CAS applicability, coverage and disclosure.

There is still considerable confusion about when cost accounting standards apply.

Cost accounting standards (CAS), established by the Cost Accounting Standards Board (CASB), have applied to negotiated federal government contracts over $500,000 since the recodified standards were published in the Federal Register on April 17, 1992. Since then, all federal departments from Agriculture to Veterans Affairs have had a new set of procurement rules to administer. One year after these other rules became applicable, many of these departments still don't realize they could have CAS-covered contracts.

Businesses with Cas-covered federal government contracts have had to implement 19 new accounting rules that address the assignment, measurement and allocation of costs. (See exhibit 1, page 71.) Some standards restrict the latitude permitted by generally accepted accounting principles while others go beyond GAAP and the tax laws. The standards require careful reading; if they are not applied correctly, the financial impact on a company can be disastrous and penalties may result.

The standards are not the only complex and confusing rules; the rules for applicability and coverage and submission of a formal CASB disclosure statement also can be difficult to understand. (The disclosure statement is a formal description of the contractor's cost accounting system prepared by the contractor or a CPA and submitted to the government contracting officer.) Because there are so many novices (government agencies, contractors, accounting practitioners) and CAS expertise is limited, there is considerable opportunity for government contractors to make mistakes in applying and interpreting the standards and rules. This is where a company may rely on a CPA's expertise.

CPA INVOLVEMENT

CPAs in industry and commerce already employed by companies with government contracts will be involved in the process even before a contract is awarded. If CAS applies to the contract to be awarded, the proposal must be priced using the standards in effect at that time. In addition, the disclosure statement may have to be submitted before the contract is awarded. Both situations could involve an accounting firm if the company does not have in-house expertise.

The six largest U.S. accounting firms already have government service divisions that deal with more than just CAS. However, now that CAS has been extended to all parts of the federal government, many more CPAs in smaller firms will need to become involved.

CPA involvement might range from being a consultant to being an expert witness. Consulting might begin with helping a contractor implement CAS and extend to negotiating on a client's behalf when the government and the contractor have different interpretations of the standards and rules. CPAs have been used by both the government and contractors when a CAS issue has been litigated. CPAs also have helped attorneys in CAS cases.

CAS COVERAGE

Before analyzing the standards themselves, all parties need to understand

* When a contract is covered by CAS.

* The extent of coverage.

* Who must complete the CASB disclosure statement.

The purpose of this article is to alleviate the confusion in each of these areas by clarifying the rules (not the standards) and eliminating myths and misconceptions.

The CASB rules, regulations and standards were recodified at title 48 of the Code of Federal Regulations, chapter 99 (48 CFR 99). Part 9903 contains sections that set forth the requirements for applicability, coverage, solicitation provisions, contract clauses and disclosure. This is the source of citations used in this article.

APPLICABILITY

When is a contract covered by CAS? All contracts subject to CASB rules and regulations should include either the full coverage clause or the modified coverage clause from 48 CFR 9903.201-4. Full coverage requires compliance with all standards in effect the contract award date. Modified coverage requires compliance with CASs nos. 401 and 402.

A list of contract and subcontract categories that are exempt from all CAS requirements can be found at 48 CFR 9903.201-1. (See exhibit 2, page 71, for a summary of these exemptions.) A contract meeting any of these exemptions should not contain a CAS clause.

Whether or not the CAS clause is in a contract, it is still incumbent on each contractor or subcontractor to know if CAS applies. Contracting offices (government buying offices) have been known to include a laundry list of clauses in a contract. However, some of these clauses may not be binding because of the applicability rules and exemptions. This list of clauses has misled many contractors and auditors into believing a contract is Cas-covered when it is not. A company can be ready for this problem if it arises by understanding the applicability rules-the government buying office probably does not.

If the CAS clause is inadvertently omitted, the contract is still subject to CAS, provided the applicability criteria have been met. The so-called Christian doctrine can be used to include the CAS clause in a contract even though it is not actually there. This doctrine is a precedent from a case (G. L. Christian and Assoc. v. U.S., 312 F. 2d 418 Ct. Cl. 1963) in which a clause was omitted from a contract but the court said the clause was binding anyway.

CAS applicability is prospective and pertains to a contract and not a contractor. Receipt of a CAS-covered contract does not mean CAS automatically applies to all of the contractor's existing government contracts. Applicability is determined on a contract-by-contract basis. Therefore, a contractor can have some government contracts that are covered by CAS and others that are not.

Subcontracts also are subject to CAS but applicability is not automatic. A subcontract is CAS-covered if the prime contract is CAS-covered and the subcontract does not meet any of the applicability exemptions.

A CAS clause flows down to a lower level subcontract only if that clause is in the contract in hand. Subcontract applicability is important because an order from one business unit of a company to another is considered a subcontract under CAS. Furthermore, adjustments for a subcontractor's CAS noncompliance are made against the prime contract.

COVERAGE

After applicability has been determined, the next step is to determine whether a contract is covered in full or modified form. Full coverage does not necessarily mean a new contractor must immediately comply with all 19 standards. Even though the effective date for each standard is the same (April 17, 1992), all standards are not applicable immediately.

The flowchart in exhibit 3, page 72, depicts the coverage rules. The first two tests concern a single award of $10 million or more in the current period. The last two pertain to the total Cas-covered contract awards in the preceding cost accounting period. Accordingly, a new contractor could receive a series of $9.9 million contracts in the current period, each of which is eligible for modified coverage. However, once a contractor receives a contract subject to full CAS coverage, all future contracts in the same period are fully covered under the single-award rule. Contracts that are awarded in the following period also are fully covered under the preceding period test.

It should be noted that if a contractor is eligible for modified coverage, the contractor must claim it by checking the box in Solicitation Notice III, "Cost Accounting Standards-eligibility for Modified Contract Coverage" (48 CFR 9903.201-3). Failure to make this claim results in the government buying office inserting the full-coverage CAS clause in the contract.

As is the case with applicability, the type of coverage is determined on a contract-by-contract as well as a period-by-period basis. Coverage also is prospective and does not change the status of existing contracts. In other words, the award of a fully CAS-covered contract does not change the status of existing modified- CAS-covered contracts or non-CAS-covered contracts. Accordingly, it would be possible for a contractor to have all three categories of contracts in one cost accounting period.

Coverage also flows down to subcontracts; however, the same type of coverage does not automatically flow down to the subcontract. Each contract or subcontract is evaluated at the business unit (performer) level to determine the type of coverage. Thus a prime contract with full CAS coverage could have subcontracts with modified CAS coverage.

The coverage type indicates the extent of compliance. Compliance means not only adhering to the standards in effect on the contract award date but also following existing accounting practices, whether they are formally disclosed or not.

DISCLOSURE

Who must complete the formal CASB disclosure statement describing the accounting practices used to estimate, accumulate and report costs? The offeror's disclosure statement is reviewed by government auditors to determine its adequacy and compliance.

Adequacy means that the statement is current, accurate and complete and clearly describes the contractor's current or intended accounting practices. It does not mean compliance because a noncompliant practice could be described clearly. Compliance means the described practices follow the standards.

A disclosure-statement compliance determination is not a contractual guaranty that all areas of noncompliance have been discovered. The Armed Services Board of Contract Appeals decided this in PAC- CAR, Inc. (89-2 BCA 21,696). Thus it is incumbent on the contractor to comply with CAS.

Just because a CAS-covered contract has been awarded does not mean disclosure is automatic. There are specific disclosure requirements shown in exhibit 4, above, that are separate from the applicability and coverage rules.

The disclosure requirements involve two tests: one at the business unit level and the other at the company (corporate) level. The first test concerns a single award to a single business unit or segment in the current period. The second looks at the total net awards of the entire company (home office plus segments) in the most recent cost accounting period.

Even if the entire company received net awards exceeding $10 million in the preceding cost accounting period, only the segment receiving the CAS-covered contract in the current period must submit parts I through VII of the disclosure statement. Disclosure also is required of any other segment providing more than 500,000 of cost input to another segment's CAS-covered contract or subcontract. There is also a requirement that the corporate or home office that allocates costs to one or more disclosing segments performing CAS-covered contracts must submit part VIII of the disclosure statement.

ELIMINATING CONFUSION

Many contractors, government employees and CPAs view CAS as a confusing and complex morass. This is especially true in the three areas (applicability, coverage and disclosure) discussed in this article. Much of the confusion occurs when rules from one area are erroneously applied to another. Confusion is compounded when all three areas are considered at the same time. The abundance of confusion leads to self-perpetuating myths and misconceptions, including

* CAS is applicable to all contracts because of the public law.

* CAS coverage automatically flows down to a subcontract.

* Disclosure is automatic.

To make matters worse, the CASB is considering extending CAS to colleges and universities, which widens the universe of confusion and creates more room for errors and misinterpretations.

Because CAS expertise is limited, CPAS can play a major consulting role for new contractors and subcontractors exposed to CAS. The first order of business is to eliminate the confusion and misapplications of the various rules by using the material in the exhibits accompanying this article. This in turn should reduce the difficulty and cost of implementing and monitoring CAS. Understanding the rules for applicability, coverage and disclosure is important, especially for prime contractors, since the prime contract is adjusted when a subcontractor is in violation of CAS.

CPAs with clients who have CAS-covered contracts should be concerned when the CASB develops and proposes changes. CPAs need to respond to these changes before they are final. To play such an active role, CPAs need to understand current CAS rules.

As more and more contractors are exposed to CAS, litigation may increase. CPAs may be asked to serve as expert witnesses or advise attorneys. In either capacity, knowledge of CAS will be necessary.

At present, the only people in the government well versed in CAS are auditors of the Defense Contract Audit Agency (DCAA). However, DCAA does not audit every contractor, so significant responsibility rests on the contractor and its CPAs (internal or external).

* COST ACCOUNTING STANDARDS (CAS) apply to negotiated federal government contracts over $500,000. Their recodification in April gave government departments and agencies new procurement rules to administer and businesses 19 new accounting rules to follow.

* THE NEW RULES COVER the assignment, measurement and allocation of costs. Failure to follow these rules carefully can result in a financial loss for companies that do business with the federal government.

* IT IS IMPORTANT TO determine when CAS applies to a contract and whether coverage is full or modified. A list of contracts and subcontracts exempt from CAS is included in 48 CFR 9903.201-1.

* ALL CAS-COVERED CONTRACTS do not automatically require the filing of a formal Cost Accounting Standards Board disclosure statement. Disclosure rules are separate from the applicability and coverage rules.

* WITH THE PROSPECT OF expanded applicability of CAS to colleges and universities, it is important for CPAS to understand when and how these rules apply.