CHAPTER 3
Accounting System Requirements
An accounting system is a combination of records, internal controls, and written policies and procedures, all of which function together in the process of estimating, accumulating, and reporting financial data. An adequate accounting system is important for any business; however, an adequate accounting system is especially important for government contractors. A government contractor must establish an accounting system consistent with “generally accepted accounting principles” (GAAP) and any other contractual requirements.
In addition to establishing an accounting system that meets GAAP requirements for financial reporting, government contractors must establish a system that records the incurrence of contract costs in accordance with government laws and regulations, particularly the cost accounting standards (CAS) and the Federal Acquisition Regulation (FAR) cost principles. Basically, contractors must establish an accounting system that accomplishes the following:
Segregates costs by contract and contract line item, depending on the type of contract and the work being performed
Provides actual cost data at interim periods to allow for contract repricing or negotiating revised contract targets
Accounts for specific unallowable costs as established in FAR Subpart 31.2, and augmented by CAS 405
Separates preproduction and nonrecurring costs from production and recurring costs
Generates reliable data for purposes of pricing new and/or follow-on procurements
Identifies and segregates direct and indirect costs
Identifies varying levels of indirect costs (e.g., fringe benefits, labor-related overhead, material-related overhead, services usage, and general and administrative—G&A—cost).
The Defense Contract Audit Agency often includes additional criteria, such as a contractor being current on the annual indirect cost rate submission and timely submission of adjustment vouchers for cost-type contracts. The government cost regulations do not require the use of any specific or uniform cost accounting system or method of determining contract costs. Accordingly, contractors are free to develop and use the type of accounting system that is most appropriate for their business. For example, there are no requirements regarding use of either a job order cost system or a process cost system. In addition, no specific direction requiring the use of actual costs versus standard costs in costing and pricing contracts is provided. However, contractors are required to incorporate certain basic elements into an accounting system before it is considered to be adequate for government contracts.
The size of the firm and the extent of its government contracts can also dictate the depth and breadth of a cost accounting system. Smaller companies with fewer government contracts can probably generate the necessary cost data using a relatively simple manual system. However, a multidivisional or multinational company engaged in developing or manufacturing complex products may require much more. In this case, it would be almost mandatory that the company establish some type of computerized cost system to ensure that its own and the government’s interests are adequately addressed. Certainly, in any enterprise engaged in government contracting, regardless of its size, costs must be addressed in logical, sensible, and suitable terms.
Manually maintained books and records are acceptable. Software that does not accommodate government contracting requirements may be supplemented with spreadsheet analyses. However, if a contractor follows this approach, care should be taken to ensure that the spreadsheets are reconcilable to the official books and records. Software especially designed for government contractors is commercially available as well.
If a contractor wants to advance into the increasingly complex government contracting arena but does not currently use a commercially available government contract-oriented accounting software package, the contactor should consider initiating a Request for Proposal (RFP) process. Through this process the contractor can seek to replace its current system with government-compliant software that will interface as necessary with corporate transaction and reporting requirements. The RFP should emphasize project management, government cost accounting and reporting, timekeeping, labor distribution, billing, revenue recognition, contract management, and financial reporting functionality.
Historically, very few cost accounting systems have met the specific needs of the government contracting marketplace. In fact, this marketplace was once dominated by a single major vendor. Recently, several products with national and international market reach have entered the market, providing more choice to the government contractor customer. These packages have been tried and tested in the commercial market as well as in the government contracting arena. These new packages offer substantial functionality, ease of use, and flexibility.
Deltek has been the major supplier of enterprise resource planning (ERP) software to both large and small corporations; one of the company’s key market areas has been defense contractors. Recently, Microsoft and other vendors have begun competing in this area. Through some careful acquisitions and development efforts, Microsoft has rolled out a suite of products targeted at government contractors. The company has developed software specifically for government contractors as well as other types of companies.
Project-based software packages such as Deltek GCS and Costpoint are geared to service contractors. While the original Deltek GCS is less expensive, the code and file formats present certain limitations. Costpoint is more robust and better for larger firms. Manufacturers might consider SAP or Oracle, being careful to understand that additional configurations may be necessary for government contracting compliance. For example, SAP often incorporates standard cost features that are not relevant to a company circumstance. Microsoft’s Dynamics SL or Dynamics NAV provide benefits to both service contractors and manufacturers based on their ease of use and seamless integration with Microsoft Office applications and Microsoft technologies. Microsoft systems also tend to be more open; therefore, a contractor is not dependent on just the Microsoft suite of products to handle all its ERP needs. However, any software can be supplemented sufficiently for use on government contracts. Modifications are even available to permit the use of Quick-Books for government contract purposes.
When configured correctly and implemented properly, these project-based packages provide major benefits. Billing, allocations, revenue recognition, time and expense recording, project profitability analysis, access rights, and organizational restructuring can be quickly and easily completed in accordance with federal and internal corporate requirements.
BASIC RECORD KEEPING
The types of books and records used in any accounting system are based on what is most suitable for a contractor’s business. The overall objective is to provide cost accounting and financial data that are adequate for government contract costing purposes. The basic record keeping system must provide sufficiently detailed contract costs so that costs can be determined at interim levels for purposes of repricing, negotiating revised targets, and determining billings. Although the use and design of certain specific accounting records may vary from contractor to contractor, the record keeping systems for all government contractors must include a general ledger, a job cost ledger, labor distribution records, time records, subsidiary journals, a chart of accounts, and financial statements.
Several key functions are essential to the adequacy of any basic record keeping system:
Segregate direct costs by contract or job and then by cost element (e.g., labor, materials, other direct charges)
Segregate indirect costs by account and title (e.g., fringe benefits, labor-related overhead, material-related overhead, service usage, G&A cost)
Accumulate costs on both a current and cumulative basis (i.e., year to date and project to date)
Establish the accounting period and perform reconciliations of time sheets to labor costs included in job cost ledgers and of basic cost records to the general books of account
Enter costs to the books on a current basis
Separately identify unallowable costs in the regular books of account (or by way of a less formal cost accounting technique, as long as adequate cost identification is established).
The cost of labor is often the most sensitive cost element. Labor costs impact a con-trac-tor’s cost structure and thus the price paid by the government. Direct and indirect labor costs are generally the single most significant cost element charged to government contracts. In addition, certain areas of labor (e.g., direct labor dollars or hours) are commonly used as the base element for indirect cost rates. Labor costs or hours are also an essential element in a contractor’s estimating system used in providing quantitative and qualitative historical data necessary for determining estimated costs for follow-on government contracts.
Thus, the accurate recording of labor costs by contractor employees is of utmost importance. Unlike other cost items, labor is not supported by third-party documentation such as an invoice, purchase order, or other receipt. The key document in a manual timekeeping system is the timecard prepared by individual employees. Since timecards can be easily altered or controlled by other persons, it is essential that individual employees be made aware of their responsibility and realize the importance of accurate timecard preparation. The government relies heavily on basic internal controls to ensure the propriety of labor costs presented for payment, contract costing, and estimating. It is therefore essential that the internal controls related to labor recording and distribution be firmly established and periodically reviewed by management.
Manual timecards and timesheets should include the following information: employee name, employee identification number, time period, employee signature, daily entries, project name, project number, daily totals, project totals, tax location identification, and a comments section to note changes or other significant matters. Figure 19 presents a sample time report for hourly employees and Figure 20 presents a sample time report for salaried employees.
Electronic timekeeping systems are acceptable, but must have adequate internal controls. For example, only the employee should be authorized to make entries and changes to the timesheet information. Any changes after initial entries have been made must be maintained in the system to provide an audit trail.
Figure 19
TIME REPORT—HOURLY EMPLOYEES
XYZ Company
Figure 20
TIME REPORT—SALARIED EMPLOYEES
XYZ Company
INTERNAL CONTROLS AND WRITTEN POLICIES AND PROCEDURES
Good internal controls and established, written policies and procedures are the backbones of a good accounting system. Although government cost regulations do not prescribe specific internal control procedures, the CAS require the establishment and use of written procedures for several areas of cost accumulation and allocation. Some of the cost areas include depreciation, capitalization of tangible assets, accounting for acquisition of material costs, and allocation of direct and indirect costs.
In addition, government auditors evaluate the strengths and weaknesses of contractor internal control systems by measuring the contractor’s adherence to its written policies and procedures. Auditors review these written policies and procedures to determine the overall adequacy of a contractor’s accounting system. If auditors find significant deficiencies, they qualify their audit reports by stating that the contractor’s record keeping system is inadequate for government contract costing purposes. This type of audit response obviously works against an organization’s efforts to establish itself as a responsible contractor.
The more significant internal control features of an acceptable accounting system for government contract costing purposes include the following:
Separation of authority between key accounting functions (e.g., payroll vs. timekeeping; requisition of materials and services vs. purchasing; purchasing vs. an accounts payable function; billing function vs. accounts receivable)
Written policies and procedures establishing the purpose and requirements of the accounting system (e.g., timekeeping, payroll, purchased services and materials, direct and indirect cost control, asset capitalization and utilization, post-retirement benefits and deferred compensation)
Internal reviews by management to ascertain employee compliance with the policies and procedures
Periodic reconciliations of cost control records from the point of original entry through cost accumulation summaries to billing records and accounts receivable
Management authorizations of critical accounting activities (e.g., issuance of payroll checks, signing of timesheets) and requisitioning/purchasing of materials and services
Budget control procedures for comparing actual cost to budget and contract financial status
Productivity measurement techniques to allow management to focus on problem areas and improve overall economy and efficiency (e.g., engineered or estimated standards)
Organizational charts to define lines of authority and responsibility and to provide for division of responsibility in operating, recording, and custodial functions
In-house suggestion boxes and hot-lines to encourage employees to make recommendations and ask questions about proper procedures or to inform management of possible areas of employee wrongdoing or fraud.
The extent of internal controls depends on the size of the organization. Obviously in a one-person organization, internal controls are very limited. This does not mean that the accounting system is unacceptable. It just means that an auditor will likely want to perform additional tests to obtain assurances.
Contractors are are advised to have written policies and procedures in the following areas:
Definition of direct costs
Description of indirect cost structure
Job cost accumulation process
Labor recording
Cost transfers between segments
Interim invoicing
Preparation of incurred cost submission
Final invoicing
Asset capitalization
Contract briefs
Documentation of expenses
Incentive compensation plans
Paid time off
Consultant costs
Employee travel expenses
Monitoring indirect costs
Employee benefits
Limitation of cost clause requirements
Segregation of unallowable costs
Adjustment vouchers
Cash discounts
Severance pay
Closing statements
Uncompensated overtime.
MANAGING CONTRACT COSTS
During contract performance, a contractor is generally paid by two methods—public vouchers and progress payments. Public vouchers are generally used for cost-reimbursement contracts. Progress payments apply to fixed-price type contracts. In either case, the contractor’s accounting system must be adequate to support the payment of costs incurred.
Costs included in a standard public voucher must reflect contract costs incurred both in the current period and cumulatively. Direct costs should be included as actually incurred, and the applied indirect costs should reflect a billing rate that is based on an estimate of year-end allowable actual costs or contractually established provisional costs. Any cost limitations resulting from a contractually established cost ceiling or limitations also must be reflected in the voucher. As a general rule, cost-reimbursement contracts are subject to a withholding of 15 percent of fee until the contract is completed and the contractor submits a final voucher. This reserve helps protect the government’s interest, including possible contractor overbillings. FAR 52.216-7, Allowable Cost and Payment, governs cost reimbursements.
FAR 52.232-16, Progress Payments, governs a contractor’s submittal of progress payments based on incurred costs. This contract clause requires that costs that are claimed have actually been paid or incurred, depending on the contract terms. The standard progress payment clause requires that the costs of “supplies and services” purchased by the contractor directly for the contract may be included in the progress payment claim only after actual payment by cash, check, etc. On the other hand, the clause allows costs for such items as direct labor, materials issued from inventory, and indirect costs, to be simply incurred, not necessarily paid, at the time the progress payment is submitted. It does require, however, that the contractor maintain a current payment status on those items. Government auditors will review the contractor’s historical payment records to ascertain that delinquency is not a problem. As of October 1, 1999, a proposed FAR change would remove the requirement to pay subcontractors before seeking reimbursement from the government.
With regard to the submittal of progress payment requests, the government requires that the contractor have reasonable visibility of the percentage of contract completion. This requirement illustrates the need for the contractor’s accounting system to accumulate costs by contract and to allow for visibility of actual costs incurred compared to budgeted costs. The accounting data will have to be merged with production data and engineering estimates to enable management to fully assess project status. This requirement also permits the government to see whether the contractor is incurring costs at the budgeted rate, or is in an overrun position. If the latter is the case, the request for progress payment will be reduced by the equivalent overrun percentage as the government attempts to protect itself from paying overrun dollars.
Another category of expenditures that is not reflected on the company books should be controlled. Those costs are open commitments, which are basically purchase orders that have been placed but remain unrecorded or unpaid because a vendor service has not been rendered or a product has not been received. A contractor needs to establish a system to track those open commitments and measure them along with their actual expended costs to ascertain valid cost-to-budget comparisons. Normally, open commitment costs are not included for cost reimbursement or progress payment requests. But measurement to budget and well-founded estimated costs to complete calculations must include this area of potential cost.
Cost-reimbursement contracts contain a limitation of cost clause (LOCC) to protect the government from unauthorized and unexpected cost overruns. This clause requires a contractor to notify the contracting officer in writing whenever he has reason to believe that: (1) the costs he expects to incur under the contract in the next 60 days (or an alternative number of days ranging from 30 to 90), when added to costs previously incurred, will exceed 75 percent (or an alternative percentage ranging from 75 to 85) of the estimated costs specified in the contract; or (2) the total cost for the performance of the contract, exclusive of any fee, will be either greater or substantially less than estimated. This clause is discussed in detail in Chapter 2.
ALLOCATING COSTS
The government will pay only for costs that it believes relate to or benefit its work. The process of assigning costs to government and commercial contracts is known as cost allocation. When the government requires that a cost be allocable to a government contract, it means that the cost is for something that benefits the government work or is necessary for the government work.
Proper cost allocation requires an understanding of the types of costs involved on a contract. Costs must then be applied consistently within an acceptable cost structure.
Direct and Indirect Costs
Direct costs are costs incurred solely for the benefit of a single final cost objective, such as a contract. Indirect costs benefit more than one contract. FAR 31.202 defines a direct cost as any cost that “can be identified specifically with a particular final cost objective. No final cost objective shall have allocated to it as direct cost any cost, if other costs incurred for the same purpose in like circumstances have been included in any indirect cost pool to be allocated to that or any other final cost objective. Costs identified specifically with the contract are direct costs of the contract and are to be charged directly to the contract. All costs specifically identified with other final cost objectives of the contractor are direct costs of those cost objectives and are not to be charged to the contract directly or indirectly.”
Direct costs are those specifically identified to various cost objectives within the company. They normally include the salaries and wages of personnel directly associated with these objectives, materials or services directly used in manufacturing the product, subcontracted costs, and other direct costs directly related to the cost objectives. A direct cost may be one for materials or services incorporated into the product or the production process.
Indirect costs are all costs that cannot be specifically identified with a single contract or with units of output because the cost either is incurred for more than one contract or unit of output or is not susceptible to measurement at the unit of output level. Such costs are necessary to produce units of output and are as much a cost of producing goods and services as costs that are specifically identified, such as direct labor and direct material.
FAR Subpart 31.203 defines an indirect cost as “any cost not directly identified with a single, final cost objective, but identified with two or more final cost objectives or an intermediate cost objective. It is not subject to treatment as a direct cost. After direct costs have been determined and charged directly to the contract or other work, indirect costs are those remaining to be allocated to the several cost objectives. An indirect cost shall not be allocated to a final cost objective if other costs incurred for the same purpose in like circumstances have been included as a direct cost of that or any other final cost objective.”
Indirect costs are commonly separated into overhead and G&A costs. A business may have several overhead cost pools, but only one G&A cost pool. Small companies often combine overhead and G&A into a single cost pool, whose title might be indirect cost pool, overhead cost pool, or G&A cost pool. The number of overhead cost pools at a business depends on the circumstances.
A small company might have one indirect cost pool and rate for both overhead and G&A costs. A larger company might have a single overhead pool for indirect costs related to contract performance and a G&A cost pool for overall operations costs. Additionally, a large contractor that has several functions or locations might use overhead pools. For example, the contractor could have one overhead cost pool for plant A and another for Plant B. There could also be one overhead pool and rate for work performed at the customer site and another for work performed at the contractor site. The contractor could have a separate overhead cost pool for materials and subcontract functions. In this latter example, the production overhead would likely be allocated based on direct labor dollars and the overhead related to ordering and handling materials would likely be allocated based on material and subcontract dollars.
Overhead Costs
Overhead costs are those not directly related to cost objectives but are support-type costs necessary for the production of goods or services. These costs may be associated with general product lines, organizational groups, or groups of contracts. Overhead costs commonly include salaries and wages of support and production personnel, facilities costs, and supplies.
Overhead costs are accumulated into overhead pools. The number of pools can vary depending on the complexity of operations. Each overhead pool is allocated to cost objectives in reasonable proportion to the beneficial or causal relationship of the pool(s) to cost objectives. Overhead costs are commonly expressed in a rate as follows:
| Direct manufacturing labor costs 2,000 hours @ $15.00 Manufacturing overhead costs Manufacturing overhead rate as percentage of labor cost ($45,000 divided by $30,000) |
$30,000 $45,000 150% |
| or Manufacturing overhead rate as a cost per hour of labor ($45,000 divided by 2,000 hours) |
$22.50 |
Manufacturing automation has grown immensely and has created another aspect of overhead allocation. As direct labor disappears in an automated environment, using direct labor as an allocation base no longer is logical. Activity-based costing (ABC) seeks cost drivers as cost allocation bases. For example, instead of allocating overhead based on direct labor dollars or hours, overhead is allocated based on machine time, operator-maintained work stations, etc. Instead of allocating material-related overhead based on material costs, this overhead is allocated based on the number of items purchased, the quantity of items passing through inventory, the number of times material is moved, etc.
Service Centers
A contractor service center furnishes services to others within a company. Good examples are the computer mainframe installations that provide shared services for other corporate segments. Complex algorithms are usually calculated for work done in these centers. The algorithms will include charges for mainframe time as well as ancillary equipment utilized in running programs for users.
Another example of a service center is a testing facility, which can range from a wind tunnel to an environmental test lab. A type of machine utilization rate may be calculated for the type of tests being performed. Some of the testing service center rates can be quite large due to the expensive original cost of the equipment and the specialized housing necessary for this equipment. Other service center examples include copying or reproduction centers, graphic arts, technical library, automobiles, and aircraft.
General and Administrative Costs
G&A costs are defined as “Any management, financial, and other cost 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.” These costs normally include compensation of company executives and their related fringe benefits, legal and professional fees, and other administrative personnel and costs.
G&A costs are frequently accumulated in a single pool and are allocated to the entire business unit based on the total cost input by way of a rate expressed as follows:
| Direct manufacturing labor cost | $ 30,000 |
| Direct material costs | $ 25,000 |
| Manufacturing overhead costs | $ 35,000 |
| Other direct costs | $ 10,000 |
| Total cost input | $100,000 |
| G&A costs | $ 10,000 |
| G&A rate ($8,500 divided by $85,000) |
10.00% |
In the total cost input G&A allocation method, all costs (labor, overhead, material, and other direct charges) are included in the G&A allocation base. An alternative G&A allocation method is called the “value added” method and would be expressed as follows:
| Direct manufacturing labor cost | $ 30,000 |
| Direct material costs | $ 25,000 |
| Manufacturing overhead costs | $ 35,000 |
| Other direct costs | $ 10,000 |
| Value added (total cost input less materials and subcontracts) |
$ 75,000 |
| G&A costs | $ 10,000 |
| G&A rate ($10,000 divided by $75,000) |
13.33% |
A third allocation method is called the single element method. This method uses only one cost element (e.g., labor as an element of the base) to allocate G&A costs. It is not used too often, however, because the smaller the base employed, the larger the G&A rate will be. This unfortunately does not present a readily acceptable, saleable G&A rate. In most instances, the lowest G&A rate possible presents a more acceptable selling point:
There have been numerous debates and a few court decisions regarding which G&A allocation method is the most acceptable. The CAS allow any of these methods. However, a non-CAS-covered business unit is not restricted to the use of only these three G&A allocation bases.
The Defense Contract Audit Agency (DCAA) has generally advocated the total cost input method as the only acceptable method. Case history indicates that the courts have not agreed with that philosophy and have allowed any of the three methods to be used based on the contractor’s selection and the equity of the resulting allocations.
Another aspect of G&A costs is multiple layers of G&A costs. These layers are represented by several different labels, such as a group or a sector. These units usually have cognizance over a number of divisions or segments producing goods and services. For contracts subject to full CAS coverage, corporate allocations are governed by CAS 403. Basically, corporate or group costs are identified as much as possible to specific segments, or groups of segments. The residual expenses, which cannot be identified, are then reviewed as a percentage of total revenue. If the residual expenses exceed specified percentages, these expenses must be allocated by a method called the “three factor formula.” This formula includes revenues, payroll, and net book value of assets.
Consistent Application
With regard to the accumulation and allocation of direct and indirect costs, both the FAR and the CAS emphasize the need for consistent allocation of costs incurred for the same purpose in similar circumstances. This fundamental requirement of government contract costing serves as a foundation in the development of any accounting system. The CAS provide specific criteria for the accumulation and allocation of both direct and indirect costs. They describe the nature of these costs and include guidance in determining acceptable, indirect allocation bases. In circumstances where the CAS do not apply to contracts, the method of allocation is to be in accordance with consistently applied GAAP and causal-beneficial relationships.
According to the FAR, the base period for allocating costs is the cost accounting period during which such costs are incurred and accumulated for distribution to work performed in that period. For contracts subject to full CAS coverage, the cost accounting periods to be used in allocating indirect costs are governed by CAS 406. This requirement is also incorporated in the FAR. For contracts subject to modified CAS coverage and for contracts not subject to CAS coverage, the base period for allocating indirect costs will normally be the contractor’s fiscal year.
Establishing a Cost Structure
When an offeror or a contractor must create a cost structure for government contracting, a spreadsheet application is helpful. The first column of such a spreadsheet contains all the nominal accounts, i.e., revenue and expense accounts. The second column presents the amount from the most recent cost accounting period or an estimate for the current cost accounting period, if this is available.
Each amount is then assigned to a column for direct labor costs, material and subcontract costs, other direct costs, fringe benefit costs (if applicable), overhead cost pool(s), and G&A. Columns for unallowable costs should also be included. The totals on these columns are used to develop cost allocation bases and cost pool amounts. A check figure can be developed to ensure that all general ledger costs are accounted for in the government cost structure. Figure 21 demonstrates this application.
Many variations are possible in Figure 21. For example, multiple overhead cost pools are common; the most common is an overhead cost pool for materials and subcontracts. Other overhead cost pools might be for contractor site and client site work, physical location, business line, profession discipline, etc.
Monitoring Indirect Costs
Indirect cost rates should be monitored to prevent over- or under-invoicing of cost-type contracts and to ensure that business decisions are based on accurate information. Rates should be monitored at least monthly, preferably quarterly. Annual revisions to interim billing rates are not required by the FAR, but agencies such as DCAA may demand that such revisions be submitted in advance of each fiscal year. Interim billing rate adjustments should be requested at any time rates are expected to vary significantly from actual rates at year-end. The test is what is expected at year end, not the year-to-date rate. At the completion of the year, DCAA encourages contractors to adjust indirect cost rates to reflect actual rates prior to audit. This is not required by the FAR, but is often a good idea to prevent under- or over-billings.
OTHER COST ACCOUNTING CONCEPTS
FAR 31.201-1, Composition of Total Costs, states “(a) The total cost of a contract is the sum of the allowable direct and indirect costs allocable to the contract, incurred or to be incurred, less any allocable credits, plus any allocable cost of money pursuant to FAR 31.205-10. In ascertaining what constitutes a cost, any generally accepted method of determining or estimating costs that is equitable and is consistently applied may be used, including standard costs properly adjusted for applicable variances.”
There are two methods of recording costs in an accounting system: a job order system and a process cost system. Similarly, there are two bases for measuring cost: actual cost and standard cost. A job order cost system accumulates costs by job or task. In other words, this system assigns costs, such as direct labor, direct material, and overhead, to specific jobs within a contract. It may assign costs to individual production units or to a lot that consists of several units. The job order cost system is common in manufacturing contracts, where the production items are dissimilar in design, processing, or cost. It is also used in research and development contracts and service contracts. Costs in job order systems are recorded at actual cost.
A process cost system accumulates costs by a specific process or by a department that may represent several processes. This system assigns the various costs to the units introduced by the department during a specific time period. It is common in manufacturing of products where identical units of production are involved, such as chemical, petroleum, and computer chips.
In a process system, costs are assigned either at actual cost or at a standard cost. A standard cost accounting system, as defined in the FAR, uses costs that have been computed using preestablished measures (e.g., estimated or engineered standards). These measures pertain to both the quantity of services (e.g., labor hours, material units) and the value per quantity of resource. Standard cost accounting systems are acceptable as long as standard costs are properly adjusted for applicable variances. The recognition that standard cost accounting systems are capable of producing actual costs (i.e., standard plus or minus variances) is important because actual costs are the basis for determining allowable contract costs and in establishing costs for contract payments.
Figure 21
INDIRECT COST STRUCTURE DEVELOPMENT
Government auditors often have difficulty reviewing process cost systems because they are unfamiliar with such systems. As a result, memorandum records might be necessary to present costs on a job cost basis. Government auditors also often have difficulty reviewing standard cost systems for the same reason. Similarly, memorandum records might be necessary to present standard costs on an actual cost basis.
CAS 407 provides criteria under which standard costs may be used for estimating, accumulating, and reporting costs of direct material and direct labor, and provides guidance relating to the establishment of standards, accumulation of standard costs, and accumulation and disposition of variances.
When a contract is not subject to the CAS, only the FAR cost principles and GAAP will apply. For the most part, the FAR cost principles are not as specific as the CAS; however, many of the same cost accounting concepts are included in both. In fact, some of the CAS are incorporated by reference or by restatement in the FAR cost principles.
CREDITS
FAR 31.201-5, Credits, states “The applicable portion of any income, rebate, allowance, or other credit relating to any allowable cost received by or accruing to the contractor shall be credited to the Government either as a cost reduction or by cash refund.”
This requirement compels contractors to analyze any and all credits received to ascertain their direct or indirect impact on government contracts. For example, a vendor may issue credit for direct material that was not used and was returned. This would be credited directly back to the applicable contract or contracts.
Sometimes contractors receive an annual or semiannual credit from the travel agency they employ for airline tickets purchased. This credit, because it covers all tickets written in the period, would usually be credited into overhead and/or G&A pools. This would be an indirect type of credit and the most equitable method of relaying it to the government is via the indirect pools. Another indirect credit is found in the income from the sale of scrap. These credits, which resulted from working on many contracts, are again most equitably handled by credits to an indirect pool. In these instances of contractors receiving credit for some reason, it is important to avoid automatically taking the credit to “Other Income.”
Any credit received needs to be scrutinized to ensure that the government receives its due cost reduction. For cost-reimbursement contracts, any credits must be given to the government even after the contract has been closed.