Merger & Acquisitions for Federal Contractors: Unallowable Costs

At a Glance:

• Main Takeaway: Federal Acquisition Regulations (FAR) Part 31 Contract Cost Principles and Procedures contain guidance as to what are considered allowable and unallowable costs related to mergers and acquisitions.
• Business Impact: With the increased scrutiny of federal contracts, it is important to mitigate your risk with compliant cost classification, establish a clear timeline regarding economic planning and acquisition and integration costs, and maximize the benefit of your new acquisition.
• Next Steps: Aprio’s experienced Government Contracting professionals are dedicated to helping you navigate the complexities of government contract accounting and compliance. Contact our team today.

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The Full Story:

Despite the changes that came with the new administration, M&A activity continues in the government contractor space. And while what is being bought and sold may be different, the FAR guidance regarding associated unallowable costs remains a requirement. Notwithstanding the recently announced plan to rewrite and streamline the FAR, these regulations are presently in effect and provide protection to the federal purse.

It is, therefore, likely that FAR 2.0 will treat acquisition expenditure in a similar manner. Costs incurred prior to, during, and after the transaction may all have different treatments and considerations for allowability. In addition, the Department of Defense has special considerations for restructuring costs incurred following business combinations.

M&A Costs Before and During the Transaction are Generally Unallowable

FAR 31.205-27 (Organization Costs) states that costs related to planning or executing M&A activities, corporate reorganizations, and business combinations are unallowable. These expenses may include investment banking/brokerage fees, valuation services, due diligence, and other legal, accounting, or consulting costs related to the transaction. The costs incurred to negotiate or secure financing are also not allowable.

However, understating FAR 31.205-12 (Economic Planning) may help identify costs prior to the acquisition that can be considered allowable—if related to long-term management planning concerned with overall organizational development or market planning.

Post Transaction Costs: Some Allowable, Some Unallowable

Once the deal is done, some integration costs may be allowable provided that the nature of the cost meets the underlying FAR criteria of reasonable, allocable, allowable, and in accordance with contract terms. 

Types of allowable costs may include:

• Severance that is in line with FAR 31.205-6(g) and according to the company’s established policies and practices.
• Employee Relocation of a reasonable amount and in accordance with FAR 31.205-35
• Training to integrate employees and train on new systems and procedures per FAR 31.205-44.
• IT Systems Integration Costs that are necessary for continued contract performance may be allowable under FAR 31.205-6 or for labor cost FAR 31.205-11 if capitalized.
• New Asset Depreciation if costs meet capitalization requirements in FAR 31.25-11.
• Facility Consolidation Costs of rent, utilities, and maintenance of government used space as outlined in FAR 31.205.36.

Selected unallowable costs may include:

• Goodwill amortization or other write offs
• Costs to transfer stocks or other equities
• Executive compensation in excess of published thresholds
• Restructuring costs – Generally unallowable unless it is a cost reduction that benefits government contracts.

Special Considerations for Department of Defense Contracts

The Defense Federal Acquisition Regulation Supplement (DFARS) provides additional requirements regarding restructuring costs. The key factors are, first and foremost, that expenditure must result in overall savings to the DoD showing an allowable cost factor of at least two to one. Second, you must submit a detailed plan and gain written approval before expenses are incurred.

An audit of projected restructuring costs and restructuring savings is also required. With the exception that if restructuring costs are less than $2.5 million, they are not subject to audit.

Allowable restructuring costs continue to include employee severance/relocation, facility consolidation, and business system alignment and training, provided they comply with DFARS guidance.

Expressly unallowable costs as outlined above remain unallowable, as well as any costs incurred prior to DoD approval. 

The Bottom Line:

Understanding how to manage and categorize these costs in advance of an M&A transaction can help you make informed decisions and demonstrate financial compliance with your newly acquired customers—while optimizing cost recovery.

Need further assistance? Don’t hesitate to schedule a consultation with Aprio’s team of Government Contracting advisors to help you get started.

Related Resources:

• Navigating FAR 31.205: Selected Costs: Costs that ARE Allowable
• Navigating FAR 31.205: Selected Costs: Can a company incur or reimburse an employee’s unallowable costs?
• Navigating FAR 31.205: Selected Costs: Penalties on Unallowable Costs
• Facilities Service Center for Federal Contractors
• Creating a Chart of Accounts for a Federal Contractor