Definition. FAR 31.205-17 defines "facilities" as land, plant, equipment or other tangible assets owned or leased by the contractor. "Capacity" refers to the unused capacity of partially used facilities where "unused" is the difference between what was used in an accounting period versus what a facility would use under 100 percent operating time on one shift less normal operation disruptions (e.g. set-up, repair, rework, etc.). A multiple shift basis could be substituted if it could be shown to be normal usage for the facility.
Types of cost. Before discussing questions of allowability and allocability, FAR 31.205-17 identifies the type of cost attributable to idle facilities or capacity as rent, depreciation, repair, maintenance, property taxes and insurance costs. In General Dynamics (ASBCA 19607), other costs under appropriate circumstances can qualify such as salaries, wages, fringe benefits of maintenance and security personnel as well as travel and communication expenses related to managing activities associated with idle facilities.
Allowability. Costs that arise from idle facilities are unallowable unless they meet one of the following criteria:
The facilities were necessary when acquired but are now idle because of changes that could not be forseen (because, for example, of unforseen changes in government requirements, production economics, reorganization or terminations).
The facilities are necessary to meet workload fluctuations.
If these conditions are met the costs of idle facilities are not allowable indefinitely but only for a reasonable time – usually one year – depending on the actions taken to avoid them. We will look at a few of these considerations in more detail.
"Necessary When Acquired." The Appeals Boards have interpreted "necessary" as a "reasonable expenditure" which is appropriate for conducting business (Boeing Co. ASBCA 13625). Thus allowability hinges on whether the contractor can demonstrate it made a reasonable business decision at the time the facility was bought or leased. Board decisions have ruled that the business decisions may be based on (1) anticipated increases in business (Vare Industries, ASBCA 12126) (2) need to expand facilities to produce at a rate to provide economies of scate to compete in a particular market (Raytheon ASBCA 32419) and (3) the unique characteristics of a product preclude use of its other facilities (Aerojet-General, ASBCA 15703). However, another case – Hercules Inc., ASBCA 18382 – ruled that the costs of idle facilities were unallowable when they were not needed when obtained (they were acquired to enter a new market but the new business could have been handled by existing facilities) and hence the new facilities were considered a calculated business risk the contractor chose to take rather than a necessary action.
Length of Time. After determining the costs were necessary, how long the costs are to be allowed must be addressed. This is the most contentious issue we encounter. FAR 31.205-17(b)(2) suggest the period "generally" should not exceed one year. As a practical matter, when left to its own judgment, DCAA interprets the one year as a maximum period while Board Decisions offer opportunities to go beyond one year. For example, in General Dynamics, the Board ruled a showing of "diligent or reasonable efforts" to dispose of facilities "permits recovery of costs for a longer period." The Board went further recognizing that diligent efforts to mitigate the costs may be unsuccessful for several years resulting in extending the period of allowability. The board has not decided what constitutes "reasonable effort" though the authors indicate the "prudent business person" standard should apply and be decided on a case-by-case basis.
(Editor’s Note. Though some Board cases and as we show below, even DCAA guidance, indicates the one year language of the FAR should be a general guideline allowing some flexibility to negotiate longer periods, it is usually quite an uphill battle to convince DCAA or a contracting officer to go beyond one year. If the cost of idle facilities is expected to exceed one year, your best chances of prevailing is to go to the CO (DCAA will rarely take the initiative to extend the period) and negotiate, beforehand, a special agreement rather than attempt to justify a longer period after the costs were incurred and a longer period has elapsed.)
Workload Fluctuations. FAR 31.205-17(b)(1) permits contracts to treat didle facilities costs as allowable if they are necessary to meet fluctuations in workload. Board decisions provide little guidance to when this condition is met, leaving such determinations to be made on an individual basis. The discussion above related to "necessary" can be used and on case – Aeroject-General Corp. – has validated the principle that facilities need not be used continuously for them to be allowable. Facilities used intermittently for research and development or to store unused equipment and machinery meet the non-continuous princople (see Cook Electric Co. ASBCA 17100).
To better ensure recovery of idle facilities costs, the authors recommend contractors maintain detailed records of all efforts taken to use, lease or dispose of those facilities. The records should document unique circumstances such as environmental problems, the local real estate market (e.g. preventing subleasing or only partial recovery of lease costs). Also, market projections, production schedules or other information useful to justify a decision to retain facilities to meet expected fluctuations in workload.
FAR 31.20517(a) defines idle capacity as the "unused capacity of partially used facilities.: Under FAR 31.205-17(c), the costs of idle capacity are viewed as normal costs of doing business and are considered as a factor in the normal fluctuations of usage or overhead. Like idle facilities, they are allowable proved the capacity (a) "is necessary" or (b) "was originally reasonable and not subject to reduction or elimination by subletting, renting or sale." The cost principle does advise that widespread idle capacity in a plant or group of assets may be considered idle facilities, subject to the same rules as idle facilities.
There have been some cases ruling on when capacity is considered idle but there is no clear guidance. In AVCO Construction (ASBCA 10858), 13 percent of the company’s capacity was considered idle and hence unallowable. In Cook Electric, the Appeals Board ruled that buildings with less than 25 percent idle capacity did not gie rise to unallowable costs but higher amounts did. When the government suggested idle capacity existed due to excessively high overhead rates, the Board ruled in Stanley Aviation Corp. (ASBCA 12292) that high overhead rates, in themselves, did not establish the existence of idle capacity.
Standby Costs. Standby costs, which are costs incurred to maintain a facility at a capacity higher than currently needed, are usually allowable if reasonable. In Big Three Industries, Inc. (ASBCA 16949), the Board allowed standby costs when the government reduced its contract needs but failed to notify the contractor who presumably could have taken action to either reduce costs or obtain other business with better notification. In Fred D. Wright Co. (ASBCA 7200), the board ruled reasonable standby costs were allowed, because the standby costs were for the government’s convenience.
Allocability. Once a facility become idle the basis for allocating the facility’s continuing costs becomes an issue. The Aerojet-General decision established that consistency with past parctices should be seriously considered. The case established other criteria to be considered when establishing an appropriate allocation base: (1) the relationship of thw work previously performed at the idle facility to the contractor’s other work (2) historical relationship of the idle facility with other business units within the company and (3) the effect of reactivating the facility would have on the contractor’s other work.
In General Dynamics, the Appeals Board endorsed the principle that idle facility costs can be likened to independent research and development/bid and proposal costs characterized as normal costs of an ongoing business and hence allocated on a broad base (e.g. G&A base). The Board rejected the government’s attempt to restrict allocation of the costs to only those contracts directly related to the closed facility, reasoning such a approach would systematically deny recovery of otherwise allowable costs. The Board said the criteria for allocations should be what is "equitable", indicating "burdening small firms with large extraneous sums" (???) was inappropriate.
The authors say that DCAA guidance on how to treat environmental cleanup costs incurred at contractors’ previous sites constitutes sound guidance on how to allocate idle facilities costs. In that guidance (DCAA MRD No. 92-PAD163IR, October 14, 1992), DCAA suggests that continuing costs from closed sites be assigned to the business unit where the remaining work of the closed site was transferred and included in that unit’s G&A expense pool. If no work remains from the site that was closed then the guidance suggests the site costs be transferred to the next higher group or home office and be included in the residual expense pool of the office and then be allocated just like any other residual pool expense.
DCAA Guidance. DCAA audit guidance in Chapter 7-1906.3a only addresses the length of time issue. Other references related to idle facilities (e.g. depreciation costs of idle facilities) reference the FAR cost principle only. In our experience, we have never seen DCAA allow a period longer than one year for otherwise allowable idle facilities costs unless there was a prior agreement with the ACO. Interestingly, the guidance explicitly recognizes the validity of extending the period beyond one year and provides some detailed conditions and criteria for extending this period. It states the regulation provides the CO with flexibility to accept a longer period. It urges auditors to recommend the CO obtain justification for a longer period when the facilities are expected to be idle for more than one year. The guidance specifies, at a minimum, the proper justification to ?? including (1) whether the facility will be needed in the future and why (2) if not needed, what actions are being taken to lease or dispose of the facility and (3) an estimate of time to lease or dispose of the facility based on current market conditions, surveys of real estate prices, public record of real estate sales for similar facilities, etc.
The guidance states the auditor should assist the CO in determining a reasonable period bu stresses both the CO and contractor should seek an advance agreement specifying the maximum period for which idle facility costs will be reimbursed. Without such an agreement, DCAA will question any amount over one year.
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