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Public Works and Government Services Canada

10.4. Annex: Reasons for the non-applicability of certain costs when utilizing Contract Cost Principles 1031-2

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The following costs are considered non-applicable to government contracts when utilizing contract cost principles 1031-2 for the reasons given.

  1. Allowances for interest on invested capital, bonds, debentures, bank or other loans together with related bond discounts and finance charges
    Interest on borrowing, however represented, is not an acceptable cost. There are several reasons for this. In the first place, it is impossible to know how much of a contractor's capital should be properly provided by equity capital and how much by borrowed capital. If it were fair to allow interest on the borrowed capital (the financial reward to the lender), it would also seem fair to allow dividends (the financial reward to the investor). As dividends are recognized as a distribution of profits and therefore not an item of cost, so too with interest. Another consideration is the determination of what a contractor's capital properly should be, regardless of what it may actually happen to be. If interest were to be an acceptable cost, then a contractor financed by bonds, debentures or long term loans would be in an advantageous position compared to a contractor financed by the sale of equity. The government recognizes the cost-of-money (interest) associated with capital employed, however financed, as a factor in the calculation of profit.
  2. Legal, accounting and consulting fees in connection with financial re-organization, security issues, capital stock issues, obtaining of patents and licences and prosecution of claims against Canada
    A distinction should be drawn between the occasional expenses in relation to the raising of capital referred to here, which are not an acceptable cost, and the normal recurring expenses associated with the day-to-day management and recording of capital transactions, which are an acceptable cost. The latter expenses include those arising from the registry and transfer of share capital when they form part of the activity of the company secretary, costs of share holders' meetings, normal proxy solicitations, reports to shareholders, submission of required reports to government agencies, reasonable directors' fees and incidental expenses of directors and for committee meetings.
  3. Losses on investments, bad debts and expenses for the collection thereof
    Since interest on capital invested in a contractor's business is not considered a business operating cost, neither is interest received by a contractor from funds invested outside the business considered a necessary credit against business operating costs. However, it also follows that any losses sustained by a contractor from these outside investments are not considered to be a business operating cost and thus are not acceptable on government contracts.
    Since the government as a debtor always pays its just debts, while it is only the commercial customers who have bad debts on a contractor's books, the losses due to bad debts and the expenses of collection thereof are not an acceptable cost to government contracts.
  4. Losses on other contracts
    An excess of costs over income on a contract is not acceptable as a cost to any other contract. This principle also applies to application by a contractor of preferred overhead rates to certain contracts. Where this occurs, the excess of actual overhead over the preferred overhead amount will not be absorbed by government contracts.
  5. Federal and provincial income taxes, excess profit taxes or surtaxes and/or special expenses in connection therewith
    In general, taxes which a contractor is required to pay and which are computed in accordance with sound accounting principles are acceptable costs, except for those included under this heading and/or other taxes in connection with financing, refinancing or re-organizing.
    On the other hand, all tax refunds, federal or provincial, are not required to be applied to reduce any related expenses.
  6. Provisions for contingencies
    A contingency liability is a liability which could arise on the happening of some event which may or may not occur. The initial provision or increase of funding for a contingent liability is considered to be a setting aside of earned profits to meet possible liabilities against future profits and not a business operating cost and therefore not an acceptable cost to government contracts.
    There is one exception to the above and that is in respect of the acceptability of costs for the provision of warranties. In any firm price contract, a contractor may include as a cost a reasonable amount to be set aside as a provision for the absorption of expenses associated with warranties given under the terms of the contract. In determining a reasonable amount, the following factors should be taken into account:
    1. the amounts provided for warranty expenses should be separate for each distinctive product or family of products;
    2. the amounts provided should reflect, where available, the previous performance of the product(s) in regard to warranty, using an average of three to five years;
    3. the cost of any provision for warranty charged to a specific contract should reflect any difference in the warranty period from that normally granted by a contractor on the product(s); and
    4. the costs should be net of any warranty contract sales to other customers.
  7. Premiums for life insurance on the lives of officers and/or directors where proceeds accrue to the contractor
    Similarly, proceeds from such life insurance need not be applied to reduce any cost to the contractor.
    Premiums on this type of insurance are not acceptable in government contracts since Canada does not derive any benefit therefrom.
  8. Amortization of unrealized appreciation of assets
    See Annex 10.5.2: Cost Interpretation Bulletin - Number 02 Depreciation, "Depreciation".
  9. Depreciation of assets paid for by Canada
    See Annex 10.5.2: Cost Interpretation Bulletin - Number 02 Depreciation, "Depreciation".
  10. Fines and penalties
    The amounts of fines and penalties imposed by federal, provincial or local authorities are not an acceptable cost to government contracts, for to accept such amounts would be tantamount to the government's supporting financially the offense which gives rise to the imposition of a fine or penalty.
  11. Expenses and depreciation of excess/idle facilities
    For this purpose, excess/idle facilities means the sum of all fixed assets appearing in a contractor's books of account which are not in use or for which no use is anticipated within a reasonable period. The expenses associated with the maintenance and/or the amounts of depreciation attributable to such fixed assets are not acceptable costs to government contracts.
    The expenses and/or depreciation of excess/idle facilities, as defined above, which the government has ordered retained for defence purpose, should be charged to a separate contract set up for that purpose.
  12. Unreasonable compensation for officers and employees
    The extra costs associated with the above are not an acceptable charge to government contracts.
  13. Product development or improvement expenses not associated with the product being acquired under the contract
    See Annex 10.5.7: Cost Interpretation Bulletin - Number 07 Research and Development Expenses.
  14. Advertising, except reasonable advertising of an industrial or institutional character placed in trade, technical or professional journals for the dissemination of information for the industry or institution
    1. Assuming that a contractor's employees enhance their knowledge by reading trade, technical or professional journals, and, in turn, government contracts benefit from this increased knowledge by way of increased efficiency and productivity, and that the advertising supports these publications, the expenses of advertising in this manner are an acceptable cost to government contracts, provided:
      1. it is in the nature of institutional or support advertising only, and not in the form of display advertising;
      2. it does not advertise a particular product or service of a contractor;
      3. it is placed in trade, technical or institutional journals (financial publications are primarily for investors, not for an industry or trade; and so do not qualify); and
      4. the cost is reasonable.
    2. Expenses associated with the help wanted advertisements are an acceptable cost, provided they are reasonable and only for the purpose of recruiting personnel.
    3. The expenses associated with advertising through any media for other than (1) and (2) above, are not an acceptable cost to government contracts. For this purpose, advertising media are: magazines, newspapers, television and radio programs or "commercials", brochures, direct mail, outdoor advertising, conventions, exhibits, free goods and samples.
  15. Entertainment expenses
    Although expenses for amusement, diversion, social activities and incidentals relating thereto are not acceptable, the expenses associated with meetings and conferences, when called for the dissemination of technical information or discussion of production problems and the like, are acceptable. These latter expenses may include those for meals, transportation, rental of meeting places and other incidentals provided they are reasonable.
  16. Donations, except those to charities registered under the Income Tax Act
    Donations, except those to political parties, are an acceptable cost provided they comply with the Income Tax regulations and are taken into overhead in the period they are paid rather than pledged.
  17. Dues and other memberships other than regular trade and professional associations
    The expenses associated with membership, either of the company as a whole or individual officers or employees in associations whose prime purpose is to provide entertainment or recreation, are not an acceptable cost to government contracts.
  18. Fees, extraordinary or abnormal, for professional advice in regard to technical, administrative or accounting matters, unless approval from the Contracting Authority is obtained
    The fees associated with obtaining this assistance are not an acceptable cost, unless a contractor demonstrates, to the satisfaction of the contracting officer, the circumstances giving rise to the need for this assistance.
  19. Compensation in the form of dividend payments or calculated based on dividend payments
    Dividends are not organization costs; they are a distribution of earnings to shareholders. Therefore since dividends are not organization operating costs they are disallowed contract costs.
  20. Compensation calculated, or valued, based on changes in the price of corporate securities, such as stock options, stock appreciation rights, phantom stock plans or junior stock conversions; or, any compensation in the form of a payment made to an employee in lieu of an employee receiving or exercising a right, option, or benefit
    Disallowing this type of expense as a contract cost is already addressed as per paragraph f. provisions for contingencies of section 07 Non-applicable Costs of SACC General Conditions Contract Cost Principles 1031-2. This contingent liability is the setting aside of a provision to retain the employee and motivate future performance, based on events which may or may not occur. The provision for a contingency is considered to be a setting aside of earned profits to meet possible future liabilities and is not a business operating cost. Therefore it is not an acceptable cost to government contracts.
    Further, compensation based on changes in securities price is not based on work actually performed and thus, is unallowable. Regardless of the name given to the plan, stock-based compensation scenarios continue to emerge, and rather than trying to cover each scenario individually, in Contract Cost Principles 1031-2, a general disallowance addresses compensation based on changes in prices of corporate securities.