CAS Working Group Item 78-21 CAS 410

Subject

Implementation of CAS 410, Allocation of Business Unit General and Administrative (G&A) Expenses to Final Cost Objectives

Reference

W.G. 78-21, 16 January 1978 W.G. 77-11 DAR 15.201.4

Background

W.G.78-21 provided guidance in response to specific qustions which had been surfaced during the implentation of CAS 410. However, questions remain concerning the most appropriate cost input allocation base to be used in the distribution of G&A expenses to final cost objectives. Basically, the underlying issues concerned the answers to Question #3 and Question #5 in W.G. 78-21. Specifically, is total cost input the preferred allocation base (Question #3) and under what conditions would the inclusion of material and subcontract costs in the allocation base distort the assignment of G&A expense to final cost objectives, therefore, requiring selection of the value-added cost input base (Quesion #5)?

Discussion

Question #3

The question of whether the total cost input allocation base is preferred base under CAS 410 has been emphasized beyond its relevance to the proper implementation of this standard. Therefore, the guidance contained in W.G. 78-21 is restated as follows.

Answer

There is no specific statement of preference in the standard. The standard says, "A total cost input base is generally acceptable as an appropriate measure of teh total activity of a business unit." The prefatory comments say, "...the term total activity refers to the production of goods and services during the cost accounting period." Thus, unless circumstances exist where a significant difference is apparent between the activity involved in the production of goods and services during the cost accounting period and the costs of such activity, a total cost input base would satisfy the requirements of the standard. When circumstances exist where total cost input does not appear to be an appropriate measure of total activity of the business unit, other bases available in the standard should be considered. The value-added base shall be used where inclusion of material and subcontract costs would significantly distort the allocation and where costs other than direct labor are significant measures of total activity. What constitutes a significant distortion in this context is addressed in Question #5. The criteria for use of a single element cost input base are very specific. The standard says, "A single element cost input base, e.g., direct labor hours or direct labor dollars, which represents the total activity of a business unit may be used to allocate the G&A expense pool where it produces equitable results. A single element base may not produce equitable results where other measures of activity are also significant in relation to total activity. A single element base is inappropriate where it is an insignificant part of the total cost of some of the final cost objectives."

A perfect reflection of total activity may not be reasonably expected from any of the three cost input bases available in the standard. The selection of a cost input allocation base which best represents total activity must be predicated on an analysis of the relevant circumstances at each business unit. The relevant circumstances considered should be those experienced in a typical cost accounting period rather than unique circumstances existing at one time or within a single accounting period. Purification of the G&A expense pool is a viable approach to minimizing any potential inequities which may surface in implementing the standard.

Question 4

Should interdivisional transfers be included in a total cost input base?

Answer

Yes. The inclusion of interdivisional transfers in a total cost input base is supported by several provisions of the standard. CAS 410.40(b)(I) states that business unit G&A Expenses shall be allocated "....by means of a cost input base representing the total activity of the business unit..." CAS 410.50(d) supplements that fundamental requirement by stipulating that the cost input base used to allocate G&A costs include "all significant elements of that cost input which represents the total activity of the business unit." Prefactory comment no.1 also lends support by stating that "... when a total cost input base has been selected, all significant costs other than the costs included in the G&A expense pool should be included in the base.

Given this interpretation of CAS 410, there are only two ways in which interdivisional transfers may be excluded from the receiving division's G&A base. These are (1) the use of a base in appropriate circumstances whose constituent parts do not include material, such as value-added or single element base or (2) when the interdivisional receipts are not significant.

Question #5

The criteria for establishing the existence of a significant distortion appears to have been confined in practice to the two examples contained in W.G. 78-21 guidance: Government-furnished components and precious metals. The two examples had not been intended to be all-inclusive as instances where the value-added base must be selected. To illustrate this point the answer to Question #5 in W.G. 78-21 is amended to include another example where a significant distortion may exist, as follows:

Answer

C. Disproportionate Material and Subcontract Content

The existence of a wide range of material and subcontract content among contracts may signal the precondition for potential significant distortion. For example, suppose that a contractor's material and subcontract content for most of a business units total activity normally ranges from 20 percent to 70 percent of total contracts. This situation, in and of itself, does not prove that a significant distortion exists. Such a distortion may exist if the material and subcontract content of most contracts falls at the range's extremes. However, no significant distortion would likely exist if the material and sub