GAB Decision 770
July 23, 1986
California Department of Social Services;
Docket No. 85-82;
Audit Report No. 09-42200
Ford, Cecilia S.; Stratton, Charles E. Ballard, Judith A.
The California Department of Social Services (State or DSS) appealed
a decision of the Social Security Administration (SSA) disallowing
claims for $572,382 in costs associated with the California Disability
Evaluation Division (DED). The claims disallowed were costs of building
alterations, equipment, furniture, and financing incurred by the State
in operating the DED.
The DED determined whether individual applicants were disabled
and
entitled to benefits under the Social Security Act. Until May 29,
1981,
the DED was operated pursuant to a written agreement between the
State
and SSA. After that date, DED was operated pursuant to
regulations
issued by SSA. The agreement and the regulations provided
that SSA
would reimburse the State for all allowable costs necessary to
make
disability determinations. General principles of cost allowability
in
this Department's regulations and guidance documents were
incorporated
by reference; these included the Disability Insurance
State Manual
(DISM), which in 1981 was integrated into the Program Operations
Manual
System (POMS).
The determinations by SSA that certain costs were unallowable were
based
on information contained in Audit Report No. 09-42200, covering
the
period October 1, 1977 through September 30, 1981. Appeal File, Tab
2
(Audit Report). The original determinations by the
Regional
Commissioner of SSA were reconsidered by the Commissioner of SSA,
who
reversed certain determinations and upheld others. The State
then
appealed five of these determinations to the Board. During
Board
proceedings, the State withdrew its appeal of $59,877 disallowed
for
claimed costs of building alterations. Furthermore, SSA withdrew
its
disallowance for claimed costs of $148,894 for a remote
telephone
dictation system. The remaining determinations appealed to
the Board
are: $332,405 disallowed for the alleged excessive cost to
purchase
certain modular furniture; $30,652 disallowed for interest
costs
incurred in financing office equipment; and $554 disallowed
for
interest costs associated with the(2) Oakland DED branch. On April
22,
1986, the Board held a hearing to obtain evidence on the
modular
furniture determination.
For the reasons stated below, we affirm the SSA determinations on
interest
costs but reverse the determination regarding modular furniture
costs.
The Modular Furniture Purchases
In the final days of federal fiscal year 1981, the State purchased
modular
furniture for DED offices at a total cost of $575,282. /1/
Modular furniture
is a type of furniture used in open office plans in
which special,
weight-bearing, accoustical panels support accessories
such as shelves, work
surfaces, drawers and filing cabinets. These
accessories are hung onto
the panels themselves.
SSA's auditors determined that the modular furniture exceeded
the
quality of conventional furniture used at other State offices,
and
recommended disallowing the alleged excessive costs of the
modular
furniture. The conventional furniture used as a comparison by
SSA was
the type of furniture in which all the components are
free-standing;
desks, chairs, filing cabinets, bookshelves and partitions,
which all
rest upon the floor independently.
The auditors based their recommendation on section 426.51 of the
DISM
(incorporated by reference into the POMS in July 1979). This
section
stated that:
The quality of items should not exceed the quality of similar
office
equipment in general use in other offices of the (State) agency.
In applying this standard, the auditors found that DSS had shown no
other
offices which used "the complete complement(3) of modular
furniture
components." Audit Report, p. 13. The auditors used cost as
a
determinant of the relative quality of the furniture, finding that
the
cost of individual modular component systems, as well as workstations
as
a whole, was significantly more than conventional furniture
components
or workstations.
Based on our evaluation of the evidence in the record, we find that
the
State effectively rebutted the audit findings and proved that
its
purchase of modular furniture was reasonable under the
circumstances.
Accordingly, we conclude that the DISM provision does not
support a
disallowance under the circumstances presented here.
At the outset, we note that SSA's approach to this case was flawed
in
three respects. First, SSA treated the DISM provision on quality
of
equipment as a mandatory standard, which, if violated, would render
the
costs unallowable. This view was based on a version of the
provision
which was not effective until 1984, after the audit period in
question.
Unlike the later version, the version in effect during the audit
period
(quoted above) was neither labeled nor phrased as a mandatory
standard.
We agree with the State that the applicable provision was simply a
guide
to states in making equipment purchases. /2/ This does not mean that
the
State could ignore the provision (or its underlying purpose of
ensuring
that states do not indulge in lavish offices in a program that is
fully
federally funded), but simply that the State could
appropriately
consider a range of factors, including costs and space savings,
in
deciding whether to make an equipment purchase. Second, the wording
of
the provision (using subjective terms such as "quality" and
"similar")
does not clearly require the type of comparative analysis the
auditors
engaged in, but permits some discretion in applying the
provision.
Third, SSA adopted the auditors' overly restrictive view that
furniture
used in other DSS offices was not "modular" (and, therefore, not
of
comparable quality) unless used with the full complement of
modular
furniture components. We evaluate the evidence in the record in
this
context.
To rebut the audit finding that the quality of the DED furniture
was
higher than that of furniture used in other DSS offices, the
State
presented credible evidence that(4) other DSS offices used
modular
furniture of the same brands used at DED during the audit
period. See
Appeal File, Tab 4, p. 12. Although it was undisputed
that these
offices did not use the full complement of modular accessories to
the
extent that DED did, the evidence proved that these offices used
the
same type of partitions with some hanging components together
with
conventional furniture. See Declaration of Arch Price, dated
October
23, 1985 (and accompanying purchase orders). Furthermore, the
State
presented credible evidence that conventional desks were used in
at
least one of the DED offices in a similar fashion. State's Hearing
Ex.
1, photo 7. In making their finding, the auditors determined that
DED's
use of the full complement of modular accessories resulted in
higher
quality furniture for DED. We find that determination to be
unduly
restrictive; it fails to address other factors such as the
relative
quality of the functional components at issue.
As further support for its contention that DED used furniture of a
higher
quality than other DSS offices, SSA presented, at the hearing,
audit
workpapers allegedly recording statements by State employees which
indicated
that DED had higher quality furniture than other DSS units.
These statements
were allegedly made to an auditor who did not appear at
the hearing.
SSA Hearing Ex. F. We cannot give much weight to this
hearsay evidence,
however, without knowing the context and exact nature
of the questions
asked. The answers appear to have been in the nature
of casual remarks,
rather than careful responses based on a studied
comparison. While one
of the persons making these remarks to the
auditor appeared at the hearing
and acknowledged that he may have made
such remarks (Tr., p. 22), we found
this witness, on the whole, to be
less careful in his answers and less
knowledgable about the subject
matter than the State's second witness.
SSA also presented testimony by an audit supervisor, who stated that
the
two brands of modular furniture purchased for DED were "toward the
high
end of the scale" of relative quality of modular furniture. Tr.,
p.
121. We discredited this testimony for two reasons. First,
modular
furniture components used in other DSS offices were purchased from
the
same manufacturers. Second, this testimony was contradicted,
by
testimony by the State's second witness, who testified that
the
manufacturers were at the low end of the scale. Tr., p. 109.
We accord
greater weight to the State's second witness because he had
more
extensive experience in purchasing office furniture than the
audit
supervisor. The audit supervisor had been an "equipment planner"
in an
architectural firm but had never actually purchased modular
furniture.
Tr., pp. 134-35. On the other hand, the State's second
witness had been
responsible for the acquisition of all equipment for DED for
six years
and(5) had examined numerous brochures on various modular
furniture
systems. Declaration of Douglas D. Park, dated June 9, 1986,
p. 1;
Tr., p. 109. The audit supervisor admitted that he had not
examined
common indicators of relative quality, such as life
expectancy,
workmanship, or materials. Tr., p. 135. The State's
second witness, on
the other hand, testified that the quality of materials
between the
conventional furniture used by DSS and the modular furniture
purchased
by DED were "rather equal" and that the State was getting
approximately
the same life expectancy for both types of furniture.
Tr., pp. 109-110.
/3/
The State did not dispute that the modular furniture may, for
some
workstations, cost more initially than conventional furniture,
but
disputed SSA's calculation of the cost difference. The State
agreed
that clerical workstations purchased cost approximately $1000 more
than
conventional clerical workstations, but presented testimony
that
clerical workstations with modular furniture used more partitions
than
those with conventional furniture. Thus, the price differential
was, in
substantial part, attributable to the use of more, rather
than
qualitatively better, furniture. Tr., p. 104. In contrast to
the
conclusory finding in the audit report that the analyst
workstations
purchased cost $1200 more than conventional furniture, the
State
provided detailed evidence that the cost of analyst
workstations
purchased was roughly equal to, or less than, the cost of
conventionally
furnished analyst workstations. Appeal File, Tab 2,
p. 9.
Although SSA disputed minor details in the State's calculations, we
find
that none of these disputes contradicted the underlying premise that
the
auditors had miscalculated the cost comparison of an
analyst
workstation. Furthermore, the State successfully disputed the
one
direct cost comparison in the audit report between individual pieces
of
modular and conventional furniture. The audit (6) report compared
a
modular filing system with a traditional file cabinet, finding a
$950
cost difference. Testimony by a State witness indicated that
this
comparison was not accurate, due to the substantially larger capacity
of
the modular system. Tr., p. 59.
Moreover, the State also presented uncontradicted evidence that
the
modular furniture had been purchased through a competitive
bidding
process and was not an abuse of the procurement system used for
DED.
Appeal File, Tab 3, p. 1; Appeal File, Tab 4, p. 2. Although
the
purchase orders specified particular manufacturers, these resulted
from
requirements that the furniture be compatible with existing
equipment
and could be filled by competing sales outlets. Id. SSA
did not allege
that the prices paid were unreasonable for furniture of this
type.
To show the reasonableness of its purchase, the State presented
evidence
proving that the State reasonably believed that the higher initial
cost
of the modular furniture would be offset by anticipated cost savings
in
rental expenses because of the more efficient space
utilization
characteristic of modular furniture systems, and that the
State
reasonably equipped the DED offices in expectation of a growing
staff.
Tr., pp. 79-100; Declaration of Douglas D. Park, dated June 9,
1986, p.
7. Although SSA disputed whether any actual savings had
accrued, SSA
did not rebut the evidence that the State reasonably believed
that such
savings would occur. /4/ SSA(7) did not contest the State's
argument
that the use of modular furniture saved space for each type
of
workstation. SSA argued, instead, that the State was unreasonable
to
purchase space-saving furniture when there was sufficient space
for
current staff levels. SSA and the State presented conflicting
evidence
on the space utilization at DED branches with modular and
conventional
furniture. We do not need to determine which evidence was
correct,
because we find that the State's evidence of potential space saving
due
to smaller individual workstations, and the reasonable anticipation
of
large and sudden staff increases, supported the reasonableness of
the
State's purchase. Although SSA disputed whether the State
reasonably
anticipated staff growth during certain limited periods, SSA
presented
no reason why the State should not have considered staff increases
at
the time of purchase.
SSA did not allege that the State purchased too much furniture;
that
would be the logical result of mistakes in predicting
short-term
staffing levels. The problem SSA alleged (i.e., too much
concern about
space needs) would result from faulty long-term forecasting of
staff
levels; the State, however, presented credible evidence which
would
reasonably explain the uncertainty inherent in long-term forecasts
made
during the audit period. Tr., pp. 79-100.
Finally, we note that there are at least three additional factors
which
support the reasonableness of the State's purchase at issue
here.
First, the three branch offices of DED for which the furniture
was
purchased already had modular furniture (purchased when DED was not
yet
part of DSS); thus, the furniture purchased was intended
to
inter-member with the existing furniture. Tr., p. 101. Second,
the
State presented uncontradicted testimony that the "flipper door"
filing
system used in modular furniture promoted compliance with SSA's
"clean
desk policy" (the requirement that disability determination
workers
maintain the privacy of client information). Third, the State
presented
uncontradicted evidence that the cost of storage is less for
modular
furniture than for conventional furniture. Tr., p. 110.
In summary, after considering the record as a whole, we find that the
DISM
provision SSA relied on did not prohibit the purchase at issue.
The
provision, with its vague reference(8) to "quality" gives no
indication that
cost should be the only factor which a state should
consider in purchasing
furniture. We accept the State's explanation
that the decision was
based on other factors, including a reasonable
belief of cost savings on
rental charges, that the furniture was similar
in type to furniture used in
other offices of DSS, and that the cost of
the furniture was not unreasonable
for furniture of its type. In
addition, the evidence shows no
indication of an abuse of standard
procurement policies, and does not show
that the cost differential
between modular and conventional furniture was as
large as alleged.
For these reasons, we reverse the disallowance of $332,405 for the
costs
of modular furniture.
The Interest Costs
Paragraph D.7 of Office of Management and Budget Circular A-87,
Attachment
B, provides:
Interest on borrowings (however represented), bond discounts,
cost of
financing and refinancing operations, and legal and professional
fees
paid in connection therewith, are unallowable except when authorized
by
federal legislation . . . . /5/
Despite that clear statement that interest costs are
unallowable,
California argued that the Board should allow the $30,652
claimed for
the cost of photocopy machines and text editors in fiscal years
1979
through 1981, but designated on the contract as interest costs.
The
State based its argument on SSA's prior approval of the
installment
purchase plans entered into by the State. In a letter dated
August 22,
1978, SSA approved the purchase and stated that, of the five
possible
purchase options, the most cost-effective appeared to be an
installment
purchase plan. Appeal File, Tab 7. The State
contended that the
installment purchase plan was the "best deal"
notwithstanding any part
of the price designated by the seller as interest
costs, and was
significantly less expensive than the alternative of
continuing the
existing lease arrangement. State's Brief, p. 12.
The State further
contended that the(9) amount labeled as interest should
merely be
regarded as part of the purchase price, since the designation was
made
by the seller and was regarded by DED as an inseparable part of the
cost
of the machines. Id., pp. 12-13.
SSA's letters granting approval to enter into contracts for the
equipment
requested did not waive the cost principles applicable to
those transactions.
Washington Department of Social and Health Services,
Decision No. 741, April
11, 1986. The State should have been aware of
the clear, longstanding,
regulatory directive regarding the allowability
of interest costs.
While the transactions may have been (as the SSA
letter stated with respect
to the photocopy machines) the most
"cost-effective" means of purchasing the
equipment, the interest costs
were nonetheless not allowable costs. As
this Board has previously
stated, even the regulatory provisions which
require sound management do
not function as an exception for otherwise
prohibited costs. Missouri
Department of Social Services, Decision No.
560, August 13, 1984, p. 2.
Although 20 CFR 404.1626 provides that a state will not be paid for
costs
not approved by the Agency, this does not mean that all costs
arising from a
transaction approved by the Agency will be paid. The
same regulation
also provides that state will be paid for "necessary
costs" as defined in 41
CFR Subpart 1-15.7. Thus, costs must not only be
approved by the Agency, but
must also be necessary costs within the
meaning of 41 CFR Subpart
1-15.7. That regulation specifically provides
that interest costs are
unallowable. Washington, supra, p. 4. Even if
the State
reasonably relied on Agency approved, the Agency cannot be
estopped from
taking the disallowance in the absence of affirmative
misconduct (and it is
unclear that even affirmative misconduct would
justify estoppel). See
Schweiker v. Hansen, 450 U.S. 785 (1981);
Heckler v. Community Health
Services of Crawford County, 467 U.S. 51
(1984). Here, there has been
no allegation of affirmative misconduct.
As the Board has stated in prior decisions, the mere fact that a part
of
the payments for the equipment was labelled interest is not
conclusive
evidence that these costs were unallowable. Missouri,
pp. 3-4. In
this case, however, the descriptions of the purchase
options make clear
that these costs were not mislabelled; the
descriptions show that both
the buyer and seller considered these costs to be
interest charges. The
costs were computed as a percentage of the
purchase price and varied
with the length of time over which full payment
could be made. The
State's letter of August 17, 1978, describing the
purchase options,
clearly listed the applicable interest rate and discussed
the impact of
changes in that rate. Appeal File, Tab 6.(10)
While the interest cost policy might lead to a result which was not
the
most cost effective use of funds in a fully federally funded
program,
since a state may not be willing to enter into appropriate
transactions
which involve an interest component, the Board has no authority
to grant
a waiver. The Board is bound by all applicable
Departmental
regulations. 45 CFR 16.14. If the State had needed a
waiver to
encourage it to enter into the appropriate transaction, it should
have
specifically requested such a waiver prior to entering into
the
transaction, pursuant to formal procedures such as those outlined in
the
DHHS Grants Administration Manual, Chapter 1-105.60, Paragraph B.2,
as
cited in the State's Brief at 16.
For these reasons, the Board will uphold the disallowance for $30,652
for
interest costs related to the purchase of copy machines and text
editors.
SSA also imposed a disallowance of $554 based on an audit
recommendation
that the State "(submit) a revised expenditure report for
fiscal year
1982 to exclude $554 of unallowable interest costs related to
equipment
purchases and interest claimed related to Oakland Branch
alteration
costs." Audit Report, p. 43; Disallowance Letter (State's
Ex. 1), p. 7.
Although this sentence is not perfectly clear, a close reading
of the
Audit Report indicates that the $554 was attributable only to
interest
costs from the purchase of photocopy machines. Audit Report, p.
42. The
$554 did not refer to an unstated amount of interest alleged to
have
been paid for Oakland Branch alternation costs in fiscal 1982.
This reading is also supported by the reconsideration decision,
which
upheld the auditor's recommendation but deleted the reference
to
building alternation. SSA letter to DSS, March 20, 1985, p. 6.
In responding to the disallowance with an argument based on the
mistaken
notion that the $554 was all or partly related to interest costs
for
building alterations necessary when the Oakland Branch was
relocated,
the State did not refute the finding that the disallowance was
proper
under the principle set forth above regarding interest
costs.
Therefore, we uphold the disallowance for $554.
In deleting the reference to building alternations in its
reconsideration
decision, it appears that SSA is not pursuing that audit
finding at this
time. Thus, we do not reach the issue of the
allowability of interest
costs paid for building alterations performed
during the relocation of the
Oakland Branch office.(11)
Conclusion
For the reasons stated above, we reverse the disallowance of
$332,405
related to the purchase of modular furniture, uphold the
disallowance of
$30,652 related to interest costs for the purchase of copy
machines, and
uphold the disallowance of $554 related to equipment
purchases. /1/ As
this case
developed, it became clear that an underlying reason
for the disallowance was
SSA's concern with the timing of the modular
furniture purchase. We
recognize that states may, in some instances,
make last minute purchases to
avoid losing the authority to obligate
federal funds, rather than because the
purchases are necessary. Thus,
it is appropriate for SSA to subject
such purchases to greater scrutiny.
Here, however, the State presented
uncontradicted evidence that the
timing of the obligation was due to a
lengthy planning and approval
process within the State. Appeal File,
Tab 4, p. 1; Tr., pp. 69-70.
/2/ We disagree with the State's
contention that only regulations
promulgated pursuant to the Administrative
Procedure Act (APA) are
binding on the State. The agreement (between
the State and SSA) under
which DED was operated expressly applies the DISM to
the State. By
signing this agreement, the State agreed to be bound by
its terms.
/3/ SSA attempted to discredit this witness by challenging the
figures
he presented in support of the State's position. In general, we
found
his explanations of why various numbers were used and what
they
represented to be persuasive. With respect to the
calculations
concerning actual space utilization, moreover, he candidly
acknowledged
that such calculations have little meaning without an analysis
of
various factors such as the configuration of the buildings compared
and
space devoted to common areas such as aisleways and conference
rooms.
Tr., pp. 98-99. We do not adopt either party's figures
concerning
actual space utilization, since this is not necessary to our
decision.
/4/ In its latest submission in this case, SSA asserted that it
would
not withdraw its audit exception for the modular furniture even if
the
State showed an actual cost savings; SSA stated that the purchase
was
not originally approved by SSA and that retroactive approval would
have
the potential to establish precedent for unapproved purchases since
the
equipment was better quality than normally authorized and the
equipment
was never properly utilized. SSA had not previously alleged,
however,
that the purchase in question here did not have required prior
approval.
Although the auditors found that some equipment purchases did not
have
approval (a finding which was resolved by the Commissioner
granting
retroactive approval), the modular furniture purchase was not
included
in that finding. See Audit Report. SSA may have simply
meant that it
did not approve specifically the purchase of modular furniture,
but the
State rebutted SSA's evidence that SSA would not have known
when
approving a purchase request that modular furniture was being
purchased.
Declaration of Douglas D. Park, dated June 9, 1986, Ex. 8.
Finally, we
note that SSA's rationale is based on unsupported allegations
that the
equipment was better quality than normally authorized and that it
was
never properly utilized.
/5/ The principles contained in OMB
Circular A-87 (previously designated as
FMC 74-4) are made applicable to
states operating disability determination
programs at 20 CFR
404.1626(a). An identical provision is contained in
41 CFR Subpart
1-15-7, which is also made applicable by 20 CFR
404.1626(a). 384 MARCH
28, 1987