Testimony of POGO's Danielle Brian to the Cost Accounting Standards (CAS) Board Review Panel
Thank you for the opportunity to appear before the CAS Board Review Panel. POGO is a nonprofit, nonpartisan organization that has, for over 17 years, investigated, exposed and worked to remedy abuses of power, mismanagement, and subservience to special interests, by the federal government. I want to add that it is particularly symbolic that we should be meeting here in the Elmer Staats' Room of the General Accounting Office. General Staats served with distinction not only as Comptroller General, but as Chairman of the CAS Board for ten years. More recently, he served as Chairman of the Federal Accounting Standards Advisory Board. General Staats was a fearless and tireless advocate for the CAS Board, and the need for Cost Accounting Standards. I hope this Panel serves in the tradition and spirit that he established for the CAS Board, and more importantly for the general public interest.
In June 1996, when establishment of the CAS Board Review Panel was requested by the former Chairman of the House Committee on Government Reform and Oversight and the Chairman of the Committee on National Security, POGO became concerned that this action would be another attack on the need for Cost Accounting Standards and the CAS Board. We remain concerned. Over the years since establishment of the original CAS Board, the Government contracting industry has generally opposed many of the accounting standards-setting activities of the Board. In other cases, industry has sought to restrict the application of CAS in Government contracting. This is understandable. The purpose of CAS is to increase the uniformity and consistency with which cost accounting data is supplied by contractors to the Government for the purposes of assisting in either negotiation, pricing or administration of contracts. Such increased uniformity and consistency necessarily restricts contractors in the accounting methods and techniques used to measure costs, assign costs to accounting periods, or allocate such costs to cost objectives when estimating, accumulating or reporting contract costs.
In our view, the stated Congressional basis for this Panel's review of CAS and the CAS Board in many ways "places the cart before the horse." For instance, recent acquisition reform initiatives have sought to increase the Government's reliance on commercially available goods and services. Similarly, other aspects of acquisition reform have sought to lessen the Government's need for cost accounting data when purchasing non-commercial (military or Government unique) goods and services. The Panel has talked extensively about commercial products as though their existence is relevant to this debate. In truth, I would love to talk about how the government has gone back to buying $76 screws, as well as the absurdity of negotiating "commercial" prices, but that is not at issue here. To the extent that the Government does purchase commercial items, such contracts are by definition, exempt from CAS coverage. Even when purchasing Government unique goods and services, CAS only applies when cost data is provided by the prospective contractor; and even then only when significant dollar thresholds are satisfied. Thus, POGO is somewhat mystified at what this Panel is seeking to review. Whether a contract may be subject to CAS seems to us to be an issue relative to the contracting method deemed appropriate for use under the circumstances. If cost accounting data is required, then CAS applies. If such data is not required, then CAS obviously does not apply. It is the Government's need for, or requirement to provide cost data, in its various contracting strategies, that triggers application of CAS, not vice versa. Why would the government want to enter into a contract that requires cost data, but not want that data to comply with CAS standards? Since CAS is by definition only used when cost-based pricing arrangements are used in government contracting, we have to question whether this Panel is in fact responding to contractor complaints regarding the substance of the CAS Board decisions.
At this point, I would like to address the specific issues for which comments were requested via the General Accounting Office (GAO) world wide web page.
(1) The Cost Accounting Standards Board's mission in a rapidly evolving integrated civil- military industry.
Whether the Government's supplier base is "rapidly evolving" into an "integrated civil-military" industry is in our view not particularly germane. Rather, stripped to its core, the real issue is the future role of cost-based contracting methods in the Government's procurement process.
According to information from the Federal Procurement Data System and the Department of Defense (DOD) Inspector General (IG), at present, cost-based Government contracting accounts for approximately 70% ($125 billion +) of all contracts let by the Government. Roughly 60% of these contracts are cost-reimbursement, and another 40% are fixed-price, but involve the submission of cost data for contract pricing, payment or incentive purposes.
If, in the future, there is a large shift to price-based contracting, then any CAS issue will automatically become moot. This brings us to POGO's chief concern. If CAS applicability is dependent upon the use of cost-based pricing or contracting techniques to purchase non-commercial items, then the only real CAS issue seems to us to be the specific content of the CAS Board's Standards, disclosure requirements or contract price and cost adjustment provisions. This is very troubling.
Without cost accounting principles, as embodied in the Standards, how will contract prices, target costs and estimated cost ceilings, including fees or profit, be determined? What will Government payments for contractor reimbursement claims be based upon if the Government will no longer rely upon CAS for the determination of actual contract costs accumulated in a contractor's cost accounting records? We are already seeing signs that although much new "acquisition reform" terminology is often being used, only the names have changed, the underlying contracting concepts have not changed at all. A good example of this is the use of so-called "other transactions." Such "other transactions" blur the distinctions between financial assistance instruments (grants and cooperative agreements that are generally used to support an entity's independent research and development efforts) and acquisition contracts where the Government acquires research and prototypes. To date, such "other transactions" have generally been placed in the form of cost-type contracts by another name, but without the traditional audit and cost allowability/allocability provisions. We are told that "other transactions" are designed to bring new firms into the defense industrial base. Yet, recent DOD IG testimony reveals that over 80% of such "other transactions" are being awarded to traditional defense firms. In these circumstances where research or prototype units are "acquired" by the Government, we would ask, how will cost sharing under the new "other transactions" concepts be validated? To what extent are projected or actual cost accumulations relied upon? How is such reliance different from the traditional cost-reimbursement contracting process?
Cost-Based Contracting in the Federal Acquisition Streamlining Act/Federal Acquisition Reform Act Era
While acquisition reform as embodied in the Federal Acquisition Streamlining Act and the Federal Acquisition Reform Act has unfortunately decreased cost data submission requirements, it has not significantly changed the ratio of commercial or price-based contracting methods to cost-based contracting methods. A recent GAO report showed that only about $10 billion of goods and services purchased by DOD in FY 1997 were classified as "commercial" and conducted pursuant to Federal Acquisition Regulation Part 12. As previously mentioned, if at some point in the future, the Government were to significantly shift to price-based contract pricing techniques, then any CAS issues would automatically dissipate. Again, the question is not CAS, but rather the Government's continuing use of cost-based pricing. That is not a CAS issue. CAS exists to provide meaningful accounting conventions in a cost-based contract pricing environment. Thus, in a cost-based contract environment where civil and military products or services are provided to customers from a common work force or production line, there is a clear need for an agreed-to set of rules governing a contractor's cost accounting practices, particularly when the projected or actual costs of contract performance are a factor influencing the negotiation of a contract price or the payments to be made for allowable costs. This is because the total costs of the contractor's overall operations have to be accounted for. Then, the portion of the total costs of operation to be identified with individual orders, Government contracts, and other direct or indirect activities need to be identified in an equitable manner. CAS is designed to accomplish this objective by requiring cost- based contractors to apply their cost accounting practices consistently when estimating, accumulating and reporting the costs of performing individual contracts. CAS also specifies how costs are to be "allocated" to intermediate and final cost objectives. It is my understanding that for selected items of costs, certain CAS either constrain or modify the period cost assignment principles applied for financial statement reporting purposes under Generally Accepted Accounting Principles (GAAP).
(2) Costs, benefits, and risk assessment in the application of cost accounting standards to government contractors (including differences based on industry, segment, type of cost, character of goods or services, contract type, and so forth)
CAS rules address such issues as disclosure and consistent application of accounting practices, and the methodology for the allocation of indirect costs. Because of CAS and the associated disclosure requirements, less auditing effort is required because the range of acceptable accounting alternatives is understood by both contracting parties. Selective audit review can be limited to a compliance check rather than an open debate on the judgmental interpretations between the Government and the contractor regarding what is acceptable accounting for costs. Smaller samples can provide adequate assurance levels to conclude that contractor accounting methods are compliant.
Costs and Benefits of CAS
In 1978, a distinguished panel of accountants and economists reviewed the costs and benefits of the CAS Board and its rules, regulations and standards. It concluded that CAS have had a significant and desirable influence on defense contracting. In particular, the panel concluded that CAS reduced the level of misunderstandings, increased the level of reliance on contractor cost data representations and increased auditor productivity.
More recently, in late 1996 (post-acquisition reform) the DoD gave a strong endorsement of CAS and concluded that CAS was critical in protecting the government's interests: Without rules to require consistent treatment of costs, the government could not rely upon a contractor's cost representations and would bear significant risks of inequitable contract prices and cost allocation. Since the GAAP are not equipped to address these concerns, the CAS play a vital role in protecting the government's interests.
POGO has heard an increasingly loud shrill sound emanating from some Government contractors that they should be exempt from CAS because they are "commercial." POGO believes that these claims are a smoke screen for the real issue -- not being held reasonably accountable to the taxpayer when engaged in cost-based pricing or contracting. Perhaps a more objective review of these "commercial company" claims would suggest that the Government should not consider such firms for cost-based pricing or contracting arrangements. In POGO's view, a firm that cannot comply with CAS when engaged in large dollar cost-based pricing with the Government should be considered ineligible for contract award. Companies should not be allowed to avail themselves of the advantages of cost-based pricing and contracting with the Government, without also being required to step up to the responsibilities this imposes. Sadly, some have seized on "acquisition reform" to shirk those responsibilities -- at least insofar as accountability to the public for their contract cost representations and claims for reimbursement.
Other groups or companies, for instance, colleges and universities, health insurance carriers, and so- called Integrated Dual Use Commercial Companies (IDCC), are also hoping to be exempted from CAS. Although these three groups all have unique claims to make, they are not unique to the extent that cost-based pricing or reimbursement is used in their dealings with Federal contracting agencies. For instance, we have seen claims that so-called IDCC firms should be relieved from CAS coverage because these companies are "commercial." However, our review of the record indicates that what is really sought is relief from cost accounting requirements that have been carefully considered and developed for use in cost-based pricing situations. Similarly, colleges and universities have lobbied for CAS exemptions based on their "uniqueness," but fail to mention that like their commercial counterparts, they receive reimbursements from the Government based on actual costs claimed. This was recognized by GAO in its 1993 recommendation to the CAS Board that CAS application be extended to college and university contracts (and grants) with the Government.
(3) The relationship of cost accounting standards to generally accepted accounting principles, activity-based cost systems, and cost allowability principles (including levels of complexity, overlap, duplication, conflict, and so forth).
CAS vs. GAAP
This is perhaps the most misunderstood aspect of CAS. Simply put, the purposes of GAAP and CAS are different. GAAP applies to the reporting of an entity's annual results of operations and financial condition at the end of a year. GAAP is intended to guide stockholders, potential investors and creditors. CAS, on the other hand, is concerned not only with the assignment of costs to particular cost accounting periods, but also with the allocation of the assigned direct and indirect costs to contracts and to other cost objectives.
As I mentioned above, the 1996 DoD study dispelled the notion that GAAP could in any way replace CAS in protecting the government's interests. The DoD opinion further stated: GAAP provides guidelines for financial reporting, but are inadequate for contract costing purposes . . . GAAP cannot provide reasonable assurance that such procurements will be fairly priced or will receive equitable cost allocations. In contrast, CAS contain criteria that provide the necessary assurance.
The original GAO Feasibility Study Report clearly concluded that GAAP does not serve contract costing purposes or address the identification of direct and indirect contract costs. This continues to be the case today in current accounting literature. This situation was recognized as recently as the "Report of the Section 800 Panel," and the Department of Defense response to the TASC/Coopers & Lybrand Report. The American Institute of Certified Public Accountants' (AICPA) most recent edition of "Audits of Federal Government Contractors" stresses this point. Is this panel going to reverse the accounting profession's long-standing conclusion?
Those who argue that GAAP may be used in lieu of CAS misunderstand both the nature of CAS and GAAP. CAS are the exclusive authoritative guidance for the cost accounting principles and practices used to estimate, accumulate, and report the costs of individual contract performance. Thus, the underlying purpose of CAS differs from GAAP in that CAS is concerned with the identification and allocation of an entity's costs to individual contracts, as either a direct cost or an indirect cost.
Some companies have also claimed that CAS imposes "new" or "burdensome" accounting requirements, or that it requires companies to "change" or establish separate accounting systems. In its 1996 opinion, the DoD also dismissed this myth: CAS evolved from sound commercial cost accounting concepts that are compatible with GAAP, consequently there should be no need for new or separate accounting systems, and extensive changes to existing systems generally should not be necessary to comply with CAS.
CAS is simply different than GAAP, because it serves a different purpose. CAS does not require a company to replace or modify its financial accounting system utilized for reporting the results of its overall operations. It only requires companies to utilize a cost accounting system that is adequate to record and allocate direct and indirect costs to particular jobs in an equitable manner. Obviously, CAS does require a company to establish a compliant cost accounting system. However, in our view, companies that have trouble with this fundamental concept have no business receiving or performing cost-based contracts.
CAS and the Contract Cost Principles
Over the years, a recurrent theme has been periodically raised that CAS and the contract cost principles in FAR Part 31 are in conflict with one another in various areas. To some extent this is true. The cost principles, of course, govern what costs are allowable (based on public policy considerations) under Government contracts. By contrast, CAS is concerned with the measurement, assignment and allocation of costs to contracts. Rather than eliminating CAS, we would suggest that one solution would be to combine authority for both allocability and allowability under the CAS Board in an effort to maintain these standards government-wide. I understand this approach was already suggested by the National Security Industrial Association in their response to the "Section 800 Panel," as well as by several academics.
During the debate on CAS, POGO has heard a number of complaints about Government "cost accounting rules" (for instance those of the IDCC member companies). Upon closer examination, however, it would appear that many of these "complaints" stem from, or more accurately relate to, the contract cost principles in FAR Part 31 -- particularly those relating to unallowable costs. Still other Government "cost accounting problems" more properly appear to be a matter of debate and/or interpretive disputes between the Defense Contract Audit Agency and various contractors. In our view, perhaps more rather than less specificity may be needed in the CAS in order to resolve these various ambiguities. We think that as this debate evolves, the various parties need to more specifically state what parts of CAS (or the contract cost principles) are in issue, rather than relying on generic broad brush statements.
We have also heard it said on occasion that the CAS Board has gotten itself into matters concerning the allowability of costs. We think these statements tend to come from quarters that are disappointed with the outcome of specific CAS Board rulemakings -- such as the ones that resulted in the changes to the pension costing standards, or the rule requiring that depreciation be based on original acquisition cost rather than a "stepped-up" basis following a merger or a business combination. We have also heard the reverse, that the cost principles frequently get into matters of allocability that are reserved for the CAS Board. Although reasonable people may disagree concerning these technical matters, POGO believes that we should leave these accounting issues to the people best qualified to assess their merits -- the Members of the CAS Board.
CAS and Activity-Based Costing
Activity-based costing or ABC, is a relatively new term designed to reflect increased emphasis on cost management techniques in business process reengineering. While the term is relatively new, the basic concepts are not. We have heard accusations that CAS is an impediment to those firms seeking to implement ABC. We respectfully disagree. We can find no provision in CAS that would prohibit use of any particular cost driver (indirect cost pool structure or cost allocation base) in an ABC environment. To the contrary, the CAS are quite conceptual in nature. The only basic CAS requirement is that there be a causal or beneficial relationship between the particular cost and its allocation to specific cost objectives, e.g., contracts. Perhaps the real reason why some firms have raised ABC as an issue, is that in their desire to implement an ABC system, they are unwilling to comply with the "no increased cost" to the government provision of the CAS contract clause. We see nothing wrong with the "no increased cost" prohibition in the CAS contract clause. If a contract was negotiated on the basis of one set of accounting conventions, a decision to switch to a different set of accounting conventions should not place the buyer - the taxpayer - in a worse off position. This is the basic reason why CAS was established in the first place.
POGO is very concerned by the direction of the current debate concerning CAS and the CAS Board. The arguments against CAS being heard today are no different than the ones that were espoused in 1970 in opposition to the creation of the original Board, or again in 1980, when contractors succeeded in cutting off funding to the Board. These arguments are as hollow now as they ever were. Even the buzz phrases remain unchanged, "use GAAP," "don't apply CAS to commercial companies or commercial items," "you need to change your whole accounting system for CAS." Even the "civil-military integration" argument has been made before. All of these make for great sound bites, but they mask the underlying issues. The real issue is: What cost accounting conventions or principles should apply to cost-based pricing arrangements used between the Government and many of its contractors? What is wrong with disclosure of a company's major cost accounting practices when dealing with the Government under cost-based pricing arrangements? I have heard a number of generalizations concerning CAS and the CAS Board these past few days, but little that is specific. I am inclined to ask: Where's the beef? If the beef is that the Government needs to review its procurement policies regarding the use of cost-based pricing - fine. I would love to have that debate. But, that is not a debate about CAS. However, if the debate concerns the contents of the CAS Board's rules, presumably after a decision to use a cost-based contract pricing arrangement has been made, then this Panel is going down a road in which it substitutes its judgment for that of a responsible accounting standards setting body established for that purpose. I respectfully suggest this is not the body to review the decisions made by the CAS Board.
GAO has always been supportive of the work of the CAS Board. Indeed, the Comptroller General chaired the original Board, and GAO, by statute, continues to play a vital role in the current Board's standards-setting process. In 1994, GAO issued a supportive report about the current Board which stated that its work is very important, and that the Board's biggest failing was that it was too short- staffed to timely complete projects on its agenda. Not surprisingly, this GAO report did not please some of the contractor critics of the Board. Thus, we find ourselves in a very curious situation where the Acting Comptroller General is the Co-Chairman of a Review Panel concerning CAS and the CAS Board that is not being conducted by GAO. Perhaps the requestors of this review were concerned that if GAO itself undertook to perform the current review, it would have reached a conclusion not too different from its 1994 report -- CAS is very important and the work of the CAS Board should be supported, not denigrated or politically attacked.
In 1996, at the close of Comptroller General Bowsher's term, GAO issued a landmark report on the independence of the accounting profession and its standards setting bodies. Although that report generally related to the work of setting accounting standards for financial reporting, its conclusions apply equally to the CAS Board's work. The independence of accounting standards setting bodies needs to be strengthened, not decimated. The establishment of accounting standards should be done in an environment that fosters objectivity and neutrality, sound principles and theory, logic and creativity; not in one dominated by politics, or a concern for specific outcomes. POGO hopes that GAO's involvement in this study will serve to enhance the CAS Board's independence, not make it subservient to special interests at the expense of taxpayers and the public interest.