(Editor’s Notes. DCAA has consistently selected accounts to audit where advertising or public relations costs may reside even if the accounts do not necessarily include those names. That practice, if anything, has increased. Since there is a limited number of cases addressing these costs, we find DCAA often takes expansive positions in questioning these costs where non-DCAA auditors (e.g. other federal agencies, local and state auditors) take even more creative positions on questioning any cost such as marketing and sales that may possibly be interpreted as advertising or public relations. Though we have addressed such costs in the distant past we thought it would be a good idea to provide an update since these costs are increasingly subject to audit scrutiny and are being questioned more often. We have used an article by Karen Manos in the May 2011 issue of the CP&A Report and our own experience working with various types of auditors.)
History
Though advertising is obviously an ordinary and necessary cost of doing business advertising costs have long been treated as unallowable unless permitted by the cost principle under the theory that the government receives no benefit from contractor advertising. Under the Armed Services Procurement Regulation (precursor of the FAR in 1986) there was a fairly long history of identifying allowable and unallowable advertising costs where some changes were more and other changes were less restrictive. By 1962, all costs of advertising were prohibited as either direct or indirect costs except for three exceptions: (1) recruitment by the contractor of personnel required for contract performance (2) procurement of scarce items required under the contract and (3) disposal of scrap or surplus materials acquired by the contractor in performance of its defense contracts.
Up to this time public relations costs were not considered to be advertising costs and were not covered by the cost principle. However the cost principle was revised to include public relations in response to a seminal case that was decided in rejection of DCAA’s long contention that public relations costs were a form of advertising costs and hence unallowable. In Aerojet General (732 BCA) the Appeals Board defined “advertising” as “paid use of time or space” noting that Aerojet’s public communications department did not pay for time or space to communicate its messages and hence its related activities (e.g. printing and distributing company brochures, conducting liaison activities with media and government) were allowable business expenses.
Unsuccessful in its attempts to have public relations added as a cost principle, DCAA took it upon itself to make public relations costs unallowable in its Contract Audit Manual on the basis of reasonableness. Over half a billion dollars a year were questioned by DCAA but much of it was subsequently allowed by Contracting Officers. Finally, the Defense Procurement Act of 1985 directed the DOD Secretary to include 10 types of costs to be unallowable, which included advertising designed to promote contractors’ products, and 16 other categories of cost principles “to be clarified” which included public relations. Effective April 7, 1986 the advertising cost principle was re-titled “Public relations and advertising costs” where certain public relations costs were made unallowable. Similar to the current cost principle the April 7 revision made expressly unallowable the costs of (1) air shows, conventions and exhibits (2) sponsoring meeting and other events unless the principle purpose was the dissemination of technical information or stimulation of production (3) ceremonies such as corporate celebrations or new product introductions (4) promotional material, motion pictures, brochures, handouts, magazines and other media designed to call favorable attention to the contractor or its activities (5) souvenirs, models, imprinted clothing, buttons or other mementos (6) costs of membership in civic and community organizations and (7) all other public relations costs, except those expressly allowed by the cost principle, whose primary purpose is to promote the sales of products or services by stimulating interest in them or disseminating messages calling favorable attention to the contractor for enhancing the image of the company to sell products or services.
Changes to the cost principle as well as the selling cost principle on May 15, 1991 were made to allow costs to promote exports of the US Defense Industry that includes air shows, special events or trade shows. In addition relatively minor changes were added in the 1990’s to add the costs of “conventions” to the list of unallowable public relations and advertising costs.
Analysis
First, the cost principle treats public relations differently than advertising. Paragraph (d) of the cost principle contains an exclusive list of allowable advertising costs where those not specified are unallowable. In contrast, the list of public relations costs in the same paragraph are intended to be illustrative rather than exclusive. Therefore, the costs of similar activities are allowable provided they meet the general tests of allowbility and are not prohibited by section (f).
The author states the unallowable rules in (f) focus on both the purpose and form of the activities. Public relations and advertising costs, other than those identified in sections (d) and (c) of the cost principle, are unallowable if their primary purpose is to promote the sales of the company’s products and services by either stimulating interest in a product or product line or disseminating messages for the purpose of enhancing the company’s image. And regardless of the purpose, the costs of souvenirs, models, imprinted clothing, buttons and other mementos provided to customers or the public are unallowable. The author notes, which is consistent with our experience, that DCAA often questions such costs even when they are provided to employees.
Also the term “costs” is broadly defined to include not just costs of media time, space and services but also applicable portions of salaries, travel and fringe benefits paid to employees engaged in public relations and advertising. DCAA has taken upon itself, without any citations, to expand this list in its DCAM Chapter 1202.c(2)(ii) to include “an allocable share of supervision, space, utilities and administrative costs.” Nonetheless, DCAA is instructed to consider only “material” (not defined) amounts of salary or wage costs associated with public relations and advertising costs when deciding on questioning these associated costs.
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