A recent settlement between Booz Allen Hamilton (“Booz Allen”) and the US Department of Justice (“DOJ”) is a stark reminder that contractors must be diligent and thoughtful in setting up their cost accounting structures and practices, particularly where the costs of various functions will support both government and commercial work. At the same time, contractors should be careful to not read too much into the settlement agreement or the underlying allegations, none of which were admitted to, which wrongly suggest that contractors have an obligation to establish an infinite number of indirect cost pools and no flexibility to commingle indirect functions simply because the cost pools serve both government and commercial customers.

On July 21, 2023, Booz Allen and DOJ entered into a settlement agreement through which Booz Allen will pay $377M to resolve a qui tam relator’s allegations that it violated the civil False Claims Act (“FCA”) by improperly billing costs allegedly allocable to its commercial and international costs to its government contracts. The relator alleged that from approximately 2011 to 2021, Booz Allen improperly charged costs to its government contracts (and subcontracts) that should have been charged to only its commercial and international contracts. The settlement agreement identifies the following five accounting practices that were allegedly noncompliant with the Cost Accounting Standards (“CAS”) and the Federal Acquisition Regulation (“FAR”) and, in turn, contributed to the alleged violations of the FCA:

1. Allocating indirect costs supporting commercial and/or international businesses to government contracts that should have been allocated to commercial and/or international contracts, or treated as unallowable costs;

2. Creating and maintaining indirect cost pools that included commingled costs supporting both commercial and/or international contracts, as well as government contracts;

3. Using indirect cost rates that included costs for supporting commercial and/or international businesses to seek inflated payments and reimbursements under government contracts, and failing to disclose current, accurate, and complete cost or pricing data related to such costs;

4. Submitting inaccurate and/or misleading statements (e.g., CAS Disclosure Statements) regarding the methods for accounting, and the nature of, indirect costs supporting commercial and/or international businesses; and

5. Shifting employees and work relating to commercial and/or international businesses between work centers, and therefore creating and maintaining indirect cost pools that resulted in misallocations of indirect costs to government contracts.

This laundry list of allegedly noncompliant practices, in conjunction with the accompanying DOJ press release warning that “[g]overnment contractors must turn square corners when billing the government for costs under government contracts,” appears to muddy the concept of cost allocability, particularly with respect to indirect functions that may support the overall management of a contractor, and may be interpreted by some as a signal that contractors are required to establish a myriad of indirect cost pools to separately accumulate indirect costs that may benefit both government and commercial work. Although establishing discrete indirect cost pools may be appropriate in some cases, it is clearly not appropriate in others. See FAR 31.203, Indirect Costs.

To start, cost allocability is “an accounting concept involving the relationship between incurred costs and the activities or cost objectives (e.g., contracts) to which those costs are charged” and is governed by the CAS and FAR. See Boeing N. Am., Inc. v. Roche, 298 F.3d 1274, 1280 (Fed. Cir. 2002). Cost allocability is a prerequisite for cost allowability, although just because a cost is allocable to a contract does not automatically mean the cost is necessarily allowable for government contract cost accounting purposes.

With respect to allocating indirect costs (e.g., general and administrative, overhead, fringe), contractors must develop an indirect cost rate structure that results in an appropriate reflection of the beneficial or causal relationship between the costs accumulated in an indirect cost pool and the cost objectives. Generally, contractors must accumulate indirect costs by “logical cost groupings” and “determine each grouping so as to permit use of an allocation base that is common to all cost objectives to which the grouping is to be allocated.” See FAR 31.203(c); see also CAS 403, Allocation of Home Office Expenses to Segments, and CAS 418, Allocation of Direct and Indirect Costs. The base must then allocate the indirect cost grouping “on the basis of the benefits accruing” to the cost objectives. FAR 31.203(c). As a result, a contractor is permitted to have an indirect cost pool that commingles costs supporting both government and commercial work so long as the contractor’s chosen base results in an appropriate distribution of the costs to work in a manner that is reflective of consumption or the beneficial/causal relationship.

General and administrative (“G&A”) expenses, for example, are quintessential costs that can support both government and commercial work, and can be accumulated in the same cost pool to the extent there is a beneficial or causal relationship between the G&A expenses and all of the final cost objectives of the relevant reporting unit (i.e., a business unit or segment). See CAS 410, Allocation of Business Unit General and Administrative Expenses to Final Cost Objectives. In Boeing v. Roche, the Federal Circuit found that the legal costs of defending a shareholder derivative suit that were accumulated in the contractor’s home office overhead cost pool were allocable to both government and commercial contracts as part of G&A expenses. The court, after reviewing relevant precedent and regulations in detail, held that:

[A]llocability is an accounting concept and that CAS does not require that a cost directly benefit the government’s interests for the cost to be allocable. The word “benefit” is used in the allocability provisions to describe the nexus required for accounting purposes between the cost and the contract to which it is allocated. The requirement of a “benefit” to a government contract is not designed to permit contracting officers, the [Armed Services Board of Contract Appeals], or this court to embark on an amorphous inquiry into whether a particular cost sufficiently “benefits” the government so that the cost should be recoverable from the government.

To oversimplify, the court held that there must exist a “sufficient nexus” (i.e., a relationship) between the indirect cost and a cost objective such that “the cost benefit[s] the contract to which it is allocated for the cost to be allocable,” but this does not mean that every cost that is accumulated in a cost pool and allocated to a contractor’s government and commercial work must be incurred for the benefit of government contracts.

Thus, while the settlement is a reminder that government contractors should be fastidious in examining their accounting structures and practices to ensure they are not inadvertently commingling costs in a manner that is noncompliant, an indirect cost pool that commingles government and commercial costs is not precluded by the CAS or the FAR and, indeed, is anticipated. In the context of the FCA, the settlement also is a reminder about the importance of creating and maintaining a culture that encourages compliance, including having an internal control system that meets the minimum requirements of FAR 52.203-13, Contractor Code of Business Ethics and Conduct, and taking seriously internal complaints by adequately investigating and responding to such complaints.