unwarranted by the character and circumstances of the work or because they are discriminatory against the Government. The application of the provisions of a labor-management agreement designed to apply to a given set of circumstances and conditions of employment (for example, work involving extremely hazardous activities or work not requiring recurrent use of overtime) is unwarranted when applied to a Government contract involving significantly different circumstances and conditions of employment (for example, work involving less hazardous activities or work continually requiring use of overtime). It is discriminatory against the Government if it results in individual personnel compensation (in whatever form or name) in excess of that being paid for similar nonGovernment work under comparable circumstances. Disallowance of cost will not be made under this subparagraph unless:

(i) The contractor has been permitted an opportunity to justify the costs, and

(ii) Due consideration has been given to whether unusual conditions pertain to the Government contract work, imposing burdens, hardships, or hazards on the contractor's employees, for which compensation that might otherwise appear unreasonable is required to attract and hold necessary personnel.

(5) In addition to the general requirements set forth in subparagraphs (1) through (4) of this paragraph, certain forms of compensation are subject to further requirements as specified in paragraphs (b) through (i) of this section.

(b) Salaries and wages. (CWAS) Salaries and wages for current services include gross compensation paid to employees in the form of cash, products, or services, and are allowable.

(c) Cash bonuses and incentive compensation. (CWAS) Incentive compensation for management employees, cash bonuses, suggestion awards, safety awards, and incentive compensation based on production, cost reduction, or efficient performance, are allowable to the extent that the overall compensation is determined to be reasonable and such costs are paid or accrued pursuant to an agreement entered into in good faith between the contractor and the employees before the services were rendered, or pursuant to an established plan followed by the contractor so consistently as to imply in effect, an agreement to make such

payment (but see § 15.107). Bonuses, awards, and incentive compensation when any of them are deferred are allowable to the extent provided in paragraph (f) of this section.

(d) Bonuses and incentive compensation paid in stock. (CWAS) Costs of bonuses and incentive compensation paid in the stock of the contractor or of an affiliate are allowable to the extent set forth in paragraph (c) of this section (including the incorporation of the principles of paragraph (f) of this section for deferred bonuses and incentive compensation), subject to the following additional requirements:

(1) Valuation placed on the stock transferred shall be the fair market value at the time of transfer, determined upon the most objective basis available; and

(2) Accruals for the cost of stock prior to the issuance of such stock to the employees shall be subject to adjustment according to the possibilities that the employees will not receive such stock and their interest in the accruals will be forfeited.

Such costs otherwise allowable are subject to adjustment according to the principles set forth in paragraph (f) (3) of this section. (But see § 15.107.)

(e) Stock options. (CWAS-NA) The cost of options to employees to purchase stock of the contractor or of an affiliate is unallowable.

(f) Deferred compensation. (CWASNA). (1) As used herein, deferred compensation includes all remuneration, in whatever form, for which the employee is not paid until after the lapse of a stated period of years or the occurrence of other events as provided in the plans, except that it does not include normal end of accounting period accruals. It includes (i) contributions to pension, annuity, stock bonus, and profit sharing plans, (ii) contributions to disability, withdrawal, insurance, survivorship, and similar benefit plans, and (iii) other deferred compensation, whether paid in cash or in stock.

(2) Deferred compensation is allowable only to the extent that:

(i) It is, together with all other compensation paid to the employee, reasonable in amount; and

(ii) It is paid (a) pursuant to an agreement entered into in good faith between the contractor and employees before the services are rendered, or (b)

pursuant to a plan established and consistently applied thereafter by the contractor; and either

(1) It is deductible for the same fiscal year for Federal income tax purposes under section 404 (excluding subsection (a) (5)) of the Internal Revenue Code of 1954 as amended and the regulations of the Internal Revenue Service: Provided, That

(i) Normal costs of pension plans incurred subsequent to the effective date of this section, not funded in the year incurred, shall not be allowable in subsequent years (except that a payment made to a fund by the time set for filing of the Federal income tax return for any taxable year shall be deemed to have been made during such taxable year);

(ii) Allowable costs of contributions for past service or supplementary pension or annuity credits (including contributions for the equivalent of interest that would have been earned on previously unfunded costs, sometimes called "freezing payments") shall not exceed, for any year, amounts required to systematically amortize the actuarial liability annually over not less than 10 or more than 40 years beginning with the year that the liability was first assumed, either by announcement, agreement, regular practice or other means which would reasonably inform employees that continuing service would result in retirement benefits based in part on the previously unfunded past service;

(iii) Pension costs of previous years which have not been funded as of the effective date of this section are allowable to the extent they are systematically funded over not less than 10 years, provided the contractor can demonstrate that pension costs were allocated to Government contracts on a funding rather than an accrual basis in the accounting periods previous to the effective date of this section and also provided that the systematic funding starts no later than the contractor's first full fiscal year after the effective date of this section;

(iv) The determination of allowable costs shall take into consideration unrealized, as well as realized appreciation in the market value of the fund assets, established on a rational and systematic basis. This recognition shall include unrealized appreciation on equity securities taking into account both the investment policy and prior growth experience of the fund. The appreciation to be recog

nized for equity securities generally shall be the amount by which 80 percent of the market value exceeds the total adjusted book value. The adjusted book value is defined as the acquisition cost adjusted for appreciation or depreciation previously recognized whether or not actually recorded in the asset account. Unrealized depreciation of equity securities may be recognized to the extent of unrealized appreciation previously recognized, but the total of value of all equity securities in a fund shall not be depreciated below the acquisition cost. Initial recognition of accumulated unrealized appreciation may be spread over a period of time not to exceed 10 years. Ordinarily, appreciation and depreciation need not be recognized for debt securities expected to be held to maturity and redeemed at face value;

(v) Abnormal forfeitures, due to significant reduction in the contractor's level of employment, that are foreseeable and which can be currently evaluated with reasonable accuracy, by actuarial or other sound computation, shall be reflected by an adjustment of costs otherwise allowable; where abnormal forfeitures were not taken into account previously, appropriate credit shall be given to the Government pursuant to

§ 15.201-5;

(vi) Any amount paid or funded and deductible in any year under section 404 (excluding section 404 (a) (5)) of the Internal Revenue Code of 1954 as amended prior to the time it becomes allowable under this subdivision shall be applied to future years, in order of time, as if actually paid and deductible in such years;

or

(2) It is deductible in the same fiscal year for Federal income tax purposes under section 404 (a) (5) of the Internal Revenue Code of 1954 as amended and the regulations of the Internal Revenue Service, except that the costs of unfunded pension and retirement benefits paid directly to, or on behalf of, former employees shall be allowable only to the extent the contractor demonstrates that such costs, together with any pension and retirement costs allowed pursuant to (1) of this subdivision, do not exceed the amount that would be allowable under (ii) (b) if the contractor were providing for equivalent benefits on an actuarial basis in the current period.

(3) In determining the cost of deferred compensation allowable under the contract, appropriate adjustments shall be made for credits or gains, including those arising out of both normal and abnormal employee turnover, or any other contingencies that can result in a forfeiture by employees of such deferred compensation. Adjustments shall be made only for forfeitures which directly or indirectly inure to the benefit of the contractor; forfeitures which inure to the benefit of other employees covered by a deferred compensation plan with no reduction in the contractor's costs will not normally give rise to adjustment in contract costs. Adjustments for normal employee turnover shall be based on the contractor's experience and on foreseeable prospects, and shall be reflected in the amount of cost currently allowable. Such adjustments will be unnecessary to the extent that the contractor can demonstrate that his contributions take into account normal forfeitures. Adjustments for possible future abnormal forfeitures shall be effected according to the following rules:

(1) Abnormal forfeitures that are foreseeable and which can be currently evaluated with reasonable accuracy, by actuarial or other sound computation, shall be reflected by an adjustment of current costs otherwise allowable; and

(ii) Abnormal forfeitures, not within subdivision (i) of this subparagraph, may be made the subject of agreement the Government and the contractor either as to an equitable adjustment or a method of determining such adjustment.

(4) In determining whether deferred compensation is for services rendered during the contract period or is for future services, consideration shall be given to conditions imposed upon eventual payment, such as, requirements of continued employment, consultation after retirement, and covenants not to compete.

(g) Fringe benefits (CWAS). Fringe benefits are allowances and services provided by the contractor to his employees as compensation in addition to regular wages and salaries. Costs of fringe benefits, such as pay for vacations, holidays, sick leave, military leave, employee insurance, and supplemental unemployment benefit plans are allowable to the extent required by law, employer-em

(1) Training and education expenses (CWAS). See § 15.205-44.

[33 F.R. 277, Jan. 9, 1968, as amended at 36 F.R. 7952, Apr. 28, 1971; 36 F.R. 21162, Nov. 4, 1971]

§ 15.205-7 Contingencies (CWAS-NA).

(a) A contingency is a possible future event or condition arising from presently known or unknown causes, the outcome of which is indeterminable at a present time.

(b) In historical costing, contingencies are not normally present since such costing deals with costs which have been incurred and recorded on the contractor's books. Accordingly, contingencies are generally unallowable for historical costing purposes. However, in some cases, as for example, terminations, a contingency factor may be recognized which is applicable to a past period to give recognition to minor unsettled factors in the interest of expeditious settlement.

(c) In connection with estimates of future costs, contingencies fall into two categories:

(1) Those which may arise from presently known and existing conditions, the effects of which are foreseeable within reasonable limits of accuracy; e.g., anticipated costs of rejects and defective work; in such situations where they exist, contingencies of this category are to be included in the estimates of future cost so as to provide the best estimate of performance costs; and

(2) Those which may arise from presently known or unknown conditions, the effect of which cannot be measured so precisely as to provide equitable results to the contractor and to the Government; e.g., results of pending litigation, and other general business risks. Contingencies of this category are to be excluded from cost estimates under the several items of cost, but should be disclosed separately, including the basis upon which the contingency is computed in order to facilitate the negotiation of appropriate contractual coverage (see, for example, §§ 15.205-16, 15.205-20, and 15.205-39).

[25 F.R. 14294, Dec. 31, 1960, as amended at 33 F.R. 278, Jan. 9, 1968]

[25 F.R. 14294, Dec. 31, 1960, as amended at 33 F.R. 278, Jan. 9, 1968]

§ 15.205-9 Depreciation (CWAS-NA).

(a) Depreciation is a charge to current operations which distributes the cost of a tangible capital asset, less estimated residual value, over the estimated useful life of the asset in a systematic and logical manner. It does not involve a process of valuation. Useful life has reference to the prospective period of economic usefulness in the particular contractor's operations as distinguished from physical life and shall be evidenced by the actual or estimated retirement and replacement practice of the contractor.

(b) Normal depreciation on a contractor's plant, equipment, and other capital facilities is an allowable element of contract cost provided the contractor is able to demonstrate that such costs are reasonable and properly allocable to the contract. Subject to paragraphs (e) and (f) of this section:

(1) Depreciation will ordinarily be considered reasonable if the contractor follows depreciation policies and procedures which:

(i) Are consistent with the policies and procedures he follows in the same cost center in connection with his business other than Government business;

(ii) Are reflected in his books of accounts and financial statements; and

(iii) Are used by him for Federal income tax purposes, and are acceptable for such purposes;

(2) Where the depreciation reflected on a contractor's books of account and financial statements differs from that used and acceptable for Federal income tax purposes, reimbursement shall be based upon the cost of the asset to the contractor amortized over the estimated useful life of the property using depreciation methods (straight line, sum of the years' digits, etc.) acceptable for income tax purposes. Allowable depreciation shall not exceed the amounts used for book and statement purposes and shall be determined in a manner consistent with the depreciation policies and procedures followed in the same cost cen

ter in connection with his business other than Government business.

(3) Depreciation for reimbursement purposes in the case of tax-exempt organizations shall be determined on the basis outlined in subparagraph (2) of this paragraph.

(c) Special considerations are required for assets acquired prior to the effective date of this principle where, on the effective date of this principle, the undepreciated balance of such assets resulting from depreciation policies and procedures used previously for Government contracts and subcontracts is different from the undepreciated balance of such assets on the books and financial statements. Generally, the undepreciated balance for contract cost purposes shall be depreciated over the remaining life using the methods and lives followed for book purposes. The aggregate depreciation on any asset allowable after the effective date of this section shall not exceed the cost basis of the asset less any depreciation allowed or allowable under prior procurement regulations.

(d) Depreciation should usually be allocated to the contract and other work as an indirect cost. The amount of depreciation allowed in any accounting period may, consistent with the basic objectives set forth in paragraph (a) of this section, vary with volume of production or use of multishift operations.

(e) In the case of emergency facilities covered by certificates of necessity, a contractor may elect to use normal depreciation without requesting a determination of "true depreciation" or may elect to use either normal or "true depreciation" after a determination of "true depreciation" has been made by an Emergency Facilities Depreciation Board. The method elected must be followed consistently throughout the life of the emergency facility. When an election is made to use normal depreciation, the criteria in paragraph (b) of this section shall apply for both the emergency period and the post-emergency period. When an election is made to use "true depreciation", the amount allowable as depreciation

(1) With respect to the emergency period (5 years), shall be computed in accordance with the determination of the Emergency Facilities Depreciation Board and allocated rateably over the full 5year emergency period; provided no

other allowance is made which would duplicate the factors, such as extraordinary obsolescence, covered by the Board's determination; and

(2) After the end of the emergency period, shall be computed by distributing the remaining undepreciated portion of the cost of the emergency facility over the balance of its useful life provided the remaining undepreciated portion of such cost shall not include any amount of unrecovered "true depreciation.”

(f) No depreciation, rental, or use charge shall be allowed on property acquired at no cost from the Government by the contractor or by any division, subsidiary or affiliate of the contractor under a common control.

(g) The depreciation on any item which meets the criteria for allownace at a "price" in accordance with § 15.205-22 (e) may be based on such price, provided the same depreciation policies and procedures are used for costing purposes for all business of the using division, subsidiary, or organization under common control.

(h) No depreciation or rental shall be allowed on property fully depreciated by the contractor or by any division, subsidiary, or affiliate of the contractor under a common control; however, a reasonable charge for the use of fully depreciated property may be agreed upon and allowed (but see § 15.107). In determining this charge, consideration should be given to cost, total estimated useful life at time of negotiation, effect of any increased maintenance charges or decreased efficiency due to age and the amount of depreciation, if any, previously charged to Government contracts or subcontracts.

[34 F.R. 17904, Nov. 5, 1969]

§ 15.205-10 Employee morale, health, welfare and food service and dormitory costs and credits (CWAS).

(a) Employee morale, health and welfare activities are those services or benefits provided by the contractor to its employees to improve working conditions, employer-employee relations, employee morale and employee performance. Such activities include house publications, health or first-aid clinics, recreation, employee counseling services and, for the purpose of this section, food and dormitory services. Food and dormitory services include operating or furnishing facilities for cafeterias, dining rooms,

canteens, lunch wagons, vending machines, living accommodations or similar types of services for the contractor's employees at or near the contractor's facilities.

(b) Except as limited by paragraph (c) of this section, the aggregate of costs incurred on account of all activities mentioned in paragraph (a) of this section, less income generated by all such activities is allowable to the extent that the net amount is reasonable.

(c) Losses from the operation of food and dormitory services may be included as cost incurred under paragraph (b) of this section, only if the contractor's objective is to operate such services on a break-even basis. Losses sustained because food services or lodging accommodations are furnished without charge or at prices or rates which obviously would not be conducive to accomplishment of the above objective, are not allowable, except that a loss may be allowed to the extent the contractor can demonstrate that unusual circumstances exist (e.g. (1) where the contractor must provide food or dormitory services at remote locations where adequate commercial facilities are not reasonably available or (2) where it is necessary to operate a facility at a lower volume than the facility could economically support) such that, even with efficient management, operation of the services on a break-even basis would require charging inordinately high prices or prices or rates higher than those charged by commercial establishments offering the same services in the same geographical areas. Cost of food and dormitory services shall include an allocable share of indirect expenses pertaining to these activities.

(d) In those situations where the contractor has an arrangement authorizing an employee association to provide or operate a service such as vending machines in the contractor's plant, and retain the profits derived therefrom, such profits shall be treated in the same manner as if the contractor were providing the service (but see paragraph (e) of this section).