SIGNIFICANT, WE BELIEVE THEY WOULD BE ALLOWED UNDER THE EXISTING FPR. UNDER THE PROPOSED COST PRINCIPLE, THE GOVERNMENT MAY BE BOUND TO REIMBURSE THE CONTRACTOR HIGH RENTAL COSTS SIMPLY BECAUSE THE ALTERNATIVES WERE NOT CONSIDERED IN ADVANCE OF CONTRACT PERFORMANCE.

SUBSECTION (C) (IV) IMPLIES THAT A RENTAL AGREEMENT ENTERED INTO BY THE CONTRACTOR MAY BE DEMONSTRATED TO BE THE "LEAST COST" METHOD AND THEREFORE APPROPRIATE IN A GIVEN SITUATION AND, BECAUSE OF THE ANNUAL EVALUATIONS, BE DECLARED INAPPROPRIATE AT A LATER DATE. WE DOUBT THAT THIS WOULD BE THE PROPER POSITION FOR THE GOVERNMENT TO TAKE IN CASES WHERE THE CONTRACTOR IS BOUND BY A LONG-TERM LEASE. IT WOULD APPEAR THAT ANNUAL EVALUATIONS ARE APPROPRIATE ONLY WHERE LEASES ARE ENTERED INTO ON AN ANNUAL BASIS, UNLESS SOME PROVISION IS MADE FOR CONSIDERATION OF LEASE CANCELLATION COSTS. WE UNDERSTAND THAT THE WORDING OF THE PROPOSED SECTION 1-15.205-34 WAS INITIALLY DEVELOPED BY THE ASPR COMMITTEE AND RECOMMENDED FOR PUBLICATION. FOR REASONS NOT DISCLOSED TO US THE COST PRINCIPLE WAS NOT PRINTED. THE ESSENCE OF PARTS OF THE COST PRINCIPLE IS CONTAINED AS AUDIT GUIDANCE IN THE CONTRACT AUDIT MANUAL OF THE DEFENSE CONTRACT AUDIT AGENCY. INFORMAL DISCUSSIONS WITH PERSONNEL OF THAT AGENCY GIVE US THE IMPRESSION THAT THE GUIDANCE IS UNCLEAR AND THAT CONSIDERABLE REVISION IS PLANNED.

IN VIEW OF THE FOREGOING, WE BELIEVE THIS SECTION REQUIRES FURTHER CONSIDERATION.