               ARMED SERVICES BOARD OF CONTRACT APPEALS

Appeal of --                                 )
                                             )
Northrop Grumman Corporation                 )      ASBCA No. 60190
                                             )
Under Contract No. N68936-05-C-0059          )

APPEARANCES FOR THE APPELLANT:                      Terry L. Albertson, Esq.
                                                    Stephen J. McBrady, Esq.
                                                     Crowell & Moring LLP
                                                     Washington, DC

APPEARANCES FOR THE GOVERNMENT:                     E. Michael Chiaparas, Esq.
                                                     DCMA Chief Trial Attorney
                                                    Robert L. Duecaster, Esq.
                                                     Trial Attorney
                                                     Defense Contract Management Agency
                                                     Chantilly, VA

                OPINION BY ADMINISTRATIVE JUDGE PEACOCK 1

        This appeal resolves the "quantum phase" of the parties' disputes regarding
a government disallowance, totaling $253,361,512, of post-retirement benefit (PRB)
costs associated with the "transition" of Northrop Grumman Corporation (NGC or
appellant) from its "pre-transition" accrual methodology to the methodology prescribed
in FAR 31.205-6( o). In our "entitlement phase" decision, we concluded, inter alia, that
NGC failed to accrue its PRB costs in the manner specified in that provision and
remanded "quantum" issues to the parties for resolution. Northrop Grumman
Corporation, ASBCA No. 57625, 14-1BCAii35,501, aff'd on recon., 14-1 BCA
ii 35,743. Familiarity with that decision is presumed. We conclude that the government
suffered no damages as a result of appellant's noncompliance with the FAR 31.205-6( o)
accrual methodology. Accordingly, the disallowance was improper and we sustain the
appeal.




1
    Administrative Judges Mark Stempler and Jack Delman, who participated in the prior
        "entitlement phase" opinions of the Board, have retired.
                                  FINDINGS OF FACT

        A.     Background

       1. Prior to 1995, for government contract accounting and tax purposes, NGC
accounted for PRB costs associated with its Northrop Retiree Health Plan (the Plan)
using an accrual costing method that conformed with the provisions in the Deficit
Reduction Act of 1984 (DEFRA) and generally accepted actuarial principles. There is
no dispute that the use of that method prior to 1995 complied with government
contract accounting requirements. (APF ~ 1) 2

       2. From 1995 until November 2006, for government contract accounting and
tax purposes, NGC continued to account for the PRB costs associated with the Plan
using the DEFRA method. NGC documented its accrual costing method in the
company's cost accounting standards (CAS) Disclosure Statement that was reviewed
and approved by the government. No allegation was made during that period that
NGC's accounting for the Plan's PRB costs using the DEFRA method was
noncompliant with NGC's disclosed practices or with CAS. Further, during that
period, no unallowable Plan costs were identified by DCAA in any audit of the NGC
Corporate Home Office final indirect cost submissions for any period between 1995
and 2005 (the last year audited). (APF ~ 2)

       3. In December 1990, the Financial Accounting Standards Board (FASB)
issued a rule titled "Employers' Accounting for Postretirement Benefits Other
than Pensions," which is referred to as "Financial Accounting Standard 106" or
"FAS 106." For financial reporting purposes, FAS 106 required all companies
covered by FASB requirements to account for costs using a specific accrual costing

2   Because of the phased processing of this dispute and the multiple evidentiary records
        in both the entitlement and quantum phase appeals, the Board issued a Briefing
        Order requiring the parties to propose, in their initial post-hearing briefs,
        numbered and detailed findings of fact with supporting citations to the record
        compiled in both phases of the dispute. In their reply briefs, the parties were
        further directed by the Board to note specific objections to the proposed
        findings and citations to the record in the opposing party's initial brief, if any.
        The reply briefs confirm that the facts in this appeal are not substantively in
        dispute and have been in essence "stipulated" pursuant to the ordered briefing
        process. Accordingly, the Board's findings rely heavily on the excellent briefs
        prepared by both parties and we have adopted undisputed (or undisputed
        portions) of the parties' proposed findings as our own factual findings, without
        the undisputed, accompanying supporting citations to the record. Appellant's
        proposed findings and the government's proposed findings are identified as
        APF or GPF respectively.

                                             2
method. The FAS 106 accrual methodology differed from that required by DEFRA.
(APF, 3)

       4. FAS 106 required the recognition, for financial reporting purposes, of net
periodic PRB costs over the working lives of employees earning PRBs, such that the
employer's obligation for each employee's PRBs would be fully accrued by the time
the employee attains full eligibility. Unlike FAS 106, the DEFRA accrual method
does not factor in expected future increases in medical costs due to either increased
usage of medical services by plan participants or the general increase in the cost of
medical services until the year in which the resulting cost increases are experienced.
The result of the difference, keeping all other factors the same, is that annual costs
computed under DEFRA tend to start lower and increase over time while annual costs
computed under FAS 106 tend to start higher and then decrease over time. (APF ~ 4)

        5. NGC implemented FAS 106, for financial reporting purposes only, on
1 January 1991. NGC continued to use the DEFRA method for government contract
cost accounting purposes until 1November2006. NGC's PRB costs calculated during
this period were less than the costs would have been had NGC instead used FAS 106
to measure and assign costs. (APF , 5)

        6. In 2006, NGC initiated a discussion with DCMA concerning NGC's Plan to
reduce future PRB costs and requested an advance agreement with DCMA pursuant to
which NGC would continue using the DEFRA method for calculating PRB costs.
DCMA declined to enter into such an advance agreement. NGC then proposed to
DCMA that NGC adopt FAS 106 for government contract accounting purposes
coincident with the changes NGC was contemplating in plan policy. In order to avoid
any disagreement about the impact of the adoption of FAS 106 for contract costing
purposes, NGC also requested an advance agreement with DCMA that would
expressly permit NGC to measure PRB costs in accordance with the delayed
recognition methodology described in FAS 106. Again, DCMA ultimately refused to
enter into the proposed advance agreement. (APF, 6)

       7. DCMA issued a notice of intent to disallow costs on 26 July 2007. DCMA
contended that, effective 27 February 1995, FAR 31.205-6( o)(2)(iii) had required
contractors to use only the FAS 106 method to measure and assign costs of PRB plans.
DCMA also contended that FAR 31.205-6( o )(3) required that PRB costs be funded by
the contractor's federal income tax return date to be allowable. Based on these
contentions, DCMA asserted that PRB costs that would have been assignable to prior
years using the FAS 106 method, but that were not funded, paid, or otherwise liquidated
by the tax return date, were not allowable in any subsequent year. Because NGC had
used the DEFRA method to calculate PRB costs for government accounting purposes
and Plan funding in prior years, its funding amount was less than the full amount that
would have been assignable in prior accounting periods using the FAS 106 method.


                                          3
DCMA contended that the so-called "additional" PRB costs-costs calculated under the
FAS 106 method since 27 February 1995, which NGC had not previously claimed or
funded were therefore not allowable in future periods. (APF ,-r 7)

       8. DCMA issued a "Final Determination" to disallow PRB costs on 9 April 2008.
In response, in June 2008, NGC presented a briefing to DCMA. On 11 July 2008, the
DCAA issued an audit report regarding the Plan. DCAA concluded that $253,361,512 of
PRB costs were unallowable due to NGC's failure to fund Plan costs that would have
been assignable under the FAS 106 method from 28 February 1995 to 31October2006.
(APF i-18)

       9. The DEFRA method of accounting did not assign to any year prior to 2007 any
portion of the $253 million identified as unallowable in the DCAA audit report. NGC
has never claimed or otherwise sought to recover the PRB costs that DCAA identified as
unallowable in the 2008 audit report. Under the DCAA argument, the $253 million that
had not been claimed prior to NGC's use of the FAS 106 method for government contract
costing purposes would be unallowable and unrecoverable in future years. (APF ,-r 9)

         10. NGC submitted a certified claim to DCMA on 20 May 2010. In its claim,
NGC identified multiple reasons supporting allowability of the "additional" PRB costs,
i.e., the unfunded costs that could have been charged to the government under FAS 106
between 27 February 1995 and 31 October 2006, but were not because NGC used the
DEFRA method rather than the FAS 106 method. Because the 26 July 2007 initial notice
of intent to disallow costs and the 9 April 2008 Final Determination to disallow costs did
not list the affected contracts, include an estimated dollar value, or describe the potential
impact on billing rates and forward pricing rates, NGC based the total amount claimed on
the $253,361,512 amount alleged to be unallowable by the DCAA in its 11July2008
Audit Report and identified the captioned contract as a "test" contract that would
determine the allowability of $6,232.11 for purposes of the claim and any appeal that
might be necessary. (APF ,-r 10)

       11. The Defense Corporate Executive (DCE) issued a final decision on
18 February 2011 denying NGC's claim. NGC filed a timely appeal from that
decision. (APF ,-r 11)

       B.     FAR 31.205-6(0) and the Regulatory Framework for PRB Accounting

       12. The parties stipulated to the version of FAR 31.205-6( o) in effect as of
22 September 2005 (the date of award of the "test" contract). Under the relevant
provisions of FAR 31.205-6(0), NGC was permitted either (1) to recover its PRB costs on
a cash basis as it actually paid the retiree medical expenses (referred to as pay-as-you-go
(PA YGO) accounting) or (2) to accrue the costs as the benefits were earned during the
                                                                                                I
                                            4
working lives of the employees (i.e., before those employees retired and the benefits
were actually paid). NGC elected to accrue the costs for the Plan. 3 (APF ~~ 12-13)

        13. Regardless of whether a contractor uses a cash/PAYGO method or an accrual
method to account for its PRB costs, the present value of the total cost eventually
incurred by the contractor to provide the PRBs will be the same. The principal difference
between PA YGO and accrual accounting is one of timing. Generally, accrual accounting
recognizes costs as the benefits are earned, but before they are actually paid, accrual
accounting produces higher costs than PA YGO accounting in early years and lower costs
in later years, but the ultimate sum paid for benefits to plan participants will be the same.
(APF ~ 14)

       14. Another important difference between PAYGO and accrual accounting is the
method used to measure and assign the cost. Measurement of PA YGO costs involves no
judgment or choice-costs are recognized equal to the amount of benefits that are actually
paid. Accrual accounting is more complicated, particularly for costs like PRBs that will
be paid many years in the future. For accrual accounting, the future costs must be
estimated on the basis of actuarial assumptions that include factors such as the life
expectancy of the retirees and their eligible dependents likely future benefit costs, the
investment return on the amounts set aside in trust accounts and other actuarial variables.
As a result, calculation of accrued PRB costs is an actuarial calculation. NGC engaged
external actuaries to compute the annual cost based on data the company provided.
(APF ~ 15)

         15. Prior to FAS 106, most companies had been accounting for and reporting PRB
liabilities on a PA YGO basis in financial reports. Because most companies had to
"transition" from PA YGO to accrual accounting for PRB costs to comply with FAS 106,
FAS 106 also addressed how that "transition obligation" should be reported. The
"transition obligation" consists of PRB costs that were earned, but not paid, accrued or
funded before FAS 106 became effective. FAS 106 permitted companies to choose one
of two alternatives for recognizing the transition obligation: either (1) immediate
recognition of the entire transition obligation in the year of the transition; or
(2) recognition of the obligation on a delayed basis, typically over twenty years. For
financial reporting purposes, virtually all companies, including NGC, elected to use the
immediate recognition method at the time of the transition to FAS 106 for financial
accounting purposes. (APF ~ 16)



3
    NOC had a number of other plans that provided post-retirement medical benefits
       to employees and former employees who were not covered by the Plan in
       dispute. The costs of these other plans were recovered on a PA YOO basis
       and are not at issue.

                                            5
        16. The adoption of FAS 106 also triggered changes to the allowable cost
regulations. Prior to 1991, there was no specific provision in the FAR or in predecessor
regulations addressing PRB costs; PRB costs were instead covered only by the
general provisions in FAR 31.205-6(m) concerning the allowability of fringe benefits.
In response to the promulgation of FAS 106 in 1991, subsection ( o) was added to
FAR 31.205-6 as an interim rule. Unlike FAS 106, the FAR provision permitted
contractors to continue to use PA YGO accounting for PRB costs, and new subsection (o)
also specifically permitted accrual accounting and addressed, for the first time, the
allowability of PRB costs calculated on an accrual basis. The revised regulation provided
in pertinent part:

                  (2) .. .In addition, to be allowable in the current year,
             PRB costs must be paid either to an

                    (i) insurer, provider, or other recipient as current
             year benefits or premiums, or (ii) an insurer or trustee to
             establish and maintain a fund or reserve for the sole
             purpose of providing PRB to retirees. The costs in
             paragraph (o)(2)(ii) of this subsection must also be
             calculated in accordance with generally accepted actuarial
             principles and practices as promulgated by the Actuarial
             Standards Board, and be funded by the time set for filing
             the Federal income tax return or any extension thereof.
             PRB costs assigned to the current year, but not funded or
             otherwise liquidated by the tax return time, shall not be
             allowable in any subsequent year.

                    (3) Increased PRB costs caused by delay in funding
             beyond 30 days after each quarter of the year to which they
             are assignable are unallowable.

The drafters' comments explained the purpose of the new subsection as follows: "The
purpose of the FAR rule is to establish a clear requirement that contractor accruals of
PRB costs must be funded to be allowable." There was and is no requirement in
FAS 106 that accrued PRB costs be funded and most companies subject to FAS 106 do
not fund PRB liabilities on an accrual basis. Like the FAR provision, however, DEFRA
required that accrued costs be funded in order to be deductible for federal income tax
purposes. (APF ~ 17)

      17. Another interim rule issued two months later added a specific reference to
FAS 106 in subparagraph (o)(4) to limit assignment of transition obligation costs:




                                           6
                       (4) Costs of postretirement benefits attributable to
               past service ("transition obligation") as defined in
               Financial Accounting Standards Board Statement 106,
               paragraph 110, are allowable subject to the following
               limitation: The allowable amount of such costs assignable
               to a contractor fiscal year cannot exceed the amount of
               such costs which would be assigned to that contractor
               fiscal year under the delayed recognition methodology
               described in paragraphs 112 and 113 of Statement
               [FAS] 106.

The drafters' comments focused on the limits of allowability, explaining that the new
subparagraph ( o)( 4) "limits the allowable amount of contractor PRB transition costs
for any fiscal year to the amount which would be assigned to that year using the
amortization method described in FASB Statement No. 106." (APF ,-i 18)

       18. A final rule issued in December 1994 took effect on 27 February 1995 and
provided in part:

                       (iii) Accrual basis. Accrual costing other than
               terminal funding must be measured and assigned according
               to Generally Accepted Accounting Principles and be paid
               to an insurer or trustee to establish and maintain a fund or
               reserve for the sole purpose of providing PRB to retirees.
               The accrual must also be calculated in accordance with
               generally accepted actuarial principles and practices as
               promulgated by the Actuarial Standards Board.



                      (3) To be allowable, costs must be funded by the
               time set for filing the Federal income tax return or any
               extension thereof. PRB costs assigned to the current year,
               but not funded or otherwise liquidated by the tax return
               time, shall not be allowable in any subsequent year.

(APF ,-i 19)

       19. The drafters' promulgation comments to the final regulation stated that "it is
intended that the methods allowed by CAS for prefunding retiree insurance programs be
allowable for all contractors." The only cost accounting standards provision that deals
with prefunding retirement insurance costs is CAS 416. CAS 416.SO(a)(l)(v)(A). It is



                                            7
undisputed that the DEFRA method used by NGC from 1995 to 2006 to account for PRB
costs complies with the requirements of CAS 416. (APF , 20) 4

       20. The major difference between the DEFRA and FAS 106 calculation is that
FAS 106 includes health care cost trend rates, i.e., medical cost escalation, and DEFRA
does not (APF, 24). Under DEFRA, PRB costs must be computed "on the basis of
current medical costs" (APF , 22).

       21. NGC's PRB costs from 1995 to 2006 (sometimes referenced herein as the
"pre-transition" fiscal years) using DEFRA for government contracting purposes were
lower than what its PRB costs would have been using FAS 106. If NGC had used the
FAS 106 method instead of DEFRA, the costs assigned to that period would have been
approximately $253 million more (the amount of the disallowance) than were assigned
under DEFRA. (APF, 23)

       22. At some future point, costs calculated using the DEFRA method
would exceed FAS 106 calculated costs, barring reduction in Plan benefits. NGC's
position is that when and if the cross-over occurred, allowable costs would be limited to
the amounts calculated using FAS 106 (pursuant to FAR 31.201-2(c)). (APF, 24 n.11)

         C.    Appellant's Accrual Practices and Development of Dispute

        23. Although this dispute concerns the 11-year time period 1995-2006, for at least
the 21-year time period 1985-2006, NGC accounted for Plan PRB costs in accordance
with DEFRA (APF, 26). At all times between 1995 and 2006, NGC disclosed to the
government in its CASB Disclosure Statements that it accounted for the Plan's PRB costs
in accordance with DEFRA (APF , 27). The government never objected to NGC
accounting for PRBs in accordance with DEFRA at any time during the 11-year period
1995-2006 and gave NGC no reason to suspect that its use of DEFRA was noncompliant.
Neither NGC nor the government calculated the delta between FAS 106 and DEFRA for
government contracts purposes during that time period. (APF, 35) Throughout
1995-2006, the DCE, as required by FAR 30.207(a) and (b), issued multiple compliance
letters in response to NGC's disclosure statements. These letters always indicated that
NGC's use of DEFRA was compliant with CAS and FAR and that there were "no
instances of noncompliance with applicable Cost Accounting Standards or FAR Part 31
cost principles." (APF, 37)

       24. Although DCMA's position in this litigation is that NGC should have changed
its accounting practice from DEFRA to FAS 106 in February 1995, when the revision to
FAR 31.205-6( o) concerning generally accepted accounting principles (GAAP) compliant

4
    The government has not advanced any issues regarding compliance with the CAS or
         associated regulations.

                                           8
accounting methods became applicable, the DCMA PRB experts at its CIPR (Contractor
Insurance Pension Reviews) division took the opposite position prior to and after the
commencement of this litigation. Senior DCMA actuary Mr. George Matray testified that
in late 1999 he drafted the CIPR Division Technical Position Paper. That document, used
for internal training of CIPR actuaries, states that DEFRA is an acceptable actuarial cost
method for purposes of the regulation, that it complies with the requirements of CAS 416,
and that the difference between the lower DEFRA that amount was charged to the
government and the higher FAS 106 amount that could have been charged (i.e., the
"ceiling"), does not become unallowable because it was not assigned during that year.
(APF, 40)

         25. Although the CIPR team raised the issue ofNGC's use of DEFRA in 2004
internally, it ultimately concluded that NGC's accounting practice was compliant and no
one from the CIPR team raised the issue with NGC. In March 2004, the position that
some portion of NGC's PRB costs would become "forever unallowable" was first raised
by DCMA in a series of internal emails among members of the DCMA CIPR team.
Mr. Reginald Nichols, who is not an actuary but who is a member of the CIPR team on
the West Coast, asked whether the team should put NGC on notice that its accrual of
costs using DEFRA might be noncompliant with FAR accrual requirements and might be
creating "forever unallowable" costs in future years. Mr. Ed Espiritu (another CIPR team
member in Los Angeles), Mr. Matray (the senior DCMA actuary in New York), and
Mr. Ring (an actuary and the DCMA policy expert on CIPR matters in Washington)
concluded that NGC's method was compliant with the relevant requirements and
communicated that conclusion to Mr. Nichols. They concluded that the DEFRA method
was an acceptable actuarial method, that it complied with the requirements of CAS 416,
that it produced costs that were less than the maximum costs permitted by FAR, and that
there was accordingly no need to provide any notice to NGC about any potential
noncompliance. Therefore, the CIPR team concluded that the issue should be "buried."
(APF, 41)

       26. Both Mr. Matray and Mr. Ring testified at the entitlement hearing that they
continue to believe that NGC's use of DEFRA from 1995 to 2006 complied with CAS
and FAR, and that the CIPR Division Technical Position Paper correctly interprets the
regulations (APF , 42).

       27. In 2006, NGC was approaching the time when its PRB costs calculated under
FAS I 06 were likely to reach the "crossover" point, i.e., the point at which the DEFRA
costs would begin to exceed the FAS I 06 costs, and NGC considered amending its PRB
plan to limit the impact of future increases in medical costs (and therefore stay below the
FAS I 06 ceiling), but to continue accounting for PRBs in accordance with DEFRA after
making that change. NGC preferred DEFRA to FAS I 06, in part, because DEFRA
provided a more predictable cost pattern. (APF, 48)



                                           9
        28. NGC discussed the possible changes with the DCAA auditor who had been
primarily responsible for auditing NGC's PRB costs during most of the period at issue.
In those conversations, the auditor suggested that the DEFRA method was not compliant
with the FAR and that NGC might have created a pool of "forever unallowable" costs by
failing to accrue and charge the maximum amount permitted by the FAR. (APF, 49)
After discussing this issue with the auditor, NGC formally disclosed to the DCMA DCE,
that it was considering a plan to reduce future PRB costs and requested an advance
agreement with DCMA pursuant to which NGC would continue using the DEFRA
method for calculating PRB costs, regardless of whether they exceeded the FAS 106
costs. DCMA refused to enter into such an agree_ment. NGC then proposed to DCMA
that NGC adopt FAS 106 for government contract accounting purposes effective at the
same time as the Plan policy changes. In order to avoid any disagreement about the
impact of the adoption of FAS 106 for government contract costing purposes, NGC also
requested an advance agreement with DCMA that would expressly permit NGC to
measure PRB costs at the time of the change in accordance with the delayed recognition
methodology described in FAS 106. DCMA also declined to enter into that advance
agreement. (APF , 50)

       29. Effective I November 2006, NGC adopted the FAS 106 method for
government contract accounting purposes. Concurrently, also effective I November 2006,
NGC adopted a Plan design change (amendment) that capped future benefit increases for
participants in all plans, including the Plan at issue in this case. The combined effect of
those two changes was to reduce PRB costs substantially for government contract
accounting purposes in periods after the changes. (APF , 51)

       30. NGC has, since 2007, included a 20-year amortized portion of the transition
obligation, in its incurred cost submissions. It has also been deducting an amount
from its incurred cost submissions that corresponds to a 20-year amortization of the
unfunded FAS 106 costs that total $253,361,512. This deduction is pursuant to the
DCE's determination that the unfunded 1995-2006 costs are unallowable costs in years
subsequent to 2006. (GPF, 8)

      31. From 1995-2006, NGC consistently disclosed its accounting practice of
measuring and assigning PRB costs in accordance with DEFRA, and consistently
followed that accounting practice; and the government consistently approved this
accounting practice (APF, 52).

         32. In the final decision, the government took the position that, ·'Because
Northrop chose not to measure and assign PRB costs from 1991 to 2006 using the
required GAAP method, it may not now charge out-of-period costs which were allocable,
if at all, to prior periods" (APF , 53 ).




                                          10
       33. When NGC changed its accounting practice from DEFRA to FAS 106 in
2006, it simultaneously made substantial reductions in future Plan benefits. Effective
1November2006, NGC amended the Plan by capping future benefits at fixed dollar
amounts. The effect of the 2006 Plan Amendment was to ensure that NGC would not
have to pay PRB costs arising from future increases in healthcare costs in excess of the
fixed dollar "cap." (APF, 61)

        34. The 2006 Plan Amendment was a "negative plan amendment." FAS 106
prescribes how changes in plan benefits, including negative plan amendments, should
be reflected in calculation of PRB costs. Pursuant to FAS 106, paragraph 28, the
accumulated post-retirement benefit obligation (APBO) that was calculated when
FAS 106 was first adopted-and which was used to compute the transition obligation when
NGC transitioned to FAS 106 for government contract purposes effective 1 November
2006-was required to exclude obligations associated with the future health care cost
increases that were eliminated pursuant to the 2006 Plan Amendment. (APF, 62)
Because NGC executed the negative plan amendment reducing future benefits, FAS 106
required NGC to remove approximately $307 million from the APBO for the Plan
(APF, 63). The $307 million was removed from NGC's APBO before NGC calculated
the transition obligation (APF , 64 ).

        35. NGC's transition obligation for government contract purposes was calculated
by outside actuaries for the company, and reviewed by NGC's senior actuary (APF, 65).
The only independent expert actuarial testimony at the "Quantum Phase" hearing was
given by appellant's expert Mr. John McQuade. Mr. McQuade concluded and we find
that by eliminating $307 million in future medical cost trend from the APBO, the 2006
Plan Amendment actually eliminated more than the $253 million of unfunded costs
at issue in this case. Because the costs that were eliminated before computing the
transition obligation were the same costs that comprised the $253 million of unfunded
pre-transition costs, it would not have been possible for NGC to include the $253 million
of unfunded costs in its calculated PRB costs in 2007 or thereafter, which in tum means
that NGC could not have claimed those costs in the 2007-2026 period. Mr. McQuade's
conclusions were substantially corroborated and concurred in by the NGC's former
senior actuary, whom the Board finds was highly credible. (Joint Quantum R4 (JQR4),
tab 89, §§II-III; tr. 11109, 121-24, 164-66, 2/53-55, 64-67) The government presented no
testimony or report from an actuarial expert rebutting the conclusions of appellant's
senior actuary and its actuarial expert, Mr. McQuade. The only government actuarial
witness in this appeal was called by appellant and agreed with the analysis of
Mr. McQuade (APF , 69; tr. 1/108-10).

       36. None of the $253 million disallowed in the final decision has been claimed
by NGC in 2007 or any subsequent year. The $253 million disallowed represents the
"lion's share" of the $306 million APBO calculated pursuant to FAS 106 that would
have been assigned had it not been eliminated/reversed by the 2006 Plan amendment.


                                          11
(JQR4, tab 29; tr. 2152-55, 63-67) NGC's use of DEFRA from 1995-2006, and
subsequent Plan Amendment and transition to FAS 106 in 2006, did not lead to any
recovery of claimed but unfunded costs, or to duplicate recovery (id.; tr. 11204-66, 2131;
APF ~ 71).

                                      DECISION

       This is the "quantum" phase of the resolution of the parties' dispute regarding the
allowability of appellant's PRB costs. Previously in the "entitlement" phase, the Board
determined that, for government contract accounting purposes, NGC failed to measure,
accrue, assign and fund its PRB costs in accordance with FAS 106 and FAR 31.205-6( o)
allowability criteria during FYs 1995-2006, prior to NGC's 2006 "transition" to the
FAR-compliant methodology. The quantum consequences of that noncompliance are now
before us for decision. The Board's "entitlement" decision held that FAS 106 via the FAR
controlled the allowability of PRB costs. We did not definitively address the "quantum" or
damages consequences of noncompliance with FAS 106 requirements. We conclude for the
reasons detailed below, that the government unreasonably interpreted the cost principle and
ultimately suffered no damages as a result of appellant's use of DEFRA from 1995-2006 for
government accounting purposes because of appellant's 2006 Plan amendment implemented
concurrently with NGC's transition to FAS 106.

      The government has summarized its position as follows:

             From 1995 through 2006, NGC measured, assigned,
             and funded the costs of the Plan using a FAR noncompliant
             accounting method. During this time, NGC funded the Plan
             with less than what it would have funded had it used the
             FAR compliant method. In November 2006, Appellant
             started to comply with the FAR by beginning to account for
             the Plan's costs using the FAR compliant accounting
             methodology. This switch to the FAR compliant
             methodology ("GAAP IF AS 106") necessitated the
             calculation of a transition obligation to account for this
             shortfall in funding. NGC has been and continues to
             include an amortized portion of this transition obligation in
             its incurred cost submissions since 2007. The FAR section
             at issue disallows that portion of the transition obligation
             that is attributable to NGC's choice not to fund costs of the
             plan in accordance with GAAP IF AS 106 prior to 2007.
             Regardless of what accounting method NGC actually used
             to measure, assign, and fund the Plan's costs, it incurred
             costs after 1995 as measured by the GAAP/FAS 106
             methodology because the FAR required that methodology


                                           12
              to measure and assign PRB costs. Any costs as measured
              by GAAP IF AS I 06 methodology that were not funded by
              the end of each tax year are unallowable in later years.
              Appellant's 2006 Amendment that reduced the benefits of
              the Plan had no effect on the costs that NGC incurred in
              maintaining the Plan prior to that Amendment.

(Gov't reply hr. at 2-3) (Footnote omitted)

       A. The Pre-Transition Years

        Although the Board's "entitlement" decision held that the GAAP/F AS 106
requirement was clearly specified, the gravamen of the dispute involves the quantum
consequences of appellant's continued use of the DEFRA accrual methodology for
measuring and assigning PRB costs during the pre-transition fiscal years. The
damages or "quantum" consequences advocated by the government by no means
"plainly" follow from the language of the FAR 31.205-6( o ). Those consequences are
not manifest and are not specifically addressed in the cost principle viewed in
isolation. Appellant has presented the only reasonable interpretation of the
consequences of noncompliance.

        We consider that FAR 31.205-6( o ), properly construed, establishes a cost
allowability "ceiling," and focuses on whether the contractor overcharged the
government for PRB costs in its relevant cost-related submissions. There is no dispute
that for more than a decade preceding the "transition" NGC did not. From the onset of
the FAR requirement in 1995 through 2006, NGC's use of the DEFRA method resulted
in the contractor annually charging the government less than it could have claimed had it
elected to use the FAS I 06 methodology for government accounting purposes during
those pre-transition years. For that decade, the government unsurprisingly did not object.
In fact, the government was well aware that appellant continued to use the DEFRA
methodology but repeatedly approved its use as being in compliance with regulatory
criteria. The drafters' comments accompanying promulgation of the pertinent revisions
of FAR 31.205-6( o) further indicate that other CAS-compliant accrual methods were not
prohibited by the regulation. Although we determined in the "entitlement phase" that the
government was not bound by its acquiescence and did not waive compliance with the
FAR in the pre-transition years, the parties effectively interpreted the cost principle to
provide that PRB "costs" computable using FAS 106 criteria served as a "ceiling" on
allowability, while permitting use of DEFRA to the extent that DEFRA-measured,
accrued and assigned costs did not exceed that "ceiling." Only when the 2006
"transition" issues arose did the government first advocate its current theories.

      Interpretation of the provision with respect to "quantum" was not even clear and
uniform within the government. The CIPR team's analysis and interpretation differed


                                              13
from that proffered by DCAA and ultimately adopted by the DCE. We consider that the
CIPR team correctly interpreted the principle in the first instance. Regardless of their
implications relative to appellant's estoppel and corollary course of dealing contentions,
the differing internal interpretations by the cognizant DCMA audit and CIPR personnel
are relevant to evaluating the "clarity" of the provision regarding the "quantum"
consequences of non-compliance as well as the reasonableness of the government's
interpretation as ultimately advocated in this litigation. Even within DCAA, there were
differing interpretations. For years, DCAA routinely determined that DEFRA-computed
costs were allowable because they did not exceed amounts computed using the
FAR-consistent, FAS 106 methodology. See FAR 31.201-2. The lesser-funded
DEFRA-determined costs have never been questioned. The division arose when
appellant, after the failure of its attempts to reach an advance agreement with the
government approving and memorializing continued use of DEFRA, changed its cost
accounting practice5 regarding PRB costs to comply with the prescribed FAR accrual
methodology and switched to FAS 106 for government contract accounting purposes.

        The government interpretation advocated in this appeal regarding the
pre-transition years also contradicts the general rule regarding the quantum consequences
of noncompliance prescribed in FAR 31.201-2( c). That provision states, "When
contractor accounting practices are inconsistent with this Subpart 31.2, costs resulting
from such inconsistent practices in excess of the amount that would have resulted from
using practices consistent with this subpart are unallowable." Here, NGC failed to
comply with the FAR requirement that allowable costs be accrued in accordance with
FAS 106 criteria where an accrual methodology was used by the contractor to determine
its allowable PRB costs. Although appellant failed to use the proper accrual
methodology, there is no evidence or government contention that the amount accrued by
appellant pursuant to DEFRA in the pre-transition years exceeded the amount of costs
that would have been allowable applying FAS 106 or even an amount calculable for the
Plan using the "pay-as-you-go" methodology. In fact, precisely the opposite is true.
Moreover, as discussed more fully below, because of the 2006 Plan amendment, recovery
of the amount disallowed by the government will never be sought or claimed by appellant
in the post-transition years. There is no excess to disallow.

       More fundamentally from an accounting perspective, the government
interpretation assumes that NGC properly could, should, and in fact was required to,
charge/claim unincurred PRB costs in relevant cost/pricing-related submissions during
the pre-transition years. Although the government recognizes that the approximately
$253 million "excess" FAS 106 costs in dispute were never claimed or included in any
incurred cost or forward pricing proposals for the years in question, it contends that
appellant, nevertheless, "incurred" those costs by "operation of law" in accordance with

5
    The government has not raised any issues regarding compliance with the Cost
         Accounting Standards and their implementing regulations.

                                           14
the express requirements of the FAR. No precedent in support of this novel concept is
cited.

       The government disregards fundamental concepts related to cost "incurrence"
and misfocuses on an "allowability" regulation rather than the NGC Plan itself. The
foundational assumption of the government interpretation is erroneous and illogical
insofar as it relates to the pre-transition years.

       Compliance with FAR 31.205-6( o) was only one of the criteria for allowability.
Perhaps most basically, to be allowable, the contractor must incur the costs in dispute.
Compliance with the government's interpretation of FAR 31.205-6(0) would have placed
NGC in violation of that key prefatory requirement for allowability. Appellant did not
"incur" the disputed costs in the pre-transition years and, as discussed below, will not
"incur" them in the post-transition years as a consequence of the 2006 Plan amendment.
IfNGC had included non-incurred costs in its various cost, pricing and claim submissions
during the pre-transition years, it faced their disallowance for that reason as well as other
possible adverse consequences and penalties.

       Cost incurrence is driven and defined by the Plan obligations creating NGC's PRB
cost benefits and structure. The accounting/actuarial measurement methodologies and
requirements developed for, and governing, tax and/or financial/GAAP accounting are not
the sole drivers of the amount of PRB costs actually incurred by NGC. The regulatory tail
does not wag the Plan dog. The amount measured/incurred, accrued, assigned and funded
pursuant to Plan obligations and associated actuarial assumptions may be more or less than
required for FAS 106 purposes. For the pre-transition years in question in this appeal, the
Plan's DEFRA-based costs were always less than costs computable using the actuarial
assumptions and requirements of FAS 106. The contractor measured/incurred, accrued,
assigned, funded and charged the government less than it could have if the Plan had
adopted FAS 106 accounting for those periods. Fundamentally, the government should
only be concerned where the contractor claims more than permitted by regulation.

        The requisite PRB funding levels (and costs flowing therefrom) are for NGC to
determine. The accounting obligation triggering "cost" incurrence for the corporation
stems from its specific contractual relationship with covered employees and the future
benefit levels prescribed therein, i.e., the Plan. There is no dispute that the amounts
measured, accrued and assigned to FYs 1995-2006 were compliant with NGC's
obligations under its Plan. Just as tax rules and regulations are not the sole driver of
business decisions, government contract cost allowability regulations are not the sole
criteria for establishing, employee compensation levels generally and PRB funding levels
more specifically. Here, NGC's consistent business judgment, both before and after
transition, was that it was unnecessary to fully fund future medical escalation costs to the
extent required by FAS 106. Appellant determined that it could maintain a quality,
competitive workforce without doing so. Consequently, NGC could offer more favorable


                                           15
cost-based pricing to the government under its flexibly-priced contracts. It is illogical
and shortsighted for the government to interpret the provision in a manner dictating that
appellant must charge or should have charged the government the full FAS 106 amount,
where the contractor determines it is not necessary to pay that full amount to attract and
maintain a quality workforce. IfNGC had done so, presumptively the excess
compensation cost would also be unreasonable as beyond its agreement with covered
employees as reflected in the Plan. The assignment and funding requirements are
designed to protect the government from paying excessive costs. Any "failure" to assign
and/or fund, whether the result of the contractor's best business judgment or other factors
specific to the contractor, benefits the government. The government's legitimate concern
was whether the unfunded "excess" assignable to the non-compliant years would be
carried forward and included in the transition obligation and amortized/"incurred" and
assigned to future fiscal years. As discussed below, issues raised by the potential
inclusion of such unincurred, unassigned and unfunded costs in the transition obligation
were effectively mooted by the 2006 Plan amendment.

       Company-specific PRB costs in this appeal are not "incurred" for government
contract accounting purposes based on generic FAS 106 requirements established for
purposes of cross-corporate financial comparisons and standardized public reporting.
Nor is the amount of cost "incurred" for government contract accounting purposes
determined by, or equal to, allowability maximums calculable under the FAR.
The regulation does not dictate PRB benefit levels and costs contractors must incur. It
simply and solely sets a ceiling limiting the PRB cost allowable and payable under
flexibly-priced government contracts. Prior to transition, the government implicitly
recognized this and never alleged that NGC's DEFRA methodology was noncompliant
with the FAR or CAS.

        The government relies heavily on NGC's failure to fund the excess computable
in the pre-transition years using FAS 106 precepts. According to the government,
appellant thereafter lost the right to assign, fund and recover the excess in subsequent
fiscal years. For government contract purposes, PRB costs must be properly assigned
and timely funded to be allowable. Here there is no dispute that NGC fully and timely
funded the incurred amounts assigned by it to FY s 1995-2006 in accordance with Plan
requirements. The government myopically alleges that appellant should have "assigned"
more than required by the Plan to each of those years. However, if PRB costs are not
incurred, there is no requirement to assign, much less fund, "phantom" costs. There is no
evidence or allegation that a major contractor such as NGC would be unable or otherwise
fail to fund properly incurred, measured and assigned costs. NGC funds what it properly
accrues and assigns. The funding prong of the allowability test has obvious purposes.
The requirement ensures that there is no shortfall in the amount funded versus the amount
measured, assigned and accrued. Here the government interpretation focuses on funding
while disregarding the basics of cost incurrence. Again, it would have been improper for
NGC to "assign" and claim costs in excess of the amount incurred. The regulation must


                                           16
be interpreted in the context of and in conformance with basic accounting principles of
incurrence, assignment and accrual.

       B. The Transition Obligation and Post-Transition Years

       The propriety of the pre-transition DEFRA accounting for the cost is linked to the
post-transition accounting. The government's basic premise is that there should not have
been any excess attributable to FY 1995 through 2006 if appellant had properly measured
and assigned the costs in accordance with FAS 106 and timely funded the amount the
government asserts should have been assigned to those accounting periods. The issues
presented arose at the time, and as a result of, appellant's computation of the transition
obligation. The government was justly concerned with allowability considerations
regarding the potential amortization of that obligation. Thus, it developed the
unreasonable interpretation of FAR 31.205-6( o) which we have rejected for the reasons
detailed above. Among other things, the government misfocused its attention on the
regulation as the cost incurrence driver rather than NOC's Plan. There were no "excess,"
"incurred" PRB costs prior to the transition to disallow. However, to the extent that the
amortizable transition obligation included PRB costs that should properly have been
assigned to the non-compliant pre-transition years and funded, the government position
had merit. The potential existed that the "excess" would be included in the transition
obligation to be amortized, incurred, assigned, funded and recovered during the
post-transition years.

       Recognizing potential allowability issues with the transition obligation, and true to
the consistently intended scope and coverage of its Plan with respect to excluding or
capping future medical escalation, NOC specifically and expressly executed a "negative"
Plan amendment at the time of transition for government contract accounting purposes to
the FAS 106 methodology. The 2006 Plan amendment, issued simultaneously with, and
closely related to, the transition, ensured that NOC would never incur the costs disallowed
and effectively mooted allowability issues associated with the transition obligation and the
change in NOC's cost accounting practices related to PRB costs.

       As established by the only expert actuarial testimony in the record, we have found
that any adverse cost consequences resulting from the change to FAS 106, and potential
inclusion of costs properly assignable to the pre-transition years, were reversed and
removed as a result of the Plan amendment. The government will not pay the pre-transition
"costs" in dispute. They were not, and will never, be incurred, accrued, or assigned. The
disputed post-transition FAS 106 costs were not included in the transition obligation having
been eliminated prior to its calculation as a consequence of the 2006 Plan amendment. The
unrebutted expert testimony to that effect was corroborated by the persuasive testimony of
appellant's former senior actuary whom we have found to be highly credible, as well as the
only government actuary addressing the issue. The government has failed to sustain its
burden of proving that any of the disallowed amount was or will be amortized as part of the


                                           17
transition obligation and claimed during the post-transition years. Its argument is founded
on theoretical constructs that have no factual basis or evidentiary support here. In this case,
the government's concerns were legitimate, albeit its legal and factual analysis was faulty.
NGC removed properly objectionable portions of the transition obligation via the 2006 Plan
amendment before computing that obligation. That amendment should have assuaged and
eliminated the government's valid concerns here.

       Consequently, for the aforementioned reasons, we conclude that the
government suffered no damages as a consequence of appellant's use of the DEFRA
methodology during the pre-transition years. The contractor has never, and will never,
claim, and the government will never pay, amounts disallowed by the final decision.
That disallowance was improper as were the associated deductions taken by the
government with respect to the amortized amounts of the transition obligation assigned
during the post-transition years.

      The appeal is sustained.

      Dated: 13 July 2017



                                                   Administrative Judge
                                                   Armed Services Board
                                                   of Contract Appeals


I concur



RICHARD SHACKLEFORD
Administrative Judge                              Administrative Judge
Acting Chairman                                   Acting Vice Chairman
Armed Services Board                              Armed Services Board
of Contract Appeals                               of Contract Appeals




                                           18
     I certify that the foregoing is a true copy of the Opinion and Decision of the
Armed Services Board of Contract Appeals in ASBCA No. 60190, Appeal of Northrop
Grumman Corporation, rendered in conformance with the Board's Charter.

      Dated:



                                              JEFFREY D. GARDIN
                                              Recorder, Armed Services
                                              Board of Contract Appeals




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