National Defense Industrial Association
Cross Border Cost, Accounting and Pricing
Considerations
Associated with Federal Government
Contracts
Mary Karen Wills, Partner
Beers & Cutler PLLC
March 2006
Topics

Contracting Considerations
 Pricing Considerations
 Cost Issues
 Cost Accounting Standards Considerations
 Government Audit Considerations
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Contracting Considerations
Contract Considerations

Contracting method will dictate many cross border
issues
– Commercial item contract
– Negotiated contract
– Specific contract type, e.g. cost type, fixed-price, T&M

Contracting agency and associated regulations will
also dictate cross border issues
– United States government agency
– Foreign government agency

Our Focus will be primarily on contracts with United
States government
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Commercial Item Acquisition
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Commercial item contracts more prevalent
Negotiated commercial item contracts provide for
government access and right to examine records
related to contract – information other than cost or
pricing data
Most Favored Customer Clause Compliance deserves
consideration – often included in agreements
Consider how foreign contractors can or will support
comparable pricing data for discounts and pricing
history—accuracy, completeness and verifiability
Anticipate unique clauses for inclusion
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Negotiated Procurement
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If contract exceeds $550,000, the Truth in Negotiation
Act applies unless an exemption is met. No special
exemptions for foreign concerns.
Contractors required to submit current, accurate and
complete cost and/or price information.
Responsibility for subcontractor cost or pricing data
could raise issues with foreign companies and ability to
substantiate with cost or pricing data. Also consider
prime’s responsibility for reviewing cost or pricing data,
and how this will be accomplished.
Consider how to accomplish “assist audits” overseas.
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Options for Structuring Foreign Work

Contract/subcontract with a separate foreign
company
 Contract/subcontract with an existing foreign
related party entity
– Subsidiary
– Division
– Branch

Set-up a new related party foreign entity
 Joint Ventures and teaming arrangements
 Strategic alliances
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Options for Structuring Foreign Work

Tax issues may be important in driving
selection of entity
 Consider obtaining in-country local knowledge
 Many companies outsource accounting and tax
functions in-country, especially payroll
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Pricing Considerations
Incremental Costs To Include in Cost
Estimates or Bid Prices

Many contracts with foreign concerns result in
significant incremental costs over domestic concerns.
Consider:
– International transportation/shipping – impact can often be as
high as sales price. Not typically included in domestic bids.
– Insurance – multiple handling points and differing risks warrant
consideration
– Taxes – employee and employer, VAT, local, income taxes
– Export licenses, permits and legal fees
– Employee Wage Differentials
– Foreign currency translation costs
– Letter of credit/financing costs
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Employee Compensation Costs

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Expatriates or local hires?
Country specific rules and agreements:
– Residency
– Requirement to pay personal income tax in country and United
States
– Credit available to United States tax ($80,000 exclusion)
(United States, Germany, Italy, United Kingdom)

Compensation differentials often include:
–
–
–
–
–
–
Cost of living increases
Housing
Relocation
Tax gross up
Travel in country and to US
Education expenses
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Employee Compensation Costs

FAR 31.205-6 Compensation explicitly covers
allowability for additional income tax resulting
from foreign assignments

FAR 31.205-6 also includes limits on
severance payments to foreign national
performing on contracts outside the US.
Amounts deemed allowable up to amounts
typically paid in U.S. Other provisions also
included.
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Consider Incremental Costs in Pricing
Contract

Contract type may dictate need for inclusion of
special clauses to ensure adequate recovery of
additional costs due to cross-border issues.
 Cost-type contract, consider clauses detailing
types of costs considered to be reimbursable
 Fixed-price contract, consider EPA clause or
other clause to mitigate foreign currency
exchange risk
 Ensure bids include adequate estimates for
incremental costs
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Payment Considerations

Complexities can arise in relation to obtaining
payments. Consider currency to be used? What
exchange rate applies? How payment will be secured?
 Clarify payment method in contract, if unusual – eg,
advance payments, negotiated payment schedule
 Consider ability of foreign entity to timely submit
progress payment support
 Consider working capital requirements related to
progress payments
 Consider how to structure payment terms with foreign
payors, often letters of credit need to be established by
US companies.
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Cost Matters
Cost Matters
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Certain costing issues arise in connection with dealing
with related party foreign concerns, e.g. joint venture,
subsidiaries, branches, etc.
These costing issues often arise as entities fulfill
contractual obligations using multiple entities of the
organization, e.g. borrowed labor, intercompany
purchase of products, maximizing existing capabilities.
These issues create a need for supportable transfer
pricing methodologies between related party entities.
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Transfer Pricing Example
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Entity A provides IT services, installs hardware and
performs training. Entity is located in Houston, TX
Entity B is a subsidiary located in India that provides
call center services to government and commercial
entities.
Entity C produces computer hardware in China only for
sale to US Government.
All three entities are collaborating on a US Government
contract. How will costing and pricing be performed for
all entities?
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Transfer Pricing Issues
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Related party entities typically establish transfer pricing
policies, that is pricing policies for products or services
sales between segments or geographic locations
Transfer pricing includes how the price is determined,
e.g. base cost, indirects, G&A and profit to be applied
between related party entities
These transfer pricing policies should be established
and should ensure consistency of pricing methods
Need to consider whether transfer pricing policies have
already been established in CASB Disclosure
Statements or GAAP accounting and how they will be
adhered to and comply with FAR and CAS.
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Transfer Pricing

Often transfer pricing is determined based on
trying to minimize taxes. Typically required to
be arm’s length. Arm’s length definition varies
by country and is often subjective.
 Many times, transfer pricing includes a profit
element.
 Contractors can use differing transfer pricing
methodologies for contract costing purposes
than are used for tax or reporting purposes.
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FAR 31.205-26 Material Costs

FAR 31.205-(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 at 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
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Transfer Pricing for Internal Services

Companies often look to other parts of a
consolidated entity to provide not only contract
or end product items, but also internal services,
like accounting, HR, legal, IT.
 Transfer pricing policies, or written MOUs
should be developed that detail how these cost
transfers will be determined.
 These must also be consistently adhered to
and used for cost buildup purposes, where so
required.
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Cost Allowability Considerations

Federal Acquisition Regulations – FAR Part 31
cost principles do not cover all costs
associated with foreign contracts
– GAAP (Generally Accepted Accounting Principles)
provides guidance on accounting treatment where
FAR is silent
– International Accounting Standards may differ from
US GAAP
– Examples, foreign currency translation costs
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Foreign Currency Cost Considerations

Denomination of Contract in local currency or dollars
– Highly inflationary economy? Cumulative inflation of approx
100% over 3 year period
– Stability of local currency?
– Ability to hedge exchange risk. Assess historic exchange rate
risk and economic data for future.

Contract Type – contractor assumes foreign currency
risk in fixed-price contract. Consider including EPA or
other adjustment clause to mitigate risk. (Elter S.A.
case, ASBCA No. 52441, 01-1 BCA)
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Foreign Currency Cost Considerations

Foreign Currency Translation Costs typically treated as
allowable costs
– No mention in FAR Part 31 cost principles
– GAAP – Statement of Financial Accounting Standard No. 52
(SFAS 52)
– Exchange gains and losses recorded under GAAP represent
allowable costs
– GE Case – Government originally disallowed a portion of
depreciation charges on spare parts order. re translation of
depreciation expense “in converting into dollars the
depreciation cost of a contractor’s foreign affiliate whose local
economy is highly inflationary, historic exchange rates must be
used.
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Cost Accounting Considerations
Cost Accounting Standards (CAS)
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Foreign contractors and subcontractors are subject to
the same CAS and Disclosure Statement requirements
applicable to domestic firms.
However, in lieu of filing a CASB DS-1 Disclosure
Statement, a foreign concern may, with CAS Board
approval, use a form prescribed by an agency of its
government.
The CAS Board has approved alternative forms for
contractors from Canada, Federal Republic of
Germany and the UK.
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Cost Accounting Standards Coverage

If contract value exceeds $50 million or $50
million of CAS covered contracts in last fiscal
year, full CAS Coverage (19 Standards apply)
 If contract value exceeds $7.5 million, modified
CAS coverage (4 Standards apply)
 Disclosure Statement required at full CAS
Coverage (consider Home Offices and
Segments)
 Must consistently follow disclosed practices
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CAS Considerations

CAS provides an exemption for:
– Contracts and subcontracts executed and
performed entirely outside the U.S., its territories
and possessions (may go away?)
– Contracts and subcontracts with foreign
governments or their agents and instrumentalities
– Contracts and subcontracts awarded to foreign
concerns (except CAS 401 and 402)
– Subcontracts under the NATO PHM Ship program to
be performed outside the US by a foreign concern
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UK CAS Disclosure Statement
Considerations

UK contractors are allowed to substitute the
UK QMAC “Questionnaire on Method of
Allocation of Costs” and recent Supplemental
QMAC for the DS-1.
 QMAC consists of 9 schedules detailing
general accounting system disclosures, along
with bases for recovery of indirect expenses,
and detailed supporting schedules.
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CAS Considerations

Note that when a subcontract is awarded under
a CAS-covered prime contract or higher-tier
subcontract, CAS coverage of the subcontract
is determined in the same manner as it is
determined for the prime contract.
 Ensure that prime contract is CAS covered
before assuming subcontracts are subject to
CAS!
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Government Audit Considerations

DCAA presence limited overseas
 Foreign audit agencies experience and
capabilities differ
 Consider
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–
–
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How to affect assist audits on foreign companies
Financial capability assessments
Indirect rate agreements
Forward pricing agreements
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Tips for Consideration
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Include contract clauses regarding treatment of unique
costs as allowable and reimbursable, or determine the
basis will be used to determine allowability
Consider impact of potential contract termination and
how termination recovery will be determined, including
cost differentials
Anticipate incremental costs to maximum extent at time
of proposal preparation or contract negotiation
– Put cost differentials in bids
• Employee compensation
• Taxes
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