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    Is the salary expense for employees participating in MAD activities expressly unallowable, or do they meet the definition of a directly associated cost that may be subject to the materiality criteria in FAR 31.201-6(e)?


    The question posed and its related answer involve legal questions that require detailed knowledge of facts and  circumstances as well as unsettled and disputed legal interpretation.  Accordingly, it is recommended that you consult your assigned legal counsel before making decisions in the area.  Notwithstanding, the following comments are provided for your consideration.
    There may be another option other than the two (“expressly unallowable” or “directly associated costs.”) identified in the question.  Not all unallowable costs are expressly unallowable.  Salary expense for employees participating in MAD activities might also be unallowable, although not expressly so. 
    First let’s address determining whether the salary expense for employees participating in MAD activities are expressly unallowable.  Cost Accounting Standards (9904.405-30) provides a relevant definition:
    “(2) Expressly unallowable cost means a particular item or type of cost which under the express provisions of an applicable law, regulation, or contract, is specifically named and stated to be unallowable.” 
    There have been only a small number of published court/ASBCA decisions interpreting this provision (i.e., what costs are expressly unallowable) and as a result there is a fairly high level of disagreement in practice about what constitutes an expressly unallowable cost vice an unallowable cost (not expressly so).  In determining whether or not the “salary expense for employees participating in MAD activities are expressly unallowable” it does seem clear that one should look closely at the words of the regulation involved. Here that is FAR 31.205.27.
    The Armed Services Board of Contract Appeals (ASBCA) in a somewhat recent opinion issued in mid-2015 (Raytheon Co., ASBCA No 57576) specifically addressed what FAR 31.205-27 makes expressly unallowable.  In Raytheon, the ASBCA considered whether or not bonus and incentive compensation (BAIC) of individuals performing efforts related to Organization Costs (FAR 31.205-27) were expressly unallowable. 
    In Raytheon Co., ASBCA No 57576 the Board focused quite heavily upon the first two sentences of FAR 31.205-27(a):
    “(a) Except as provided in paragraph (b) of this subsection, expenditures in connection with (1) planning or executing the organization or reorganization of the corporate structure of a business, including mergers and acquisitions, (2) resisting or planning to resist the reorganization of the corporate structure of a business or a change in the controlling interest in the ownership of a business, and (3) raising capital (net worth plus long-term liabilities), are unallowable. Such expenditures include but are not limited to incorporation fees and costs of attorneys, accountants, brokers, promoters and organizers, management consultants and investment counselors, whether or not employees of the contractor.”  
    The Board applied the definition of “expressly unallowable” costs previously quoted above.  Applying this definition, the ASBCA concluded that Raytheon’s BAIC were not expressly unallowable primarily because “BAIC cost is an item or type of cost, but it is not specifically named and stated as unallowable.”  In this regard, the ASBCA further stated, “neither ‘BAIC’ cost nor “compensation’ cost is specifically named and stated as unallowable under this regulation, nor are these costs otherwise identified in any direct or unmistakable terms.”
    Although the ASBCA did not conclude that Raytheon’s BAIC were “expressly unallowable” under FAR 31.205-27, the Board did conclude that the BAIC was unallowable.  In this regard this partial quote from the opinion may provide insight into the Board’s analysis:  “ . . . we believe that a basic element of a contractor’s organization-type activity cost is the compensation paid to those who perform these activities.  Such compensation is reasonably ‘in connection with’ this activity so as to be unallowable under this cost principle.” 
    Returning to the salary expense at hand, and making reference to the ASBCA opinion in Raytheon, the salary expense in connection with planning or executing the organization or reorganization of the corporate structure of a business, including merger and acquisitions would appear to also be unallowable, although arguably not expressly so.
    As mentioned in the posed question background, FAR 31.201-6 (Accounting for unallowable costs) paragraph (e )(1) deals with ‘directly associated cost” and more specifically the materiality of directly associated costs.  FAR 31.201-6(d) tells us that only if material must directly associated cost be purged as unallowable cost.  Consistent with the previously cited Raytheon ASBCA case, if it is determined that the salary expense at issue are themselves unallowable (expressly or not) they are not directly associated costs and the materiality factors of FAR 31.201-6 (e ) would not need to be reached.
    As stated before, the issue asked about here involves a complex somewhat unsettled area of law and you should seek the advice of your assigned legal counsel before proceeding to a decision.  

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