Independent Research & Development (IR&D) and Bid & Proposal (B&P) Costs - FAR 31.205-18

Allowable or Unallowable: Allowable

Source: DFAR, CAS, FAR

Introduction

Independent Research and Development embraces technical efforts performed by government contractors that is not required for any particular contract. The effort is taken in order that the contractor remain competitive in a world of innovation, and that contractors look for solutions to current and future problems. This helps the US Government develop the latest technologies. Reimbursement of these costs are provided within the G&A pool of a contractor.

Government officials have always questioned the benefits, management, and oversight of IR&D reimbursements. The approach has been inconsistent, in that in some instances, the government directly reimburses for these costs through R&D efforts, which are contracts directly associated with R&D, in other cases, the government provides grants for R&D efforts, and finally, the government allows through reimbursement of these costs through a contractors indirect G&A rate. A Flint study, explained it this way.

“At its best, reimbursement of IR&D means that the government initiates and encourages research and development in innumerable areas and advances science generally by paying only a fraction of the cost. At its worst, reimbursement of IR&D means that the government has expended public funds on a program of purely commercial interest to a particular contractor, a program which would have been undertaken even without the expenditure of public funds, and a program which is being duplicated elsewhere by another company working without government support. Moreover, there is no assurance that the results of the IR&D, even though supported in part by public funds, will be made available to the scientific community.”

The 1948 Cost Principle - Armed Services Procurement Regulation

The inception of regulations regarding IR&D, began with this cost principle. Under this regulation reimbursement of IR&D costs was determined by two separate provisions:

1. Research and Development costs were compensable if "specifically applicable to the supplies or services covered by the contract"
2. General research was an unallowable cost "unless specifically provided for elsewhere in the contract."

The rule implied that General Research was unallowable, however, it was common practice to negotiate overhead rates in advance of performance and these overhead rates included an allocable share of the contractors R&D (Really IR&D) effort. Since these rates were incorporated into contracts, the cost of generally research was specifically provided for in the contract. This stopped in 1956, with a Comptroller General ruling. Following this ruling, contractors had limited ability to recover IR&D costs, and the industry moved to contractors making specific efforts to incorporate the requirement of "specifically applicable" to contracts.

Amortization of IR&D Costs under the 1948 Cost Principle

Under Kellett Aircraft Corp., ASBCA 5658, 60-1 BCA 2584, the Board allowed amortized cost to be applied to two other later contracts, since the products were similar, however, the Board disallowed these costs in a 3rd contract with dissimilar products. While this case was frequently cited as the interpretation that IR&D costs could be amortized, that interpretation is misunderstood. Really what the Board was saying is that cost "specifically applicable" to a specific contract per the regulations could be allowed. The Board did not clarify the amortization issue, but actually added additional confusion.

The 1960 Cost Principle - Armed Services Procurement Regulation

This cost principle was promulgated in late 1959 and became effective in 1960. This cost principle gave more clarity to the terms:

• Basic Research - was defined as that type of research directed toward an increase knowledge in science.

• Applied Research - was research that attempted to determine and expand the potentialities on new scientific discoveries.

• Development was defined as that systematic use of scientific knowledge which was directed toward the production of useful products.

The 1960 Cost Principle also brought in the principles of allowability, reasonableness and allocability.

Allowability under the 1960 Principle

With the new definitions, the revised principle provided that Independent Research (Basic and Applied) were allowable without limitation. However, Independent Development, looked more like the 1948 principle, in that those costs had to be tied to "product lines" for which the government had contracts with the contractor.

R&D costs incurred in accounting periods prior to contract award were NOT ALLOWABLE unless they fell within the scope of "precontract costs." This was to discourage a tendency to turn R&D costs into IR&D costs so that losses could be amortized over future contracts.

Reasonableness under the 1960 Principle

There are 3 items that came out of the revised cost principle. They are:

1. Reasonableness would be determined by the contractor's prior IR&D activity and cost history,
2. Contractors whose work was substantially with the US Govt., should seek advance agreements placing ceilings on IR&D costs, and
3. The US Govt., would reimburse less than it's allocable share of IR&D. In essence, placing cost sharing on the contractor. The thought being that the contractor would be more cost-conscious of the costs, and cost born by the contractor would reduce profit through additional profits. Therefore the contractor would be conservative in incurring IR&D costs.

Allocability under the 1960 Principle

The revised cost principle provided that independent research costs were to be allocated to all contracts, whereas, independent development costs would only be allocated to contracts to which product lines were related to US Govt., contracts.

The Military Procurement Act of 1970

In late 1969 Congress enacted the Military Procurement Authorization Act of 1970. That Act limited the Department of Defense to limited reimbursement of IR&D costs to 93% ninety-three percent of its otherwise allocable share of IR&D costs. This was a statutorily mandated cost-sharing approach. In addition, DoD funds could not be used to reimburse any research project or study "unless such project had a direct and apparent relation to a specific military function or operation.

The Military Procurement Act of 1971

Under the 1971 Act, the 93% ninety-three percent rule was dropped. Congress sought to encourage the use of advance agreements to establish ceilings on IR&D for contractors. Contractor's in excess of $2M two million dollars of IR&D effort were required to establish an advance agreement.

FAR 31.205-18 - The New Cost Principles

The cost principles were extensively revised and published in the Defense Procurement Circular No. 90 on September 1, 1971 and later incorporated into ASPR on May 23, 1973.

The new cost principles address the familiar and recurring issues of burdening and amortization. Amortization is only allowed in very narrow, exceptional circumstances.

Applicable sections of the Cost Principles are shown below in the subheadings.

(b) Composition and Allocation of Costs

The requirements of 48 CFR 9904.420, Accounting for independent research and development costs and bid and proposal costs, are incorporated in their entirety and shall apply as follows—

(1) Fully-CAS-covered contracts. Contracts that are fully-CAS-covered shall be subject to all requirements of 48 CFR 9904.420.

(2) Modified CAS-covered and non-CAS-covered contracts. Contracts that are not CAS-covered or that contain terms or conditions requiring modified CAS coverage shall be subject to all requirements of 48 CFR 9904.420 except 48 CFR 9904.420-50(e)(2) and 48 CFR 9904.420-50(f)(2), which are not then applicable. However, non-CAS-covered or modified CAS-covered contracts awarded at a time the contractor has CAS-covered contracts requiring compliance with 48 CFR 9904.420, shall be subject to all the requirements of 48 CFR 9904.420. When the requirements of 48 CFR 9904.420-50(e)(2) and 48 CFR 9904.420-50(f)(2) are not applicable, the following apply:

• (i) IR&D and B&P costs shall be allocated to final cost objectives on the same basis of allocation used for the G&A expense grouping of the profit center (see 31.001) in which the costs are incurred. However, when IR&D and B&P costs clearly benefit other profit centers or benefit the entire company, those costs shall be allocated through the G&A of the other profit centers or through the corporate G&A, as appropriate.

• (ii) If allocations of IR&D or B&P through the G&A base do not provide equitable cost allocation, the contracting officer may approve use of a different base.

(c) Allowability

Except as provided in paragraphs (d) and (e) of this subsection, or as provided in agency regulations, costs for IR&D and B&P are allowable as indirect expenses on contracts to the extent that those costs are allocable and reasonable.

d) Deferred IR&D costs

(1) IR&D costs that were incurred in previous accounting periods are unallowable, except when a contractor has developed a specific product at its own risk in anticipation of recovering the development costs in the sale price of the product provided that—

• (i) The total amount of IR&D costs applicable to the product can be identified;

• (ii) The proration of such costs to sales of the product is reasonable;

• (iii) The contractor had no Government business during the time that the costs were incurred or did not allocate IR&D costs to Government contracts except to prorate the cost of developing a specific product to the sales of that product; and

• (iv) No costs of current IR&D programs are allocated to Government work except to prorate the costs of developing a specific product to the sales of that product.

(2) When deferred costs are recognized, the contract (except firm-fixed-price and fixed-price with economic price adjustment) will include a specific provision setting forth the amount of deferred IR&D costs that are allocable to the contract. The negotiation memorandum will state the circumstances pertaining to the case and the reason for accepting the deferred costs.

DoD Cost Principle - DFARS 231.205-18 Independent Research and Development and Bid and Proposal Costs

(a) Definitions. As used in this subsection—

(i) “Covered contract” means a DoD prime contract for an amount exceeding the simplified acquisition threshold, except for a fixed-price contract without cost incentives. The term also includes a subcontract for an amount exceeding the simplified acquisition threshold, except for a fixed-price subcontract without cost incentives under such a prime contract.

(ii) “Covered segment” means a product division of the contractor that allocated more than $1,100,000 in independent research and development and bid and proposal (IR&D/B&P) costs to covered contracts during the preceding fiscal year. In the case of a contractor that has no product divisions, the term means that contractor as a whole. A product division of the contractor that allocated less than $1,100,000 in IR&D/B&P costs to covered contracts during the preceding fiscal year is not subject to the limitations in paragraph (c) of this subsection.

(iii) (iii) “Major contractor” means any contractor whose covered segments allocated a total of more than $11,000,000 in IR&D/B&P costs to covered contracts during the preceding fiscal year. For purposes of calculating the dollar threshold amounts to determine whether a contractor meets the definition of “major contractor,” do not include contractor segments allocating less than $1,100,000 of IR&D/B&P costs to covered contracts during the preceding fiscal year.

(c) Allowability

(i) Departments/agencies shall not supplement this regulation in any way that limits IR&D/B&P cost allowability.

(ii) See 225.7303-2(c) for allowability provisions affecting foreign military sale contracts.

(iii) For major contractors, the following limitations apply:

(A) The amount of IR&D/B&P costs allowable under DoD contracts shall not exceed the lesser of—

(1) Such contracts’ allocable share of total incurred IR&D/B&P costs; or

(2) The amount of incurred IR&D/B&P costs for projects having potential interest to DoD.

(B) Allowable IR&D/B&P costs are limited to those for projects that are of potential interest to DoD, including activities intended to accomplish any of the following:

(1) Enable superior performance of future U.S. weapon systems and components.

(2) Reduce acquisition costs and life-cycle costs of military systems.

(3) Strengthen the defense industrial and technology base of the United States.

(4) Enhance the industrial competitiveness of the United States.

(5) Promote the development of technologies identified as critical under 10 U.S.C. 2522.

(6) Increase the development and promotion of efficient and effective applications of dual-use technologies.

(7) Provide efficient and effective technologies for achieving such environmental benefits as: improved environmental data gathering, environmental cleanup and restoration, pollution reduction in manufacturing, environmental conservation, and environmentally safe management of facilities.

(C) For a contractor's annual IR&D costs to be allowable, the IR&D projects generating the costs must be reported to the Defense Technical Information Center (DTIC) using the DTIC's on-line input form and instructions at http://www.dtic.mil/ird/dticdb/index.html. The inputs must be updated at least annually and when the project is completed. Copies of the input and updates must be made available for review by the cognizant administrative contracting officer (ACO) and the cognizant Defense Contract Audit Agency auditor to support the allowability of the costs. Contractors that do not meet the threshold as a major contractor are encouraged to use the DTIC on-line input form to report IR&D projects to provide DoD with visibility into the technical content of the contractors' IR&D activities.

Industry Portal...https://defenseinnovationmarketplace.dtic.mil/industry-portal/

(iv) For major contractors, the cognizant administrative contracting officer (ACO) or corporate ACO shall—

• (A) Determine whether IR&D/B&P projects are of potential interest to DoD; and

• (B) Provide the results of the determination to the contractor.

(v) The cognizant contract administration office shall furnish contractors with guidance on financial information needed to support IR&D/B&P costs and on technical information needed from major contractors to support the potential interest to DoD determination (also see 242.771-3(a)).

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Class Deviation 2017-O0010 - Independent Research and Development Technical Interchange

Effective Sept. 14, 2017 Contracting Officers shall not require a major contractor as defined at DFARS 231.205-18(C)(7)(C)(1), to engage in our document a technical interchange as described in DFARS 231.231.205-18(c)(iii)(C)(4), as part of the criteria for determining a contractor's annual independent research and development (IR&D) costs to be allowable.

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  Shay D. Assad Memo - Director Defense Pricng

Cost Accounting Standard 420

CAS 420 - Accounting for Independent Research & Development and Bid & Proposal Costs

Deferred IR&D Costs - CAS Board and Admiral Rickover