1 CAS Harmonization: Post Final Rule NDIA Contract Finance Committee March 12, 2012

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CAS Harmonization: Post Final Rule

NDIA Contract Finance Committee

March 12, 2012

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Agenda• Background of CAS Harmonization

• Highlights of the Final Rule

• Typical Cost Trend Post Harmonization

• Activities post final rule

– Determining Period of Applicability

– Five Year Phase-in

– Cost Accounting Practice Change

– Revised Disclosure Statement

– Revised Forward Pricing Rates

– Requests for Equitable Adjustments

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Background of CAS Harmonization

• PPA amended pension trust funding requirements (ERISA rules)– Effective in 2008 for most contractors– Deferral until 2011 for a few large “eligible contractors” (expired)

• Significant contributions into pension trusts required by PPA– Expect 7 years of large contributions into trust to reach “full funding”– Significant negative cash flow to government contractors

• Decades before PPA funding recognized as cost under existing CAS• Total industry amount of funding not recognized as cost is significant

• PPA mandates harmonization of CAS with PPA funding requirements– Final CAS Rule mandated to be effective by January 1, 2011 (missed)– Expect accelerated recognition of pension costs when harmonized– Final Rule published December 27, 2011 (Effective February 27, 2012)

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Highlights of the Final Rule• Required change in regulation entitling contractors to equitable adjustments

• Trigger contract subject to CAS 412/CAS 413 needed for applicability

• PPA benefit freezes due to funding level will not be considered benefit curtailment

• Amortization period of actuarial gains/losses from 15 to 10 years– Differences between actual experience and actuarial assumed – Not subject to phase-in rules

• Starts in first accounting year beginning after 6/30/2012 when a difference occurs

• New liability measure similar to PPA minimum funding– Contractor elects source of bond interest rate as accounting practice– Current low bond rates will result in higher liability and higher CAS cost– Phase-in rules apply to recognition of higher liability

• Year 1, 0%; Year 2, 25%; Year 3, 50%; Year 4, 75%, Year 5, 100%• Phase-in is independent of receipt of trigger contract

• No harmonization for segment closings

Typical Cost Trend Post Harmonization

-

50

100

150

200

250

300

350

400

450

500

2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024

Millions

CurrentAlternative

• Illustration of pension cost trend of typical contractor based on Towers Watson analysis– “Alternative” line provides illustration based on last proposed rule but with changes requested

• Changes included in “alternate” were generally included in final rule, except different phase-in % used– Final rule includes phased-in 5-yr transition to gradually recognize increase

• Delays greatest cost impacts until future contracts/appropriations • Minimizes number and amount of equitable adjustments

– Pension costs under new rule will drop below current CAS level after initial acceleration period decreasing backlog of PPA funding (CAS prepayments)

Note: Years shown presume calendar year contractor who receives a trigger contract after effective date during 2012

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Sequence of Activities Post Final Rule

Fed Reg NoticePublishedFinal Rule

(12/27/2011)

Effective Date 2/27/2012

•Begins period to get trigger contract for applicability;

•New contracts not entitled to equitable adj

•New FPR must be in usefor pricing new contracts with

performance periods after applicability

About 60 days

Existing CAS-covered contracts prior to effective date entitled to equitable adj

(FAR 30.603-1(d), FAR 52.230-2)

BEFORE EFFECTIVE DATE:•Notify DCMA of change in cost Acct’g. practice and revise DS-1•Revise FPR for periods after

Applicability date

Contractor receivesnew (sub) contract

award subject to CAS 412/413

(“trigger contract”)

<1 yearE

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New rule applicable1st day of FY after Trigger (sub) contractReceived•Revised FPR for Yr 2 forward (0%impact to Yr 1)

5 Yr phase-in Rules Yr 1 0%Yr 2 25%Yr 3 50%Yr 4 75%Yr 5 100%(cost impact begins in yr 2)

New contract awards on or after effective date NOTentitled to equitable adjustments

(bids for new (sub) contracts with performance periods after Applicability Date priced under new rule)

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Implementation Date

(earliestApplicability date

7/1/2012)Note: Irrelevant to

calendar yr contractor

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Determining Period of Applicability• CAS 9904.412-63(b), “Following receipt of a contract or subcontract subject to this Standard on

or after the Effective Date [February 27, 2012], contractors follow this Standard, as amended, beginning with its next cost accounting period beginning after the later of the Implementation Date [June 30, 2012] or the receipt date of a contract or subcontract to which this Standard is applicable.”

• No applicability date earlier than July 1, 2012 due to Implementation Date.

• Most calendar year contractors likely to receive new contract in 2012 after effective date, so applicability will be January 1, 2013.

• Applicability for Contractors with FY beginning between February 27

and June 30 may be delayed a year due to Implementation Date

Fed Reg NoticePublishedFinal Rule

(12/27/2011)Contractor receivesnew (sub) contract

award subject to CAS 412/413

(“trigger contract”)March 15, 2012

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Determining Applicability• CAS 9904.412-63 (b)(1), “Beginning with the Applicability Date of the CAS

Pension Harmonization Rule, such contractors shall follow this Standard, as amended, for all contracts or subcontracts subject to this Standard.”

• Assume only Segment #2 triggers applicability with a new contract; does the contractor follow revised CAS for all pension plans? Why or Why not?

– Does this answer change if costs for pension plans A, B, and C are allocated to a fringe pool at Corporate which burdens Corporate labor costs allocated to all the segments? What about pension plan D?

Corporate OfficeCentrally Managed

Pension Plan APension Plan BPension Plan C

Segment #1Receives allocation of pension plan A

Segment #2Receives allocationof pension plan A

and pension plan B

Segment #3Receives allocationof pension plan B

and pension plan C

Segment #4Receives no

allocation but hasown pension plan D

for this segment

Presume all segments have CAS-covered USG contracts and each segment and Corporate office has a DS-1.

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Five Year Phase-in Transition• Not applicable for 15 to 10 year change in amortization period for actuarial gains and losses

– Shortened amortization period begins with new actuarial gain/loss in first year of applicability

• CAS 9904.412-64.1(a), “The Pension Harmonization Transition Period is the five cost accounting periods beginning with a contractor’s first cost accounting period beginning after June 30, 2012, and is independent of the receipt date of a contract or subcontract subject to this Standard.”

• Phase-in of the Minimum Actuarial Liability and the Minimum Normal Cost is Yr 1, 0%;Yr 2, 25%; Yr 3, 50%; Yr 4, 75%; Yr 5, 100%

Fed Reg. NoticePublishedFinal Rule

(12/27/2011)

Contractor receivesTrigger contract 3/2015

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Con

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FY

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(cal

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2013 FY 2014 FY 2015 FY2016 FY

2017 FY 2018 FY +

Contractor uses 10 yr

amortization period for actuarial

gains/lossesJan 1, 2016

Transition Phase-in Period

Year 1Phase-in0%

Year 2Phase-in25%

Year 3Phase-in50%

Year 4Phase-in75%

Year 5Phase-in100%

Contractor uses

Amended CAS for

MALat 75%

Phase-in

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Five Year Phase-in Transition• Equitable Adjustments: Affected contracts entitled to equitable adjustments for periods of

performance after Applicability Date would rely on pension cost data calculated including appropriate phase-in % applied to the liability (MAL) for each period

• Segment Closings: Since the amended rule did not revise segment closing adjustments, the transition rules that phase-in the MAL are irrelevant for segment closings


(12/27/2011)


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(FY

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2013 FY 2014 FY 2015 FY 2016 FY 2017 FY 2018 FY +


amortization period


Year 1Phase-in0%

Year 2Phase-in25%

Year 3Phase-in50%

Year 4Phase-in75%

Year 5Phase-in100%

Contract C

Contract B

Contract A

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Change in Cost Accounting Practice• A single required change applied prospectively

– FAR 52.230-2(a)(3), “Such compliance shall be required prospectively from the date of applicability to such contract or subcontract.”

– Harmonization Final Rule Preamble, “The [CAS] Board believes that the final rule changes cost accounting practices contained in CAS 412 and that are necessary to implement the CAS Pension Harmonization Rule required by section 106 of the PPA.”

– CAS 9903.201-6(a)(2) “Required change means a change in cost accounting practice that a contractor is required to make in order to comply with applicable Standards, modifications, or interpretations thereto…” [Also see FAR 52.230-2(3)]

• FAR 30.603-1(c)(2), the contractor submits a description of the required change in practice to the CO

– CO to request a general dollar magnitude (GDM) proposal• GDM compares the most current pension costs under CAS to the new pension costs under the

amended CAS for periods after the Applicability Date for the contractor• This GDM sets the baseline measures (old pricing to new pricing) for equitable adjustments, as long

as only those changes required by the modification to CAS are included in the new pension costs used

• GDM likely to reflect contract type mix but not specific amounts by contract– CAS 9903.201-6(a), the Contracting Officer makes a finding that the practice change was

required to comply with a modification to CAS– Cognizant CO for this expected to be the same as for routine pension FPR updates– Unclear to industry who will conduct the reviews—DCAA or DCMA CIPR team?

• Anticipated priority level

• DCMA Board of Review requires HQ level review for change to cost accounting practices for pension costs, but it is unclear what this review entails

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Disclosure Statement Revision

• Revisions necessary to contractor DS-1 likely minimal – Prescriptive regulatory requirements not included in contractor DS-1

only contractor specific cost accounting practices

– Amendments to CAS predominately prescriptive rather than election by contractor. For example…

• “For period beginning on or after the ‘Applicability Date of the CAS Pension Harmonization Rule,’ such actuarial gains and losses shall be amortized over a ten-year period in equal installments…”

• “The minimum actuarial liability shall be the actuarial accrued liability measured under the accrued benefit cost method…”

– Actuarial interest rate assumption for new liability measure (MAL)• Amended Standard provides for election of rate source by contractor

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Forward Pricing Rate (FPR) Revisions• Considerations in making revisions to forward pricing rates to comply with final rule for calendar

year contractors– Contractors will need to predict when they will receive trigger contract to determine Applicability Date– Calendar Contractor will revise FPR for 2014 and later (presuming 2012 trigger contract)

• Year 1, 0% Phase-in results in no impact to year 1 of applicability (2013)• Since actuarial gain/loss is based on actuals identified, no FPR impact for 2013 although actuals when known could result

in a new 10 year amortization layer for 2013

• Revised FPR must be used for pricing bids and proposals, with performance periods after Applicability Date, for new contract awards made on or after the effective date [February 27, 2012]

• Judgment involved in MAL interest rate assumption for FPR– CASB FAQ, “the contractor must…examine the historical average rates on corporate rate of return on

corporate bonds by duration tempered with the recent past and anticipated future rates.”• Audits of new FPR being done jointly by DCMA CIPR team and DCAA


(12/27/2011)

Contractor anticipates receiving

trigger contract in 2012

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2013 FY 2014 FY 2015 FY 2016 FY 2017 FY

Contractor revises FPR for

anticipated periods of

Applicability2013+


Year 1Phase-in0%

Year 2Phase-in25%

Year 3Phase-in50%

Year 4Phase-in75%

Year 5Phase-in100%

•Contractor new FPR for Periods of Applicability 2013+•No change to 2012 FPR (no applicability yet) •No change to 2013 FPR (no impact since 0% phase-in for new liability and no actuarial gain/loss yet identified)

Note: Contractor FPR may include only 3-5 years,Including current year 2012

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Contract C, 1/15/2012

Contract B, 11/30/2011

Identifying Contracts for Equitable Adjustments• Criteria for entitlement

– Period of performance after the Date of Applicability for contractor• Change in cost to affected contract only for future periods of performance (prospective), no retroactive adjustments

– Cost-based contracts subject to CAS 412 and CAS 413– Includes priced options – Excludes unpriced work (e.g., UCAs)

• Examples below– Contract A does not exist prior to Effective Date (2/27/2012), so not entitled to equitable adj– Contract B does exist prior to Effective Date, so entitled to equitable adj for periods after applicability begins– Contract C does exist prior to Effective Date, so entitled to equitable adj for periods after applicability begins


(12/27/2011)


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Contractor Applicability Begins January 1, 2013(FY calendar year)

2013 FY 2014 FY 2015 FY 2016 FY 2017 FY 2018 FY +


amortization period


Year 1Phase-in0%

Year 2Phase-in25%

Year 3Phase-in50%

Year 4Phase-in75%

Year 5Phase-in100%

Contract A, 6/30/12

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Equitable Adjustment Calculation

• Calculation of adjustment amount for affected contracts– Leverage GDM prepared for change in cost accounting practice

• Identifies change in pension cost from most recent FPR used for estimates to complete to pension costs revised only for harmonized rule (i.e. new rates must isolate only those changes in practice required by the amended Standard)

• GDM includes all future performance periods after contractor applicability date for affected contracts

– FAR 52.230-6(d) provides for several methods to choose from as the basis for Contracting Officer evaluation of the change in costs for affected contracts

• A representative sample of affected contracts• Change in rate multiplied by the total estimated base for fixed-price contracts and

for flexibly-priced contracts• Any other method that provides a reasonable approximation of the total increase

in costs for affected fixed-price and flexibly-priced contracts

– Adjustments relate to contract prices, target prices, cost ceilings, etc.– Adjustments include all future periods of performance after contractor

applicability date for affected contracts

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Equitable Adjustment Administration• FAR 52.230-2(a)(4)(i), entitles contractor to an equitable adjustment if the

contract cost is affected by a required change in cost accounting practice– CAS 9903.201-6(a), prior to any equitable adjustment, the Contracting officer makes a

finding that the practice change was required to comply with a modification to CAS

• Resolving adjustment amount for affected contracts– Desirable to resolve GDM prepared for change in cost accounting practice centrally

with one cognizant Contracting Officer– Regulatory latitude on resolving Requests for Equitable Adjustment (REAs)

• CAS 9903.306(f), “Whether cost impact is recognized by modifying a single contract, several but not all contracts, or all contracts, or any other suitable technique, is a contract administration matter. The Cost Accounting Standards rules do not in any way restrict the capacity of the parties to select the method by which the cost impact attributable to a change in cost accounting practice is recognized.”

• What may be practical at one contractor may be wholly impractical at another contractor– Flexibility desirable to accommodate circumstances

– Subcontractor Requests for Equitable Adjustment• Coordinated through prime contractor or directly to Sub’s Contracting Officer?• Prime unlikely to be provided access to subcontractor data• Different fiscal years may create complexities

• Availability of DoD funding equitable adjustments?

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Opportunities for an Organized Process

• Role of DPAP – Guidance memo within DoD to educate, provide centralized oversight

• Role of DCMA HQ– Guidance memo to Contracting Officers, provide centralized oversight– CIPR

• Technical interpretation of amended Standards, especially where judgment involved • Engagement in initial audits on harmonized CAS costs

– Board of Review• Centralized oversight of Contracting Officer’s decisions for consistency

• Role of DCAA– Engagement in audits

• Role of Industry Associations– Disseminate information to member contractors– Facilitate mutually beneficial meetings with Government agencies

Documents

1 CAS Harmonization: Post Final Rule NDIA Contract Finance Committee March 12, 2012