[Federal Register: October 5, 2000 (Volume 65, Number 194)]
[Proposed Rules]
[Page 59503-59548]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr05oc00-18]
[[Page 59503]]
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Part II
Office of Management and Budget
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Office of Federal Procurement Policy
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48 CFR Part 9904
Cost Accounting Standards Board; Accounting for the Costs of Post-
Retirement Benefit Plans Sponsored by Government Contractors; Proposed
Rule
[[Page 59504]]
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OFFICE OF MANAGEMENT AND BUDGET
Office of Federal Procurement Policy
48 CFR Part 9904
Cost Accounting Standards Board; Accounting for the Costs of
Post-Retirement Benefit Plans Sponsored by Government Contractors
AGENCY: Cost Accounting Standards Board, Office of Federal Procurement
Policy, OMB.
ACTION: Advance notice of proposed rulemaking.
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SUMMARY: The Office of Federal Procurement Policy, Cost Accounting
Standards Board (CASB), invites public comments on a proposed Cost
Accounting Standard (CAS) on the costs of post-retirement benefit plans
to be recognized as contract cost under Government cost-based contracts
and subcontracts. This is a new Standard that would directly address
the costs of post-retirement benefit plans for the first time in
detail. The proposed Standard provides criteria for measuring the costs
of post-retirement benefit plans, assigning the measured costs to cost
accounting periods, and allocating the assigned costs to segments of an
organization. The allocation of a segment's assigned post-retirement
benefit costs to contracts and subcontracts is addressed in other
existing Standards. The proposed Standard also provides for the
adjustment of post-retirement benefit costs for the effect of a
curtailment of a post-retirement benefit plan, a settlement of a post-
retirement benefit obligation, a granting of termination benefits, a
termination of a post-retirement benefit plan, or a segment closing.
DATES: Comments must be in writing and must be received by December 19,
2000.
ADDRESSES: Comments regarding this Advance Notice of Proposed
Rulemaking should be addressed to Mr. Eric Shipley, Project Director,
Cost Accounting Standards Board, Office of Federal Procurement Policy,
725 17th Street, NW, Room 9013, Washington, DC 20503, Attn: CASB Docket
No. 96-02A. Please include an electronic copy of your comments in a
format readable by MS Word.
FOR FURTHER INFORMATION CONTACT: Eric Shipley, Project Director,
(telephone: 410-786-6381 or e-mail: EShipley@hcfa.gov) or Rein Abel,
Director of Research, Cost Accounting Standards Board (telephone: 202-
395-3254).
SUPPLEMENTARY INFORMATION:
A. Regulatory Process
The Cost Accounting Standards Board's rules, regulations and
Standards are codified at 48 CFR Chapter 99. Section 26(g)(1) of the
Office of Federal Procurement Policy Act, 41 U.S.C. 422(g)(1), requires
that the Board, prior to the establishment of any new or revised Cost
Accounting Standard, complete a prescribed rulemaking process. The
process generally consists of the following four steps:
1. Consult with interested persons concerning the advantages,
disadvantages and improvements anticipated in the pricing and
administration of Government contracts as a result of the adoption of a
proposed Standard (e.g., promulgation of a Staff Discussion Paper.)
2. Promulgate an Advance Notice of Proposed Rulemaking (ANPRM).
3. Promulgate a Notice of Proposed Rulemaking (NPRM).
4. Promulgate a Final Rule.
This ANPRM is issued by the Board in accordance with the
requirements of 41 U.S.C. 422(g)(1)(B) and (C) and is step two of the
four-step process.
B. Background and Summary
Prior Promulgations
Post-retirement benefit plans have existed for many years,
sometimes as an adjunct to a company's pension plan, but they generally
received little attention until the Financial Accounting Standards
Board (FASB) decided to examine the potential liabilities and costs of
these plans and ultimately issued Statement No. 106, ``Employers'
Accounting for Post-Retirement Benefits Other Than Pensions,'' (SFAS
106) in December of 1990. The adoption of SFAS 106 had the effect of
exposing the substantial unfunded liabilities associated with post-
retirement benefit plans.
The Cost Accounting Standards Board has received numerous public
comments recommending that it establish a case concerning the
measurement, assignment, and allocation of the costs of post-retirement
benefit plans. These letters came from Federal Government agencies,
Government contractors, law firms, trade associations and other
respondents. The Board recognized the need to establish a case
addressing contract cost accounting issues related to post-retirement
benefit plans, but because of the similarities between post-retirement
benefit plans and more traditional pension plans, it was decided to
defer commencement of this case until the pension case was completed.
The pension case was completed when the amendments to Cost Accounting
Standards 9904.412 and 9904.413 were published as a final rule on March
30, 1995 (60 FR 16534). At its February 24, 1995 meeting, the CAS Board
directed the staff to begin work on a Staff Discussion Paper addressing
the accounting treatment of costs of post-retirement benefit plans.
As part of the development of the Staff Discussion Paper, the staff
solicited preliminary comments from certain interested and
knowledgeable organizations and individuals from both the procuring
agencies and contractor communities. The staff also sought comments
from organizations and individuals from the accounting, actuarial, and
legal professions. The staff asked for assistance in identifying
existing guidance and operational practices that should be
investigated. These comments provided important information and ideas
that were incorporated into the Staff Discussion Paper.
The Board made available on September 20, 1996, (61 FR 49533), a
Staff Discussion Paper, Post-Retirement Benefit Plans Other Than
Pension Plans Sponsored by Government Contractors, identifying the cost
accounting issues related to post-retirement benefit plans. The Staff
Discussion Paper identified major topics for consideration by the Board
in its deliberations concerning the possible promulgation of an
Interpretation, an amendment to existing Standards, or a new Standard
regarding post-retirement benefit costs. The Staff Discussion Paper
neither advocated nor assumed any position regarding the accounting
treatment of post-retirement benefit costs. Rather, the Staff
Discussion Paper explored many different approaches in depth so that
the Board would have an opportunity to fully consider alternative
treatments for costs of post-retirement benefit plans.
As the Board and its staff analyzed the comments and other
information submitted for consideration, it became apparent that many
commenters had strongly held opposing positions regarding the firmness
of the SFAS 106 liability and the role, if any, that funding should
play. To better understand these opposing positions, and hopefully to
be able to reconcile these positions, on January 12, 1999 the Board
sent a letter to all the respondents to the Staff Discussion Paper.
This letter was also made widely available for public comment on
February 18, 1999 (64 FR 8141).
[[Page 59505]]
Public Comments
The Board received eighteen (18) sets of public comments in
response to the Staff Discussion Paper. These comments came from
contractors, Government agencies, professional associations, actuarial
firms, and individuals. These public comments are briefly summarized as
follows:
Most respondents did not favor the promulgation of a new
Standard and believed that the Board could adequately address post-
retirement benefit costs through amendments to CAS 9904.412 and
9904.413. A few respondents expressed the belief that the
measurement, assignment, and allocation of post-retirement benefit
costs were complex and technical subjects and recommended that the
Board address post-retirement benefit costs in a comprehensive
manner.
The respondents almost universally agreed that accrual
accounting following the provisions of SFAS 106 was the most
appropriate basis for measuring and assigning the costs of a post-
retirement benefit plan that created a firm liability. They stated
that the pay-as-you-go cost method (cash basis accounting) was
appropriate if there was not a firm; i.e., compellable, liability to
provide the promised benefits. However, there was no general
agreement as to the criteria for ascertaining the firmness of a
plan's liability; especially as to whether funding of the cost
should serve as a criterion. There was agreement that if funding was
to be a prerequisite for accrual accounting, then any rule or
amendments should provide sufficient flexibility in the choice of
accounting methods to permit contractors to align their cost
accounting practice with their funding opportunities.
Respondents recommended that the Board address special events
such as a curtailment of benefits or the termination of the post-
retirement benefit plan. Many commenters suggested that a funding
requirement may not be necessary if the Board provided adequate
safeguards in case of a plan termination or segment closing. Some
respondents asked that the segment closing provisions for post-
retirement benefit costs be explicitly coordinated with the segment
closing provisions of paragraph 9904.413-50(c)(12) regarding
pensions.
The Board also received ten (10) sets of comments in response to
the Board's letter of January 12, 1999 which can be summarized as
follows:
The comments from contractors and other industry representatives
reiterated their belief that funding was not necessary to
substantiate the liability. Several of these respondents opined that
funding did not improve the firmness of the liability. Instead,
these respondents expressed the belief that the terms of the post-
retirement benefit plan determined the firmness of the liability.
Most commenters, including the Office of the Under Secretary of
Defense (OUSD), argued that funding was an allowability; i.e.,
procurement policy issue, and not an accounting issue. The other two
Government respondents expressed a strong belief that funding
demonstrated the contractor's intent to continue the post-retirement
benefit plan and to be financially prepared to provide the promised
benefits.
The Board also reviewed proposed amendments to CAS 9904.412 and
9904.413 addressing post-retirement benefit costs which were
voluntarily submitted by the Council of Defense and Space Industry
Associations (CODSIA), as well as comments submitted by the American
Bar Association's (ABA) Public Contract Law Section regarding CODSIA's
proposal.
The Board reviewed information from the Towers Perrin surveys of
``SFAS 87 [Statement 87 of the Financial Accounting Standards Board]
and SFAS 106 Annual Report Footnote Data'' for years 1995, 1996, 1997,
and 1998 which was extracted from the corporate financial statements of
the ``Fortune Top 100'' companies. The Board notes three (3) major
observations that one can generally conclude from this survey
information that influenced the development of this proposed Standard.
1. For pensions, the plan assets generally equaled or exceeded the
liability for projected benefits, as measured by the SFAS 87 projected
benefit obligation. On the other hand, only slightly over one-half (\1/
2\) \1\ of the companies included in the survey reported any plan
assets for their post-retirement benefits plans. For companies that did
report plan assets, for 1998 the average plan assets only covered
around one-third (\1/3\) of the average SFAS 106 accumulated post-
retirement benefit obligation.
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\1\ 82 companies reported pension plan assets in their SFAS 87
footnotes and 45 companies reported post-retirement benefit plan
assets in their SFAS 106 footnotes.
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2. While the average SFAS 106 accumulated post-retirement benefit
obligation for these Fortune 100 companies is less than one-third \2\
of the average SFAS 87 projected benefit obligation for pensions, at
$2,312.5 million for 1998, the average post-retirement benefit
obligation is still quite large.
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\2\ The average Projected Benefit Obligation reported in the
SFAS 87 footnotes was $7,170.6 million.
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3. The 1998 average net periodic cost for post-retirement benefit
plans ($150.7 million) exceeds the average net periodic cost for
pension plans ($58.4 million).
This proposed Standard is based upon the continuing research
performed by the staff of the Cost Accounting Standards Board and the
public comments received in response to the Staff Discussion Paper and
the Board's January 12, 1999 letter.
The various comments and proposals are discussed in greater detail
under Section E, Public Comments. The Board and its staff would like to
thank all the organizations and individuals who provided comments and
information in response to the Staff Discussion Paper and the Board's
January 12, 1999 letter.
Conclusions
While accounting for post-retirement benefits has some similarities
with pension accounting, the Board has concluded that post-retirement
benefit costs should be treated distinctly from pension costs. The
Board proposes to address the accounting treatment of post-retirement
benefit costs through the promulgation of a new Cost Accounting
Standard rather than through an Interpretation of or an amendment to an
existing Standard or Standards. Post-retirement benefits, pensions, and
insurance are each intrinsically complex and technical subjects. The
Board has determined that it would be extremely difficult, if not
impossible, to effectively and efficiently interleave coverage for
post-retirement benefit costs into either the pension or insurance
Standards.
The Board believes that accrual accounting is the appropriate
method for determining the costs of post-retirement benefit plans that
create a sufficiently firm liability for contract cost recognition. The
Board has concluded that SFAS 106 with some modifications and
restrictions provides adequate and appropriate accounting guidance
regarding the measurement and period assignment of post-retirement
benefit costs when accrual accounting is utilized. In order to
implement a definite determination of a firm liability, the Board
decided that the annual accrual of the post-retirement benefit cost
must be compared to the nonforfeitable portion of the accumulated post-
retirement benefit obligation. Post-retirement benefit plans that do
not create a firm liability for contract costing purposes must be
accounted for using the pay-as-you-go cost method.
The Board has also determined that specific guidance is required
regarding the allocation of post-retirement benefit cost to segments.
Specifically, the Board believes criteria are necessary regarding when
the post-retirement benefit costs of a segment should be based on a
general allocation or a separate calculation. Furthermore, because the
current and future costs of post-retirement benefit plans are dependent
upon the costs accrued in prior periods and the funding of such prior
accruals, the Board finds it necessary to provide for the accounting
treatment for assets
[[Page 59506]]
and for the accumulation and reporting of unfunded accruals at the
segment level.
The Board has concluded that the SFAS 106 provisions on benefit
curtailments, liability settlements, and the granting of special
termination benefits are inadequate for contract costing purposes and
additional guidance is needed. The Board further concluded that
specific guidance is needed to address the appropriate contract cost
accounting when a segment, as defined by paragraph 9904.403-30(a)(4),
is abandoned, sold, or otherwise closed.
Benefits
The Board's proposal will eliminate the existing confusion as to
which Standard, if any, addresses the contract cost accounting for
post-retirement benefits. There have been various opinions and theories
as to the proper basis for contract cost accounting for post-retirement
benefit plans. Various parties have advocated using either the pension
Standards, CAS 9904.412 and 9904.413, or the insurance Standard, Cost
Accounting Standard 9904.416. Others have expressed a belief that no
existing Cost Accounting Standard addresses such costs. Many parties
have argued that Generally Accepted Accounting Principles (GAAP) as
evidenced by SFAS 106 should govern the accounting of post-retirement
benefit costs, and in fact, paragraph 31.205-6(o) of the Federal
Acquisition Regulation (FAR 31.205-6(o)) specifies SFAS 106 as the
basis for accrual accounting. A few have even suggested that the tax
accounting rules for Internal Revenue Code (IRC) section 501(c) (26
U.S.C. 501(c)) trusts might be an appropriate basis. The Board proposes
to clarify the accounting treatment of post-retirement benefit costs
for Government contract costing purposes by specifying SFAS 106 as the
basis for measurement and period assignment when the proposed criteria
for accrual accounting are satisfied.
The Board acknowledges that the accounting for post-retirement
benefit costs is a complex subject. When accrual accounting is used,
the reliance on the methods and techniques of SFAS 106 for measurement
and period assignment eases the burden of complying with this proposed
Standard because contractors will be able to use much of the same data
and methods used for financial accounting purposes. If use of the pay-
as-you-go cost method is required, the determination of costs will be
based on actual payments of benefits. Therefore, there should be
minimal additional cost associated with complying with the Standard for
the plan as a whole, although certain additional effort may be
necessary to comply with the proposed provisions regarding the
accounting for costs of segments. Furthermore, the proposed criteria
regarding when to use accrual accounting or the pay-as-you-go cost
method will eliminate disputes and will increase uniformity among
contractors.
In the Board's judgement, a Standard is needed to increase
consistency of results between accounting periods. Various provisions
of SFAS 106 permit contractors to select between full immediate
recognition, amortization, and in the case of annual gains and losses,
delayed recognition of the various components of post-retirement
benefit cost. The Standard being proposed today generally limits the
contractor's cost recognition to the amortization method. Besides
enhancing uniformity between accounting periods, dampening volatility
through amortization will increase predictability when cost data is
used to price contracts covering future periods.
The provisions of SFAS 106 and GAAP generally do not address the
allocation of costs to segments of the contractor. The additional
guidance being proposed addresses this point. While SFAS 106 addresses
how major changes in the post-retirement benefit plan; i.e., benefit
curtailments, liability settlements, and granting special termination
benefits, are to be reported within the results of operations for
financial reporting purpose, SFAS 106 does not address how such results
are allocated to cost objectives. This proposal provides guidance on
how the costs resulting from such major changes in post-retirement
benefit plans are to be allocated and recognized for Government
contract costing purposes. This proposed Standard also provides for a
final settlement based on the proposed measure of the firm liability
when the contracting relationship between the Government and a segment
ends; this is not addressed by SFAS 106.
The proposed Standard also delineates how post-retirement benefit
assets and liabilities are to be accounted for when a segment is
divided or combined with another segment as part of an internal
reorganization, corporate merger, or when part of the segment is sold
or ownership is transferred. This delineation will enable the parties
to the sale or transfer to better determine the value of the segment's
post-retirement benefit plan assets and liabilities maintained for
Government contracting purposes.
In summary, the Board believes that the consistency with financial
accounting, specificity as to which benefits are recognized on an
accrual or cash accounting basis, and the guidance on allocation of
cost to segments will enhance the cost proposal, price negotiation,
contract administration and audit processes. The benefits of such
enhancements should be substantial and should greatly outweigh any
added costs.
Summary Description of Proposed Standard
The proposed Standard is divided into six subsections which address
(a) the recognition and identification of post-retirement benefit
costs, (b) the measurement and period assignment of post-retirement
benefit costs, (c) the allocation of post-retirement benefit costs to
segments, (d) the allocation of post-retirement benefit costs from
segments to the intermediate and final cost objectives of a segment,
(e) the adjustment of the contractor's records when there is a
curtailment, settlement, or granting of special termination benefits,
and (f) the adjustment of contract pricing when a segment is closed.
Once it is determined under subsection (a) whether the cost of a
particular post-retirement benefit plan is to be accounted for using
accrual accounting or the pay-as-you-go cost method, the other sections
present the relevant provisions in the following order of
applicability: all plans, plans using the pay-as-you-go cost method,
defined-contribution plans using accrual accounting, and finally,
defined-benefit plans using accrual accounting. In this way,
readability and the ability to reference is enhanced. For example,
contractors using the more straightforward pay-as-you-go cost method do
not need to search the entire subsection for applicable guidance.
1. Definitions
Proposed subsection 9904.419-30(a) includes several new definitions
of terms that are unique to post-retirement benefit plans. These new
definitions include modified SFAS 106 definitions and selected
unmodified SFAS 106 definitions that are frequently used in the
proposed Standard. Terms that are applicable to post-retirement
benefits plans, but which have previously been defined for pensions,
have been modified (usually substituting ``post-retirement benefit''
for ``pension'') in subsection 9904.419-30(b) for purposes of this
proposed rule. Subsection (c) incorporates all other SFAS 106
definitions into the proposed Standard.
[[Page 59507]]
2. Recognition of Post-Retirement Benefit Costs
(a) Criteria for accrual accounting. For SFAS 106 purposes, the
post-retirement benefit promise arises from the written documents or
established practices that comprise the ``substantive plan.''
Subsection 9904.419-40(a) sets forth criteria for determining when the
liability for the post-retirement benefit is sufficiently estimable,
contractually obligated (compellable), and reasonably foreseeable to
warrant accrual accounting for government contract accounting purposes.
The proposed criteria require that the promise of future benefits be:
(i) Documented in writing, (ii) communicated to employees, (iii)
nonforfeitable once earned, and (iv) legally enforceable.
The proposed Standard's requirement that the benefit promise be
formalized in writing is consistent with similar CAS provisions
regarding pension, insurance, and deferred compensation costs. The
pension and insurance Standards require that costs of employee benefits
contingent on post-retirement events, such as mortality and inflation,
be actuarially determined and funded. This proposed Standard, like Cost
Accounting Standard 9904.415, which addresses the accounting for costs
of deferred compensation, does not require funding but instead requires
that the contractor have a duty to pay the benefit earned by the
employee which the contractor cannot unilaterally avoid. As with the
pension and insurance Standards, if the post-retirement benefit plan
fails to meet the specified criteria for accrual accounting, then the
contractor must use the pay-as-you-go cost method.
(b) Identification of the post-retirement benefit plan. Some
companies that have chosen to fund all or a portion of their post-
retirement liability use a combination of investment vehicles to
achieve tax-efficient funding of post-retirement benefits. Companies
sometimes find they must sponsor somewhat different retiree insurance
plans for different plants, states, or classes of employees in order to
provide an overall general post-retirement benefit promise. Thus, their
post-retirement benefit program is frequently not a single benefit
plan, but several different benefit promises to different groups of
employees.
To accommodate such pragmatic concerns associated with sponsoring
and administering a post-retirement benefit program, the proposal being
published today permits contractors to combine different investment
vehicles and trust arrangements when identifying the assets of a post-
retirement benefit plan. Similarly, the proposed Standard also provides
that different benefits provided to the same group of employees, or the
same benefit provided to different groups of employees may be
aggregated for Government contract accounting purposes. Conversely,
different benefits within a single overall plan may be accounted for
separately.
Consistent with the position taken by the FASB, the proposed
paragraph 9904.419-50(a)(7) explicitly covers separate accounts for
medical benefits that are a part of a qualified pension plan and trust
(IRC section 401(h) accounts) in this proposed Standard on post-
retirement benefits. These medical benefit accounts, which are
established, accounted for, and funded distinctly from the retirement
income benefit of a qualified pension plan, are not an ``integral part
of a pension plan.''
3. Measurement and Assignment of Post-Retirement Benefit Costs
(a) Pay-as-you-go cost method. The proposed Standard provides that
for plans using the pay-as-you-go cost method, the assignable cost is
measured by an amount equal to the payments made to or on behalf of the
plan beneficiaries, providers, and insurers for benefits incurred
during the current period, except that any amount paid to settle or
terminally fund a liability for current and future benefits must be
amortized over fifteen (15) years. Because the fifteen-year period
represents an approximation to the life expectancy of a newly retired
employee, this provision is consistent with paragraph 52 of SFAS 106
which requires the cost to be spread over the life expectancy of the
retirees if the obligation is primarily attributable to such retirees.
The proposed Standard is also consistent with the analogous provisions
for pensions and insurance which are found at 9904.412-40(b)(3)(ii) and
9904.416-50(a)(1)(v)(C), respectively. The proposed transition
provisions permit the continued use of the terminal funding method
(without amortization) for contractors who have an established practice
of terminal funding prior to this proposed Standard becoming
applicable.
When describing the post-retirement benefit payments considered
under the pay-as-you-go cost method, the proposed Standard augments the
CAS 9904.412 definition of the ``pay-as-you-go cost method'' by adding
the phrase ``or on behalf of'' because post-retirement benefit payments
are often made directly to third parties, e.g., health care providers.
The proposed Standard also refers to the ``net amount'' of the benefit
paid to indicate that the cost is based on the contractor's share of
the post-retirement benefit after considering refunds, co-payments,
deductibles, and amounts payable by unrelated third parties, such as
Medicare and Medicaid. This use of ``net amount'' is consistent with
the SFAS 106 provisions relating to ``incurred claim cost (by age)''
and ``net incurred claim cost (by age).'' This concept is also
consistent with subparagraphs 9904.416-50(a)(1)(i) and (a)(1)(vi) of
the insurance Standard, CAS 9904.416.
(b) Accrual accounting for defined-contribution plans. For defined-
contribution plans using accrual accounting, the proposed Standard
follows paragraph 104 of SFAS 106 and measures the assignable cost as
the annual amount paid to or otherwise distributed to individual
participant accounts. However, in contrast to paragraph 105 of SFAS
106, the proposed Standard does not permit the pre-retirement accrual
of contributions expected to be made after retirement. Rather,
contributions made after retirement are recognized in the period when
the contribution is required under the terms of the plan. This proposed
provision, paragraph 9904.419-40(b)(3), is generally consistent with
paragraph 9904.412-40(a)(2) of the pension Standard.
(c) Accrual accounting for defined-benefit plans. For post-
retirement benefit plans that meet the proposed prerequisites for
accrual accounting, the Standard being proposed today accepts the
actuarial cost method and actuarial assumptions used by the contractor
for financial accounting purposes under SFAS 106. The assignable cost
is based on the same six (6) components used by SFAS 106, namely:
service cost, interest cost, actual return on assets, amortization of
prior service costs, amortization of gains and losses, and recognition
of the transition obligation.\3\ However, the Board proposes to modify
or restrict the SFAS 106 measurement and assignment of some components
as explained below. Therefore, the values of these components used for
contract costing purposes may differ from the values used for financial
accounting purposes. Because the proposed measurement and assignment
methods and techniques follow SFAS 106 rather than CAS 9904.412, there
is no floor placed on the measurement and assignment of the period
cost; e.g., the
[[Page 59508]]
assignable post-retirement benefit cost could be a negative amount.
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\3\ Throughout this preamble, the term ``transition obligation''
is used to refer to either a transition obligation or a transition
asset.
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Because contractors may wish to maintain the right to curtail or
terminate the benefits for employees who have not yet reached full
eligibility, the Board has decided that it would be inappropriate for
Government contract costing purposes for the accumulated value of
accruals, whether funded or unfunded, to exceed the unavoidable
liability for post-retirement benefits. The proposed rules include a
ceiling on the accrual cost recognition equal to the benefits paid
during the period plus the unfunded portion of the accumulated post-
retirement benefit obligation for benefits that cannot be forfeited.\4\
The Board notes that the greater the portion of forfeitable benefits
included in the accumulated post-retirement benefit obligation, the
more restrictive will be the effect of the ceiling.
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\4\ Hereafter, the accumulated post-retirement benefit
obligation for benefits that cannot be forfeited is referred to as
the ``nonforfeitable post-retirement benefit obligation.''
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(i) Service cost, amortization of prior service costs, and interest
components. The Board proposes to accept the SFAS 106 provisions
regarding the measurement and assignment of the service cost and the
amortization of prior service cost components of post-retirement
benefit cost but restricts that measurement to the written terms of the
post-retirement benefit plan rather than the ``substantive plan.''
Otherwise, there are no modifications or restrictions to the SFAS 106
measurement and assignment provisions for these three components of
post-retirement benefit cost.
(ii) Return on assets component and associated asset values. The
Board proposes to accept the same measurement of the fair value of
assets and the market-related value of assets used for financial
accounting. The terminology of the proposed Standard follows that of
SFAS 106 and differs from that used for pensions in CAS 9904.412 and
9904.413. The CAS 9904.412 term ``market value of plan assets'' is
analogous to the term ``fair value of plan assets'' as used in SFAS 106
and this proposed Standard. The term ``actuarial value of assets'' used
in the Employees' Retirement Income Security Act of 1974 (ERISA) and
CAS 9904.412 is defined similarly to the ``market-related value of plan
assets'' as used by SFAS 106 and this proposed Standard. For pensions
the actuarial value of assets not only affects the recognition of gains
and losses, but also is used to determine the unfunded actuarial
liability. However, the market-related value of plan assets is only
used to measure the annual asset gain or loss under SFAS 106 and this
proposal. In SFAS 106 and in this proposed Standard, the fair value of
assets is used to determine the unfunded accumulated post-retirement
benefit obligation.
SFAS 106 is not concerned with the sources of any net accumulated
accrued (unfunded) or prepaid post-retirement benefit cost. By
contrast, the Board proposes that the contractor record and track each
portion of unfunded accrual and prepayment credit. Consistent with CAS
9904.412, the accumulated values of unfunded accruals and prepayment
credits are carried forward and adjusted for interest. The accumulated
value of unfunded accruals is treated as if it were a plan asset and
the accumulated value of prepayment credits is treated as a reduction
to assets. The proposed Standard requires that the actual return on
assets component be increased by an interest equivalent on the
accumulated value of unfunded accruals to reflect that assets would
have generated earnings had the full accrual amount been funded.
Similarly, the actual return on assets component is reduced by an
interest equivalent on the accumulated value of prepayment credits to
reflect the additional earnings generated by any funding in excess of
the annual accrual.
The Board has decided that the interest rate determined by the
Secretary of the Treasury pursuant to Public Law 92-41, 85 Stat. 97,
shall be used to measure the interest equivalent on the accumulated
values of unfunded accruals and prepayment credits. The Board notes
that for unfunded plans, there are no assets (no investments) and the
contractor does not need to make an assumption concerning the long-term
expected rate of return. In other cases, the amount of plan assets may
be so small that reliance on this assumption may be inappropriate for
Government contracting purposes. Also, use of the Treasury rate is
consistent with the other Standards.
(iii) Annual gain or loss component. In order to more closely
assign costs to cost accounting periods in which they arise, the
proposed Standard requires the amortization over the average remaining
service period of active participants \5\ of the full amount of the
annual gain or loss for a cost accounting period, that is, gains and
losses other than gains and losses attributable to curtailments,
settlements, or special termination benefits. While SFAS 106 permits
such amortization, SFAS 106 only requires amortization of that part of
the cumulative net gain or loss that falls outside a corridor defined
by 10% of the greater of the accumulated post-retirement benefit
obligation or the market-related value of plan assets. Under SFAS 106,
recognition of any gain or loss within that corridor may be delayed
indefinitely. Such delayed recognition is not permitted by this
proposed Standard.
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\5\ If the plan population is composed primarily of retirees,
the gain or loss is spread over the life expectancies of the
retirees. (See paragraphs 52 and 112 of SFAS 106.)
---------------------------------------------------------------------------
(iv) Amortization of the transition obligation component. This
proposed Standard restricts the measurement and period assignment of
the transition obligation to the delayed recognition method described
in paragraphs 112 and 113 of SFAS 106. The proposed Standard provides
that when a contractor first becomes subject to the proposed Standard,
the contractor will base its period costs on the annual amortization
installment for the unrecognized portion of the transition obligation
already established for financial accounting purposes. The proposed
transition provisions address the recognition of any portion of the
SFAS 106 transition obligation that was recognized for financial
statement purposes during prior periods for those contractors that used
the pay-as-you-go cost method for Government contract costing purposes.
(d) Post-retirement benefits provided through insurance contracts.
If the contractor provides all or a portion of the post-retirement
benefit by purchasing insurance, the Board proposes that the contract
accounting cost be determined by the net premium paid for such
insurance and that the measurement, assignment to cost accounting
periods, and allocation of such premium be subject to the provisions of
CAS 416. However, if the insurance is acquired from a captive insurer,
then the cost of the post-retirement benefit remains subject to the
provisions of this proposed Standard. Because the SFAS 106 definition
of ``captive insurer'' differs from the term as used in the FAR, a
potential for disputes exists. In addition, the proposed definition
clarifies that affiliates, related organizations and entities that are
``owned by or under the control of'' the contractor are also included
so that the proposed Standard incorporates the phrase found at FAR
31.201-19(c) which is already in use for Government contracting
purposes. Consistent with SFAS 106, this proposed Standard permits
benefits provided by purchased insurance to be accounted for separately
from any portion of a plan's benefits that are not
[[Page 59509]]
provided through such insurance. The Board notes that this treatment
contrasts with the analogous provision in the pension Standard,
paragraph 9904.412-50(a)(6), which specifies the accounting for so-
called ``split-funded'' plans.
4. Allocation of Post-Retirement Benefit Costs to Segments
The proposed Standard applies to all post-retirement benefit plans
regardless of whether accrual accounting or the pay-as-you-go cost
method is used. It embraces the general precepts of paragraph 9904.403-
40(b)(4) dealing with the allocation of central payments and accruals
to segments. However, this proposed Standard provides specific criteria
regarding the allocation of post-retirement benefit costs to
intermediate home offices and segments.\6\ The contractor must allocate
a portion of the total post-retirement plan cost to each segment,
including home offices, either by use of an appropriate allocation base
(i.e., indirect allocation) or, if certain conditions exist, by use of
post-retirement benefit costs separately computed (i.e., direct
allocation) at the segment level.
---------------------------------------------------------------------------
\6\ Throughout the discussions of allocations to segments and to
intermediate and final cost objectives, the term ``segment'' is used
to refer to a segment, home office, or intermediate home office.
---------------------------------------------------------------------------
Consistent with the pension and insurance Standards, the Board
proposes that the total post-retirement benefit plan cost be allocated
to intermediate home offices and segments based upon the factors used
to determine the costs. For plans that are accounted for using the pay-
as-you-go cost method, the cost is to be allocated only to segments and
intermediate home offices that can be identified with the post-
retirement benefit plan (e.g., those segments having inactive
participants who are eligible to receive benefits under that plan). For
defined-benefit plans using accrual accounting, the proposed Standard
requires that both active and inactive plan participants of the segment
or intermediate home office be included in the allocation base because
five of the six components of post-retirement benefit cost are
dependent upon the obligation for both groups.\7\
---------------------------------------------------------------------------
\7\ The service cost component is only determined for active
plan participants who are still in the attribution period, i.e.,
prior to the date of full eligibility. A service cost is not
developed for inactive plan participants.
---------------------------------------------------------------------------
The criteria requiring separate calculation are similar to those
found in CAS 9904.413 for pension costs of segments. If actual benefits
are disproportionately paid to participants of certain segments, the
proposed Standard requires a separate calculation of the cost for the
segment instead of an allocation, even for costs determined under the
pay-as-you-go cost method. An additional criterion for separate
calculation that looks at the ``cost of benefits'' reflects the fact
that post-retirement benefit costs may vary significantly due to
differences in state laws, geographical location, or insurance market.
Unless the post-retirement benefit cost allocable to a segment is
separately calculated, the same set of actuarial assumptions is used to
determine the cost for all segments. Similar to CAS 9904.413, if costs
are separately calculated, only those assumptions relating to the
demographic differences of a segment's employees are permitted to be
different than the assumptions used for other segments. For example,
the use of a different turnover assumption to reflect the unique
termination of employment experience of one segment does not permit the
contractor to use a different pre-retirement mortality assumption
without evidence that the segment's mortality is materially different
from the average mortality assumed for the plan as a whole.
For defined-benefit plans using accrual accounting the proposed
Standard requires that the tracking of assets and funding at the
segment level be maintained if costs are separately calculated for the
segment. This provision increases the visibility and verifiability of
post-retirement benefit costs that are separately calculated for a
segment.
This proposed Standard also requires that the market-related value
of plan assets be allocated each year in proportion to the fair vale of
plan assets allocated to the segments. This provision ensures that the
sum of the market-related value of plan assets for all segments equals
the total plan's market-related value of assets.
The proposed provisions regarding transfers of plan participants
between segments reflect the fact that the accumulated post-retirement
benefit obligation is determined by and must follow the plan
participants. Therefore, both the assets that funded the obligation and
the unfunded portion of the accumulated post-retirement benefit
obligation follow the participants, so that future contract costs
better follow the performance of future contracts. The Board notes that
the exception for immaterial transfers might create a small gain or
loss because assets and other values are not transferred.
5. Allocation to Intermediate and Final Cost Objectives of the Segment
Once the post-retirement benefit cost has been measured, assigned
to a period, and initially allocated to segments and home offices, the
Board believes that Cost Accounting Standard 9904.403 adequately
addresses the reallocation from home offices to segments and that Cost
Accounting Standard 9904.410 and Cost Accounting Standard 9904.418
fully and adequately address the intra-segment allocation of cost to
intermediate and final cost objectives.
6. Adjustments for Curtailments, Settlements, and Special Termination
Benefits
(a) Defined-contribution plans using accrual accounting. While a
defined-contribution plan is on-going, any nonvested account balances
that are forfeited by participants who terminate employment during a
cost accounting period are typically either reallocated to the other
participants or used to reduce the contribution (deposit) required
under the terms of the plan. The Board presumes that such forfeiture
credits are fairly evenly distributed among periods and therefore no
undue volatility occurs. However, when a defined-contribution plan is
terminated, the forfeiture of nonvested account balances could cause an
inordinately large and non-recurrent credit. In fact, the values of the
non-vested account balances could revert to the contractor. To prevent
the disruption to the budgeting process for cost type contracts and the
forward pricing process for cost-based fixed price contracts, the Board
proposes that forfeiture credits due to a termination of a defined-
contribution plan using accrual accounting be amortized over 10 years
so that the credit can flow to costs included in both cost type
contracts and the forward pricing of other negotiated cost-based
contracts.
The Board also proposes that this provision will apply to
forfeitures that occur whenever the plan participants' rights to become
vested are eliminated because the right to earn future vesting or
retirement eligibility service is curtailed or terminated by plan
amendment or other unilateral action of the contractor.
The pension Standards do not contain a similar provision because
qualified pension plans are subject to the vesting requirements of
ERISA. However, many post-retirement benefit plans are not subject to
similar vesting standards and the Board believes these provisions are
necessary to address the significant
[[Page 59510]]
amount of nonvested account balances that might be forfeited.
(b) Defined-benefit plans using accrual accounting. Consistent with
the Board's intention to accept the accounting provisions of SFAS 106
where practicable, the proposed Standard begins by accepting the SFAS
106 measurement of the adjustment for gains and losses due to benefit
curtailments, benefit settlements, and granting of special termination
benefits. SFAS 106 provides that any gain or loss not offset against
the unrecognized gain or loss, unrecognized transition obligation, or
unrecognized prior service cost, as appropriate under SFAS 106, will be
immediately recognized in income. To require an analogous immediate
recognition for Government contract costing purposes could disrupt the
budgeting of cost type contracts as well as the forward-pricing process
for cost-based fixed price contracts. Regardless of whether or not the
post-retirement plan is terminated, the proposed Standard requires that
an adjustment be recorded and that the adjustment for the curtailment,
settlement, or termination benefit gain or loss be amortized over a
period of 10 years.
7. Adjustments for Segment Closings.
The Board proposes to adopt the CAS 9904.413 definition of segment
closing which encompasses three situations: (i) The ownership of the
segment changes by sale or transfer, (ii) the segment discontinues
operations or is abandoned, and (iii) the contractor is no longer
performing or actively seeking government contract work at that
segment. Based on comments regarding the amendments to the pension
rule, the Board has modified the CAS 9904.413 definition of segment
closing to explicitly state that segment mergers or splits within the
contractor's on-going operations are not considered to be a segment
closing for purposes of this proposed Standard.
(a) Pay-as-you-go cost method. When a segment is closed for any of
the reasons described above, this proposed Standard does not provide
for any adjustment to current or previously determined post-retirement
benefit costs for plans that use the pay-as-you-go cost method. The
post-retirement benefit costs attributable to current and prior periods
were previously determined by the net amount paid to or on behalf of
retired employees or their beneficiaries for post-retirement benefits
incurred during those periods. The measurement of these prior actual
expenditures is unaltered by the segment closing. These previously
determined costs include any amortization installments assigned to such
prior periods for net amounts paid to irrevocably settle an obligation
for post-retirement benefits.
The proposed segment closing provisions also require that any
inactive participants left ``homeless'' (that is, inactive participants
that are no longer associated with an operational segment) when a
segment is sold or abandoned must be moved to the intermediate or
corporate home office to which the closed segment had directly
reported. In the future the pay-as-you-go costs for these transferred
inactive participants will be included in the post-retirement benefit
costs allocated by the closed segment's immediate home office (the
proximate home office to which the segment had reported.) Likewise the
amortization of lump sums and other settlements for these inactives
will continue unabated after being transferred to the closed segment's
immediate home office. Any Government contracts performed in other
segments reporting to that home office will receive an allocated
portion of the post-retirement benefit costs attributable to the
transferred inactive participants.
(b) Defined-contribution plans using accrual accounting. When a
segment is closed for any of the reasons described above, the Board
proposes that the contractor measure an immediate period adjustment to
recognize any unrecognized portions of any credits for forfeited
nonvested account balances due to plan termination or curtailment of
vesting or retirement eligibility service. Essentially, this provision
aborts the amortization of these credits because there will be no
Government contracts in future periods to absorb a share of the credit.
(c) Defined-benefit plans using accrual accounting. When a segment
is closed for any of the reasons described above, the Board proposes
that the contractor measure an immediate period adjustment based upon
the unavoidable liability for post-retirement benefits. The adjustment
is measured as the difference between the nonforfeitable post-
retirement benefit obligation and the sum of the plans assets plus the
accumulated value of unfunded accruals (net of any prepayment credits.)
Basing the segment closing adjustment on the nonforfeitable post-
retirement benefit obligation may appear to be a fundamental conceptual
departure from both the original and amended CAS 9904.412 and 9904.413.
The benefit liability for pension plans generally is subject to the
stringent controls of ERISA. For post-retirement benefit plans, the
nonforfeitable post-retirement benefit obligation provides the nearest
analogue to the ERISA protected liability.
In addition to the above proposed general rules for segment
closings, the following points should be noted:
(i) Massive layoff gains. The Board notes that when a segment
closes, often there is a sizable termination of employees which was one
of the original Board's concerns that eventually led to the original
9904.413-50(c)(12) segment closing provision. For post-retirement
benefit plans, the effects of any ``abnormal forfeitures'' or massive
layoff gain will dramatically reduce the liability such that the
remaining accumulated post-retirement benefit obligation will
approximate or equal the nonforfeitable post-retirement benefit
obligation.
(ii) Sale or other transfer of ownership of a segment. When a
segment is sold or transferred, the active participants of the segment
immediately before the sale is effective can be: (i) Transferred with
the segment and become active employees of the buyer, (ii) transferred
as active employees to other operational segments of the seller, or
(iii) terminated and become inactive participants of the seller. When
analyzing the proposed provision concerning the sale or transfer of a
segment, the reader should carefully consider the plan participants'
status in the post-retirement benefit plans of each party to the sale.
If both parties to the sale sponsor post-retirement benefit plans, the
segment's employees can be both inactive participants in the seller's
post-retirement benefit plan and active participants in the buyer's
plan.
If only a portion of the operations of a segment is acquired, the
proposed Standard provides that the selling contractor first divide the
accounting records for the segment into two groups based upon the
liability for participants being retained and transferred. Then the
segment closing adjustment will be determined using the accounting
records for the participants being transferred to the buyer or
transferee. This proposed Standard also provides that, when a segment
is divided into two or more segments as part of a reorganization, the
assets shall be divided in proportion to the accumulated post-
retirement benefit obligation. This provision is more specific than the
similar coverage found at 9904.413-50(c)(v) for pension plans.
If no active employees are retained in the segment, the
unrecognized transition obligation, prior service cost, gains and
losses attributed to the remaining inactive participants are moved up
to the next immediate home office along with the associated fair
[[Page 59511]]
value of plan assets, accumulated value of unfunded accruals and
accumulated value of prepayment credits. All amortizations continue
unabated. This amortization of these unrecognized amounts parallels the
treatment of the liability for future payments to remaining inactives
under the pay-as-you-go method.
Unless a segment is sold to a successor-in-interest, the adjustment
will be determined using the values of assets and accumulated benefit
obligations immediately prior to the sale. If the segment is sold to a
successor-in-interest, this proposed Standard provides that the segment
accounting will continue at the successor contractor based on the
segment accounting up to the time of the sale, taking into account any
division of the segment's assets and obligations.
(iii) Government's share of segment closing adjustment. The
Government's share of the segment closing adjustment shall reflect the
Government's historical participation in post-retirement benefit cost
from the time this proposed Standard first becomes applicable. The
intent of this provision is for the cognizant Federal agency official
and the contractor to generally determine the Government's historical
share of post-retirement benefit costs that were allocated to cost type
and negotiated cost-based fixed price contracts. The proposed
transition provisions extend this period of participation for
contractors who employed accrual accounting for Government contract
costing in accordance with SFAS 106 prior to this proposed Standard
becoming applicable. In such cases, the Government's participation
shall be measured from the date that SFAS 106 accruals used for
financial statement purposes were first used for Government contract
costing purposes. The proposed Standard also permits the parties to
negotiate a delayed recognition of the segment closing adjustment
through an amortization process. This proposed provision provides more
flexibility for the parties to determine the appropriate proportion
than paragraph 9904.413-50(c)(vii) of the pension Standard.
8. Illustrations
Generally the illustrations show the accumulated post-retirement
benefit obligation and other liabilities or losses as debit balances
and the fair value of assets and other asset equivalent values and
gains as credit balances. However, for consistency with financial
accounting presentation, when the illustrations include SFAS 106
disclosures, the accumulated post-retirement benefit obligations are
shown as credit balances and fair values of assets and other asset
equivalent values are shown as debit balances.
Because health and life benefits account for about 98% of all post-
retirement benefit plan obligations, there are no illustrations or
special provisions for post-retirement benefits other than health and
life benefits. This lack of text or illustrations regarding other types
of post-retirement benefits does not imply nor indicate that the
obligations for such benefits, if material, are excluded from coverage
under this proposed Standard.
9. Transition Provisions
One of the issues raised in discussions about post-retirement
benefit costs concerns inactive plan participants who may have worked
for a strictly commercial segment or a government segment that was sold
or abandoned at some time in the past. It has been argued that the
post-retirement benefit costs associated with these so-called
``homeless'' inactives should be explicitly excluded from the post-
retirement benefit costs allocated to current and future Government
contracts. However, often it is impossible to ascertain whether these
``homeless'' inactives were formerly employed in an abandoned or sold
segment or if they are ``homeless'' because of incomplete human
resource records. Rather than require a herculean and possibly futile
effort to identify where these inactive participants had been employed,
the Board proposes that the retained liability for these ``homeless''
inactive participants be assigned to an intermediate home office or
corporate office in accordance with the contractor's past practice. The
costs associated with these inactive participants will be treated as a
general cost of doing business for such home office and allocated in
accordance with CAS 9904.403.
Some contractors may not have established a specific practice or
method for assigning the ``homeless'' participants to a corporate or
intermediate home office. In that case, the Board envisions several
acceptable methods of making such an assignment to home offices. These
include, but are not limited to:
(i) Assigning all ``homeless'' to the corporate home office if
the post-retirement plan covers employees in all units that report
to the corporate home office;
(ii) Assigning the ``homeless'' to the immediate home office
that had responsibility for the closed or abandoned segment;
(iii) If the closed or abandoned segment(s) were primarily
associated with a portion of the contractor's current business,
assigning the ``homeless'' to a home office which allocates the
post-retirement benefit cost as a residual expense to segments
currently performing work for that portion of the contractor's
business; or,
(iv) Those ``homeless'' participants for whom employment records
are unavailable, or who worked in a multiplicity of the contractor's
operations could be assigned to the corporate home office.
In any of these cases, the Board accepts the fact that the costs
associated with these ``homeless'' will bear no relationship to its
current activities and the cost would be allocated to intermediate home
offices and segments as an residual expense.
The proposed transition provisions address how a contractor's prior
accounting practices are to be reconciled with the accounting
provisions of the proposed rule. Some contractors who were using
accrual accounting prior to becoming subject to the proposed rule will
continue to use accrual accounting if the criteria for accrual
accounting are satisfied. Likewise, other contractors who had been
using the pay-as-you-go method will continue to use the pay-as-you-go
method if those criteria are not satisfied. However, special provisions
are needed whenever a contractor must change its previously disclosed
accounting practice for post-retirement benefit costs.
If a contractor changes from the pay-as-you-go cost method to
accrual accounting for contract costing purposes, the transition
section of the proposed Standard provides for the establishment of a
supplemental transition obligation so that prior SFAS 106 accruals
measured during prior periods when the contractor had cost-based
Government contracts can be assigned to periods after the contractor
becomes subject to the proposed Standard. Once established, the
supplemental transition obligation is accorded the same treatment as
the SFAS 106 transition obligation. The prior accruals included in the
supplemental transition obligation are based on the delayed recognition
of the transition obligation regardless of how the transition
obligation was recognized for financial accounting purposes. As an
alternative to establishing a supplemental transition obligation, the
proposed Standard permits these contractors to use a so-called ``fresh
start'' approach provided the contractor has continually been
performing government cost-based contracts since adopting SFAS 106.
[[Page 59512]]
If a contractor switches from accrual accounting to the pay-as-you-
go cost method, this proposed Standard requires that the accumulated
value of prior unfunded accruals measured during periods when the
contractor had cost type or cost-based fixed price Government contracts
be carried forward. Like the analogous provision in the amendments to
the pension Standard, CAS 9904.412, benefit payments must be charged
against the accumulated value of unfunded accruals before pay-as-you-go
costs can be measured, assigned to cost accounting periods, and
allocated to cost objectives.
If the contractor has an established practice of using terminal
funding for its post-retirement benefit costs, that contractor may
continue the use of the terminal funding method. A switch from terminal
funding to pay-as-you-go accounting is permitted if the criteria for
accrual accounting are not met. Any payments previously considered as
terminal funding and allocated to cost objectives would not be subject
to the fifteen-year amortization requirement. If the criteria for
accrual accounting are met and the contractor switches from terminal
funding to accrual accounting, then any prior SFAS 106 accruals that
exceeded amounts paid for terminal funding may be treated as a
supplemental transition obligation
C. Paperwork Reduction Act
The Paperwork Reduction Act, Public Law 96-511, does not apply to
this proposed rule, because this rule imposes no paperwork burden on
offerors, affected contractors and subcontractors, or members of the
public which requires the approval of OMB under 44 U.S.C. 3501, et seq.
The records required by this proposed rule are those normally
maintained by contractors who claim reimbursement of post-retirement
benefit costs under government contracts.
D. Executive Order 12866 and the Regulatory Flexibility Act
Because most contractors must measure and report their post-
retirement benefit liabilities and expenses in order to comply with the
requirements of SFAS 106 for financial accounting purposes, the
economic impact of this final rule on contractors and subcontractors is
expected to be minor. As a result, the Board has determined that this
rule will not result in the promulgation of a ``major rule'' under the
provisions of Executive Order 12866, and that a regulatory impact
analysis will not be required. Furthermore, this proposed rule does not
have a significant effect on a substantial number of small entities
because small businesses are exempt from the application of the Cost
Accounting Standards. Therefore, this rule does not require a
regulatory flexibility analysis under the Regulatory Flexibility Act of
1980.
E. Public Comments
Public Comments: This proposed Standard is based upon responses to
the Staff Discussion Paper made available for public comment on
September 20, 1996, 61 FR 49533. Eighteen (18) sets of public comments
were received from contractors, Government agencies, professional
associations, actuarial firms, law firms, public accounting firms, and
individuals. The proposed Standard is also based upon the ten (10) sets
of responses to the Board's letter of January 12, 1999 which was also
made available for public comment on February 18, 1999, 64 FR 8141. The
comments received and the Board's actions taken in response thereto are
summarized below:
1. Need for a Cost Accounting Standard
Comment: The industry associations and some contractors expressed
the belief that a Standard might not be needed because GAAP, as
articulated by SFAS 106 and augmented by CAS 9904.403, 9904.412,
9904.413, and 9904.418, provide full and adequate guidance on the
measurement, assignment to periods, and allocation of post-retirement
benefit costs. Some commenters expressed the notion that the
promulgation of a Cost Accounting Standard on any subject already
addressed by a FASB Statement would be superfluous. But, many
respondents noted subject areas where SFAS 106 was either inadequate or
inappropriate for contract cost accounting purposes and suggested that
some CASB guidance would be helpful.
Both contractor and Government commenters generally preferred
amendments to the pension Standards, CAS 9904.412 and 9904.413, and
possibly the insurance Standard, CAS 9904.416, rather than the
promulgation of a new Standard. The commenters unanimously agreed that
a Board Interpretation would be insufficient to address the new and
complex issues concerning post-retirement benefit costs. Several
commenters opined that substantive action should be taken by the Board.
SDP Technologies wrote: ``While many technical questions need to be
resolved, SDP urges the CASB to pursue this effort and develop a
comprehensive solution.'' And, TRW stated, ``the level of detail and
range of issues posed in the Discussion Paper highlight the numerous
accounting, legal, and practical considerations that must be
addressed.'' The OUSD generally concurred when it stated: ``While it is
generally preferable to amend existing Standards, a new Standard may be
necessary if amendments of existing Standards cannot be accomplished
without unreasonably complicating existing Standards.''
In its letter of August 4, 1997, CODSIA submitted a straightforward
and simple proposal to illustrate how the Board might address post-
retirement benefit costs by amending CAS 9904.412 and CAS 9904.413.
CODSIA did not support the development of a separate Cost Accounting
Standard on post-retirement benefits on the grounds that it would not
be an economical and efficient way to address this issue. The Board
also received a letter from the ABA discussing some of the shortcomings
of the CODSIA proposal, but which generally favored CODSIA's approach
of amending the pension Standards.
Response: The Board recognizes the concerns expressed regarding the
promulgation of a new Standard. These concerns appear to be driven by
fears that a new Standard might be conceptually different from the
current pension and insurance Standards. However, the Board has
determined that amending CAS 9904.412, 9904.413, and 9904.416 would be
extremely cumbersome and would add unnecessary complexity. The Board
notes that the FASB did not merely extend Statements 87 and 88 (SFAS 87
and 88) to post-retirement benefits, but promulgated a separate
Statement, SFAS 106, building upon the concepts and structures of SFAS
87 and 88. The Board believes that the most manageable approach to
providing substantive measurement, assignment, and allocation criteria
is the promulgation of a new and separate Standard addressing the costs
of post-retirement benefits. The Board does not see any reason to
unnecessarily muddy the water for the sake of arbitrarily avoiding the
promulgation of another Standard.
The Board believes it is appropriate to promulgate a separate Cost
Accounting Standard on a subject matter that the FASB has addressed for
financial accounting purposes. The Board notes the CASB Concepts
Statement (57 FR 31039) which states:
The Board will give careful consideration to the pronouncements
affecting financial and tax reporting and, in the development of
Cost Accounting Standards, it will take those pronouncements into
account to the extent it can do so in accomplishing its objectives.
[[Page 59513]]
The nature of the Board's authority and its mission, however, is
such that it must retain and exercise full responsibility for
meeting its objectives.
In this regard the Board must specifically consider what elements
constitute a proper measure of post-retirement benefit costs for
contract cost accounting purposes.
The Board agrees that SFAS 106 should be used as the baseline for
the development of any promulgation regarding post-retirement benefit
costs. However, the Board believes that SFAS 106, augmented by existing
Standards, does not provide adequate guidance on contract cost
accounting for post-retirement benefit costs. The Board proposes to
generally accept the terminology, measurement, assignment, and
adjustment provisions of SFAS 106. Modifications and restrictions are
made only where necessary for Government contract cost accounting
purposes. Thus, the Standard being proposed today does modify, augment,
and restrict SFAS 106 provisions that are either inadequate or
inappropriate for contract cost accounting. This proposed Standard also
augments SFAS 106 and existing Standards by addressing the allocation
of costs to segments, segment closing adjustments, and the transition
from current contract cost accounting practices to this new Cost
Accounting Standard for post-retirement benefit costs.
The essence of the CODSIA proposal to amend CAS 9904.412 was simply
to add a sentence to subsection 9904.412-40(b) stating that for
administrative convenience, the contractor may, at its option, utilize
the methodology provided in SFAS 106 to measure the costs of
postretirement medical and life insurance costs. The CODSIA approach
would permit very different alternative accounting practices for the
same category of cost without any justification for having a choice of
accounting methods. Such an approach would be contradictory to the
Board's goal of uniformity. The Board does not believe that post-
retirement benefit costs should be subjected to the pension rules of
CAS 9904.412 and 9904.413 that were originally designed and recently
amended to coordinate with the vagaries of the tax code. Furthermore,
the subject matter and the terminology employed in the current CAS
9904.412 and 9904.413, as compared with SFAS 106, are so different that
any attempt to treat them together in a single amended CAS 9904.412 and
9904.413 would produce an unwieldy document that would be difficult to
comprehend or implement.
Thus, the Board has concluded that the promulgation of a new
Standard is necessary to adequately and clearly address the cost
accounting (measurement, period assignment, and allocation) issues
unique to post-retirement benefit costs of Government contracts. Having
a separate and distinct Standard will make it clear to users and
practitioners where the CAS Standards and GAAP are in agreement and
where the Standards and GAAP diverge. Promulgating a new and separate
Standard will reduce the administrative burden of trying to apply a
single pronouncement for two different purposes; to wit, financial
reporting and contract cost determination.
2. Relationship to Existing Standards
Comment: Generally the respondents agreed that tax consequences
should not be considered in the determination of contract cost. The
Aerospace Industries Association (AIA) did suggest that if funding were
required as a condition of using accrual accounting, the tax
consequences might have to be considered ``because funding and tax
considerations are irretrievably interwoven.'' The AIA also noted that
if the Board ``permits accrual accounting without a funding
requirement, tax consequences are generally irrelevant.'' The industry
associations and most contractors believed that CAS 9904.412 and
9904.413, possibly augmented by CAS 9904.416, should form the baseline
if there were to be a funding requirement. While some industry
commenters felt that the Board should consider tax-rate complementary
funding, others expressed their belief that tax-rate complementary
funding for nonqualified pension plans in CAS 9904.412 is overly
complicated. While Government respondents opposed the use of such tax-
rate complementary funding, the OUSD did express its belief that ``tax
consequences should be considered only to the extent the contractor is
unable to fund the entire amount of the accrued cost to a tax
deductible funding vehicle.''
Some industry commenters expressed their belief that if funding
were to be required for cost recognition, then an ``assignable cost
limitation'' would be reasonable, especially if spread-gain actuarial
cost methods were permitted. The AIA noted, ``the original CAS Board
limited the application of spread gain methods by imposing an
assignable cost limitation (see old CAS 412.50(b)(2)).'' Government
respondents believed there should be an assignable cost limitation
defined similarly to the one used for pensions regardless of whether
funding would be required as a prerequisite for accrual accounting.
The Government respondents did not favor any explicit linkage
between segment closing adjustments for pension and post-retirement
benefit plans. Industry respondents asked that the Board provide that
any pension surplus measured under 9904.413-50(c)(12) be explicitly
offset against any unfunded post-retirement benefit obligation when a
segment closes. Texas Instruments stated:
Conceivably, the same business interruption event that triggers
an adjustment to PRB costs will also trigger a similar adjustment to
pension costs. Therefore, both these determinations should be
connected.
The Department of Defense commenters expressed an interest in
amending CAS 9904.416 to reflect the differences between life
insurance, medical insurance, and property and casualty insurance.
These respondents noted that each of these types of insurance requires
unique actuarial approaches and are generally unrelated to each other.
They also recommended that the Board review workers' compensation
coverage, which includes health, disability and liability provisions.
The comments from industry generally stated that they had no major
concerns or problems with CAS 9904.416.
Response: When developing these proposed modifications to SFAS 106,
the Board sought to maintain consistency where practicable with the
analogous provisions of (a) CAS 9904.412 and 9904.413 on pensions, (b)
CAS 9904.415 on deferred compensation plans, and (c) CAS 9904.416 on
insurance costs. However, this proposed Standard addresses the
accounting issues of measurement and period assignment of post-
retirement benefit costs and does not address tax-deductibility
concerns. The recent amendments to CAS 9904.412 and 9904.413 were
exceptional in the incorporation of tax-implications into a Standard.
The Board recognizes that tax accounting rules can produce volatility
and that such tax rules primarily affect the timing of cost
recognition. The Board notes that pension accounting and practices,
unlike those for post-retirement benefits, evolved in an environment in
which funding was not only permitted, but dominated by tax law and
Internal Revenue Service (IRS) and Department of Labor regulations
regarding the determination of the benefits and the actual funding and
administration of pension plans.
In this proposed Standard, the determination of the cost for a
period when accrual accounting is used generally follows SFAS 106 with
some
[[Page 59514]]
restrictions and modifications. SFAS 106 imposes no minimum or maximum
limits, such as the assignable cost limitation, on the determination of
the net periodic post-retirement benefit cost, and neither does this
proposed Standard.\8\
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\8\ As discussed elsewhere, the proposed Standard does compare
and limit the net periodic post-retirement benefit cost so that the
accumulated value of plan assets and unfunded accruals do not exceed
the unavoidable liability, i.e., the nonforfeitable post-retirement
benefit obligation.
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The proposed Standard does not address the offsetting of a post-
retirement benefit segment closing adjustment against any pension
segment closing adjustment. The Board believes that CAS 9904.413
determines the plan termination and segment closing adjustment for
pension plans and this proposed Standard would determine the adjustment
for post-retirement benefit plans. How either adjustment is actually
transacted or effected is best determined by the contracting parties.
This proposed Standard and CAS 9904.413 neither require nor preclude
the aggregation of these adjustments with each other or other issues
for resolution and settlement purposes.
This proposed Standard addresses many issues similar to those
considered in the March 30, 1995 amendments to CAS 9904.412 and
9904.413. The fact that any of these issues are treated differently in
this proposed Standard on post-retirement benefit costs does not
necessarily imply that changes will be made to the pension Standards,
nor does it preclude such possibility.
The Board notes the comments from the Department of Defense
regarding a general review of CAS 9904.416, but believes that
addressing post-retirement benefits as defined by SFAS 106 is a
substantial task in its own right. To expand this case to include a
comprehensive review of CAS 9904.416 would make the case unmanageable.
The Board proposes that the provisions of CAS 9904.416 relating to
prefunding of retiree benefits be replaced by this Standard. Otherwise
the Board has concluded that any general review of CAS 9904.416 is
outside the scope of this project.
3. Funding as a Prerequisite for Accrual Accounting
Comment: The perception that any post-retirement benefit liability
recognized in the financial statements might be a ``soft'' liability
led some respondents, especially Government respondents, to express the
belief that funding must be used as a tool in assessing the firmness of
these liabilities.
In general, industry commenters argued funding does not necessarily
substantiate the liability. They expressed their belief that funding
may be an important business consideration, but such considerations
generally deal with cash flow consequences and income tax
considerations. They recommended that any criteria established as a
prerequisite for accrual accounting should address the existence of the
liability rather than the existence of funding. They also believed that
funding is an allowability issue, not an accounting issue.
The ABA noted that for financial accounting purposes the threshold
for recognition is met by a probability that an obligation exists. The
ABA did suggest there may be situations when the funding of the annual
accrual might serve a legitimate purpose. The ABA wrote in part:
We do, however, agree that contractors should not be permitted
to accrue costs without funding them in cases where the payment
cannot be compelled. In such cases, no valid liability has been
incurred unless the liability is funded. Additionally, if
circumstances indicate that a contractor is likely to default on its
PRB obligations, accrual without funding should not be allowed.
The NDIA also acknowledged that while funding could be one means to
substantiate (validate) the obligation, there were disadvantages to
using funding for contract cost measurement and assignment.
It is clear that funding validates a liability. It is also clear
that funding does not match cost with products. It is also clear
that the use of funding (or any other cash payment) as a determinant
of cost incurrence decreases uniformity and consistency in
accounting.
Industry representatives pointed out the reason for including a
funding requirement in the pension Standards and the inappropriateness
of a funding requirement for post-retirement benefits costs. The AIA
made the point as follows:
Public policy, as articulated in the tax code, has long
encouraged pension plan sponsors to fund their programs at an
adequate level. While industry does not agree that funding has any
place in the Cost Accounting Standards, the addition of a funding
requirement in the recent changes to CAS 412, as well as explicit
recognition of tax deductible limits, did not create tension between
public policies as expressed in the Internal Revenue Code and the
Cost Accounting Standards. ``In contrast, however, Congress has
intentionally discouraged prefunding of post-retirement medical
benefits. It would be inconsistent for the Cost Accounting Standards
Board to in essence force contractors to fund these post-retirement
benefit costs.
On the other hand, in its response to the Staff Discussion Paper,
the OUSD articulated the concern of some members of the Government
procurement community that any potential risk that the liability might
not be liquidated is unacceptable. The OUSD unequivocally stated:
Yes, funding is necessary to substantiate accrual of costs. The
level of funding necessary is 100 percent of the maximum amount of
possible funding in accordance with the contractor's funding
vehicle. Permitting funding at less than 100 percent of the cost
accrual results in a potential risk that the liabilities for which
the Government has paid its fair share might never be liquidated. A
100 percent funding requirement assures the Government that the
money will be available when the liability must be paid. If there
are valid reasons to accrue the liabilities, the accruals should be
fully funded. Permitting less than 100 percent funding effectively
results in the Government providing a long-term interest free loan
to contractors. Permitting funding at less than 100 percent of the
cost accrual would require that earnings on the unfunded amounts be
imputed each year to preclude increased costs to the Government
resulting from lost earnings on the unfunded amounts.
Government respondents stated there are no appropriate alternatives
to a requirement that the cost accrual be fully (100%) funded.
Generally, industry respondents stated that the Board did not need to
consider any alternatives to a funding requirement because funding was
unnecessary to substantiate the cost accrual. Boeing concurred with the
belief that funding does not necessarily substantiate the liability,
but suggested that more restrictive measures of accrual accounting or
cash basis accounting might be used where the contractual rights to a
benefit are lacking. Boeing commented that:
The accounting must be based upon the likelihood that the
contractor will liquidate the liability. If the likelihood is in
some doubt or remote then the costs should be recognized on more
limited accrual basis, i.e., terminal funding or those vested, or if
not appropriate on a cash basis. Otherwise the costs must be
recognized on an accrual basis over the period of time the benefit
is earned.
The responses to the Board's January 12, 1999 letter did focus and
advance the discussions regarding the role of funding. Most industry
representatives continued to argue that funding neither enhances nor
proves the firmness of the liability for post-retirement benefits. Some
industry commenters expressed the belief that once established, a
contractor's promise to provide post-retirement benefits could not
easily be avoided and therefore, a funding
[[Page 59515]]
requirement might be superfluous. Industry commenters again argued that
funding was merely a cash-flow or financial management decision and as
such, was an inappropriate consideration for an accounting standard.
These respondents did believe that funding would be a proper
consideration for an allowability rule which addresses procurement
policy concerns.
Comments from the Department of Defense Inspector General (DOD IG)
and the Department of Energy reiterated the position that full (100%)
funding of post-retirement benefit costs should be included in the
criteria for accrual accounting. The OUSD maintained its opinion that
post-retirement benefit costs must be funded, but agreed with the
industry comments that funding should be addressed as an allowability
constraint and not within the allocability criteria of an accounting
standard.
Response: In Standards promulgated by the original CAS Board
dealing with pension and insurance costs, in most instances the
applicable Standards require that pension and retiree insurance costs
be funded. Therefore, the Board believes that to maintain consistency
with the promulgations of the original CAS Board and amendments
promulgated by the current Board, the Board had to consider the role of
funding as a prerequisite for the use of accrual accounting for the
costs of post-retirement benefits. The Board considered a criterion for
accrual accounting based on the contractor's documented commitment to
fund at least the government segments' post-retirement benefit costs.
But, after reviewing the merits of assessing the liability's firmness
using funding as opposed to the terms of the post-retirement benefit
plan, the Board decided to propose criteria concerning the contractor's
ability to unilaterally reduce or eliminate benefits.
The original pension Standard, CAS 412, and the March 30, 1995
amendments were developed in an environment wherein the large majority
of pension costs arose from qualified pension plans subject to ERISA.
For qualified pensions plans there was less concern with whether the
pension obligation would be systematically funded as costs are accrued
for benefits earned by employees working on Government contracts. Tax
accounting, financial accounting and contract cost accounting for
pensions mostly differ in the pattern in which tax deductible accruals
(contributions), financial accounting expense accruals and the contract
cost accruals are ascribed to accounting periods.
Generally CAS 412 did not have to establish the contractor's
commitment to fund its tax-qualified pension plan as a prerequisite for
accrual accounting, the funding requirement was already imposed by
ERISA. Even as far back as 1968 paragraph 42 of APB-8 stated: ``This
Opinion [APB 8] is written primarily in terms of pension plans that are
funded.'' Conversely, for post-retirement benefits, financial
accounting uses ``pure'' accrual accounting while tax accounting for
post-retirement benefits is generally limited to cash basis accounting.
Thus post-retirement benefits are shown on an accrual basis for the
more conservative financial accounting purposes (which tend to maximize
liability recognition), but are usually operated on a pay-as-you-go
basis.
Despite assertions by some respondents, the original Board did
believe that funding played a legitimate role in determining whether
the liability for a pension or post-retirement benefit was sufficiently
firm for contract cost recognition. In the May 15, 1978 preamble to the
Notice of Proposed Rulemaking for CAS 416 (43 FR 20806), the original
Board addressed the funding issue when it proposed subparagraph
416.50(a)(1)(v) (which was unchanged when published in the final rule):
``One respondent objected to the requirement that costs which
represent additions to a `retired lives' reserve be evidenced by
payments to an insurer or trustee. Retired lives benefits are
analogous to pension costs in that a contract cost is to be
recognized in the present but payment of the benefit is to take
place in the relatively distant future. In most such programs, the
employer reserves the right to discontinue the program at any time,
and benefits are limited to those which can be provided by amounts
already funded. If an amount is to be recognized currently as a cost
of a retired lives program, there should be some evidence that a
contractor has, in fact, incurred a liability which he cannot
subsequently avoid by a unilateral decision.
``Some respondents suggested the deletion of the requirement
that the contractor have no right of recapture of the fund as long
as any active or retired participant in the program remains alive.
Under some fully prefunded programs, a substantial portion of the
fund is to provide for liability to active employees. Without the
cited provision, it would be possible for the contractor, at any
time, to terminate the program as to employees who had not yet
retired, thereby creating a surplus in the fund and obtaining a
windfall.''
And in Section (1) ``RELATIONSHIP TO THE EMPLOYEE RETIREMENT INCOME
SECURITY ACT OF 1974 AND TO GENERALLY ACCEPTED ACCOUNTING PRINCIPLES''
of the September 24, 1975 preamble to the promulgation of CAS 412 as a
final rule (40 FR 43873), the original Board stated:
APB-8 provides criteria for accounting for the cost of pension
plans for financial accounting purposes. The Board believes that
certain of these criteria are not appropriate for Government
contract costing purposes. For example, a fundamental concept of
APB-8 is that the annual pension cost to be charged to expense for
financial accounting purposes is not necessarily determined by the
funding of a pension-plan. The Board believes that a requirement of
law for annual minimum funding of pension costs on an irrevocable
basis, is strong evidence that an obligation for at least such
period.
The Board went on to state:
In developing the accompanying Cost Accounting Standard, the
Board has attempted to stay within the general constraints of APB-8
and the funding provisions of ERISA.
Later, in Section (11) ``ASSIGNMENT OF PENSION COST'' of the
September 24, 1975 Preamble, the Board writes:
``Certain commentators expressed their disagreement with the
sections of the Federal Register proposal dealing with the
assignment of pension costs among cost accounting periods. The
concept set forth in the proposal related in the assignment of costs
to the validity of the liability for such costs. Commentators
referred to the concept set forth in APB-8 that the accrual of
pension expenses and the funding of pensions are not necessarily
related. They stated that cost should be assigned to cost accounting
periods irrespective of whether or when funded.
``The Board believes that assigning pension costs to cost
accounting periods on a cash basis is inappropriate from an
accounting viewpoint and could lead to the improper assignment of
pension costs among periods. The Board believes also that the
concept which states that funding is unrelated to pension accruals
is not appropriate for contract costing because, under such a
concept, pension costs could be assigned to cost accounting periods
and never be funded; yet such costs would be reimbursed by the
Government. (Emphasis added)
``The underlying concept of the Standard is that when a valid
liability exists, the corresponding costs may be accrued
irrespective of when the liability is liquidated. If the liability
(to the pension fund or, for pay-as-you-go plans, to retirees) is
not valid, it cannot be accrued; in order for it to be allocated to
cost objectives of the current period, it must be liquidated
(funded) in that period or within a reasonable period of time
thereafter. In order to clarify its intent with regard to the
allocation of pension costs to cost objectives of individual cost
accounting periods, the Board has revised the wording of 412.40(c)
of the Standard.''
Clearly, the original Board believed that funding was a proper
accounting
[[Page 59516]]
consideration in promulgating a Cost Accounting Standard. This Board
agrees and recognizes that in any case, funding is one method for
validating the liability.
The Board also considered adopting the tax-rate complementary
funding requirement applicable to nonqualified pension plans. While
negating the tax consequences of funding such plans, tax-rate
complementary funding adds administrative burden and complexity. Since
the amendments to the pension Standards were published in March 1995,
it appears that very few, if any, contractors have elected to use the
``tax-complement'' approach. Furthermore, unlike pensions, the funding
of post-retirement benefits is not driven by tax law. The Board has
concluded that it is inappropriate to develop provisions of this
proposed rule based on tax law.
Looking to other accounting standards, an alternative to imposing a
funding requirement might be to follow the approach that the National
Association of Insurance Commissioners (NAIC) uses for the statutory
accounting policy for ``Employer's Accounting for Post-retirement
Benefits Other Than Pensions'' wherein the obligation is determined for
recognizing only benefits for which plan participants are currently
eligible. However, the responses to the Staff Discussion Paper,
``Accounting for Unfunded Pension Costs,'' published on June 17, 1991
(56 FR 27780), argued that such recognition would neither have the
simplicity and ease of cash basis accounting nor the matching of costs
with activities achieved by accrual accounting. These same comments and
criticisms would apply to such an approach for post-retirement benefit
costs. The Board disagrees and believes that such a restrictive
approach does have merit and can address the issue of whether a firm
liability exists. Therefore, the Standard being proposed today imposes
a cap on the net periodic post-retirement benefit cost for a period
which is based on the firm liability for benefits payable to vested and
fully-eligible participants.
There is much confusion, misinformation, and perhaps
disinformation, concerning funding as a prerequisite for accrual
accounting. The Board believes the question of whether accrual
accounting or cash basis accounting should be used to measure, assign
and allocate costs to Government contracts is an accounting question
within the purview of the Cost Accounting Standards Board. The
establishment of criteria concerning when alternative accounting
approaches (cash versus accrual) should apply is also an accounting
question that the CAS Board can and should address. (See CASB Statement
of Objectives, Policies and Concepts published May 1992, after SFAS 87
and 106 were promulgated.) The Board disagrees that requiring funding
of the period cost developed under an accrual accounting method
converts the funded accrual to cash basis accounting because the
primary measurement and assignment is still based on accrual
accounting. Although this proposal does not impose a funding
requirement, the Board reiterates its belief that funding can be an
appropriate criterion to ascertain the contractor's commitment to
ultimately provide a promised benefit.
4. Criteria for Assessing the Firmness of the Post-Retirement Benefit
Liability
Comment: The Staff Discussion Paper asked if the post-retirement
benefit liability was reasonably foreseeable and could be reasonably
estimated. The response from the National Defense Industrial
Association (NDIA) was representative of the comments from both
industry and the government when NDIA stated: ``If it can be determined
that there is a valid obligation to pay, determining an annual estimate
of the cost of that liability is feasible.'' Several commenters
concurred with AIA who noted that the FASB had ``considered this issue
at length, and concluded that these amounts could be reasonably
estimated (see paragraphs 159 through 163 of SFAS 106).'' Towers-
Perrin, an actuarial consulting firm, stated that it performs nearly
600 SFAS 106 postretirement benefit plan valuations for nearly 600
clients each year.
Most commenters who addressed the SFAS 106 definition of the
``substantive plan'' stated the definition might be inadequate for
contract cost accounting purposes. There appeared to be a general
consensus that in order for a post-retirement benefit to be
recognizable, criteria similar to that found in CAS 412 requiring that
the plan be in writing and communicated to the employees, and that the
benefits be materially nonforfeitable should be applied.
However, comments from the industry associations questioned the
usefulness of requiring that the post-retirement benefit plan be
written as adequate evidence of a firm liability. NDIA argued that the
SFAS 106 concept of established practice coupled with employee
communication might be more appropriate: ``A written document enhances
the likelihood that there is a valid obligation. However, employee
notification of future benefits, coupled with a history of payment of
benefits, also seems to be substantial evidence of an intent to pay.''
AIA agreed with NDIA: ``A formal document does not make the liability
any more compellable than informal documentation or an established
practice. A formal document may enhance the auditing of the liability
but it doesn't necessarily enhance the validity of the liability.''
Funding as a precondition to the use of accrual accounting remains
controversial and was discussed in the previous subsection (3). Other
than a funding requirement, no commenters suggested any additional or
alternative criteria that might be used to assess the firmness of the
post-retirement benefit obligation.
The Staff Discussion Paper also inquired whether the firmness of
the liability could be enhanced by not projecting benefit levels. None
of the commenters found any utility to placing such a restriction on
the recognition of the post-retirement benefit liability.
Response: The Board agrees that the liability for a plan that meets
the criteria for accrual accounting set forth in this proposed Standard
can be reasonably estimated. However, the Board does not believe that a
liability is a firm liability simply because it can be estimated. The
financial effect of many contingencies can be estimated, but the
estimated value associated with these contingencies may not rise to the
level of a firm liability for contract costing purposes without meeting
other criteria.
The SFAS 106 definition is intended to identify any potential
liability for financial accounting disclosure purposes. For contract
cost accounting purposes, the Board believes there must be a greater
expectation that the benefits will ultimately be paid to the employees.
The Board concludes that, at a minimum, when accrual accounting is used
for contract cost accounting, the benefits must be described in a
formal written document, the right to the benefits must be communicated
to the plan participants, and the benefit must be materially
nonforfeitable once eligibility is attained. The formal document
provides the vehicle by which employees can legally enforce payment of
the promised benefits. Furthermore, with the numerous changes that
corporations have been making to their post-retirement benefit plans to
reduce or eliminate benefits or shift the cost to the employees, the
Board believes that only benefits currently provided by the written
document and which the contractor cannot unilaterally negate or
otherwise eliminate form a firm liability that should be recognized on
an accrual basis.
[[Page 59517]]
The Board notes that, unlike pension benefits, employees' rights to
promised post-retirement benefits often do not vest until the employee
approaches retirement eligibility, e.g., age 50 and 20 years of
employment. Because of this substantial delay in vesting, a contractor
can have a formal, ironclad contractual promise that is communicated to
its employees, but still be able to discontinue the plan leaving only
those employees who are currently eligible or close to eligibility with
rights to post-retirement benefits. This Board, like its predecessor,
is concerned that the contractor could reap a substantial gain
attributable to the liability released by nonvested participants. The
recent court decision in Sprague v. General Motors Corporation, (Nos.
94-1896, 94-1897, 94-1898, 94-1937, U.S. Court of Appeals, 6th Circuit,
January 7, 1998) throws into question the usefulness of relying on
established practice, documentation, and communication collectively or
individually. Even when the post-retirement benefits are provided
pursuant to a collectively bargained agreement, a Circuit Court
recently found that the commitment to provide post-retirement benefits
does not survive beyond the current bargaining agreement (Joyce,
Charles v. Curtiss-Wright Corporation (1999, CA2, 1999 WL 152535). The
Board is aware that a similar systemic weakness in the promise of
pension benefits to the employees of Studebaker Corporation was a major
impetus for the enactment of ERISA in 1974.
The Board examined how the earning of post-retirement benefits is
attributed to cost accounting periods by the actuarial cost method
employed by SFAS 106. The Board also considered the ERISA and DOL rules
which require that pension benefits, once earned, cannot be reduced by
the plan sponsor. For accrual accounting, this proposed Standard
similarly requires that the portion of the post-retirement benefit for
which the employee has achieved eligibility cannot be eliminated or
reduced by the unilateral action of the contractor.
Because the Board does not accept the SFAS 106 substantive plan as
the basis for the recognizable liability and has chosen not to use
funding to substantiate the cost, the proposed rule relies on the
nonforfeitable portion of the accumulated post-retirement benefit
obligation as the measure of the valid, that is, compellable,
liability. To accomplish this, the proposed rule imposes a limitation
on the post-retirement benefit cost measured for a period. The proposed
limitation is measured as the benefits paid during the period plus the
unfunded amount of nonforfeitable accumulated post-retirement benefit
obligation. The amount of valuation assets is the fair value of plan
assets plus the accumulated value of unfunded accruals minus the
accumulated value of prepayment credits. The proposed rule further
requires that the measurement of nonforfeitable accumulated post-
retirement benefit obligation include nonforfeitable benefits that
would be earned during the year.\9\
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\9\ Including the additional nonforfeitable post-retirement
benefit obligation accrued during the year is analogous to, but more
straight-forward than, measuring and adding a nonforfeitable annual
service cost.
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5. Identification of the Post-Retirement Benefit Plan
Comment: Industry and Government commenters alike argued that the
Board should permit the use of different accounting methods for
different benefits because a post-retirement benefit plan often is not
a single-purpose, homogeneous plan. As the AIA expressed it:
One area of difference between pensions and post-retirement
benefits concerns the definition of a single ``plan.'' While the
contracting parties must be clear as to the underlying benefits that
are reflected in contract costs, and how amounts funded or accrued
relate to those individual cost elements, industry feels strongly
that the CAS Board should not require contractors to restructure
their plans from an ERISA perspective in order to achieve effective
cost allocation. In other words, form should not be elevated over
substance with regard to plan structure.
The OUSD summed it up this way:
If separate plans are used to provide different types of post-
retirement benefits, different accounting methods should be
permitted. Different accounting methods also should be permitted for
different benefits provided through the same plan, but only if
separate records are maintained. Different accounting methods
generally should not be permitted for different groups within the
same plan population (e.g., union versus non-union). However, if
contractors are permitted to use cash accounting for current retired
employees and accrual accounting for active employees, the treatment
of post-retirement benefit costs for future retirees must be on an
accrual basis. Since the post-retirement benefit liability would
have already been accrued during the period of active employment,
there is no additional liability to be recognized when active
employees retire.
Most commenters felt that immaterial benefits, e.g., legal
services, retiree discounts, etc., could be accounted for by the
contractor in any reasonable manner. They stated that, as with any item
of cost, the CAS should only address costs that are material.
Response: The Board agrees. The Board is aware that it is often
necessary for a company to use a combination of investment vehicles,
e.g., a Voluntary Employee Benefit Association (VEBA) trust combined
with an IRC Sec. 401(h) trust, to achieve tax-favorable funding of
post-retirement benefits. Similarly, slightly different retiree
insurance plans may be required in different plants, locations, or
states to provide an overall general post-retirement benefit promise.
Thus, the post-retirement benefit plan is frequently not a single
benefit plan, but several different benefit promises to different
groups of employees.
The proposed Standard permits the contractor to parse its overall
post-retirement benefit plan or its plan population into several
separately identified plans for purposes of contract cost accounting.
Once so established, such division of the plan or population must be
consistently maintained and often will require disclosure on the DS-1
Statement. For administrative ease, the proposed Standard also allows
the contractor to aggregate different plans or populations for which
the same contract cost accounting method is used.
Costs of post-retirement benefits that are immaterial may be
accounted for separately on a consistent basis. This proposed Standard
does not address post-retirement benefit costs that are immaterial.
6. Cash Basis Accounting (Pay-as-You-Go Cost Method and Terminal
Funding)
Comments: Many commenters expressed their belief that cash basis
(pay-as-you-go) accounting is appropriate whenever the post-retirement
benefit liability is not firm. Some commenters expressed a desire for
cash basis accounting to be permitted even when the criteria for
accrual accounting are satisfied so that contractors could maintain the
flexibility to coordinate their contract cost accounting with their
financial management decisions regarding the funding of the liability.
Other commenters asked that cash basis accounting be permitted as an
alternative if a funding requirement were to be imposed as a
prerequisite to accrual accounting.
The commenters who addressed terminal funding stated that while
terminal funding was not an acceptable accounting method, the Board
should permit contractors to continue use of the terminal funding
method.
Response: The Board generally agrees. Therefore, this proposal
provides that if the post-retirement benefit plan does
[[Page 59518]]
not satisfy the criteria for accrual accounting, then cash basis
accounting is the only appropriate cost accounting method. However,
this proposed Standard requires that if the plan does meet the proposed
criteria for accrual accounting, then the contractor must use accrual
accounting.
The Board agrees that terminal funding is not a generally
acceptable accounting method and may introduce excessive volatility
into costs. This proposal does not permit contractors to use the
terminal funding method, although the transition provisions permit a
contractor who has an established practice of using terminal funding to
continue such practice.
As discussed later, if the plan fails the criteria for accrual
accounting, the Board believes it is inappropriate to recognize any
unfunded liability that may exist when a segment closes.
7. Accounting for the Funding of Post-Retirement Benefit Plans
Comment: The commenters generally agreed that any portion of the
accrued cost for the period that is not funded should be accounted for
in some manner. The commenters suggested that the provisions of CAS
9904.412 regarding unfunded accruals could serve as appropriate
guidance. The NDIA suggested that some restrictions might be placed on
the interest equivalent used to update the accumulated value of the
unfunded accruals. The OUSD recommended that the accumulated value of
the unfunded accruals be reduced appropriately when post-retirement
benefits are paid.
Response: The Board agrees with these comments. For plans using the
pay-as-you-go cost method, funding is accomplished by payments made
directly to the participant or else to a third party to provide service
or insurance for the participant. The cost of defined-contribution
plans using accrual accounting is measured by the net distribution to
individual participant accounts of the amount deposited to the funding
agency or paid to cover the administrative expenses of the plan.
Interest expenses or other costs of borrowing are excluded from post-
retirement benefit costs. For defined-benefit plans using accrual
accounting, deposits to the funding agencies plus benefits paid to or
on behalf of participants comprise the funding. When accrual accounting
is used, the Board believes that contractors who pay benefits directly
from corporate resources should be accorded the same treatment as
contractors who would make a deposit to a funding agency and then
almost immediately use that funded deposit to pay benefits.
Depending on its financial management decisions, a contractor's
actual funding may be more or less than its assigned post-retirement
benefit cost, therefore the proposed measurement and assignment section
includes provisions to account for unfunded accruals and prepayment
credits. The Board proposes that any portion of the period accrual that
is not funded shall be accounted for and accumulated with interest as
an accumulated value of unfunded accruals. Generally the accumulated
value of unfunded accruals would be treated the same as a plan asset.
This proposed Standard specifically provides that prepayment
credits are not allocated to segments until used to fund the post-
retirement benefit cost in a future period. When a portion of the
prepayment credit is used to fund post-retirement benefit cost, that
portion will be allocated as part of the total funding for that cost
accounting period. This means that the paragraph 9904.419-40(b)(5)(iii)
balance tests would not include the prepayment credit when applied at
the segment level.
Consistent with the pension Standard, CAS 9904.413, a contractor
may choose to allocate funding to those segments, including home
offices, that allocate costs to contracts subject to this Standard
before allocating any funding to other segments. This proposed
provision gives contractors flexibility to comply with any funding
requirement that might be imposed by procurement allowability rules.
Post-retirement benefit plans, like nonqualified pension plans, are not
subject to plan-wide minimum funding requirements so that funding the
Government segments first could create a situation where those segments
are fully funded while the commercial segments are unfunded. The Board
is concerned that because all participants generally would have a claim
to any assets of the plan, the Government could, in fact, be
subsidizing the obligations of commercial operations and therefore
funding must then be applied to those segments once the Government
segment(s) is funded. Note that in Illustration 9904.419-60(d)(6), the
contribution in excess of the minimum required to fund the cost of the
Government segments was allocated toward the funding of the commercial
segments rather than as a prepayment credit for the Government
segments.
If the criteria for accrual accounting are satisfied, this proposed
Standard provides that the full post-retirement benefit cost be
allocated to segments based on either a separate calculation of costs
or general allocation using an appropriate base, e.g., headcount or
salaries, etc. Once the post-retirement benefit cost is allocated to
segments and intermediate home offices, this proposal provides that the
cost be allocated to intermediate and final cost objectives in the same
manner as other personal service compensation costs of that segment or
home office.
8. Accounting for the Assets of Post-Retirement Benefit Plans
Comment: Both Government and industry respondents found IRC Section
401(h) accounts within a qualified pension trust, VEBA trusts, and
secular trusts to be acceptable trust arrangements. Industry
respondents believed that ``rabbi'' trusts would be acceptable funding
agencies for post-retirement benefit plans just as they are acceptable
for nonqualified pension plans under CAS 9904.412. The AIA advised the
Board that ``any Standards should permit the use of these and other new
arrangements as they emerge.'' Government respondents expressed their
belief that any trust arrangement must not be subject to the claims of
creditors and therefore objected to ``rabbi'' trusts. The DOD IG
stated:
CAS 9904.416.50(a)(1)(v)(B) requires that there be no right of
recovery from a trust by the trustor as long as any active or
retired participant in the program remains alive unless the
interests of such remaining participants are satisfied through
reinsurance or otherwise. This provision has served to adequately
restrain contractors from attempting to cost contingent liabilities
in current costing periods.
Some industry respondents believed there was no accounting
difference between treating IRC Section 401(h) separate accounts as the
assets of a post-retirement benefit plan or the assets of an ancillary
benefit that is an integral part of the pension plan. On the other
hand, the OUSD said:
Separate 401(h) accounts should be considered part of the post-
retirement benefit plan assets because the assets are segregated in
a trust and they are restricted by the IRC to be used solely for
post-retirement benefits. This is consistent with the description of
post-retirement benefit plan assets contained in paragraph 63 of
SFAS 106.
Commenters noted many insurance arrangements, e.g., restricted
insurance reserves, separate investment accounts, trust owned life
insurance (TOLI) arrangements, that might qualify as funding agencies.
While they agreed that all insurance arrangement should be considered,
they also agreed that access to the assets must be restricted. In this
regard, the commenters
[[Page 59519]]
expressed a belief that a corporate owned life insurance (COLI)
arrangement should not be considered a funding vehicle because a COLI
is an unrestricted investment of the company and not the post-
retirement benefit plan. The Government respondents believe insurance
arrangements must be subject to the same criteria as trusts. The OUSD
echoed their concern about ``rabbi'' trusts and stated, ``Insurance
arrangements should be permitted to the extent the assets are protected
from general creditors and cannot be used at the contractor's
discretion.''
The commenters agreed that several funding agencies could be
combined to form the assets of a post-retirement benefit plan. No one
believed that any particular type of funding agency should be given
preference or priority.
Response: This proposed Standard on post-retirement benefit costs
adopts the CAS 9904.412 definition of funding agency. Any investment
vehicle or arrangement and any insurance product or reserve that
satisfies that definition can be recognized as an asset of the post-
retirement benefit plan. Several individual arrangements, such as a
VEBA trust, a TOLI arrangement, and an IRC section 401(h) subaccount
could be aggregated together to form the plan assets. The Board
expresses no preference for one arrangement over another.
The Board is not concerned about the use of ``rabbi'' trusts. If a
``rabbi'' trust meets the funding agency definition, the plan
participants' and beneficiaries' rights are superior to that of the
contractor. Because the procuring agencies are responsible for ensuring
that their contractors are financially viable, the Board does not
perceive any undue risk to the Government that should affect this
proposed accounting Standard.
9. Measurement and Assignment Under the Accrual Accounting Method
Comment: The commenters were in general agreement that accrual
accounting is the most desirable accounting method for determining the
costs of post-retirement benefit plans that meet the criteria for
establishing a firm liability. They uniformly observed that accrual
accounting affords the best matching of post-retirement benefit costs
with the contract activity.
None of the commenters favored limiting the measurement and period
assignment of post-retirement costs to a single accounting method. In
addition to the firmness of the liability, the commenters expressed
their belief that the choice of the appropriate cost accounting method
would depend on the nature of the post-retirement benefit plan, the
financial management of the plan, and factors affecting a particular
industry and employee population. As AIA observed:
CAS consistency and uniformity is referring to identical
treatment under like circumstances. In this area, it is highly
unlikely there will be like circumstance. Contractors are different,
plans are different, IRS rules are changing and the health care
environment is extremely dynamic. A ``one size fits all'' uniformity
is not appropriate for measuring, assigning or allocating this type
of cost.
Similarly, TRW stated:
Due to the different characteristics of post-retirement benefit
obligations (for example, the magnitude of the obligation or the
ability to fund in a tax-effective manner), a contractor should be
free to determine which method is most appropriate.
Response: The Board generally agrees that accrual accounting does
provide the best matching of costs associated with a firm liability
with contract activities. Therefore, for a post-retirement benefit plan
that meets the criteria set-forth in this proposed Standard the
contractor must use accrual accounting. Post-retirement benefit plans
that do not meet the proposed criteria must use cash basis accounting.
10. Actuarial Cost Methods and Assumptions
Comment: Looking to SFAS 106 as the primary model, some respondents
have implicitly advocated the use of a single method; that is, the unit
credit cost method. Other commenters, concerned with matching costing
and funding to the greatest degree possible, advised the Board to
permit any generally accepted actuarial cost method, including spread-
gain methods. Discussing why spread-gain methods should be permitted,
TRW suggested:
Spread-gain methods should be allowed because they frequently
are the basis for determining deductible contributions to 401(k)
[Sic] accounts and VEBAs. If only immediate gain methods are
permitted, many contractors will find it difficult if not
impossible, to match permitted funding with the expense accrual.
Echoing TRW's comment, the AIA recommended ``flexibility to follow tax
rules is critical if funding is to be a prerequisite for cost
allowability.'' The AIA went on to suggest that ``changes in the
techniques used from one year to the next should not be treated as
accounting changes.''
Respondents also commented that the Board should consider
addressing actuarial assumptions, especially those used for discount
rates and medical cost inflation rates. They were concerned that the
SFAS 106 emphasis on current period results, rather than long-term
expectations, would cause volatility in annual costs. Several
commenters recommended that the assumptions be subject to the same
``best-estimate,'' long-range expectation criteria as the actuarial
assumptions used for pension costs. The ABA was adamant that the Board
should ``refrain from mandating actuarial assumptions.'' None of the
commenters felt that any certification by the plan's actuary or any
sensitivity analysis was necessary.
Some commenters held the view that changes in actuarial assumptions
should not be treated as a change in cost accounting practice. Other
commenters stated that if the basis for actuarial assumptions is
changed, rather than the numeric values of assumptions themselves, such
changes would appear to meet the criteria of CAS 9903.302 as a change
to a cost accounting practice. One commenter added that the Standards
need not include guidance already provided for in the regulations.
Response: As part of its acceptance of SFAS 106 for the measurement
of post-retirement benefit obligations and costs, the Board accepts the
SFAS 106 provisions regarding actuarial assumptions. The Board does
remain somewhat concerned that currently post-retirement benefit plans
are generally unfunded or significantly underfunded. Furthermore, there
are no insurance products available to settle the liability for health
care benefits. Therefore assumptions regarding expected discount rates
cannot be based on the results of actual fund yields nor are there any
insurance contracts from which discount rates can be extracted.
The Board notes that the amended CAS 9904.412 prohibits the use of
spread-gain methods. Furthermore, when CAS 9904.412 was promulgated,
the original Board was concerned that spread-gain methods did not
separately identify gains and losses and explicitly imposed a form of
assignable cost limitation on costs determined under a spread-gain
actuarial cost method.
The Board concurs that post-retirement benefit costs are not
sufficiently distinct from pensions and insurance to warrant any
special actuarial certification. The Board also notes that when an
actuary performs a post-retirement benefit valuation or advises
contractors concerning their plans, the actuary is personally subject
to the professional standards promulgated by Actuarial Standards Board.
The Board has concluded that no special certification requirements are
necessary.
[[Page 59520]]
The Board proposes to expand the provisions of CAS 9904.416 that
require the accrual cost of prefunded retiree insurance plans be
``actuarially determined'' and move these provisions to this proposed
Standard. By accepting SFAS 106 as the basis for the actuarial
determination of the accrual accounting costs for defined-benefit post-
retirement plans, the Board is accepting the unit credit actuarial cost
method as described in SFAS 106. The proposed Standard does not
preclude the contractor from using a spread-gain actuarial cost method
to determine the annual contribution to a tax-qualified funding agency,
but the contract cost determination is limited to the unit credit cost
method as described in SFAS 106.
What constitutes a change in cost accounting practice should be
determined in accordance with the provisions of CAS 9903.302. Those
provisions describe cost accounting practices as ``* * * any disclosed
or established accounting method or technique which is used for
allocation of cost to cost objectives, assignment of cost to cost
accounting periods, or measurement of cost.'' Additional guidance
regarding the disclosure of cost accounting practices applicable to
post-retirement benefit plans is provided in Part VII of the Disclosure
Statement (Form CASB DS-1 (Rev 2/96)). The DS-1 guidance makes clear
that any disclosure only applies to the basis for setting and updating
significant actuarial assumptions. Such disclosure does not apply to
the current numerical values of the actuarial assumptions which may
change in response to experience. On the other hand, a change in the
basis used for determining actuarial assumptions would constitute a
change in cost accounting practice that should be addressed on a case-
by-case basis under the provisions of CAS 9903.302. Additional
provisions in this proposed Standard are not deemed necessary.
The Board proposes to place a restriction on the health care trend
rate assumption. The proposed limit is implemented by imposing a cap on
the health care trend rate equal to the long-term expected rate of
return. Of all the actuarial assumptions, the health care trend rate is
one of the most volatile and difficult to estimate. Moreover, many
economists and other experts do not believe that health care
expenditure can continue to increase as a percentage of Gross Domestic
Product. Therefore, the Board believes that this restriction will not
only reduce volatility, but will introduce a long-term reasonability
\10\ limit on this problematic assumption. The Board does note that
increases in the projected and accumulated post-retirement benefit
obligations that are attributable to a period of high health care cost
increases will be measured and recognized as an actuarial loss.
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\10\ The Board has generally accepted the SFAS 106 guidance on
actuarial assumptions which places more emphasis on current
conditions rather than long-term expectations. However, in this
instance, placing a long-term expectation on the health care trend
rate which can exert such a leveraging effect on post-retirement
benefit costs seems appropriate.
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11. Accounting for the Transition Obligation
Comment: Both industry and Government commenters agreed that if a
firm liability exists, then the transition obligation portion of the
total liability is a firm liability and should be included in any
accrual accounting provisions promulgated by the Board. The commenters
noted that both the original and amended CAS 9904.412 identify the
initial unfunded liability, which is analogous to the SFAS 106
transition obligation, as one of the portions of unfunded actuarial
liability to be recognized and amortized. Similarly, CAS 9904.416
recognized and amortized the actuarial present value of benefits for
employees already retired when contractors switched from the pay-as-
you-go cost method to the terminal funding method. The commenters
generally agreed that immediate recognition of the transition
obligation would be disruptive to contract cost accounting. The
commenters recommended that the transition obligation be amortized over
either a period of 10 to 30 years as required by CAS 9904.412 or else
over the average future working lives of the participants as required
by SFAS 106.
One commenter argued for some mechanism to reflect the contractor's
historical level of cost-based contracts as a means of achieving equity
for both parties if there had been a major increase or decrease in the
contractor's cost-based Government work over the last ten (10) years.
Another commenter suggested that the contractor and the cognizant
Federal agency official should be given the latitude to negotiate such
an equitable arrangement. Other commenters opined that attempting to
reflect past levels of Government participation in costs assigned to
future periods would be exceedingly complicated and would impose an
administrative burden for both parties.
Response: Consistent with the conceptual approaches of CAS
9904.412, SFAS 87 and SFAS 106, the Board agrees that if the post-
retirement benefit plan meets the criteria for accrual accounting, the
transition obligation should be recognized in accordance with SFAS 106.
However, immediate recognition of the transition obligation, as
permitted by SFAS 106, would be unmanageable and disruptive to the
budgeting process for cost type contracts and the forward-pricing
process for negotiated fixed price contracts. The Board proposes to
limit recognition of the transition obligation to the delayed
recognition method of paragraphs 112 and 113 of SFAS 106.
Neither CAS 9904.412 nor CAS 9904.416 includes any provision to
reflect past levels of Government contracting prior to the initia