(Editor’s Note. In our consulting practice, we frequently encounter numerous challenges to the way contractors allocate selling costs. Imprecise rules and conflicting appeals boards decisions provide opportunities for the government to challenge allocations of otherwise allowable selling expenses to government contracts. We have relied on one of our favorite texts, Accounting for Government Contracts Federal Acquisition Regulation, edited by Lane Anderson as well as our own experiences as consultants for this article.)
Selling is a generic term that includes all effort to market a contractor’s goods and services. Individual portions of the Federal Acquisition Regulation cover various aspects of selling and marketing activities: advertising and public relations – FAR 31.205-1, bid and proposal costs – FAR 31.205-18, market planning – FAR 31.205-12 and direct selling costs – FAR 31.205-38. We will focus on direct selling costs which are defined as actions to induce particular customers to purchase a contractor’s goods and services. These efforts are usually characterized by person-to-person contact with potential customers. Selling activities include identifying potential buyers, learning of buyers’ needs, convincing potential buyers to purchase the contractors’ goods and services, negotiation and liaison between contractor and customer personnel, technical and consulting activities and individual demonstrations.
Selling costs are allowable if they are reasonable. There are certain prohibitions: (1) if they are considered advertising costs such as sales promotion or (2) sellers’ agents’ compensation – whether called commissions, fees, percentages, retainers, brokerage fees – is not provided by "bona-fide employees or established selling agencies." The latter simply means that compensation must be for actual legitimate sales services rather than that considered "influence" payments.
Other than challenges to non-allocability, if these prohibitions are not met then the only other basis to question the expenses is they are unreasonable. In determining reasonableness, the government considers the nature and amount of expense in light of expenses a prudent person would incur, the proportionate amount spent between government and commercial business, the trend and comparability with historical costs, general level of selling costs in the industry and nature and value of the expense in relation to contract value.
Unlike CAS 420, where allocation of bid and proposal costs are spelled out, none of the cost accounting standards address selling. The original CAS Board did consider addressing selling and marketing expenses but decided against it. Though the CAS Board did not assert sales expenses were a general and administrative cost, CAS 410 states the expenses may be included in G&A costs.
In general, the government views selling costs as being more closely related to commercial business and it is not uncommon to see the government (i.e. auditors) attempt to single out selling expenses as applying to commercial work only. Where some selling costs produce a clearly recognizable "benefit" to the government (say, cost of service incurred to adapt a commercial product to government use), other costs demonstrate less direct benefit. Auditors may suggest several methods to exclude allocation of selling costs to government contracts (e.g. they should be direct charged to commercial contracts, two or more selling cost pools should be created) and contractors need to counter with arguments that justify allocation to government. For example, to the direct charge to commercial contract contention, contractors can argue that selling costs are not incurred specifically for a contract because no contract exists when the costs are incurred – after all, the purpose of the expenditure is to secure a contract. (Editor’s Note. Auditors are prone to more aggressively question costs in certain areas with the understanding they may have to soften their stand if the contractor appears adamant in challenging their position. Allocation of selling costs is one of those areas and contractors should be prepared to state their position forcibly.)
Inconclusive Board Decisions
The appeals boards decisions are not always consistent and there seems to be enough decisions to be cited on both sides. On the side justifying allocation of selling costs to government contracts, the appeal boards have sympathized with the position that selling costs included in the G&A pool that are allocated to all work is appropriate due to the fact that as the business expands all contracts benefit because G&A is allocated over a broader base. Since there is no definite cause and effect selling costs are reasonably considered an overall cost of doing business. Acceptable allocation of indirect cots to a contract often depends on whether "benefit" to that contract can be demonstrated. In Lockheed- Georgia Co. (ASBCA 27660), which cited an earlier case – Lockheed Aircraft Corp v. US 375 Fwd 786 – the Board concluded the requirement to allocate costs on a benefit basis is established by any sound method of allocating indirect costs to government and commercial work. Similarly in General Dynamics Corp (ASBCA No 18503) the requirement to distribute costs in proportion to benefit may be satisfied by any reasonable method of allocating costs to both government and commercial work. Its selling costs for a commercial contract was allocable to government work because its success would reduce fixed overhead expenses. In Daedalus Enterprise Inc. (ASBCA 43602) bid and proposal costs for a foreign contract was also allocable to a government contract because the government benefits from a lower G&A rate as a result of foreign business. The Board understands that benefit exists because fixed expenses are allocated over a larger base.
Aydin Corp (West) (ASBCA 42760) provides further justification for allocating sales expenses to government contracts. The contractor’s practice was to record all commissions as an indirect cost and in one year when a non-government contract represented 91 percent of all commissions while the contract represented only 19 percent of the G&A base costs, the government and Appeals Board asserted allocation of 81 percent of the commissions to the government contract was inequitable. The US Court of Appeals reversed this position ruling the mere size of the commissions was not sufficient to justify different allocation method of the same costs – commissions – and to do so would be to violate CAS 402.
Though the cases discussed above support the conclusion that increasing a contractor’s overall business base justifies allocation of selling costs to government contracts it is not always a "slam dunk." In Capital Engineering Corp (ASBCA 11453) and Phillips Petroleum Co. (ASBCA 6830) the appeals board held new business ventures were so clearly commercial that an allocation to government work was not appropriate. In KMS Fusion (24 Cl. Cl. 582) and Sanders Associates (ASBCA 15518) certain selling costs were also not allocable to government contracts. Numerous ASBCA cases have held that salaries of sales people who are not involved in government contracts are not properly allocable to government contracts (see Century Title Co. ASBCA No. 1733, Wichita Engineering Co. ASBCA 2522 and Habney Brothers, Inc. – ASBCA 3629).
Other Allocation Issues
Deferral. In order to better match revenue and expenses many contractors are tempted to defer selling and marketing expenses to future periods for future contracts. Most authorities will reject this deferral because they view selling and marketing as period costs. Their similarity to bid and proposal costs where FAR 31.205-18 prohibits such deferrals supports their conclusion that selling costs should not be deferred.
Foreign Selling Expenses. Foreign selling expenses related to foreign military sales (FMS) have created special problems because of the changing regulations covering them. We often encounter confusion by both government and contractor representatives. A summary of the cost rule provisions are: Before March 1979 foreign selling costs were allowable. From March 1979 to January 1986, these costs were considered "unallocable" to US government contracts. Between January 1986 and May 1991 the FAR made these costs unallowable because a court decision confirmed the earlier "unallocable" position and the FAR Council said their unallocability made them "unallowable." After May 15, 1991 these costs are allowable if they consist of significant efforts to export products normally sold to the US government.
Commissions and Retainers. Commissions were once unallowable but are now considered allowable. The government has frequently tried to insist contractors treat them as direct costs. In Cubic Corp (ASBCA 8125) the government contended that all commissions should have been treated as direct costs of the applicable contracts but the appeals board ruled that commissions, like other selling costs, be treated as indirect expenses. In Daedalus the same issued was addressed with the same conclusions.
CAS 402 (as well as FAR 31.203 for non-CAS covered contracts) requires expenses, such as selling costs, be allocated either as direct or indirect to prevent double counting where a contract is allocated its share of selling costs as a direct cost and also receives an indirect cost allocation of the selling costs related to other contracts. The Cubic and Daedalus cases discussed above ruled that selling costs are incurred for the same purpose under like circumstances whether or not the selling effort was successful in obtaining new business. If the cost of successful selling efforts are allocated direct and those unsuccessful efforts allocated indirect, the Board rules a violation of CAS 402 and FAR 31.203 results.
Retainers, which are payments for general representation without regard to sales levels (most commissions are based on actual sales made) are considered a type of commission and follow the same rules of allowability and allocability.
Separate cost pools. In one form or another, the government may propose that several selling cost pools be created. When new work – government or commercial – is performed in an indirect cost pool where the base includes government and commercial work, both types of customers reap the benefit of increased volume. The author suggests it is generally inequitable to require separate selling cost pools for government and commercial work when the work is performed in the same indirect cost pool and hence the suggestion should be resisted.
© 2024 Government Contract Associates. All Rights Reserved.
