ASBCA Holds that Leases are not Necessarily Subject to CAS 404
In Exelis, Inc., ASBCA No. 60131 (29 Aug. 2016), the Armed Services Board of Contract Appeals (“ASBCA”) held that a concern whether a building lease was a capital lease or an operating lease is not subject to Cost Accounting Standards (“CAS”) 404.
In 2007, the Defense Contract Audit Agency (“DCAA”) released its audit of Exelis’ 2004 final indirect cost rates. DCAA questioned Exelis’ lease costs, finding that the building lease was a capital lease instead of an operating lease as claimed by Exelis and that Exelis could only include building depreciation in its indirect cost pool rather than the entire lease cost. In 2015, the Defense Contract Management Agency (“DCMA”) Administrative Contracting Officer (“ACO”) found that Exelis had improperly treated the building lease as an operating lease, rather than a capital lease as described in what is now Federal Acquisition Regulation (“FAR”) 31.205-11(h). Based upon the purported FAR violation, DCMA determined that Exelis’ accounting treatment was not in compliance with CAS 404, and asserted a government claim in the amount of $3,015,813 due to increased costs purportedly paid by the government on Exelis’ contracts from 2003 through the date of the final decision. The final decision attributed $2,586,354 of the $3,015,813 in increased costs to Exelis’ firm-fixed-price contracts. At issue in this decision was Exelis’ motion to dismiss the government’s claim because the lease was not subject to CAS 404.
The ASBCA agreed with Exelis and observed “[b]y its terms, CAS 404 applies to “Tangible Assets. The CAS defines ”tangible capital asset[s]” as ”asset[s] that [have] physical substance.” Thus, the plain language of the CAS provides that CAS 404 applies to tangible assets which are assets with physical substance. A lease is an intangible rather than a tangible asset because the lease itself is a legal right to use and occupy the building and does not have ”physical substance.”
In addition, the Board rejected the government’s argument that Exelis had acquired the building through the lease by noting that “the preamble to CAS 404 provides that the CAS Board is ‘willing that the contractor determine, for each acquisition, whether it is a purchase and hence subject to this capitalization policy (which must comply with the criteria established in this Standard) or a rental transaction and hence subject to established regulations on rental costs.’”
In this regard, the ASBCA rejected the government’s argument that the Preamble to CAS 404 should be interpreted consistent with financial accounting standards using generally accepted accounting principles (“GAAP”). According to the ASBCA, GAAP is the bottom rung of the hierarchy for interpreting CAS. For these purposes, the hierarchy is the CAS Board’s standards, rules, and regulations, including the Preambles, at the top, followed by the FAR and agency FAR supplements, and then GAAP. This point is significant because DCAA auditors frequently assert that the CAS must be interpreted consistent with GAAP. Here, that position has been firmly rejected by the Board.
In concluding on this point, the Board observed that the CAS hierarchy means that the CAS concerns the measurement, assignment, and allocation of costs. However, the FAR, and not the CAS, determines the allowability of the costs. Thus, the fact that an accounting practice is CAS-compliant does not mean that the costs derived from the use of that practice are allowable pursuant to the FAR and the fact that costs are unallowable does not mean that an accounting practice adopting those costs violates the CAS. If a contractor improperly accounts for a capital lease as an operating lease, this creates an allowability problem, in violation of the FAR, and not a CAS problem.
Based on these considerations, the Board determined that the government could not assert a claim against Exelis under its fixed price contracts that were not subject to the cost principles, but could only assert a claim for a FAR violation under those contracts that based the contractor’s right to payment upon compliance with the FAR cost principles.