Government Contracting: Contractor Promotional Advertising Costs Are Unallowable

Published by the Government Accountability Office on 1990-04-10.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                   United   States   General   Accounting   Office
                   Report to the Chairman, Legislation               j
    GAO            and National Security Subcommittee
                   Committee on Government Operations
;                  House of Representatives

    April   1990
                   Advertising Costs Are
                   United States
GAO                General Accounting
                                 D.C. 20548

                   National Security and
                   International Affairs Division

                   B-23869 1

                   April lo,1990

                   The Honorable John Conyers, Jr.
                   Chairman, Legislation and National
                     Security Subcommittee
                   Committee on Government Operations
                   House of Representatives

                   Dear Mr. Chairman:

                   As requested in your letter dated July 24, 1989, we reviewed the costs
                   of major defense contractors’ national advertisements urging public sup-
                   port of weapons programs such as Northrop’s B-2 advanced technology
                   bomber, McDonnell Douglas’ F-15E Strike Eagle, Grumman’s F-14D Tom-
                   cat shipboard interceptor, and Boeing-Textron’s V-22 tilt-rotor aircraft.
                   You asked us to determine the Department of Defense’s (DOD) policy
                   with respect to such advertisements and whether the contractors
                   treated these advertising costs as unallowable charges to government
                   contracts. You also asked us to det,ermine the total dollar amount that
                   was to be spent on advertising these four weapon systems during 1989,
                   and whether the contractors planned to claim these costs as deductible
                   business expenses for federal income tax purposes.

                   The government policy on the allowability of these costs, as set forth in
Results in Brief   the Federal Acquisition Regulation (FAR), is that such costs are unallow-
                   able charges to government contracts. The contractors we visited treat
                   promotional advertising costs as an unallowable charge to government
                   contracts in accordance with the FAR. Cost Accounting Standard (w)
                   405, Accounting for lrnallowable Costs, provides that costs that are
                   expressly unallowable shall be identified and excluded from any billing
                   claim or proposal applicable to a government contract. Contractor
                   accounting and advertising officials were aware that promotional adver-
                   tising costs, such as those in question here, cannot be charged to govern-
                   ment contracts, Current accounting policies and procedures at each of
                   the contractors we visited require that these advertising costs be placed
                   in unallowable accounts. The advertising costs examined were properly
                   charged to corporate accounts and clearly labeled as not to be allocated
                   to government contracts. complying with both the FAR and CAS405.

                   The total aggregated amount that the contractors planned to spend
                   advertising these four weapon systems during 1989 was approximately
                   $2 million. Final determination of the amount deductible for federal

                    Pn(ZrI                             GAO/NSlAD-90.52 Unallowable Advertising Costs

                        Each of the accounting and advertising officials we interviewed was
                        aware that the FAR prohibits contractors from charging these promo-
                        tional advertising costs to government contracts. During our visits, these
                        officials discussed the corporate accounting procedures that are used to
                        treat promotional advertising as an unallowable cost to government con-
                        tracts. These procedures appear to meet all aspects of the FAR require-
                        ments for promotional advertising.

                        All the costs for the specific advertisements in question had not yet been
                        recorded in the official books of account. Consequently, at each contrac-
                        tor, we selected similar recent advertising costs and traced these costs
                        through the accounting system. All the costs traced were properly
                        placed in accounts to be charged to the contractor, not to government
                        contracts. One contractor official also pointed out that a contractor is
                        required to certify that its indirect cost claim does not contain any unal-
                        lowable costs. The official regards this certification as an additional
                        safeguard for the government against unallowable costs, such as those
                        in question here, from being charged to government contracts.

                        According to Defense Contract Audit Agency (DGAA)officials, LMXA
                        teams regularly review contract accounts to ensure that costs are prop-
                        erly charged. In addition, the cognizant administrative contracting offi-
                        cials are responsible for day-to-day contract administration, and are
                        familiar with the contractor’s policies and practices. Cognizant DCM and
                        government administrative contracting office officials for these contrac-
                        tors believe that these contractors follow the FAR requirement and do
                        not charge government contracts for unallowable advertising costs.

                        Table 1 contains the aggregated total dollars that the four contractors
~xpecwu Auvertising     budgeted for and expected to spend for advertising the four systems in
Expenses for the Four   9uestion during 1989. We have aggregated the data because each of the
Selected Weapon         contractors regards the actual totals for each system as proprietary
                        The contractors regard most of these promotional advertising expenses
                        as normal business expenses that are considered deductible for federal
                        income tax purposes. They plan to claim these deductible expenses in
                        accordance with 1J.S.Treasury regulations regarding federal income tax.

                        ‘Disclosure of proprietary   information, such as the amount of any expenditure   of any firm, is prohib-
                        ited by 18 IT.S.C. section 1905. unless such disclosure is authorized by law.

                        page3                                             GAO/NSIAD-9052UnallowableAdvertisingCQsts

We did not trace all of the actual costs in question through the process
because they had not yet been entered in the account books. Even for
those we did trace, we could not determine whether subsequent adjust-
ments would be made and the costs actually charged to government con-
tracts because finalization of these costs to contracts will not occur for
several years when LXAA does its final review of the contractors’ cost
claims. In lieu of that, we traced similar costs through the accounts and
verified with DC~ZA  auditors that the contractors historically have not
inappropriately charged these accounts to government contracts.

Our review was made in accordance with generally accepted govern-
ment auditing standards between -July 1989 and January 1990.

As you requested, we did not obtain agency comments on this report.
However, the views of responsible agency officials were sought during
the course of our work and are incorporated where appropriate.

Unless you publicly announce its contents earlier, we plan no further
distribution of this report until 30 days from its issue date. At that time,
we will send copies to interested congressional committees; the Secre-
tary of Defense; and the Director, Office of Management and Budget.
Copies will be made available to other interested parties on request.

Please contact me at (202) 2758400 if you or your staff have any ques-
tions concerning this report. Major contributors to this report are listed
in appendix I.

Sincerely yours,

Paul F. Math
Director, Research, Development,
  Acquisition, and Procurement Issues

Page 5                               GAO/NSIAD-9052 Unalhwable   Advertising   Costs
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Appendix I

Major Contributors to This Report

National Security and   Carol S. Markson, Assignment Manager
International Affairs   Thad L. Hecht, Evaluator-in-Charge
Division, Washington,

(396139)                Page 6                           GAO/NSlADW-6% Unallowable Advertising Cost8

                                          However, contractor officials said that some of these advertisements
                                          included sections that encouraged constituents to write their federal
                                          government representatives on behalf of the weapons programs. This
                                          “grass roots” advertising is not a deductible business expense, according
                                          to 26 CFR, section 1.162-20(c)(4), and the contractor officials said that
                                          these costs will not be claimed. The advertising costs will be reviewed
                                          and the final decision on deductibility of about $600,000 will be made at
                                          the time the 1989 income tax is filed.

Table 1: Expected Advertising Expenses
for Selected Weapon Systems of Four       Dollars spent                                                               Dollars tax deductables
Major Defense Contractors During Fiscal   $TO?~ 6O3                                                                        $1,438,221   (mtnimum)”
Year 1989
                                                                                                                          $2,038,221    (maxlmum)

                                          “These amounts do not mclude $32,382 that was spent for grass roots campaign advertlsmg. and there
                                          fore, not deductible according to Treasury regulations. 26 CFR, section 1 162-20(c)(4)
                                          “This amount does not include $600,000 that WIII be revlewd and the tax deductlblllty   determined when
                                          the company flies I& 1989 federal income tax return I” September 1990

                                          Based on our discussions with responsible officials, examination of these
Conclusion                                contractors’ practices for the classification of advertising charges,
                                          review of selected advertising transactions, and confirmation of our
                                          findings with the DCAA auditors, it appears that the contractors we vis-
                                          ited do not charge government accounts for promotional advertising
                                          costs. The contractors have an accounting system in place that complies
                                          with CAS405 and the KU and properly identifies these expenses as unal-
                                          lowable on defense contracts.

                                          The scope of our review was limited to the contractors for the four spec-
Scope and                                 ified weapon systems. We visited Northrop, Grumman, and McDonnell
Methodology                               Douglas. We also visited Textron Headquarters and its wholly owned
                                          subsidiary Bell Helicopter Textron, Inc., which is a joint venture partner
                                          with Boeing for the V-22 program. Because of time constraints, we did
                                          not visit Boeing Corporation. We met with company accounting officials
                                          and officials responsible for advertising, and cognizant ~CAAand govern-
                                          ment administrative contracting officials. We discussed advertising poli-
                                          cies, advertising costs, accounting policies and procedures, and
                                          safeguards to prevent unallowable advertising costs from being charged
                                          to defense contracts. In addition, we examined specific advertising
                                          transactions involving promotional advertising, such as those mentioned
                                           here, and traced these charges through the accounting system to actual

                                           Page 4                                           GAO/NSIAB90-52       Unallowable Advertising     Costs

                            income tax purposes has not been completed, but the contractors plan to
                            claim at least $1.4 million as deductible, in accordance with federal
                            income tax regulations.

                            Section 31,205-l of the FAR establishes government contract cost princi-
Advertising Costs Are       ples and procedures for public relations and advertising costs. Accord-
Unallowable Charges         ing to the FAR, advertising costs to promote the sale of products or
                            services are not allowable charges to government contracts. The only
                            advertising costs that are allowable are those specifically required by
                            contract, or that arise from requirements of government contracts, such
                            as recruiting qualified personnel.

                            The CASBoard promulgates cost accounting standards for defense con-
                            tractors to establish uniformity and consistency in cost accounting prac-
                            tices. These standards are intended to aid in the negotiation,
                            administration, and settlement of government contracts. One of these
                            standards, CAS405,

                        . requires that contractors identify and set aside expressly unallowable
                          costs and
                        l establishes the cost accounting treatment once unallowable charges are

                            DOD officials were aware of the FAR requirement that prohibits contrac-
DOD Policy                  tors from charging government contracts for promotional advertising
                            costs. According to DOD officials, the governmentwide policy for contrac-
                            tors’ treatment of promotional advertising costs is embodied in the cost
                            principles section of the FAR, and no separate DOD policy regarding these
                            costs is needed.

                            The contractors we visited treat promotional advertising costs as an
Advertising Costs Are       unallowable charge to government contracts as required by the cost
Properly Charged            principles section of the FAR. Contractor accounting and advertising offi-
                            cials were aware that promotional advertising costs such as those in
                            question here cannot be charged directly or indirectly to government
                            contracts. Current contractor accounting policies and procedures require
                            that these advertising costs be placed in accounts clearly marked as
                            unallowable against government contracts, and the recent advertising
                            costs we examined were properly charged to these accounts.

                            Page 2                             GAO/NSlALI-9052 Unallowable Advertising Costs