. 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 GOVl!?RNHj?NT CONTRACTING Contractor Promotional Advertising Costs Are Unallowable United States GAO General Accounting Washington, Office 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 B-238691 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 information.’ Systems 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 B-238691 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 .-__.- -..,.....-,,.,_,. ,, * U.S. General Accosting office Poet office Box 6015 Gaithersburg, Maryland 20877 Telephone 202-275-5241 i.! The first five copies of each report are free. Additional copies : pi’ : I $2.00 each. There is a 25% discount on orders for 100 or more copies .I ~1 R ?. ._ single address. Orders must be prepaid by cash or by check or money ti&?ZV?V? out to the Superintendent of Documents. 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, D.C. (396139) Page 6 GAO/NSlADW-6% Unallowable Advertising Cost8 B23S691 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 payment. Page 4 GAO/NSIAB90-52 Unallowable Advertising Costs B-238691 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 incurred. 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
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)