CHAPTER 6
Cost Accounting Standards

The Cost Accounting Standards Board (CASB) was established by law on August 15, 1970. When Congress did not appropriate funds for the CASB in 1980, the CASB ceased to exist on September 30, 1980. During its ten-year life, the CASB promulgated 19 individual cost accounting standards that will influence government contracting for many years to come. Legislation was passed in the late 1980s to authorize a new CASB under the authority of the Office of Federal Procurement Policy.

ORIGINAL CAS LEGISLATION

The original CASB was created for a variety of reasons and conditions that existed in the 1960s: (1) contractors had inconsistent accounting practices; (2) generally accepted accounting practices (GAAP) and the then-applicable procurement regulations (Armed Services Procurement Regulation, or ASPR) permitted too much perceived flexibility in cost accounting; (3) negotiated contracts were at a high volume; (4) defense spending was at a high volume; (5) the General Accounting Office (GAO) said that cost accounting standards were feasible; and (6) government agencies agreed on the need for cost standards. Industry disagreed.

At the 1968 congressional hearings on the Defense Production Act, witnesses testified that ascertaining the profit on a particular contract was nearly impossible because of the absence of consistent accounting practices by defense contractors. As a result, the development of uniform accounting standards for defense contractors was proposed. In May 1968, the House passed legislation that included a new requirement that GAO develop uniform accounting procedures for negotiated defense contracts and subcontracts of over $100,000. GAO found the terms and concepts to be unclear and suggested that a study be undertaken.

Congress was influenced heavily by two factors: (1) the large proportion (86 percent) of defense procurements entered into on a negotiated basis; and (2) testimony that different cost accounting practices followed by defense contractors could result in a lack of adequate cost information that would impair comparability among bidders. The estimate of a contractor’s cost plays an important role in establishing price.

The House Report noted that uniform cost principles were necessary because of substantially increased costs of procurement and to help prevent excessive profits. The Senate Banking and Currency Committee held hearings on the bill in June 1968. The Committee heard testimony that the essential function of cost accounting is to allocate direct and overhead costs to individual orders. The cost accounting principles followed have a significant impact on determining contractor costs. As examples, various cost items, such as depreciation and research and development, can be determined and allocated in different ways. Without uniform cost principles, a large burden is placed on procurement officials to evaluate a contractor’s accounting practices without the guidance of authoritative support for using alternatives in specific circumstances. As a result, more work by auditors and procurement officials is required, and procurement costs are excessive.

Responding to these views, Congress, in PL 90-370, provided for GAO, in cooperation with the Department of Defense (DOD) and the Bureau of the Budget (now the Office of Management and Budget) and in consultation with the accounting profession and the defense industry, to “undertake a study to determine the feasibility of applying uniform cost accounting standards to be used in all negotiated prime and subcontract defense procurements of $100,000 or more.”

In conducting the feasibility study, GAO did its own research, receiving studies and comments from various government agencies, industry associations, and accounting organizations. GAO used a questionnaire that sought information on the nature of CAS and current accounting practices and on the types of uniform standards that might be feasible.

In the Comptroller General’s Report to Congress (January 19, 1970), GAO concluded that, while establishing cost accounting standards to attain a higher degree of consistency and uniformity among government contractors in cost accounting matters was appropriate, establishing standards in such detail that would result in precisely mandated methods of computing costs for each different kind of cost under all circumstances in government contracting was not feasible. Further, GAO found that CAS should apply to all negotiated contracts, both defense and nondefense, since the same kind of potential benefits would accrue to government agencies negotiating these contracts. GAO observed that even though the subject of costs versus benefits is highly controversial, and industry strongly believed that the costs outweigh the benefits, the cumulative benefit to the federal government should exceed the implementation costs of the proposed CAS.

As a result of GAO recommendations, the proposal to create the CASB and develop CAS was included in proposed legislation. During the public hearings on the bill, representatives of the accounting profession expressed mixed feelings on the proposal. The American Institute of Certified Public Accountants maintained a rather neutral position, and government representatives strongly advocated the legislation.

Industry generally opposed the legislation for the following reasons: (1) the concepts and real objectives and methods of attaining uniform CAS had not been sufficiently described by GAO or in the proposed legislation; (2) a significant enough need for the use of CAS had not been demonstrated; (3) having to comply with standards was expected to be costly (especially in view of the lack of specific benefits that might flow from their use); and (4) congressional desires and objectives could be accomplished through appropriate modification of existing regulations.

Despite industry’s objections, the Defense Production Act Amendments of 1970 included congressional intent to establish the CASB, which became law by enactment of PL 91-379 on August 15, 1970.

BASICS OF PUBLIC LAW 91-379

Under its legal mandate, the CASB, which consisted of a five-person board headed by the Comptroller General, issued standards to achieve uniformity and consistency in cost accounting, provided certain statutory exemptions, provided for contractors to disclose existing cost accounting practices, and issued rules and regulations covering implementation.

The legislation stipulated that the CASB answer to Congress. In this connection, it paralleled GAO reporting responsibilities. The law further required that the U.S. Comptroller General serve as chairman of the CASB and be responsible for appointing four members to terms of four years each. It prescribed certain criteria that the four additional members must meet: (1) two must be from the accounting profession, one of whom is to be knowledgeable about cost accounting problems in the small business community; (2) one must be from industry; and (3) one must be from a federal agency.

The law was Congress’ attempt to capture some of the concepts described in the GAO report. Specifically: (1) the standards should achieve consistency and uniformity in cost accounting principles; and (2) the principles must be followed by prime contractors and subcontractors involved in negotiated defense contracts during the several phases of contract pricing, including the estimating, accumulation, and reporting of costs.

The law exempted contracts from coverage if the price is based on catalog or market prices of commercial items sold in quantities to the public or if the price was set by either regulation or law. In addition, the legislation granted the CASB rather broad responsibility in amending its regulations and permitting exemptions from its standards for certain classes of contracts.

The legislation required contractors to disclose to the government in writing their cost accounting practices, including a detailed explanation of their methods of cost accounting. In addition, contractors must agree that the contract price can be adjusted downward for higher costs charged against government contracts because of the contractors’ failure to comply with the CAS or with their own cost accounting practices, as described in the disclosure statement.

CASB OPERATING POLICIES

In a March 1973 document entitled Statement of Operating Policies, Procedures and Objectives, the CASB described the framework of its operation, including how it formulated the CAS and its rules and regulations. In this document, the CASB stressed objectives like uniformity and consistency, and explained the process of developing standards. The CASB believed that this statement should present the fundamental objectives of its operation, thus setting the stage for future productive dialogue with interested parties concerned with its work.

In May 1977, the CASB published a Restatement of Objectives, Policies and Concepts, based on its experience to date. The CASB stated that this document was meant to publicize its current views so that interested members of the public could better understand the complex and difficult issues the CASB faced, as well as its philosophy.

In developing a standard, the CASB used as a starting point a myriad of information gathered from a variety of sources, mostly based on potential problems in the broad area of cost accounting. The CASB screened these problems, retaining for extensive research those it believed demanded the most attention. It involved itself in a detailed investigation of prior authoritative statements. It analyzed information developed from the disclosure statements filed by contractors, and it visited a number of contractors’ offices and plants to obtain additional information on the particular cost accounting subject under scrutiny.

After having developed its own thought processes to the point where it recognized some of the existing problems associated with a potential standard, the CASB prepared a discussion paper. It circulated this paper for comment to a wide range of interested parties, including government agencies, contractors, professional groups, and trade associations. On the basis of the responses, the CASB would either abandon a project, perform additional research, or prepare a draft standard to be distributed for comments. The CASB evaluated the responses to a draft standard and appropriately modified the draft.

As required by Congress, the CASB published the draft standards in the Federal Register so that the public had at least 30 days during which it could submit comments, criticisms, and suggestions. After comments were received, the CASB evaluated them and revised the standard accordingly. Then, the CASB published the final standard in the Federal Register and submitted it to Congress for approval. No congressional objection to the standard was raised during a period of 60 continuous days of congressional session, so the standard automatically became law, effective at the beginning of the second fiscal quarter after 30 days from final publication.

AFTER THE DEMISE OF THE ORIGINAL CASB

When the CASB went out of existence in 1980, it left a void. There were 19 standards but no authoritative government agency to interpret, amend, or grant waivers to them or to promulgate new standards. In 1984, DOD decided to fill that void by establishing the CAS as regulations, which were included in the FAR, and by establishing a CAS Policy Group as a separate committee under the FAR regulatory structure to administer and provide means for changing the CAS.

The CAS Policy Group functioned within the Defense Acquisition Regulation (DAR) Council and was staffed with members of each of the Services, the Office of the Secretary of Defense, Defense Logistics Agency, National Aeronautics and Space Administration, General Services Administration, and DCAA. All members except the chairman served on a part-time basis. The CAS Policy Group did not issue any additional standards. Its efforts were directed primarily at administering the current standards and making modifications as required by the changing business environment.

Objections arose from some in industry that the government had total control of the CAS. While the CASB had representation from public accounting, academia, and industry, the CAS Policy Group had only government members. Congress believed these objections were valid. On November 17, 1988, Congress passed Public Law 100-679 to recreate the CASB as an independent unit of the Office of Federal Procurement Policy. It would consist of five members: the OFPP administrator as chairman, one each from DOD and GSA, and two from the private sector.

BASIC CAS REQUIREMENTS

Contracts subject to the CAS are required by law to include a clause fully describing compliance obligations. The clause covers a number of issues. The contractor must: (1) complete a disclosure statement describing its cost accounting practices and follow these consistently in estimating, accumulating, and reporting costs; (2) comply with the CASB’s standards; and (3) adjust the contract price on the basis of failure to comply with disclosed cost accounting practices or the CASB standards.

Price Adjustments

Because changes in CAS applicability or the contractor’s disclosed cost accounting practices may have an impact on contract pricing, paragraph (a)(4) of the CAS clause provides that the contractor shall:

These provisions of the CAS clause provide for price adjustments in three different situations: (1) initial compliance with a standard; (2) “voluntary” changes; and (3) noncompliance. Because the factors involved in each situation are significantly different, the regulations provide separate treatment. However, price adjustments to contracts for a new standard, “voluntary” changes, or noncompliance are required only if the amounts involved are material.

The CASB promulgated general criteria for determining materiality. The FAR provides that the administrative contracting officer (ACO), who is given the responsibility for CAS administration, has the right to forgo action to adjust contracts if the amount involved is not considered material. However, in the case of noncompliance, this section requires the ACO to inform the contractor that the government reserves the right and is required to make appropriate contract adjustments if, in the future, the ACO determines that the cost impact has become material and the contractor is not excused from the obligation to comply with the applicable standard or rules and regulations involved.

Covered Contracts

The cost accounting standards apply to negotiated contracts and subcontracts in excess of $650,000.¹ Explicitly excepted from the statutory coverage are contracts and subcontracts for the acquisition of commercial items and those in which the price is set by law or regulation. The term “subcontract,” as used within the statutory paragraph on the applicability of the CAS, is defined to include transfers of commercial items between divisions, subsidiaries, or affiliates of a contractor or subcontractor. As implemented in the CAS Board’s regulations, the commercial-item exemption covers firm fixed-price contracts and subcontracts, and fixed-price contracts and subcontracts with economic price adjustments, provided that such price adjustments are not based on actual costs incurred.

Before the commercial item exception was enacted in 1996, contracts in which the price was based on “established catalog or market prices of commercial items sold in substantial quantities to the general public” were excepted. The definition of established catalog or market prices and related terms was tied by CASB regulation to definitions used in the procurement regulations. The FAR provided the definitions in its coverage of cost and pricing data requirements.

A business unit that receives a covered contract of less than $50 million may elect modified CAS coverage if the covered contracts that it was awarded in the immediately preceding cost accounting period totaled less than $50 million. Modified coverage requires only that the business unit comply with: CAS 401, Consistency in Estimating, Accumulating, and Reporting Costs; CAS 402, Consistency in Allocating Costs Incurred for the Same Purpose; CAS 405, Accounting for Unallowable Costs; and CAS 406, Cost Accounting Period. Once an election for modified coverage is made during a cost accounting period, it has to be applied to all covered contracts received during that period. Award of a single covered contract of $50 million or more, however, requires compliance with all the standards.

Exempt Contracts

Contracts and subcontracts entered into under sealed bidding procedures are exempt, as are those awarded to small businesses concerns. Firm-fixed-price contracts and subcontracts awarded without submission of any cost data are exempt also. Until the early 2000s, this exemption was for situations where no cost data are submitted as opposed to where no certified cost data are submitted. However, currently, submission of uncertified data (data termed “other than cost or pricing data”) will not cause a contract or subcontract to be CAS-covered.

Exempt from CAS coverage are any contracts or subcontracts of less than $7.5 million, provided that, at the time of award, the business unit of the contractor or subcontractor is not performing any CAS-covered contracts or subcontracts valued at $7.5 million or greater. This is a significant exemption for many companies.

Prior to the statutory exemption for contracts for commercial items, procuring agencies were permitted to waive the application of the CAS to individual firm fixed-price contracts for commercial items when cost or pricing data were not obtained. The Board decided to delegate this authority in December 1995, after considering industry concerns that contractors submitting limited cost data for the purposes of cost realism evaluation or the like would subject themselves to CAS coverage. Additionally, commercial time-and-material and labor-hour contracts are exempt from all CAS requirements

Contracts and subcontracts with foreign governments are categorically exempt, and those awarded to foreign concerns are subject only to CAS 401, Consistency in Estimating, Accumulating, and Reporting Costs, and CAS 402, Consistency in Allocating Costs Incurred for the Same Purpose. An additional exemption existed for contracts and subcontracts executed and performed entirely outside the United States in late 2010; however, a proposed rule will likely eliminate this exemption. An exemption also exists for contracts and subcontracts performed in the United Kingdom by a U.K. contractor that has filed the appropriate disclosure statement in the U.K., and for certain subcontracts under the NATO Plastic Hull Minesweeper (PHM) Ship program.

Waivers of CAS Coverage

The CAS Board may waive all or part of the requirements in the CAS clauses when a contractor refuses to accept those requirements and no other source is available to meet the contracting agency’s needs.

The FAR describes the circumstances under which agencies may waive CAS coverage. Contractors or subcontractors may refuse to accept all or part of the requirements of the CAS clauses. If the contracting officer determines that it is impractical to obtain the materials, supplies, or services from any other source, the contracting officer can prepare a request for waiver describing the proposed contract or subcontract and containing:

1. An unequivocal statement that the proposed contractor or subcontractor refuses to accept a contract containing all or a specified part of a CAS clause and specific reason for that refusal

2. A statement as to whether the proposed contractor or subcontractor has accepted any prime contract or subcontract containing a CAS clause

3. The amount of the proposed award and the sum of all awards by the agency requesting the waiver to the proposed contractor or subcontractor in each of the preceding three years

4. A statement that no other source is available to satisfy the agency’s needs on a timely basis

5. A statement of alternative methods considered for fulfilling the need and the agency’s reasons for rejecting them

6. A statement of steps being taken by the agency to establish other sources of supply for future contracts for the products or services for which a waiver is being requested

7. Any other information that may be useful in evaluating the requests.

CAS STEERING COMMITTEE AND WORKING GROUP

DOD chartered the CAS Steering Committee and Working Group in August 1975 to overcome problems and delays in administration of the CAS. As described in the charter, the Working Group was intended to: (1) monitor CAS field administration; (2) identify CAS problems; (3) provide immediate reaction when appropriate, through informal or written provisional guidance; (4) determine underlying causes of CAS-related problems; and (5) initiate corrective action.

The actual functions of the Working Group included coordinating information on questions and papers submitted through the members, recommending revisions to procurement regulations when appropriate, and preparing formal interim guidance papers, after Steering Committee approval, on subjects of widespread interest. The guidance served as implementing instructions. The effort included interpreting elements of the CASB rules and regulations that needed clarification and helping ensure consistency in the implementation process.

The Working Group functioned for six years. During that time, it issued 25 working papers and one amendment on the following subjects:

Working Item No.	Group Subject
76-1	Interim guidance for implementing CAS 412
76-2	Application of the CAS to contract modifications and to orders placed under basic agreements.
76-3	Interim policy for application of the CAS to subcontracts
76-4	Interim guidance on determining increased costs to the government for “CAS-covered” FFP contracts
76-5	Interim guidance on treatment of implementation costs related to changes in cost accounting practices
76-6	Interim guidance on application of the CAS clause to changes in contractor’s established practices when a disclosure statement has been submitted
76-7	Interim guidance on the significance of “effective” and “applicability” dates included in the CAS
76-8	Interim guidance on use of the offset principle in contract price adjustments resulting from accounting changes
76-9	Interim guidance for measurement of cost impact on FFP contracts
77-10	Retroactive implementation of the CAS when timely compliance is not feasible
77-11	Interim guidance for the implementation of CAS 410, Allocation of Business Unit G&A Expenses to Final Cost Objectives
77-12	Interim guidance on deliberate noncompliance and inadvertent noncompliance
77-13	Interim guidance on the applicability of CAS 405 to costs determined unallowable on the basis of allocability
77-14	Interim guidance on early implementation of new CAS issued by the CASB
77-15	Interim guidance on the influence of the CAS regulations on contract terminations
77-16	Interim guidance on applicability of the CAS to letter contracts
77-17	Identification of the CAS contract universe at a contractor’s plant
77-18	Interim guidance for implementation of CAS 414, Cost of Money as an Element of the Cost of Facilities Capital and DPC 76-3
77-19	Administration of leased facilities under CAS 414
77-20	Policy for withdrawing determination of adequacy of disclosure statement
78-21	Allocation of business unit G&A expenses to final cost objectives
78-21	Amendment 1
78-22	Development of asset service lives
79-23	Administration of equitable adjustments for accounting changes not required by new CAS
79-24	Allocation of business unit G&A expenses to facilities contracts
81-25	Change in cost accounting practice for state income and franchise taxes as a result of change in method of reporting income from long-term contracts

THE STANDARDS

The Cost Accounting Standards Board issued 19 standards. Each standard is highlighted below.

Standard 401: Consistency in Estimating, Accumulating, and Reporting Costs

This standard requires consistency in classifying elements of costs as direct versus indirect, describing the types of costs included in indirect cost pools, and allocating indirect costs.

Because of the absence of specific criteria in the cost principles, contractors historically had considerable latitude in changing their cost accounting practices. In fact, contractors could change from one acceptable practice to another to increase the amount of costs recoverable from the government in negotiated contracts. For example, under a negotiated cost-plus-fixed-fee (CPFF) contract, contractors could use one cost accounting practice for the contract proposal and another practice after contract award, resulting in a change of costs allowable. Under these circumstances, for non-CPFF work, such as commercial or fixed-price government work, contractors would charge fewer costs (and hence earn greater profit) than originally anticipated, solely as a result of the change in cost accounting practice.

The CASB has stated that:

A contractor is restricted in several ways in classifying costs. If the contractor designates a cost as direct at the cost proposal stage, the contractor must charge it as direct during contract performance. For the composition of indirect cost pools, when a contractor has two overhead pools each consisting of different types of cost at the cost proposal stage, the contractor cannot remove certain costs from one pool and place them in the other pool during contract performance. For allocating indirect costs, if a contractor-proposed that a single overhead pool be-allocated on the basis of direct labor dollars, the contractor cannot change that basis to direct labor hours during contract performance.

This standard permits the grouping of like costs where it is not practical to estimate contract costs by individual cost element or function. However, it demands that costs estimated for proposals be presented in such a manner and in sufficient detail that any significant cost can be compared with the actual cost accumulated and reported.

Standard 402: Consistency in Allocating Costs Incurred for the Same Purposes

This standard covers equitably allocating costs to cost objectives, charging costs consistently as direct versus indirect, establishing criteria to avoid charging similar costs in like circumstances as both direct and indirect, and charging similar costs as direct versus indirect under different circumstances.

This standard also stipulates that each type of cost be allocated “only once and on only one basis to any contract or other cost objective.” It intends to “guard against the overcharging of some cost objectives and to prevent double counting. Double counting occurs most commonly when cost items are allocated indirectly to a cost objective without eliminating like cost items from indirect cost pools which are allocated to that cost objective.”

Double counting is charging any kind of cost (e.g., travel, supervision, quality control) directly to a contract without removing similar costs from an overhead pool, a portion of which is being allocated to the same cost objectives as the direct cost charges.

This standard clearly points out the government’s objective when it states:

In other words, the government is willing to absorb its fair share of any cost, whether direct or indirect, but not more than its fair share in those circumstances when the same cost is charged directly and indirectly to its contract through overhead allocations. Contractors would be well advised to plan very carefully their decisions on charging costs incurred in similar circumstances as either direct or indirect. Once these decisions are made, contractors are precluded from altering the accounting practice without becoming involved in potential price adjustments to existing contracts.

Standard 403: Allocation of Home Office Expenses to Segments

The purpose of this standard is to establish criteria for allocating the expenses of a home office to the segments of the organization based on the beneficial or causal relationship between such expenses and the receiving segments.

This standard provides for: (1) identifying expenses for direct allocations to segments; (2) accumulating expenses into separate pools to be allocated to segments on various bases; and (3) allocating to all segments any remaining or “residual” home office expenses required to manage the entire organization. The appropriate implementation of this standard will limit the amount of home office expense classified as residual. The standard seeks to decrease broad allocations and advocates charging costs directly to the segments on a beneficial/causal basis as much as possible.

Expenses incurred by a home office should be divided into the three broad categories. Expenses incurred on behalf of particular segments—central payments or accruals for pension costs, group insurance, state and local income tax, and franchise tax—should be allocated only to those segments. The direct charging of costs to benefiting segments carries out the CAS concept of beneficial or causal relationships. Under it, if the expenses are incurred specifically for a segment, they should be allocated only to that segment, and not to other segments that neither received the benefit nor caused the expense.

This standard points out that if the beneficial or causal relationship cannot be specifically identified, costs should be grouped in homogeneous pools and allocated to segments on the basis of the various services furnished to the segments. For example, various centralized service functions performed by the home office may include personnel administration and centralized data processing. In addition, there may be staff management or policy guidance to segments, such as manufacturing, accounting, and engineering.

The various bases over which these expenses should be allocated are not dictated or required specifically by this standard, but rather are left to the contractor’s judgment. The base selected must be one that appropriately measures the flow of benefits from these functions to the segments.

To help the contractor choose a base, the standard offers some valuable insight into preferred techniques; that is, using a hierarchy for cost allocations. For example, in allocating centralized service, the preferred allocation is the actual activity of the organization providing the service, such as labor hours or machine hours. If these data are unavailable, an alternative technique is measuring the output of the supporting functions, such as units or end products produced.

According to this standard, where neither activity nor output can be measured, a surrogate should be chosen to represent the activity of the segment receiving the benefit. As long as the surrogate represents a reasonable measure of the services received by the segment, it should result in varying the cost allocation in proportion to the services actually received.

This standard also deals with those broad staff management functions that are not identifiable with any segment or specific activity in the segments, but that represent costs necessary to the conduct of all segments. Called residual expenses, they should be a minimal amount after all the allocations required in the first two categories of cost and expenses have been performed. As anticipated by this standard, typical residual expenses are those of top management and their related corporate expenses. They should be allocated to the segments using a base representing the total activity of such segments.

When residual expenses amount to 3.35 percent of the first $100 million in sales and various lower percentages on higher volume, the standard calls for a three-part formula to allocate them to segments. The three-part formula encompasses payroll dollars, operating revenue, and tangible capital assets plus inventory. If inequities result from using this type of formula, the government and the contractor should agree on a special allocation of residual expenses to segments on a basis more commensurate with the benefits received, according to the standard.

An example of possible inequity in allocating residual expenses may be where one segment performs considerable functions for itself but other segments rely on the home office for those functions. This inequity might exist in foreign subsidiaries; government-owned, company-operated plants; domestic subsidiaries with less than a majority ownership; and joint ventures.

Standard 404: Capitalization of Tangible Assets

This standard requires written minimum policies for asset capitalization, requires a service life of two years or shorter and an acquisition cost criterion of $5,000, permits higher minimum dollars for original asset complement and for improvements, and requires that assets constructed for own use must absorb a full share of G&A and full indirect costs if similar to the contractor’s normal product line.

According to the CASB, this standard requires establishing and adhering to policies governing the capitalization of tangible assets on the basis of the concept of enterprise continuity; that is, tangible assets will benefit future periods of time. Asset acquisitions should be capitalized and the cost allocated to current and future accounting periods so that cost objectives in those periods bear their fair share of the asset cost.

Furthermore, capitalization should be based on a policy that is applied consistently. Certain capitalization standards are required: a service life of two years (which can be shorter) and an acquisition cost criterion of $5,000 (which can be less). Contractors also are allowed to designate higher minimum dollar amounts for original installation of low-cost equipment and for betterments and improvements, on the basis that higher limitations must be reasonable in the particular circumstances.

The standard says that when costs are incurred to extend the asset’s life or increase its productivity, and the costs exceed the capitalization criteria established by the contractor, the costs must be capitalized.

This standard includes provisions for determining the types of costs that should be capitalized. These costs include the asset’s purchase price, all costs necessary to prepare the asset for use (installation and transportation, for example), and any adjustments for discounts and premiums.

If contractors construct their own tangible assets, this standard has criteria for determining the amounts to be capitalized. It requires capitalization of amounts that take in all indirect costs properly allocable to these assets, including a full share of G&A expenses if the asset is identical or similar to the contractor’s regular product line. If the item is not similar to the contractor’s normal product, all allocable indirect costs are to be capitalized, except that G&A expenses are limited to those identifiable with the self-constructed asset. This concept is a marked departure from the actual practice of many contractors, who mostly write off indirect and G&A expenses as period costs, with no identification with the constructed asset.

For financial accounting under the purchase method of accounting for business combinations, capital assets are assigned a portion of the costs not to exceed the fair value at date of acquisition. Further, when the fair value of identifiable assets minus the liabilities assumed exceeds the purchase price of the acquired company, the value otherwise assignable to capital assets must be reduced proportionately. For government contract accounting, both asset writeups and write-downs are ignored.

In contrast, under the pooling of interest method of accounting for business combinations, amounts established for capital assets for financial statement purposes must be the values used in determining the cost of the assets.

Standard 405: Accounting for Unallowable Costs

This standard requires that unallowable costs be segregated to prevent them from being charged to the government, be nevertheless allocable to the cost objectives on the usual beneficial or causal basis, and be determined by procurement regulations rather than by the CASB.

This standard eases contract administration by establishing guidelines for identifying unallowable costs and their cost accounting treatment. It requires specific identification in the accounting records (or memo records) of costs that a procurement agency has determined to be unallowable, for the purpose of keeping those costs out of any billing, claim, or cost proposal applying to a government contract.

Costs that are “directly associated” with unallowable costs may also be disallowed by a contracting officer and, hence, be subject to the standard. For example, travel expenses incurred in connection with entertainment expenses would be “directly associated” costs, since they would not have been incurred but for the unallowable entertainment expenses.

The determination of costs as unallowable can be either a mutually agreeable issue between the contracting parties or a unilateral decision by the contracting officer. Once the decision is made, however, any cost incurred for the same purpose under similar circumstances will also be unallowable.

If any work performed is identified as not contractually authorized, and the costs associated with that work are determined to be unallowable, those costs must be segregated like any other unallowable costs and continue to bear their fair share of any indirect cost allocations.

Unallowable costs need not be identified in the formal accounting records. They must at least be maintained in informal or memorandum records, however, so that they are appropriately considered in any cost accounting determinations.

Standard 406: Cost Accounting Period

This standard requires that the cost accounting period usually be the same as the fiscal year, the same cost accounting period be used for both pool and base determination, and the following exceptions be considered: (1) an indirect function in existence for partial year; (2) a mutual agreement of contracting parties; and (3) in transitional periods, a change in fiscal year.

Because the flow of both direct and indirect costs during any 12-month cost accounting period can be erratic in terms of amounts for each month or quarter, allocating only the indirect costs that happen to occur during the few months of contract performance is not proper cost accounting. A variety of costs are properly stated only annually. Use of interim estimates for these costs, then, can produce an estimate over or under the amount of costs applicable to the contract. The example shows an improper overallocation in the shorter period, which resulted from application of an overstated overhead rate.

The standard recognizes that certain indirect cost functions may actually exist for just part of a year and so should be allocated to cost objectives only during that period. In that case, indirect costs can apply solely to contracts performed during that portion of the year. Included might be reorganizations within the company, resulting in the elimination of certain supervisory levels; marketing changes; or the installation of a data processing system.

Standard 406 also permits the use of a 12-month period other than the fiscal year as the cost accounting period if its use is an established practice. In addition, it permits the use of a transitional cost period, limited to a total of 15 months, whenever there is a change of fiscal year. Such a “change in accounting practice” is, of course, subject to that portion of the regulations.

The standard does not require that the indirect cost rates used to expedite the closing of contracts be based on the actual data for the 12-month cost accounting period. It points out that indirect rates developed for that purpose can be used as long as they represent estimates for the full 12-month cost accounting period.

Standard 407: Use of Standard Costs For Direct Material and Direct Labor

This standard deals with written policy for establishing standard costs, standard costs recorded in formal accounts, standard costs and variances booked at production unit level, criteria for labor standards, criteria for material standards, material price and quantity variance from standard, and labor cost rate and time variance from standard.

Standard 407 designates the following standard costs: labor rate, labor time, material price, and material quantity standards. It requires that:

1. Criteria for standard setting and revision be written and followed consistently.

2. Cost standards and variances be entered in the books at the production unit level.

3. Material price variances be recognized at the time purchases of material are entered into the books of account or at the time material cost is allocated to production units. (If these variances are recognized at the time purchases of material are entered into the books of account, they must be accumulated separately by homogeneous groupings of material. If they are recognized at the time material cost is allocated to production units, they may be combined with material quantity variances to form a single material cost variance account.)

4. Labor cost variances be recognized at the time labor cost is incurred in producing units. Similar to material variances, labor rate variances and labor time variances may be combined into one labor cost variance account.

5. Annual allocation of all variances to cost objectives, including ending in-process inventory, be based on various criteria described in the standard.

Standard 408: Accounting for Costs of Compensated Personal Absences

This standard covers: (1) vacation, sick leave, and holiday costs; (2) establishment of cost incurred when liability occurs (i.e., the accrual basis of accounting); and (3) method of determining amounts.

This standard is intended to improve the way in which the costs of compensated personal absence, such as vacation, sick leave, and holidays are determined, and to increase the probability that the costs will be allocated to the proper cost objectives and to the appropriate cost accounting period. Basically, it requires that these costs be assigned to the cost accounting period when the employee earns the right to be paid for the absences. Standard 408 also notes the 406 requirement that costs of compensated personal absences for the entire cost accounting period (usually 12 months) be allocated among final cost objectives during that entire period.

This standard has significant implications for those companies that are either growing or shrinking markedly, because of the lag between the time employees earn certain compensated personal absences (such as vacation) and the actual payment. Since the standard requires the accrual method of accounting, it can make a considerable difference for some companies in determining costs by accounting periods.

Determination of the cost coincides with the time the contractor becomes liable for eventual payment to the employee. Compensated personal absences will be considered as earned and, therefore, a cost to the company, only in the cost accounting period when it is paid—which is equivalent to the cash basis of accounting—as long as no outstanding liability is due the employee.

In determining the amount for the period, a company should take into account the anticipated nonuse of compensated personal absence. In other words, a company should not include as a cost an amount for compensated personal absences that is due but will, in all probability, never be paid. For example, when a company grants vacation periods, but for one reason or another the employee cannot take the vacation, the company never actually incurs the cost.

For determining the amount of cost, a company can use either the current or anticipated wage rates that will be in effect when the liability is paid. For example, if a group of employees is presently being paid an average of $10 an hour when vacation is earned but will be paid $11 per hour in the future when the vacation is actually taken, then either of these rates can be used in determining the cost for the period when the vacation is earned.

The adoption of a new plan or a change to an existing plan may increase the liability at the beginning of the first cost accounting period for which that new plan or change is effective. In that event, the excess costs may not be recognized as costs for the period in which the recognition of the greater liability occurs. The excess costs should be held in a “suspense account” and charged as a contract cost when the amount of the total suspense account is greater than the liability for a future period.

Standard 409: Depreciation of Tangible Capital Assets

This standard addresses: (1) service lives based on records of past retirements; (2) grouping of assets; (3) two-year period to develop records of past retirements; (4) modification of depreciation life for expected physical economic changes; (5) no experience with similar equipment (IRS guideline data); (6) sampling of asset lives; (7) method of depreciation as a reflection of consumption of services (financial statement basis ordinarily acceptable); and (8) gains and losses on disposition of assets.

This standard furnishes guidelines for determining the cost of tangible capital assets assignable to the several cost accounting periods over which the assets are used and provides criteria for allocating depreciation costs to the various cost objectives within the accounting periods. It states that annual depreciation costs should be a financial measure of the use of the tangible assets and, as a result, those costs should flow systematically and rationally to the various accounting periods over which the assets are used.

The total cost of the asset subject to depreciation is the amount of the capitalized cost less its estimated residual value. The method of depreciation to be used—straight-line, sum-of-the-years-digits, declining-balance, etc.—should be based on the pattern of consumption of services furnished by the asset over its entire life. For example, if a significant amount of a particular asset is consumed in its early stages, a depreciation method that results in higher amounts in the earlier years should be used. In contrast, if an asset is used up in equal annual amounts over its service life, the straight-line method of depreciation would more accurately reflect its use pattern. This standard describes a variety of criteria to help determine the asset consumption by accounting periods.

Depreciation may be charged directly to cost objectives under certain circumstances, but it should be allocated to appropriate indirect cost pools in other circumstances. If depreciation costs are charged directly to cost objectives rather than to indirect cost pools, the contractor must consistently charge depreciation costs of all similar assets used for similar purposes in the same manner. The years of service life for assets must be based on the contractor’s actual experience with the retirement of similar assets.

This standard describes some of the techniques for its application by giving background on the nature of depreciation charges. These charges basically consist of two factors: (1) the number of years the asset will be used (i.e., its service life); and (2) the likely pattern of the consumption or use of the asset for each year of its useful life, commonly defined as the depreciation method.

In determining these factors, the standard considers both physical and economic aspects, including the quantity and quality of expected use of the asset in terms of its output, the amount of repair and maintenance, the particular cost accounting periods during which such costs would be incurred, and technical or economic obsolescence (which can be substantial depending on the industry).

This standard requires that a consistent policy—which recognizes that assets are acquired during the year, not just at the beginning—be followed for determining the beginning and ending cost accounting periods of asset use. Assets need not be dealt with individually under the standard if a combination of assets is simpler and more practical for the contractor. Again, consistency is important in making the decision. Under this standard, the estimated years of usefulness, or service life, must be based on the contractor’s actual experience with similar assets and must be supported adequately by records maintained for retirements or withdrawal from active use.

For determining the number of years an asset will be used, the standard permits a modification based on changes that might be expected in the future. For example, a replacement asset for a piece of equipment that lasted 10 years in the past may not last 10 years in the future. The contractor must fully demonstrate that the future life of the replacement equipment is less than 10 years, for reasons such as changes in the quality or quantity of expected output of the newly acquired asset or changes related to its economic usefulness, influenced by technical or economic obsolescence of the asset prospectively.

If the contractor has had no experience with a particular type of asset, he can estimate the future service life of newly acquired assets on the basis of the Internal Revenue Code guideline period (mid-range). However, once the contractor has acquired sufficient experience, he must use the data based on that experience. This standard also permits the contracting parties to agree on shorter estimated service lives if the equipment is being acquired or used for unique purposes.

Standard 409 specifically points out that the depreciation method used for financial accounting purposes (not federal income tax purposes) must be used for contract costing purposes, unless it does not reflect the expected consumption of asset services or is unacceptable for federal income tax purposes. This provision is important because it focuses on the depreciation method. For this reason, a contractor’s choice of a method can be significant in relation to government costing purposes; it should be very carefully thought out.

If a contractor decides to change the method of depreciation for newly acquired assets from the one used for like assets under similar conditions, he must document that decision by projecting the expected consumption of services of those new assets. To change a depreciation method for newly acquired assets, the contractor should develop the proper technical support to justify the change, using the criteria described in the standard.

This standard points out that an amount should be determined and considered in arriving at the total cost subject to depreciation, as long as the estimated residual value is greater than 10 percent of the asset cost. In this case, the standard seems to have adopted a practical threshold that precludes taking into account residual values less than 10 percent of the asset cost. The standard also says that the residual value need not be deducted from capitalized costs in determining depreciable costs when the depreciation method used is either the declining-balance or the class-life asset method.

A contractor may revise the estimated service life or depreciation method, as well as the residual value, during the life of the asset when its operational circumstances or other outside factors change so significantly that distortions would result if modifications were not made.

Gains and losses when assets are sold must be allocated to the cost accounting period when the disposition is actually made. When assets combined or grouped along with other assets for service life and depreciation purposes are disposed of, gains or losses are not to be recognized but must be processed through the accumulated depreciation reserve account. In addition, if an asset is traded in on a new asset, gains or losses are included in computing the depreciable cost of the new asset.

Industry objected to this standard primarily because it believed recognition of cost (via longer service life) would be delayed and, hence, significantly decrease cash flow to the contractor from depreciation costs included in contract pricing. Industry’s objections were so strong that the CASB departed from its usual promulgation process and republished the proposed standard for a second round of comments.

In addition, congressional hearings were held in response to the strong opposition. The CASB stated, in its testimony, that it intended to issue another standard that would tend to offset some of the claims of negative effects raised by contractors. This standard became 414, Cost of Money as an Element of the Cost of Facilities Capital.

Standard 410: Allocation of Business Unit General and Administrative Expenses to Final Cost Objectives

This standard deals with: (1) the definition of G&A expenses; (2) the allocation of G&A expenses only to final cost objectives; and (3) the use of cost input base (sales/cost of sales not acceptable) to allocate G&A expenses, including total production cost, value added (labor and overhead but excluding material and subcontract cost), single-element cost input (such as labor cost), and special allocations.

This standard provides criteria for allocating G&A expenses on the basis of their beneficial/causal relationship to final cost objectives. It intends to achieve a higher degree of objectivity as well as a higher degree of comparability among contractors in such allocations.

G&A expense as included in this standard is: “Any management, financial and other expense which is incurred by or allocated to a business unit and which is for the general management and administration of the business unit as a whole. G&A expense does not include those management expenses whose beneficial or causal relationship to cost objectives can be more directly measured by a base other than a cost input base representing the total activity of a business unit during a cost accounting period.”

Several fundamental requirements are described in this standard:

1. G&A expenses should be accumulated in a single indirect, cost pool and allocated only to final cost objectives.

2. The G&A expense pool should generally be allocated via a cost input base representing the total activity of the business unit.

3. If G&A expenses have a particular beneficial/causal relationship to a particular cost objective that is not reflected in the amounts allocated on a cost input basis, special allocations must be made.

4. If the contractor includes costs that do not now satisfy the definition of G&A expenses but have historically been classified as G&A expenses, these expenses can remain in the pool unless they can be allocated to cost objectives on a beneficial or causal relationship measured by a base other than cost input.

Various techniques may be used to apply these requirements. Where one segment of a contractor’s operation incurs G&A expenses that benefit another segment, these expenses must be removed from the pool of the incurring segment and allocated to the benefiting segment on a beneficial or causal relationship basis. The G&A expense pool may be combined with other non-G&A expenses for allocation to final cost objectives only if the combined pool is appropriate for allocation under the standard.

The cost input base required in the standard for allocating G&A expenses basically underlines the premise that G&A costs incurred in any cost accounting period are related to the total activity during that period as measured by costs incurred. Although, historically, many companies allocated G&A expenses on the basis of cost of goods sold, the CASB concluded that this base is not indicative of the total activity carried out during the period since the cost of goods sold is merely an accounting reflection of the items sold during the period without taking into account increases or decreases in inventory levels, which is a measure of plant/company activity.

Although the standard favors the total cost input as the generally acceptable measure of the total activity of a business unit, it permits several alternatives, such as value-added and single-element cost input. The standard points out that the value-added cost input, which excludes material and subcontract costs, may be appropriate when the inclusion of these costs would distort the allocation of G&A expenses in proportion to the benefits received. While the standard permits the use of a single-element cost input base, such as direct labor hours or dollars, it points out that this base may not produce equitable results when that single element does not really indicate the total activity of the cost objectives involved or is an insignificant part of the total cost of at least some of the final cost objectives.

CAS 9904.410-40(b)(1) prohibits cost of sales/services as an allocation base for G&A and requires a cost input base (but not necessarily total cost): “The G&A expense pool of a business unit for a cost accounting period shall be allocated to final cost objectives of that cost accounting period by means of a cost input base representing the total activity of the business unit…. The cost input base selected shall be the one which best represents the total activity of a typical cost accounting period.” (Emphasis added)

CAS 9904.410.50(d) expands on the different cost input base alternatives. “The cost input base selected to represent the total activity of a business unit during a cost accounting period may be: Total cost input; value-added cost input; or single element cost input. The determination of which cost input base best represents the total activity of a business unit must be judged on the basis of the circumstances of each business unit.” (Emphasis added) Furthermore, this CAS citation states: “Value-added cost input shall be used as an allocation base where inclusion of material and subcontract costs would significantly distort the allocation of the G&A expense pool in relation to the benefits received, and where costs other than direct labor are significant measures of total activity. A value-added cost input base is total cost input less material and subcontract costs.”

Some have mistakenly interpreted the CAS provisions to state a preference for a total cost input base. This CAS citation should be sufficient to reject this misconception. The DOD CAS Working Group attempted to clarify this in Working Group Item 78-21 (Amendment 1): “There is no specific statement of preference in the standard.” In addition, this item states: “The existence of a wide range of material and subcontract content among contracts may signal the precondition for a potential significant distortion.”

The DCAA Contract Audit Manual at DCAM 8-410.1 expands on these points: “The selection of the best base [for G&A] involves judgments on whether inclusion of certain base costs cause ‘distortions’ in allocating G&A to some contracts…. The ASBCA, in essence, ruled that there is no preferred allocation base to distribute G&A expenses other than the one which best represents total activity (Ford Aerospace and Communications Corporation, Aeronutronic Division, ASBCA No. 23833). The following are some examples where the value-added or single-element base may be appropriate: … Contractors whose business activity is clearly labor intensive, but have contracts that include major purchasing and subcontracting responsibility on a ‘pass-through’ basis which causes significant distortions in allocated G&A. Consideration should be given to a value-added or single element base.”

This standard describes how the cost allocations received from a home office should usually be included in the receiving segment’s G&A expense pool. These costs would consist of various line management costs of particular segments or groups, any residual expenses allocated from the home office, and any directly allocated expense related to the general management and administration of the receiving segment as a whole.

Separate allocations from the home office related to such specialized functions as centralized services, staff management of specific activities (e.g., engineering, manufacturing), or central payments or accruals received by a segment (e.g., taxes), however, should not be allocated to the receiving segment’s G&A expense pool. These various techniques may be used to apply these requirements. Where one segment of a contractor’s operation incurs G&A expenses that benefit another segment, these expenses must be removed from the pool of the incurring segment and allocated to the benefiting segment on a beneficial or causal relationship basis. The G&A expense pool may be combined with other non-G&A expenses for allocation to final cost objectives only if the combined pool is appropriate for allocation under the standard.

This standard recognizes that, in certain companies, a home office segment might perform the home office functions and also be responsible for an operating segment that has its own final cost objectives. In these circumstances, the expenses of the home office functions should be segregated from those of the operating segment.

While this standard requires that G&A expenses be allocated to items produced or worked on for stock (since those costs represent part of the cost input base), it recognizes that some contractors do not charge G&A expenses to inventory in their accounting records. Therefore, this standard permits contractors to use the G&A rate of the cost accounting period in which the items are issued to final cost objectives in determining the G&A expense applicable to those issues of stock.

In addition, this standard also realizes that a certain final cost objective, in relation to other cost objectives, may receive significantly more or less benefit from G&A expenses than would ordinarily be recognized by the allocation methods described. In those circumstances, the standard permits special agreements between the contracting parties to allocate the expenses in different amounts to more appropriately accomplish its beneficial/causal objectives. The cost objectives and amounts of G&A expenses subject to special allocations should be excluded from base and pool before the rest of the G&A expenses are allocated to all other cost objectives.

Standard 411: Accounting for Acquisition Costs of Materials

This standard: (1) requires policies and practices in writing; (2) permits costing methods, such as first-in, first-out (FIFO), last-in, first-out (LIFO), weighted/moving average, and standard costs; (3) rejects annual LIFO adjustment method; (4) requires consistency for similar material; (5) charges material to cost objectives; and (6) provides for allocating cost of materials to indirect functions.

Generally, this standard provides criteria for determining the cost of materials, including the inventory costing method to be used. According to the CASB, it should improve the measurement and assignment of costs to cost objectives as well as to cost accounting periods.

CAS 411 contains a few fundamental requirements, such as written statements of accounting policies and practices for material costs and the methods to be used in allocating such costs to cost objectives. In addition, while it permits a contractor to allocate the costs of material used directly in production directly to an indirect cost pool, if those costs are not consumed in a particular cost accounting period, the standard requires that the amount not used up, when significant, be established as an asset at the end of the period.

The standard also seeks to achieve uniformity in a contractor’s methods by requiring that the same costing method be used within the same business unit for similar categories of materials. This standard includes in its definition of material costs the acquisition costs of the material, properly adjusted for any extra charges, discounts, or credits that might have been earned. That inclusion does not mean, however, that the contractor is prevented from accumulating net adjustments in appropriate overhead pools and allocating them in some consistent fashion to cost objectives.

This standard permits the several conventional inventory costing methods to be used when materials are issued from company-owned inventory, such as (1) FIFO, (2) LIFO, (3) weighted/average cost, (4) moving/average cost, or (5) standard cost. It precludes, however, the use of the annual LIFO adjustment method of determining inventory costs. According to the CASB, this method of inventory valuation violates the “systematic and rational costing of issues of materials to cost objectives.” To offset this prohibition, however, the standard permits direct charging of materials to contracts where the materials are appropriately identified.

Standard 412: Composition and Measurement of Pension Cost

The following key issues are covered in this standard: (1) components of pension costs, including defined-contribution plans and defined-benefit plans; (2) handling of unfunded actuarial liabilities; (3) methods of measuring pension costs, including accrued benefit cost method and projected benefit cost method; (4) actuarial assumptions; and (5) assignment of pension costs to periods on the basis of liability that has to be liquidated or compelled.

This standard contains criteria for determining the amount of pension costs that is applicable to particular cost accounting periods as well as guidelines for calculating the essential elements of pension costs. The standard deals broadly with two types of pension plans: defined-benefit and defined-contribution. A defined-benefit plan is one in which the benefits to be paid in the future are firmly established in the present. Contributions paid by the employer are the pension costs, which are intended to pay benefits to employees in some future period. By contrast, a defined-contribution plan is one in which the ultimate benefits are unknown. Only the employer’s contributions are known.

Under each plan, different elements contribute to the total pension costs paid. Under a defined-benefit pension plan, several specific elements constitute the total cost: (1) the normal cost for the period; (2) part of any unfunded actuarial liability; (3) an interest equivalent on the unamortized portion of any unfunded actuarial liability; and (4) an adjustment for any actuarial gain or loss that might be present. In the defined-contribution pension plan, on the other hand, the amount of the net contribution required for that particular cost accounting period, after dividends and other credits where applicable, determines the total cost.

For defined-benefit pension plans accounted for under the pay-as-you-go cost method, the components of pension cost for a cost accounting period are: (1) the net amount of periodic benefits paid for that period; and (2) an amortization installment, including an interest equivalent on the unamortized settlement amount, attributable to amounts paid to irrevocably settle an obligation for periodic benefits due in current and future cost accounting periods.

For defined-benefit pension plans other than those accounted for under the pay-as-you-go cost method, the amount of pension costs of a cost accounting period must be determined by use of an immediate-gain actuarial cost method. Each actuarial assumption used to measure pension cost is to be identified separately and is to represent the contractor’s best estimates of anticipated experience under the plan, taking into account past experience and reasonable expectations. The validity of each assumption used should be evaluated solely with respect to that assumption. Actual assumptions used in calculating the amount of an unfunded liability should be the same as those used for other components of pension cost.

Except for costs assignable to future periods, the amount of pension cost computed for a cost accounting period is assignable only to that period. For defined-benefit pension plans other than those accounted for under the pay-as-you-go cost method, the pension cost is assignable only if the sum of (1) the unamortized portions of assignable unfunded actuarial liability and (2) the unassignable portions of unfunded actuarial liability separately identified and maintained equals the total unfunded actuarial liability. Pension costs assigned to a cost accounting period are allocable to intermediate and final cost objectives only if they meet the requirements for allocation. Pension costs not meeting these requirements may not be reassigned to any future cost accounting period.

A liability is considered liquidated during a period if funding actually occurs by the time the federal income tax return is filed. The standard defines “actuarial liability” as “Pension cost attributable, under the actuarial cost method in use, to years prior to the date of a particular evaluation. As of such date the actuarial liability represents the excess of the present value of the future benefits and administrative expenses over the present value of future contributions for the normal cost for all plan participants and beneficiaries. The excess of the actuarial liability over the value of the assets of a pension plan is the unfunded actuarial liability.”

Since many pension plans carry a certain amount of unfunded actuarial liability, the standard addresses the required cost accounting for that amount. When part of any unfunded liability is included in pension costs, it must be separately identified and included in equal annual installments. Further, the annual installments must include two elements: an amortized portion of the liability plus an interest equivalent on the unamortized portion of that liability.

If the contractor has already begun amortizing the unfunded actuarial liability, this standard requires no change in the amortization period adopted by the contractor. If, on the other hand, the contractor had not yet started amortization when this standard was issued, the amortization period could be no more than 30 years or less than 10 years, except if the plan was in existence on January 1, 1974. In that case, the amortization period cannot exceed 40 years or be less than 10.

This standard requires that pension cost applying to prior years that was specifically unallowable then under existing government contract provisions must be separately identified and eliminated from any unfunded actuarial liability being amortized. The standard also stipulates that when a defined-benefit pension plan is funded exclusively with individual or group permanent insurance or annuity contracts, the plan be treated as a defined-contribution plan even though it may, in fact, be called a defined-benefit pension plan.

Under those plans where the benefits that ultimately flow to the employees are a function of salaries and wages, the calculation of “normal cost” for the year must be based on a percentage of the payroll. On the other hand, where the pension benefit is not a function of salaries and wages, the calculation is based on employee service.

To avoid any short-term fluctuations, this standard proposes that actuarial assumptions reflect long-term rather than short-term trends. This standard requires that any pension costs funded in excess of amounts computed as applying to a cost accounting period consistent with the criteria in the standard be applied to pension costs of future cost accounting periods, not the current cost accounting period.

Standard 413: Adjustment and Allocation of Pension Cost

Standard 413 covers the following issues: (1) annual actuarial gains and losses, including immediate-gain actuarial method and spread-gain actuarial method; (2) circumstances requiring separate calculation of pension cost by segment, including termination gain or loss, different level of benefits/eligibility/age, different assumptions, and merged plans; and (3) actuarial value of fund assets.

This standard, like 412, Composition and Measurement of Pension Cost, is quite complex. Fundamentally, it requires that: (1) actuarial gains and losses be calculated annually and be assigned to the cost accounting period for which the actuarial valuation is made and to subsequent periods; (2) the value of all pension fund assets be determined under an asset valuation method that accounts for unrealized appreciation and depreciation of pension fund assets; and (3) pension costs be allocated to each segment having participants in a pension plan.

A separate calculation of pension costs for a segment is required when these three conditions are present. When these three conditions are not present, allocations may be made by calculating a composite pension cost for two or more segments and allocating this cost to these segments by means of an allocation base. When pension costs are computed separately for a segment or segments, the assignable cost limitation is based on their assets and liabilities. In addition, the amount of pension cost assignable to a segment or segments may not exceed the maximum tax-deductible amount computed for the plan as a whole and apportioned among the segments.

For contractors who compute a composite pension cost covering plan participants in two or more segments, the base used for allocating such costs must be representative of the factors on which the pension benefits are based. For example, a base consisting of salaries and wages should be used for pension costs that are calculated as a percentage of salaries and wages; a base consisting of the number of participants should be used for pension costs that are calculated as an amount per participant. If pension costs are calculated separately for one or more segments, the contractor should make a distribution among the segments for the maximum tax-deductible amount and the contribution to the funding agency.

When apportioning the maximum tax-deductible amount (which is determined for a qualified defined-benefit pension plan as a whole pursuant to the Employee Retirement Income Security Act of 1974—ERISA) to segments, the contractor must use a base that considers the otherwise assignable pension costs or the funding levels of the individual segments. When apportioning amounts deposited to a funding agency to segments, the contractor must use a base that is representative of the assignable pension costs, determined in accordance with the CAS for the individual segments. However, for qualified defined-benefit pension plans, the contractor may first apportion amounts funded to the segment or segments subject to this standard.

Pension cost for a segment should be calculated separately whenever any of the following conditions materially affect the amount of pension cost allocated to the segment:

1. A material termination of employment gain or loss is attributable to the segment.

2. The level of benefits, eligibility for benefits, or age distribution is materially different for the segment than for the average of all segments.

3. The appropriate actuarial assumptions are, in the aggregate, materially different for the segment than for the average of all segments.

Calculations of termination of employment gains and losses should take into account factors such as unexpected early retirements, benefits becoming fully vested, and reinstatements or transfers without loss of benefits. An amount may be estimated for future reemployments.

Pension cost should also be calculated separately for a segment when: (1) the pension plan for that segment becomes merged with that of another segment, or the pension plan is divided into two or more pension plans; and, in either case, (2) the ratios of market value of the assets to actuarial accrued liabilities for each of the merged or separated plans are materially different from one another after applying the benefits in effect after the pension plan merger or division.

For a segment whose pension costs are required to be calculated separately, such calculations are to be prospective only; pension costs need not be redetermined for prior years. For a segment whose pension costs are required to be calculated separately, an initial allocation of a share in the undivided market value of the assets of the pension plan to that segment should be made as follows:

1. If the necessary data are readily determinable, the funding agency balance to be allocated to the segment should be the amount contributed by, or on behalf of, the segment, increased by income received on such assets and decreased by benefits and expenses paid from such assets. Likewise, the accumulated value of permitted unfunded accruals to be allocated to the segment should be the amount of permitted unfunded accruals assigned to the segment, increased by interest imputed to such assets and decreased by benefits paid from sources other than the funding agency.

2. If the data are not readily determinable for certain prior periods, the market value of the assets of the pension plan should be allocated to the segment as of the earliest date such data are available. This allocation should be based on the ratio of the actuarial accrued liability of the segment to the plan as a whole, determined in a manner consistent with the immediate-gain actuarial cost method or methods used to compute pension cost.

The actuarial value of the assets of the pension plan are to be allocated to the segment in the same proportion as the market value of the assets. If, prior to the time a contractor is required to use this standard, it has been calculating pension cost separately for individual segments, the amount of assets previously allocated to those segments need not be changed. After the initial allocation of assets, the contractor should maintain a record of the portion of subsequent contributions, permitted unfunded accruals, income, benefit payments, and expenses attributable to the segment and paid from the assets of the pension plan. Income and expenses should include a portion of any investment gains and losses attributable to the assets of the pension plan. Income and expenses of the pension plan assets should be allocated to the segment in the same proportion that the average value of assets allocated to the segment bears to the average value of total pension plan assets for the period for which income and expenses are being allocated.

In late 2010 the CASB was in the process of harmonizing the requirements of CAS 412 and 413 with the Pension Protection Act. The latter legislation significantly accelerated payments to defined-benefit pension plans beyond the cost that is allowable per CAS. The proposed CAS revisions would close the gap between the amount required by the Pension Act and the amount allowable per CAS.

Standard 414: Cost of Money As an Element of the Cost of Facilities Capital

This standard deals with measuring the cost of facilities capital, determining “imputed” interest rates, and identifying facilities capital. This standard is an outgrowth of CAS 409, which addresses depreciation, in response to contractors’ strong objections that CAS 409 tends to minimize cost recovery related to use of assets.

The CASB recognized an imputed cost of capital for facilities used in performing government contracts. Even though government contract costing does not generally allow interest costs and conventional accounting practice does not permit recording imputed cost of capital, the CASB acknowledged that fixed assets and other facilities used in conducting government business require investment by the contractor. Through this standard, the CASB attempted to recognize and quantify the amount of imputed interest on these investments. The CASB intended to put all contractors on an equal footing as far as recovering the financing costs of facilities, regardless of the extent of debt or equity financing used.

According to this standard, the cost of capital must be computed separately for each contract by identifying those facilities that will be used on the contract and calculating the cost of money in relation to those facilities. The amount so determined is then included as a separate line item of cost in negotiating the contract price.

The investment in capital assets used for computing the cost of money should be based on the accounting information used for contract cost purposes. This information basically includes the fixed assets giving rise to depreciation costs (plus cost of land) that are included in overhead costs applying to government contracts. The net amount of the assets, or depreciated value—rather than the gross—is the base. Any accumulated depreciation incurred by the contractor to date has been recovered in contract pricing and, hence, should not be part of the base for computing the imputed cost of capital on the unrecovered investment in those assets.

The rate to be used is published semiannually by the Secretary of the Treasury under PL 92-41. The cost of capital must be determined for facilities whose related depreciation has been included in each indirect cost pool. In this manner, the cost of capital within each overhead pool can be calculated as part of the overhead rate, and each contract share can be calculated on the basis of the portion of the base contributed by each contract. Basically, if a contractor has only a single government contract for the full year and the facilities’ net book value amounted to $1 million, recovery under this standard (assuming an 8 percent rate) would amount to $80,000.

Standard 415: Accounting for the Cost of Deferred Compensation

This standard deals with: (1) cost to be assigned to the period when the obligation is incurred (accrual accounting), including conditions of “obligations incurred”; (2) cost amount as present value of future benefits, including how to determine “future benefits” in the form of money, stock, or options; and (3) forfeitures (cost reduction) in period of occurrence.

This standard applies to the cost of all deferred compensation plans except those dealt with specifically in other standards (i.e., pension plans). It provides criteria for determining the cost of the various deferred compensation plans that companies adopt and for assigning those costs to the appropriate cost accounting periods.

Deferred compensation is an award given for services rendered in one or more cost accounting periods before the date the employee actually receives the award. (Deferred compensation does not include year-end accruals for salaries, wages, or bonuses that are generally paid within a short period of time after the close of the year.) This standard attempts to inject the accrual accounting concept into that of deferred compensation by requiring that the benefits eventually to be paid be assigned to the period when the entitlement was earned. If the benefits are not firmly obligated, however, and thus do not occur in the year the services were rendered, they should be dealt with on a cash basis of accounting when payment is made.

Recognizing that future payments to employees are worth less at the present time than they will be in the future (because of the time value of money), the standard establishes appropriate criteria for discounting the future amounts to be paid in determining present costs.

The firmness of an obligation before it qualifies as a cost in the current accounting period is an important consideration. The future payment of money, other assets, shares of stock, or other items of value must be required so that the contractor cannot unilaterally avoid this payment. Further, the amount of the future payment must be measurable with reasonable accuracy and the recipient of the award must be known. If the terms of the deferred compensation agreement call for certain events, it must be reasonably probable that those events will occur. If these conditions are not met, the cost of the deferred compensation must be included as a cost only in the accounting period when the compensation is actually paid to the employee.

The eventual amount of deferred compensation, when it includes principal plus interest as a fixed rate, must include the interest in the computation. When no interest is included in the award, the compensation is limited to the amount of the award itself.

In calculating the present value of the future award, the amount to be paid has to be discounted to its present value using the Secretary of the Treasury’s semiannually published interest rate under PL 92-41.

Forfeitures sometimes occur in deferred compensation plans. When they do, they reduce the amount of the award originally assigned to a prior period plus the same rate of interest described above, compounded annually. The forfeiture calculated in this manner is dealt with as a reduction of the contract cost in the period when the forfeiture occurs.

Logical and reasonable rules apply to determining awards of deferred compensation that are made in other than money. For example, in the case of stock, its market value on the day the award is made is a proper basis for valuation. For stock options, the amount by which the stock’s market value exceeds the option price on the measurement date is the proper basis for valuation. For valuing other types of assets, an orientation toward market value is appropriate.

Standard 416: Accounting for Insurance Costs

This standard addresses: (1) calculating the amount of cost for premium payments, including accounting for deposits, reserves and funds, prefunding of retired workers and terminally funded plans, and self-insurance, including purchasing coverage and measuring loss or cost when amounts are paid and unpaid; and (2) allocating cost on the basis of the beneficial/causal relationship, including segment identification and catastrophic losses.

Fundamentally, this standard requires that: (1) the amount of insurance cost be equal to the “projected average loss” for the period plus related administration expenses; and (2) the allocation of insurance costs to cost objectives be based on the beneficial or causal relationship with cost objectives.

The projected average loss can be based on the amount of premium paid, less dividends received, allocated among the cost accounting periods covered by the policy term. Where insurance applies only to a single, final cost objective, the premium need not be prorated among cost accounting periods.

When any part of a premium can be included as a deposit in published financial statements, it should be accounted for as a deposit in determining insurance costs. Deposits include amounts retained by the insurer for inclusion in a reserve (or fund) for the insured’s benefit, unless: (1) the reserve objectives are stated in writing; (2) the required reserve amounts are determined actuarially; (3) additions to the reserve are made systematically; and (4) if payments to attain reserve objectives are made from a source other than the reserve, the payments into the reserve are reduced accordingly.

If an insurance program is designed to prefund coverage on retired persons, the following four criteria need to be met: (1) payments must be made to an insurer to establish a reserve specifically for that purpose; (2) the policyholder must have no right of recapture of the reserve as long as any active or retired participant remains alive, unless the financial interests of the remaining participants are satisfied through other means; (3) the annual amount added to the reserve cannot be greater than would be required to apportion the cost of the insurance over the working lives of the active employees; and (4) in a terminally funded plan, the actuarial present value of benefits applying to retired employees must be amortized over 15 years.

In addition to these “funded” types of insurance expenses, this standard recognizes that projected average loss may be based on a program of “self-insurance.” If insurance could be purchased against the self-insured risk, its cost could be used as the amount of the projected average loss, adjusted in the future for actual loss experience the same way that purchased insurance would be. On the other hand, if insurance cannot be bought, the amount of projected average loss must be based on the contractor’s experience, relevant industry experience, and -anticipated conditions in accordance with accepted actuarial principles. In these cir-cum-stances, the amount of actual losses may be used as costs for the period only if they are expected to approximate the projected average loss. However, any actual losses arising under self-insurance programs for retired persons should be allowed as costs for the period unless a reserve is established.

Under a self-insurance plan, actual losses are measured by: (1) the actual cash value of property destroyed (not depreciated book value); and (2) amounts actually paid to repair damaged estates, to beneficiaries, or to claimants. If claims are not yet paid, they should be estimated in an amount that could be included as an accrued liability in financial statements prepared in accordance with GAAP. If the liability will not be disbursed for more than one year, it should be discounted to its present value.

Standard 417: Cost of Money As an Element of the Cost of Capital Assets Under Construction

This standard establishes criteria for measuring the cost of money attributable to tangible or intangible capital assets under construction as an element of the cost of those assets.

Fundamentally, this standard requires that interest be capitalized by applying an interest rate, determined by the Secretary of the Treasury under PL 92-41, to the construction costs incurred in each accounting period, after appropriately considering the rate at which the construction costs are incurred. For example, if all construction costs of $1 million were made equally during an accounting period, the average construction costs during the period would amount to $500,000. Using an 8 percent interest rate, this means that $40,000 of interest would have to be capitalized.

This standard also states that other methods (Financial Accounting Standard No. 34: Capitalization of Interest Cost) for calculating the cost of money to be capitalized may be used as long as the resulting amount does not differ materially from the one above.

Standard 418: Allocation of Direct and Indirect Costs

This standard addresses: (1) consistent determination of direct and indirect costs; (2) criteria for accumulating indirect costs in cost pools; and (3) guidelines for selecting an allocation measure on the basis of the beneficial or causal relationship between an indirect cost pool and cost objectives.

Each business unit must have a written statement of accounting policies and practices for classifying costs as either direct or indirect. In this connection, the CASB defines a direct cost as one that can be identified specifically with a particular final cost objective, and an indirect cost as one with two or more final cost objectives or one or more intermediate cost objectives.

Actual or standard costs may be used in determining direct labor and material costs. In addition, an average cost or preestablished rates for labor may be used for groups of employees performing interchangeable functions or for groups performing their functions as an integrated team. Significant cost variances should be allocated, at least annually, to cost objectives in proportion to costs previously allocated.

Indirect costs must be accumulated in homogenous cost pools, that is, pools in which all significant costs have similar beneficial or causal relationships to cost objectives.

Each separate cost pool must be allocated to cost objectives in reasonable proportion to the beneficial or causal relationship of the pooled cost to cost objectives. To comply, the basis used for allocation depends on the type of costs included in the pool. For example, if the cost pool consists primarily of managing direct labor activities, a direct labor hour or dollar base is appropriate. Similarly, if pool costs are primarily facility-related, such as depreciation, maintenance, or utilities, a machine hour base is appropriate.

If overhead pool costs are allocated over a base such as direct labor, those costs are charged to all appropriate direct labor, including final cost objectives (such as contracts), goods produced for inventory, IR&D and B&P projects, process cost centers under a process cost system, intra- or inter-company work, and self-construction of tangible capital assets.

On the other hand, if the pool costs consist primarily of costs other than direct labor management, such as those for occupancy, a service center, or the company aircraft, resource consumption can be specifically identified with cost objectives and the following hierarchy for cost allocation should be followed: (1) a measure of the resource consumption of the cost-pool activities; (2) an output measure of the cost-pool activities; or (3) a surrogate representative of resources consumed, which varies in proportion to the services received.

Indirect cost pools that benefit one another may be allocated using such methods as cross-allocation (reciprocal) or sequential. On the other hand, an indirect cost pool may be allocated using a different base if that base better represents the benefits received by the cost objective.

Standard 420: Accounting for Independent Research And Development (IR&D) and Bid and Proposal (B&P) Costs

This standard covers: (1) types of costs to be included; (2) level of cost accumulation; (3) method of allocating costs incurred at business unit and home office levels; (4) possible difference in assigning costs to cost accounting periods between IR&D and B&P expenses; and (5) accounting for costs incurred by one segment that benefit other segments.

Some of the standard’s more significant fundamental requirements are:

• IR&D and B&P costs are to be accumulated at the individual project level, unless the amounts are not material. If they are not, the costs may be combined into one or more projects, separately identified in cost pools.

• The individual project costs are to include all allocable costs, both direct and indirect, except G&A expenses, and are to be accumulated in cost pools.

• Allocation from cost pools, both at the business unit and home office level, is to be on the basis of the beneficial or causal relationship.

In its promulgation comments, the CASB stated that G&A expenses should not be allocated to IR&D and B&P project costs because these costs are of general benefit and, as such, resemble G&A expenses. Although B&P costs incurred in a cost accounting period may not be assigned to any other period, IR&D costs may be assigned to some other period if permitted under existing laws and regulations or by other controlling factors.

The cost of IR&D and B&P projects performed by one segment for another segment should be considered IR&D and B&P work of the receiving segment, not of the performing segment. The performing segment should allocate G&A expenses to those project costs. Further, where costs of projects incurred at a segment benefit more than one segment of the business unit, they should be allocated as home office projects in accordance with certain criteria. Specifically, contractors first must allocate the costs of projects accumulated at the home office to its segments on a direct basis if such projects can be identified with specific segments. They must then allocate the costs of remaining or residual projects among all segments on the same basis.

DISCLOSURE STATEMENT

The disclosure statement satisfies statutory requirements, establishes a company’s cost accounting practices for determining costs under affected government contracts, and provides a data bank of a company’s cost accounting practices to be used by the CASB in researching and developing proposed standards.

Dollar Threshold of Contract Awards For Determining Filing Requirements

A disclosure statement is required for any business unit selected to receive a CAS-covered contract or subcontract of $50 million or more. The statement must be submitted prior to contract award. Moreover, any company that, together with all its segments, received net awards of negotiated prime contracts and subcontracts subject to the CAS totaling more than $50 million in its most recent cost accounting period, must submit a disclosure statement before award of its first CAS-covered contract in the immediately following cost accounting period. If the first CAS-covered contract is received within 90 days of the start of the cost accounting period, the contractor is not required to file until the end of 90 days.

When a disclosure statement is required for a company, a separate statement must be submitted for each segment whose costs included in the total price of any CAS-covered contract or subcontract exceed $650,000 unless: (1) the contract or subcontract is of the type or value exempted by the rules; or (2) in the most recently completed cost accounting period, the segment’s CAS-covered awards were less than 30 percent of total segment sales for the period and less than $10 million.

Each corporate or other home office that allocates costs to one or more disclosing segments performing CAS-covered contracts must submit Part VIII of the disclosure statement. Foreign contractors and subcontractors who are required to submit a disclosure statement may, in lieu of filing a Form No. CASB-DS-1, make disclosure by using a disclosure form prescribed by an agency of their government, provided that the CASB determines that the information disclosed will satisfy the objectives of Public Law 100-679. The use of alternative forms has been approved for contractors in Canada and the Federal Republic of Germany. The submission of a new or revised disclosure statement is not required for any non-CAS-covered contract or from any small business.

For educational institutions, the disclosure requirements are similar to those for commercial organizations. Educational institutions are required to submit disclosure statements for any unit that is part of a college or university location identified in Exhibit A of OMB Circular A-21 that is selected to receive a CAS-covered contract or subcontract in excess of $650,000. This submission must be made prior to contract award. A disclosure statement is not required, however, if the listed entity can demonstrate that the net amount of federal contract and financial assistance awards received during its immediately preceding cost accounting period was less than $25 million.

Any educational institution unit that is selected to receive a CAS-covered contract or subcontract of $25 million or more must submit a disclosure statement before award. Also, any education institution that, together with its segments, received net awards or negotiated prime contracts and subcontracts subject to the CAS totaling $25 million or more in its most recent cost accounting period, of which at least one award exceeded $1 million, must submit a disclosure statement before award of its first CAS-covered contract in the immediately following cost accounting period. However, if the first CAS-covered contract is received within 90 days of the start of the cost accounting period, the institution is not required to file until the end of 90 days.

Revisions to Disclosure Statements

A disclosure statement must be revised to implement requirements of new standards, to correct noncompliance practices, and to reflect changes in cost accounting practices agreed to by the contracting parties. Equitable adjustments of contract prices apply to these changes.

The CASB defined “cost accounting practice” as any accounting method or technique that is used to measure cost, assign cost to cost accounting periods, or allocate cost to cost objectives.

Measurement of cost encompasses accounting methods and techniques used in defining the components of cost, determining the basis for cost measurement, and establishing criteria for using alternative cost measurement techniques. Determination of the amount paid or a change in the amount paid for a unit of goods and services is not a cost accounting practice. Examples of costs are: (1) the use of historical cost, market value, or present value; (2) the use of standard cost or actual cost; and (3) the designation of those items of cost that must be included or excluded from tangible capital assets or pension cost.

Assignment of cost to cost accounting periods refers to a method or technique used in determining the amount of cost to be assigned to individual cost accounting periods. Examples of cost accounting practices that involve the assignment of cost to cost accounting periods are requirements for the use of specific accrual basis accounting or cash accounting for a cost element.

Allocation of cost to cost objectives includes both direct and indirect allocation of cost. Examples of cost accounting practices involving allocation of cost to cost objectives are the accounting methods or techniques used to accumulate cost, to determine whether a cost is to be directly or indirectly allocated, to determine the composition of cost pools, and to determine the selection and composition of the appropriate allocation base.

A “change to either a disclosed cost accounting practice” or an established cost accounting practice is any alteration in a cost accounting practice, whether or not such practices are covered by a disclosure statement. However, the initial adoption of a cost accounting practice for the first time a cost is incurred, or a function is created, is not a change in cost accounting practice. Also, the partial or total elimination of a cost or the cost of a function is not a change in cost accounting practice. (Function is an activity or group of activities that is identifiable in scope and has a purpose or end to be accomplished.) Finally, the revision of a cost accounting practice for a cost that previously has been immaterial is not a change in cost accounting practice.

Exemptions

In addition to the CASB’s authority to exempt contractors from all or part of its regulations and standards, the only other exemption from filing a disclosure statement for a company otherwise required to do so is allowed when an agency head decides that securing the statement is impractical. In this event, the agency head may authorize award of a contract or subcontract.

Review and Approval of Disclosure Statement

The FAR provides for review and approval of the disclosure statement by the responsible ACO, based on DCAA advice. The auditor’s review is confined to determining whether or not the statement adequately describes the cost accounting practices and is current, accurate, and complete.

Ordinarily, the disclosure statement as submitted by the contractor is presumed to be adequate. A disclosure statement is only an expression of a contractor’s cost accounting practices and in no way represents approval of such practices by the contracting agency, the CASB, or DCAA.

When a cost accounting practice is changed, the disclosure statement must also be changed. The revised statement is subject to a review similar to the one described above to judge whether the change complies with CASB promulgations and FAR Part 31.

Detailed Requirements of Disclosure Statement

The disclosure statement is quite detailed; it calls for the following data: (1) general information and certification; (2) direct costs; (3) direct versus indirect costs; (4) indirect costs; (5) depreciation and capitalization practices; (5) other costs and credits; (6) pension costs, deferred compensation, and insurance costs; and (6) corporate and/or group expenses.

General Information and Certification

Required data include name of the company and designation of the type of reporting unit (i.e., corporate home office, group, division, or subsidiary). The required certificate states “… this statement is the complete and accurate disclosure … of its cost accounting practices, as required by the disclosure regulation of the [CASB].”

The general type of information required includes, for the most recently completed fiscal year, amounts of government prime contracts and subcontracts and commercial sales and principal products sold to the government (by SIC code). More detailed information is called for to explain the nature of the cost accounting system (standard job order, process, or average) and the extent of integration of the cost accounting system with financial accounting records.

Direct Costs

Direct costs are materials, labor, and other costs charged as direct (rather than as indirect via overhead) to government or commercial contracts. For material costs, information is requested regarding whether the charge is through an inventory account or directly from purchases. If through an inventory account, the method should be described (i.e., standard or average costs, FIFO, or LIFO). Other information asked for includes the method of accumulating variances from standard (plantwide, by product, by department, etc.), disposition of variances (prorated between inventories and cost of goods sold or charged or credited to overhead), and frequency of standards revisions.

For direct labor costs, information is needed for categories of labor (manufacturing and engineering); classes of labor included in each category; and whether actual or average rates are used, as opposed to standard rates. If standard costs are used, considerable data on variances are required, including type of variance (rate or efficiency) and method of accumulating and disposing of variances, similar to material variances.

Regarding interorganizational transfers of materials and labor costs, information is requested on the calculation of amounts (i.e., at fully absorbed costs, including G&A expenses, full cost plus an arbitrary markup, or catalog/market price).

Direct versus Indirect Costs

A narrative is required to describe when costs are charged as direct versus indirect. In addition, treatment code data need to be completed for direct materials, labor, and miscellaneous costs involved, with appropriate designation of direct versus indirect and related overhead pools where those costs would be charged.

Indirect Costs

Allocation base codes are provided to describe how various indirect, G&A, and service center cost pools are allocated to government contracts. Each of the overhead pools described should be assigned the proper allocation base code to designate how those costs are allocated to government contracts. G&A expenses are handled in a similar manner, by designating how the costs accumulated in these pools are allocated to government contracts.

The disclosure statement describes service centers and departments or functions that perform services for others in the reporting unit. In addition to the allocation base code, the category code and rate code are required to be designated for the various service centers if applicable:

• Category code. Generally, costs incurred by service centers are, or can be, charged or allocated: (1) partially to specific final cost objectives as direct costs and partially to other indirect cost pools (such as a manufacturing overhead pool) for subsequent reallocation to several final cost objectives, referred to as Category “A”; and (2) only to several other indirect cost pools (such as manufacturing overhead pool, engineering overhead pool, and G&A expense pool) for later reallocation to several final cost objectives, referred to as Category “B.”

• Rate code. Some service centers may use predetermined billing or costing rates to charge or allocate the costs (Rate Code A), while others may charge or allocate on an actual basis (Rate Code B).

The disclosure statement requests information about those circumstances when overhead and G&A rates are allocated at less than full rate. For example, subcontract costs may not carry a full G&A allocation or purchased labor may not carry a full overhead allocation.

For IR&D and B&P costs, disclosure must be made for the method of allocation, such as part of G&A pool, as a separate rate, or transferred to corporate or home office level (and subsequently reallocated to all segments on some basis).

Depreciation and Capitalization Practices

For each category of asset (e.g., land improvement, buildings, machinery), a designation is required for cost accounting under government contracts regarding depreciation methods, such as straight-line or declining-balance; method of determining useful life, such as IRS guidelines, replacement experience, or engineering estimate; and treatment of residual value. These methods must then be compared with accounting for financial and tax purposes, and differences must be noted.

Additional questions relate to use charges for fully depreciated assets; gains and losses on disposition of depreciable property; capitalization or expensing of specific costs, such as freight-in installation costs; and minimum dollar and useful life criteria for capitalization.

Other Costs and Credits

The accounting must be explained for miscellaneous costs and credits, such as vacation, holiday, and sick pay; supplemental unemployment benefits; severance pay; miscellaneous receipts (property rental and selling services); and proceeds from employee welfare activities.

Pension Costs, Deferred Compensation, and Insurance Costs

Considerable detailed information regarding pension costs of the three largest plans is required in the following areas: extent of funding; actuarial cost method; frequency of actuarial computations and assumptions; amortization of prior service costs; adjustment for actuarial gains or losses; unrealized gains and losses; and amortization of actuarial gains or losses.

The questions on deferred compensation, like profit-sharing or stock bonus plans, relate to whether or not the plan is qualified under Section 401(a) of the Internal Revenue Code and the method of charging costs to government contracts (i.e., when accrued as a cost, when contributions are made to a trust fund, or when paid to employees).

Insurance questions relate to: method of providing insurance; type of purchased insurance plans; accounting for earned refunds and dividends; employee contributions; employee sharing in refunds and dividends; and self-insured and purchased workers’ compensation, liability, and casualty insurance.

Corporate and/or Group Expenses

The disclosure statement segregates these expenses into three categories: directly chargeable to corporate segments for centrally performed services or purchase; separately allocated to a limited group of corporate segments; and residual expenses allocated to all corporate segments.

For each of these three categories, the statement requires an identification of the costs allocated and the method of allocation, using the allocation base previously described. In addition, it questions the circumstances under which segment expenses are transferred to the corporate or group office, whether or not fixed management charges are made to segments in lieu of pro rata or allocation basis, and the extent to which government-owned, company-operated plants are allocated corporate expenses.