1. finance
2. accounting and auditing
3. tax preparation and planning

Government and
Commercial Work
Watkins Meegan,
A Division of CohnReznick
Should you organize your company to isolate its Government
work from its commercial work?
March 26, 2015
1
Maybe
Just because you are in a highly regulated industry doesn’t mean that the laws
of economics are suspended for you.
March 26, 2015
2
Objectives
What should determine how my business is structured?
What problems are not solved by my business structure?
What is my organization structure going to do to how I price
interdivisional transfers?
What is the underlying problem I am trying to solve?
March 26, 2015
3
W h a t S h o u l d D e t e r m i n e H o w Yo u r
Business is Structured?
Business Considerations
Capital Utilization - Economic reasons
Risks - Internal control and cultural reasons
Legal and Tax Considerations
March 26, 2015
4
W h a t S h o u l d D e t e r m i n e H o w Yo u r
Business is Structured?
Legal Entities – see your attorney and / or tax advisor
March 26, 2015
5
W h a t S h o u l d D e t e r m i n e H o w Yo u r
Business is Structured?
Business Unit
“any segment of an organization or an entire business organization that
is not divided into segments” (FAR Part 2, CAS 410, 411, and 414).
General and Administrative (G&A) expense “any management,
financial, and other expense which is incurred by or allocated to a
business unit and which is for the general management and
administration of the business unit as a whole…” (FAR Part 2)
March 26, 2015
6
W h a t S h o u l d D e t e r m i n e H o w Yo u r
Business is Structured?
Organization Structure
Management establishes structures, reporting lines, and appropriate authorities
and responsibilities in the pursuit of objectives. (COSO Integrated Framework Principle No. 3 of 17).
March 26, 2015
7
Business Considerations
Product or Service
• What do you sell and how do you sell it?
Capital Utilization
• Cost Saving Synergies
• Hard Assets, Soft Assets, and
• Support Functions – Management & Administration
Resources
• People (expertise, etc.)
• Physical (e.g. location, facilities, etc.)
March 26, 2015
8
Legal Considerations
Laws,
Regulations,
&
Compliance
Infrastructure
Reliance on Legal Protections or Barriers to Entry
Intellectual Property Protection
International Traffic in Arms Regulations (ITAR), Classified Contracts, etc.
Commercial Pricing Support
Compliance Systems
March 26, 2015
9
Cultural Considerations
Government contractor doing commercial work
vs.
Commercial contractor doing government work
March 26, 2015
10
What problems will not be solved?
Government Oversight
Use of commercial pricing for Government work
 Establishment of commerciality
 Support for price reasonableness
Audits of commercial entities
 Termination of commercial items
 Supporting allocations of items required to be transferred at cost
 Audit support
March 26, 2015
11
What problems will not be solved?
Cost Allocation
Home Office allocations
Costs benefiting other or multiple divisions
Service center costs
Intercompany transfer pricing / costing
March 26, 2015
12
March 26, 2015
13
Interdivisional Transfer Pricing
FAR 31.205-26(e)
Allowance for all materials, supplies, and services that are sold or transferred
between any divisions, subdivisions, subsidiaries, or affiliates of the
contractor under a common control shall be on the basis of cost incurred in
accordance with this subpart. However, allowance may be price when-1) It is the established practice of the transferring organization to price interorganizational transfers at other than cost for commercial work of the
contractor or any division, subsidiary, or affiliate of the contractor under a
common control; and
2) The item being transferred qualifies for an exception under 15.403-1(b) and
the contracting officer has not determined the price to be unreasonable.
March 26, 2015
14
Interdivisional Transfer Pricing
Remember the PED rule for interdivisional transfer pricing?
 Practice
 Exception
 Determined
What is considered adequate policies and procedures?
•
•
•
•
Established (practice) policies and procedures
Adequately describing how transfer pricing is billed and booked to projects
Issue standardized Purchase Order (PO)
Invoices from related party transaction – i.e. treated like a third-party
transaction
March 26, 2015
15
Interdivisional Transfer Pricing
FAR 15.403-1(b)
Exceptions to certified cost or pricing data requirements…(but may
require data other than certified cost or pricing data as defined in FAR
2.101 to support a determination of a fair and reasonable price or cost
realism)—
(1) Adequate price competition
(2) Set by law or regulation
(3) Commercial item
(4) Waiver has been granted
(5) Modifying a contract or subcontract for commercial items
March 26, 2015
16
Interdivisional Transfer Pricing
Market Price controlled by Forces of Economics?
• The intercompany, division, or affiliate is buying the products or services at
prices established by the market.
• The Market determines a fair and reasonable price not the relationship
between the related parties. (Market pressures control the price, not the
relationship.)
• Commercial divisions may offer the related division a discount on the price
March 26, 2015
17
Interdivisional Transfer Pricing
Commercial Product / Item – FAR Part 12
•
•
•
•
Fair and Reasonable Price – Not based on Cost
Commercial Market exists for goods or services
Substantial Quantity Sold
Evidence
March 26, 2015
18
Interdivisional Transfer Pricing
Two Separately disclosed & established practices:
• Intercompany Transfer-ins
• Intercompany Transfer-outs
March 26, 2015
19
Interdivisional Transfer Pricing
FAR 31.205-26(f)
When a commercial item under paragraph (e) of this subsection is transferred
at a price based on a catalog or market price, the contractor-1) Should adjust the price to reflect the quantities being acquired; and
2) May adjust the price to reflect the actual cost of any modifications
necessary because of contract requirements.
March 26, 2015
20
Interdivisional Transfer Pricing
Accounting for Intercompany Transfer Pricing
Can a division purchasing commercial goods apply G&A to the
intercompany transfer-in if the G&A (or home office costs) were
already allocated to the product?
How about applying profit on a good from a commercial division
that already includes profit?
March 26, 2015
21
Interdivisional Transfer Pricing
What is the difference between transfer at Price versus Cost?
Cost
Price
‒ Direct Material
‒ Direct Labor
‒ Other Direct Costs
‒ Subcontractor Costs
Total Direct Costs
‒ Direct Material
‒ Direct Labor
‒ Other Direct Costs
‒ Subcontractor Costs
Total Direct Costs
‒ Fringe
‒ Overhead
‒ G&A
Total Indirect
‒ Fringe
‒ Overhead
‒ G&A (only once)
Total Indirect Costs
Total Costs
Total Costs
Profit
Price = Includes Profit
Profit
March 26, 2015
22
Interdivisional Transfer Pricing
Best Practices
• Obtain commercial determination from the Contracting Officer
• Document, document and document to support practice (i.e. PO, Invoices,
Policies & Procedures, etc.)
• Consistently Practiced – no matter the pressure from Management
• Train Proposal Teams, Pricing and Buyers in Procurement on policy and
procedures
• Offer Quantity Discounts, if appropriate
• Avoid Modifying Item or services – to avoid reporting actual cost
March 26, 2015
23
What is the underlying problem we
were trying to solve?
Government Oversight
March 26, 2015
24
DoD IG Report of Significant
Incurred Cost Audits
Questioned
Amount
Unsupported
$
Statute of Limitations (FY + 7)
CAS and Other Allocation Issues
Not Described
Material or Subcontracts
Other FAR Part 31
Other (e.g., Calculation Errors, etc.)
Legal Costs
Health Insurance Costs
T&M Qualifications
Labor
Executive Compensation
Not in Accordance with Contract
Travel Costs
Total
$
Reports
%
644.3
596.5
453.4
402.7
285.3
233.9
166.6
137.0
97.9
91.2
62.4
51.6
40.8
39.6
24
14
12
45
11
21
15
5
5
5
2
8
3
4
20%
18%
14%
12%
9%
7%
5%
4%
3%
3%
2%
2%
1%
1%
3,303.2
60
100%
25
DCAA Audit Support
What is the greatest audit risk for the contractor?
How to avoid that risk?
Understanding of the auditee
Communication with auditee
Understanding of relevant controls
Obtaining sufficient evidence
March 26, 2015
26
Conclusion
Should you organize your company to isolate its Government work from
its commercial work?
March 26, 2015
27
Contact Information
Steven Shamlian
Director
[email protected]
703-847-4428
Darrell Hineman
Director
[email protected]
703-286-1722
March 26, 2015
28