Joint Venture (JV), Teaming Agreement (TA), and Special Business Units (SBU's)
Audit, Cost and Pricing Considerations?
PART 1
Interest has been increasing with many members on this topic. I have been receiving increasing requests for information pertaining to the cost, pricing, and audit considerations for JV's and TA's as well as clarification on what an SBU is. So I have decided to share the many audit, cost and pricing issues to be considered. And there are a lot! As a result, this topic will be covered in several parts. I would recommend you share the information with your CPA's, Audit/Accounting Staff, and Legal Representatives.
Often, firms go into great detail on the technical and legal side of these arrangements but fail to put the effort and resources in ensuring the arrangements will stand muster under potential future audit and review. So, here I am to put this forth for your information and to show you where to go to find out for yourself what you and your support personnel need to know.
In this part we will start by discussing the first four (4) of eleven (11) areas of consideration as outlined by DCAA in providing guidance to their auditors. Remember my training class discussion on "subject to interpretation"? Well there is much on this subject where interpretation applies. So, do your homework, get proper and strong counsel, and be sure to include in your pricing any projected additional cost you may incur as a result of moving in this direction.
This information is not proprietary. It is available to all and I don't mind saying so. What I have done was to identify, format, and excerpt the information that will address the many questions our member colleagues have asked.
1 Introduction
a. This discussion is to provide guidance on understanding joint ventures, teaming arrangements, and special business units (SBUs) from the Cost and Pricing aspect.
b. The form of business organization chosen by a contractor to carry on its business or to bid on Government contracts significantly affects contractor costs and income taxes. This discussion is focused on contractor costs. The contractors Tax or CPA Accountants should already have an understanding of applicable Internal Revenue Service Regulations and provisions of both Federal law and state law and their tax implications.
c. Eligibility for award of a Government contract may be directly linked to the form of business organization under which a contractor elects to bid. Concurrently, the form of business organization will have a significant bearing on determining the allowability and allocability of costs incurred under Government contracts. Therefore, in reviewing a contractor's business organization, an auditor must consider the related business circumstances and the contractor's compliance with generally accepted accounting principles, FAR, and CAS where applicable.
2 lets start by reviewing some General Terms and Definitions
a. Joint Venture.
(1) An enterprise owned and operated by two or more businesses or individuals as a separate entity (not a subsidiary) for the mutual benefit of the members of the group. Joint ventures possess the characteristics of joint control; e.g., joint property, joint liability for losses and expenses, and joint participation in profits.
Joint ventures can be either incorporated or unincorporated.
a) The incorporated joint venture involves the issuance of stock and is most common on large construction type contracts. These joint ventures possess the typical characteristics of a corporation.
b) The unincorporated joint venture can be a partnership or teaming arrangement between two or more corporations usually involved in large research and development and/or major weapons systems contracts. Usually in this type of joint venture, the joint venture is the contracting entity and is designated to act as the prime contractor.
(2) Joint venture ownership seldom changes, and the stock of an incorporated joint venture is normally not traded publicly. Furthermore, under the usual arrangement:
a) each investor participates, directly or indirectly, in the overall management of the joint venture (i.e., joint venturers usually have an interest or relationship in the venture other than as passive investors);
b) significant influence of each of the investors is presumed to be present; and
c) one investor does not have control by direct or indirect ownership of a majority voting interest (otherwise the venture is likely to be a subsidiary of the controlling investor).
b. Teaming Arrangement.
An arrangement between two or more companies, either as a partnership or joint venture, to perform on a specific contract. The team itself may be designated to act as the prime contractor; or one of the team members may be designated to act as the prime contractor, and the other member(s) designated to act as subcontractors. (See FAR Subpart 9.6.)
a) When the characteristics of joint control are evident (i.e., joint property, joint liability for losses and expenses, and joint participation in profits), then the teaming arrangement is a joint venture.
b) When these characteristics are not present then the arrangement may more closely resemble that of a prime contractor/subcontractor.
c. Special Business Unit (SBU).
SBU is the term used within the contract audit manual (CAM) and other Agency guidance to describe business organizations established by a single contractor to:
a) support a single contract, program, or product line,
b) limit financial, tax, or legal liability, and/or
c) gain a technical or cost advantage. For purposes of this guidance, an SBU may be a wholly-owned subsidiary, a corporate division, or a joint venture/partnership composed of segments of the contractor.
d. Corporation. A business organization of one or more persons, partnerships, associations, or corporations chartered by the state for the purpose of conducting profit making endeavors with the objective of dividing the gains. A corporation is a separate legal entity with the following usual characteristics: continuity of existence, centralized management, liability limited to corporate assets, and free transferability of interest. A corporation may perform any business action that can be performed by a natural person.
e. Partnership. An ordinary partnership occurs when two or more entities (persons) combine capital and/or services to carry on a business for profit. From a legal standpoint, it is a group of separate persons.
f. Cooperative Research Consortiums. A cooperative research consortium is a partnership, joint venture, or corporation organized pursuant to the 1984 National Cooperative Research Act. Research consortiums involve collaborations among competitors and are usually formed to explore specific research areas. Unlike other business entities discussed in this section, cooperative research consortiums are not formed to bid on Government contracts.
g. Subsidiary. An entity controlled, directly or indirectly, by another entity. Control is usually conditioned upon ownership of a majority of the outstanding voting stock. It may also exist, however, with less than a majority of the outstanding voting stock under certain conditions (e.g., there is a contract, lease, agreement with other stockholders, or court decree).
3 Characteristics of a Joint Venture
a) An incorporated joint venture normally has characteristics common to a corporation (discussed in 2d.). It is a separate legal entity and acts as a contracting party.
b) An unincorporated joint venture usually is either a partnership or a teaming arrangement and most often has:
1. few or no employees hired and paid by the joint venture,
2. little or no assets or separate facilities,
3. no separate financial statements, and
4. little or no G&A, B&P, or material handling expenses. All contract work is performed by the venturing organizations or other subcontractors. Employees are paid by their respective companies. The terms of the formation, operation, and dissolution of the venture are usually specified in a written agreement between the venturing organizations (see 7a.).
4 Characteristics of SBUs (used within a single contractor organization)
a. An SBU is a segment of the establishing contractor since the SBU is either a subdivision of that contractor or is controlled by that contractor.
1. Some SBUs have employees hired and paid by the SBU who actually perform the required contract effort. These SBUs may also have their own assets and liabilities and have profit and loss responsibility. They are usually reportable segments for financial and tax purposes. These SBUs are often engaged in foreign military sales or direct commercial sales to foreign governments. These SBUs are usually formed to limit tax and /or legal liability.
2. Other SBUs are more like joint ventures and teaming arrangements. These business organizations have no employees and subcontract virtually all (over 90 percent) contract effort to other contractor division s and/or outside subcontractor(s). Often these SBUs have little or no assets. This type of SBU may have been formed to gain competitive, cost, and/or technical advantages.
b. The audit concern is that any cost advantage be based on valid cost allocation practices. Basically, there are two types of cost advantages that SBUs can attain.
1. The first type results from the fact that an SBU is a specialized contracting entity supported by one or more established contractor entities.
2. The second type results from cost allocation practices that enable an SBU contract to significantly reduce, or altogether avoid, the amount of material overhead and G&A that the contractor would normally have to allocate to its subcontracts and/or interdivisional work. If the cost allocation practices cause a significantly different allocation to a SBU contract than would have been allocated to the same contract if issued directly to the contractor's operating segment, the cost allocation practices may be inequitable and/or FAR/CAS noncompliant.
· Audit Considerations;
· Characteristics of a Legitimate Business Unit/Segment;
· Relationship between Business Organizations (Form and Substance);
· Accounting Considerations;
· Federal Tax Issues;
· FAR and CAS Cost Allocation Considerations; and
· Changes in Cost Accounting Practices.