Cost Accounting Practice - Preample J

Preamble J

Preamble to Amendments of 3-10-78

The document published at 43 FR 9775, Mar. 10, 1978, added 331.20(h), (i), and (j), 331.50(a)(4)(C), 331.51, 332.50(a)(5),and 332.51, revised 331.50(a)(4)(B), and (d) introductory text and (d) (1) and (2), and amended Parts 351, 403, 406, and 409.

The purpose of this publication by the Cost Accounting Standards Board is to adopt a modification to part 331 Contract Coverage, and part 332 Modified Contract Coverage, of its rules and regulations. The Board is also withdrawing a proposal to modify 331.70. This modification being adopted will:

(1) provide definitions of the terms ”cost accounting practice,” and “change to either a disclosed cost accounting practice or an established cost accounting practice,”

(2) permit the negotiation of equitable adjustments to reflect the cost impact changes agreed to by both parties to the contract, and

(3) establish the effective date for application of standards to subcontracts. The December 1976 proposal to modify the method of determining increased costs is being withdrawn.

The Board is authorized by Pub. 91-379 to prescribe rules, regulations, and modifications for implementing cost accounting standards. Pursuant to this authority, the Board is today issuing modifications to its regulations.

Contractors and procurement agencies engaged in the implementation and administration of CASB rules, regulations, and standards have recommended that the Board provide guidance concerning the meaning of “cost accounting practice” and “change to either a disclosed cost accounting practice or an established cost accounting practice.”

Representatives from various organizations affected by standards have pointed out that guidance in the areas will reduce disagreement and facilitate the implementation and administration of CASB pronouncements. Similar recommendations were also received by the Board at evaluation conferences in June 1975 and October 1977. The General Accounting Office’s Status Report on the Cost Accounting Standards Program -- Accomplishments and Problems,” (PSAD-76-154, August 20, 1976), also referred to the need for guidance on these subjects.

Research in this area included review of data submitted by participants in the evaluation conference, an analysis of papers submitted various contractors, professional groups, trade associations, and Government agencies, as well as a review of existing procurement regulations, the Internal Revenue Code, Accounting Principles Board Opinion No. 20, and existing CASB promulgation’s, staff draft of amendments containing definitions of “cost accounting practice” and “change to either a disclosure cost accounting practice or an established cost accounting practice” distributed on August 13, 1976. Responses from 53 sources contributed the Board’s further consideration of the issues involved in these proposed amendments.

Proposed amendments to Board’s regulations were published the Federal Register on February 3, 1977 (42 FR 6591). A total of 45 responses were received from individual companies, Government agencies, professional associations, industry associations, universities and others. The proposed amendments were revise and republished for comment on October 21, 1977 (42 FR 56130) and included a proposed change to the CAS contract clause. A total of 40 responses were received to that publication.

The Board takes this opportunity to express its appreciation for the helpful suggestions and criticisms which have been furnished. These comments have resulted in a number of changes and improvements in the amendments being promulgated today. The following material summarizes the issues discussed by respondents in connection with the proposed modification and explains the changes made to the proposals published February 3 and October 21, 1977. The still relevant portions of the comments which accompanied the earlier publications have been incorporated in this material.

Definition of Cost Accounting Practice

The need for a definition of “cost accounting practice” has been raised by numerous inquiries from the field and by participants in the evaluation conferences. The Board agrees, and believes that a definition of this term can reduce disputes and contribute to increased uniformity in the administration of the CAS contract clause. A number of commentators expressed the view that the proposed definition was workable and useful as presented, would serve to reduce disagreements, and would facilitate the administration of cost accounting standards. Some said that the proposal, if adopted, would go a long way towards solving several problems identified in earlier written communications to the Board and oral presentations to the Board and its staff. Some encouraged the Board to promulgate the rule at an early date and commended the Board for taking a very significant step towards solving one of the troublesome and difficult areas of Cost Accounting Standards.

Other commentators suggested that the proposed definition went beyond the authority of the Board in that it included both the measurement of cost and the assignment of cost to cost accounting periods.

They asserted that these are financial accounting topics and are not within the realm of cost accounting. Still other commentators stated that the Board was dealing with detailed practices and procedures rather than Cost Accounting Standards and principles.

As early as March 1973, in the “Statement of Operating Policies, Procedures, and Objectives” and more recently in the May 1977, “Restatement of Objectives, Policies and Concepts,” the Board stated that Cost Accounting Standards will be established to define and measure cost, determine the cost accounting periods to which costs are assigned, and determine the manner in which costs are allocated to covered contracts.

The Board has spoken directly to the measurement of cost in Cost Accounting Standards 404 and 412 and to the assignment of costs to cost accounting periods in Cost Accounting Standards 403, 409, and 412. The definitions being promulgated today are consistent with the Board’s authority and previously adopted view that cost accounting practices include measurements of cost, assignment of cost to cost accounting periods and allocation of costs to cost objectives.

Questions have been raised as to whether the measurement of cost includes the determination of the price to be paid by the contractor for goods and services. From the beginning of the project to define a cost accounting practice, the Board has taken the position that the determination of the amount paid or a change in the amount paid for units of goods and services does not constitute a change in cost accounting practices. The definition has been revised to convey this concept more clearly.

With respect to commentators’ views on the difference between Cost Accounting Standards, principles, and practices, the Board’s 1973 “Statement of Operating Policies, Procedures, and Objectives” and the 1977 “Restatement” describe a Cost Accounting Standard as:

A Cost Accounting Standard is a statement formally issued by the Cost Accounting Standards Board that:

(1) Enunciates a principle or principles to be followed,

(2) establishes practices to be applied, or

(3) specifies criteria to be employed in selecting from alternative principles and practices in estimating, accumulating, and reporting costs of contracts subject to the rules of the Board. A Cost Accounting Standard may be stated in terms as general or specific as the Cost Accounting Standards Boards considers necessary to accomplish its purpose.

This position is similar to the approach the accounting profession takes in dealing with accounting principles for financial reporting. The Accounting Principles Board Opinion No of 20, Accounting Changes, states:

The term accounting principle includes not only accounting principles and practices, but also the method of applying them.

Thus, in line with previous statements, the Cost Accounting Standards Board reiterates its position that the terms “principles and practices” include methods and techniques. The Board’s position is consistent with Pub.L.91-379 and reflects one of the principal purposes of setting Standards, which is to measure the full cost of supplies and services acquired by the Government in a way that is fair to both buyer and seller.

Commentators also raised the question of what should be the required level of detail of a cost accounting practice. The issue is what is the appropriate and necessary level of accounting detail for effective implementation of Pub.L.91-379. For cost allocation purposes the Board has concluded that the level of detail should include not only the type of base, e.g., direct labor, but also the composition of that base, e.g., the elements of labor costs comprising the base. Similarly, the level of detail should include the types of indirect cost pools as well as the components or items of cost which make up those pools. As to measurement of cost, the level of detail includes identification of components of a particular item of cost and the basis on which cost is measured.

Definition of Change to Either a Disclosed Cost Accounting Practice or an Established Cost Accounting Practice

With respect to the February 3, 1977, proposed definition, commentators requested expansion of those changes in cost accounting practices which would not be subject to the provisions of paragraphs (a)(4) and (a)(5 of the Cost Accounting Standards contract clause (4 CFR 331.50). Commentators recommended that changes to improve management controls, accounting changes which the Government and contractors believe would be beneficial in the long run, and change due to changed business circumstance should be added to 331.20 as action which are not considered as a change in cost accounting practice for purposes of paragraphs (a)(4) and (a)(5) of the Cost Accounting Standard Contract Clause (4 CFR 331.50).

The Board notes that in a dynamic business environment it may be desirable to make changes of many types. These changes may include organizational changes, changes in the way work is performed, and changes in the product produced. There may be a Variety of reasons for these changes such as better managerial control, new technology, or changed business conditions.

These business changes by themselves are not changes in cost accounting practices. Such changes may, however, cause a change in a contractor’s cost accounting practices. In a circumstance where there is a change in cost accounting practice, the contractor and Government must take certain action under the provisions of the CAS contract clause. Only when the contracting officer does not make the required determination under the new 331.50(a)(4)(C) would contracts be amended to insure that the Government does not pay any increased cost as a consequence of the change.

The decision as to whether there is a change in cost accounting practice is made through an analysis of the circumstances of each individual situation based on the criteria being promulgated in these regulations.

It is to be expected that the accounting system must change betterments, improvements, modifications or alterations to the system are necessary to accommodate the business changes discussed above. The Board notes that Pub.L.91-379, in its provisions relative to failure of a contractor to follow consistently his disclosed practices, makes no distinction among the causes of changes in cost accounting practices. Thus, accounting changes of the types described by the commentators, which result in a failure of a contractor to follow consistently his previously disclosed or established practices, remain subject to the CAS contract clause (4 CFR 331.50). While a number of the suggestions made have been adopted and are discussed in the following material, the suggestions that changes in cost accounting practice due to changed circumstances or to improve management control be excluded from adjustment under the CAS contract cause have not been adopted by the Board. These types of changes are subject to review and agreement by the contracting officer and the contracts may be adjusted under new 331.50(a)(4)(C).

A number of commentators urged that changes resulting from issuance’s of the Financial Accounting Standards Board should also be excluded from paragraphs (a)(4) and (a)(5) adjustments. The legislative history leading to creation of the Cost Accounting Standards Board shows that standards and principles issued for financial accounting purposes were not deemed suitable for cost accounting for negotiated Government contracts. The Cost Accounting Standards Board views its own work as relating directly to the preparation, use and review of cost accounting data in the negotiation, administration and settlement of negotiated defense contracts. The Board is the only body established by law with the specific responsibility to promulgate Cost Accounting Standards and these Standards have the force and effect of law in the negotiation, administration and settlement of defense contracts.

The Board seeks to avoid conflict and disagreement with similar organizations having other responsibilities in the area of accounting Standards and through continuous liaison makes every reasonable effort to do so. The Board will give careful consideration to the pronouncements affecting financial reporting and in the formulation of Cost Accounting Standards it will take these pronouncements into account to the extent it can do so in accomplishing its objectives. Nevertheless, the nature of the Board’s statutory authority and its mission to establish Cost Accounting Standards for negotiated defense contracts is such that it must retain and exercise full responsibility for meeting its objectives. Accordingly, the Board has not adopted this suggestion.

Alterations Not Considered Changes in Cost Accounting Practices

The February 1977 proposed definitions specifically provided that certain contractor actions should not be considered as changes in cost accounting practices. These include the initial adoption of a cost accounting practice or the elimination of a cost accounting practice. A number of commentators expressed the opinion that the accounting treatment of a cost which up to a given point in time has been immaterial in amount and now becomes material in amount is a situation very similar to the establishment of a practice for the initial incurrence of a cost. They pointed out that Accounting Principles Board Opinion No. 20, Accounting Changes, treats this situation as a first time incurrence of a cost rather than a change in accounting principle or practice.

The Board has previously expressed the position that administration of the Cost Accounting Standards should be reasonable and not seek to deal with immaterial amounts of costs. In concert with this position, the Board in the October 1977 proposal modified 331.20(i) to provide that a change in its accounting for a cost which has previously been immaterial and now becomes material is not a change in cost accounting practice.

The alterations described above are not treated under the CAS contract clause as changes in cost accounting practices. They can, however, result in establishment of cost accounting practices. Where such is the case, the requirements of the CAS contract clause (4 CFR 331.50) will apply. The new practices must be followed consistently on all CAS contracts, Disclosure Statements updated where appropriate.

Subsequent Changes Under a Standard

The Board’s October 1977 proposal provided that when a Standard with which the contractor has complied subsequently requires the contractor to alter a cost accounting practice in order to remain in compliance, that alteration shall not be a change in cost accounting practice for purposes of paragraphs (a)(4) and (a)(5) of the CAS clause. Some commentators said that their proposal was inconsistent with the Board’s position in 4 CFR Part 403. Others said that unless a contract adjustment can be made under CAS regulations no acceptable adjustment mechanism was available. Most commentators generally felt that changes of this type should be dealt with under CAS regulations. The Board believes that this provision is not inconsistent with 4 CFR Part 403. In that Standard, the Board was limiting use of equitable adjustment to the first time that a particular allocation provision of the Standard was applied.

The Board recognizes the points made by the commentators, however, and has concluded that a change in cost accounting practice to remain in compliance with a Standard does not constitute a failure to comply with Cost Accounting Standards or to follow consistently disclosed cost accounting practices. Accordingly, the Board has deleted from the regulations being published today the provision excepting adjustments for subsequent changes under a Standard from being considered under paragraph (a)(4) of the Board’s regulations, because changes of this type will be covered by new paragraph (a)(4)C) of the CAS contract clause which calls for negotiation of an equitable adjustment. The Board also notes that contractors who have filed Disclosure Statements would be required to amend such Statements to describe the practices to be followed.

Change Compelled by Law or Regulation

A number of commentators urged the Board to delete the exception in its October 1977 proposal for price adjustments under cost accounting standards for changes compelled by law or regulation 331.20(i)(3). Some contended that all changes, regardless of motivation, should be considered for adjustment under the Board’s new proposed subparagraph dealing with changes agreed to by the parties. Other commentators urged the Board to remove the exception to preclude a contractor from experiencing a windfall or suffering a loss because of such changes. The Board agrees with the suggestions made to delete this paragraph, because the Board feels that all contractor proposed changes in cost accounting practice should be considered for contract adjustment. Therefore, contractor desiring to make a change in cost accounting practice for any reason must negotiate with the contracting officer under the appropriate paragraph of the CAS contract clause.

Should a situation arise where major changes in cost accounting practices would be required by contractors to comply with express provisions of law or regulation, the Board would seek to accommodate any such requirement by a change in its standards, rules or regulations.

The Board has deleted from these amendments the proposed 331.20(I)(3) which dealt with changes compelled by law or regulation.

Illustrations

Many commentators said that all or some of the illustrations should be deleted, while other commentators said they should be retained. The Board included the illustrations to demonstrate the application of the definitions in situations of the type which have been reported to the Board in the past.

The Board noted that some of the illustrations dealing with changes in organization were being misinterpreted. In effect, the commentators expanded the illustrations to include situations not set forth in the illustrations. The Board concluded that in view of the extent of misinterpretation, it would be questionable value to revise the illustrations to cover all the situations described by commentators. Accordingly, several illustrations dealing with accounting changes related to organizational changes have been deleted.

As the Board stated when the proposed definitions were published in February 1977, the accounting effects of any organizational change must be considered separately and a final decision concerning a change must be based on an evaluation of those effects. Thus, an organizational change per se is not a change in cost accounting practice. One must look at any accounting revision brought about for any reason, including one caused by a change in organization.

By including the illustrations the Board does not intend to imply that all possible situations are covered nor are the illustrations to be used as limitations for accounting changes. The Board believes that the changes made to this section are responsive to the statements made by commentators.

Contract Clause

The Board proposed in October 1977 that where the parties agree to a change in cost accounting practice they should negotiate an equitable adjustment for any cost impact on existing contracts. Most commentators agree with this proposal but some felt that the contracting officer’s agreement should not be necessary. Others urged the Board to state that a contracting officer’s disagreement with a change is subject to the disputes clause of the contract. Further, a number of commentators suggested that the new contract adjustment paragraph be renumbered (a)(4)(C) to avoid confusion with the preexisting numbering series. Finally, some commentators asked if the Board planned to make comparable revisions to its Part 332, Modified Contract Coverage.

The October 1977 proposal was in response to urging by both contractor and Government agency representatives to establish an alternative to paragraph (a)(4)(B) for adjusting contracts where both parties agreed that a change in cost accounting practice was desirable. Under that proposal, a method was established providing for equitable adjustment for these changes. The Board does not agree that contracting officer’s agreement is not necessary and remains convinced that Government agreement to the change is essential to protect the Government’s interests.

With respect to the treatment of a contracting officer’s disagreement with a proposed change in cost accounting practice under the disputes clause of the contract, the Board believes this should be determined under agencies’ general rules governing appeals from various types of decisions by contracting officers. Accordingly, the Board has not specifically provided for the application of the disputes clause in this situation.

The Board agrees with the suggestion concerning the renumbering of the paragraph dealing with equitable adjustments for changes in cost accounting practices agree to by the parties. The amendments being published today have that paragraph numbered (a)(4)(C). Designating the new paragraph as (a)(4)(C) eliminates the need to change citations in other subparagraphs in section 331 from those previously existing in CASB regulations.

With respect to the question concerning comparable revisions to Part 332, the new definitions and illustrations are incorporated in 332.20 by the existing cross reference to 331.20. The Board’s regulation concerning changes in cost accounting practices agreed to by the contracting officer will be incorporated in 332.50(a) and 332.51 by amendments being published today.

Increased Cost Paid

Commentators at the 1977 Evaluation Conference and respondents to e the February 3 and the October 21, 1977, proposals requested that the Board remove from its regulations the prohibition against increased costs paid because of changes in cost accounting practices 331.50(a)(4)(B)) and/or that the expression “increased costs paid” (4 CFR 331.70) be redefined to exclude fixed price contracts. The Board has established a priority project to perform a comprehensive review of Part 331 of its regulations including the treatment of increased costs paid.

Contracting Officer Determination

Many commentators objected to the Board’s including a requirement that contracting officers make a finding that a change is desirable and is not detrimental to the interest of the Government. Some claimed that such a requirement encroached on management’s prerogative to design an accounting system to meet its needs; others said the decision concerning changes was an administrative matter better left to the agencies. Others suggested that different terms be substituted for some of the words. Finally some commentators said that the Board should require only that agencies prescribe appropriate regulations for the use of the equitable adjustment provision for accounting changes agreed to by the parties.

The Board understands the concerns expressed by the commentators on this matter. It should be recognized, however, that the Board is proposing that equitable adjustments be negotiated for accounting changes not required by Standards. This type of Provision was requested by many contractors and Government agencies in the past. These groups insist that agreed-to changes should be allowed and the contractor should not be required to pay for any increased costs on existing contracts resulting from such desirable changes. The Board is responding to these requests by providing for equitable adjustments for those proposed changes with which the contracting officer agrees if he finds them to be desirable and not detrimental to the interests of the Government.

Management certainly can propose any changes it feels desirable for its own accounting system. If a change is not desirable from the Government point of view, the Board sees no justification for permitting the contractor to realize economic benefits on existing contracts from the change.

The Board’s regulation merely recognizes the contracting officer’s position and does not encroach on the administrative responsibilities of the procurement agencies. A contracting officer would routinely make certain that a contractor’s proposed change is not detrimental to the Government before agreeing to allow increases in contract prices.

Some suggested alternative words for “desirable” were: “Appropriate, warranted, equitable, fair or reasonable.” The Board concludes that all these tests are encompassed by the Board’s language. Accordingly, this statement has not been changed.

The Board expects administration agencies to publish regulations they feel necessary to define what they conclude is “desirable and is not detrimental to the interest of the Government.” Thus, the Board does not agree that it is getting involved in administrative matters. The Board agrees with the commentators who suggested that the second sentence of 331.51, which required that the contracting officer document the basis for his finding, be eliminated. The Board believes that the stated documentation requirement is redundant with other language in this subparagraph, and accordingly, that sentence has been eliminated.

Withdrawal of Proposed Alternative Method of Determining Increased costs

On December 29, 1976, a proposal was published in the Federal Register to amend 331.70(b) which, if adopted, would have permitted procurement agencies to use either an estimate-to-complete approach or an original-negotiation-data approach to determine increased costs paid by the United States. As proposed, agencies would have been authorized to use the estimate-to-complete method when negotiations had not been based on cost estimates or such estimates were not readily determinable by the procuring agency.

Most of the comments received expressed opposition to all or part of the proposal. Upon reexamining the subject in light of the comments received, the Board concludes that the proposed alternative method would not provide sufficient improvement in the administration of Standards to warrant its adoption. Additionally, none of the alternatives suggested by the commentators appears likely to benefit the procurement process materially. Accordingly, the proposal to amend 331.70(b), Contract Coverage, as published in the Federal Register of December 29, 1976, is hereby withdrawn. This subject will be considered in the Board’s comprehensive review of Part 331.

Costs and Benefits

The definitions promulgated today fill a void that had been recognized in numerous comments to the Board and the procurement agencies. The Board believes that the material being promulgated today is in keeping with its responsibility and authority as provided in Pub.L.91-379. The Board believes further that the appropriate use of the definitions can significantly reduce the time and effort involved in the administration of Cost Accounting Standards. The Board concludes, therefore, that there will be virtually no costs involved in implementing these regulations and that there will be significant benefits with no inflationary effects.

Miscellaneous Amendments

A number of miscellaneous amendments are being published today to conform language in certain paragraphs of Title 4 CFR Parts 351, 403, 406 and 409. These amendments add references to the new 331.50(a)(4)(C).

Effective Date

The following changes to the Board’s regulations are being made effective today, March 10, 1978.