Cost Accounting Standard 406 - Preambles

Preamble A

Preamble to Original Publication, 11-7-73

The material below is the preamble to the original publication of Part 406, on Nov. 7, 1973, at 38 FR 30732.

The Standard on Cost Accounting Period published today is one of series being promulgated by the Cost Accounting Standards Board pursuant to section 719 of the Defense Production Act of 1950, as amended (Pub. 91-379, 50 U.S.C.App. 2168), which provides for the development of Cost Accounting Standards to be used in; connection with negotiated national defense contracts.

Work preliminary to the development of this Standard was initiated as the result of recognition that the selection of time periods to be used for contract cost accumulation and allocation has been the source of continuing problems between contractors and the Government. The problems include:

(1) The lack of a firm requirement specifying the cost accounting period to be used,

(2) the absence of specificity as to when a cost accounting period other than a contractor’s fiscal year should be used, and

(3) the lack consistency in selecting the cost accounting period in which specific types of expenses and adjustments are recognized.

Early research on this Standard included an extensive review of available literature on the subject and a review of decisions of contract appeals boards and courts. A preliminary draft of the Standard on Cost Accounting Period was widely distributed for informal comment by interested parties.

The Standard now being promulgated is derived from the proposal which was published in the Federal Register for August 7, 1973, with an invitation for interested parties to submit data views, and arguments to the Board. The Board supplemented that Federal Register publication by sending copies of the Federal Register directly to organizations and individuals who were expected to be interested. Responses were received from 50 sources, including individual companies, Government agencies, professional associations, and industry associations. All of the comments have been carefully considered by the Board.

Most of those who replied to the Board’s solicitation indicated satisfaction with the proposal as published. Several contractors indicated that their practices already complied with the Standard. Several commentators voiced objection to parts of the Standard.

The Board takes this opportunity to express its appreciation for the helpful suggestions and constructive criticisms which have been furnished, both informally in response to the circulation of a Staff draft of a Standard and formally in response to the initial Federal Register publication.

The comments below summarize the major issues raised in connection with the August 7 proposal and explain the decisions which have been made.

(1) Monthly allocations

A few commentators felt that the Standard should permit monthly allocations of indirect costs on the basis of the data accumulated for each month. This alternative was considered by the Board; however, the idea of monthly cost accounting periods is not appropriate for contract cost accounting. A number of fairly stringent requirements for accruals, deferrals, and other adjustments would have to be incorporated in the provisions of any Standard if there were to be assurance that monthly accruals, deferrals, and other adjustments were appropriate. The administrative costs would outweigh any benefits. To allow monthly closings for some contract situations and to require full-year allocations for others would not be in the interest of comparability and uniformity. The Board, therefore, has not adopted the suggestion.

(2) Identity of cost accounting periods for indirect cost pools and allocation bases

A few commentators stated that it may not be necessary to require in every instance the identical allocation base period as the cost accumulation period. They stated that they presently use various clerical expedients to accomplish this, such as measuring the base for a period other than, but representative of the activity of, the period used for accumulating costs in an indirect cost pool. As a matter of principle, the Board does not agree that mismatched periods are proper. The Board, however, recognizes the value of appropriate expedients where cost allocations are not expected to be materially affected. It acknowledges that there may be occasions when it is necessary to use combinations of actual and estimated data to comply with this Standard.

The Board has given recognition to issues of materiality in its Statement of Operating Policies, Procedures, and Objectives in the Federal Register of March 6, 1973, and believes that materiality should be considered in the administration of its Standards. In order to alleviate practical problems which might be experienced in implementing this concept of materiality, the Board has changed 406.40(c) and has added 406.50(e).

(3) Use of a cost accounting period for estimating

Several commentators stated that 406.50(c) was ambiguous. Some pointed out that this provision might be interpreted as always requiring the use of a full fiscal year, not withstanding the permissible use of short period under the conditions provided in 406.50(a). There was no provision in 406.50(a) which precluded its application, when appropriate, in the circumstances described in 406.50(c). Nevertheless, the Board has modified 406.50(c) to assure that there is no misinterpretation of its intent.

One commentator recommended that detailed guidelines be established for estimating cost data when estimates were necessary under the provisions of 406.50(c). The Board believes that this is a matter of contract administration and negotiation. If the parties do not agree on proposed overhead rates for early settlement or closing of contracts, they are not required by this Standard to agree to an expedited settlement.

Two commentators recommended that variances resulting from a difference between the estimated overhead rates used for expediting the closing contracts and the rates finally negotiated or determined for a cost accounting period should be accounted for by making appropriate elimination’s from affected indirect cost pools and allocation bases. As a matter of principle, the Board believes that actual cost should be allocated in accordance with the contractor’s disclosed or established practices to all cost objectives of the cost accounting period, including closed or settled contracts. In a settlement the price is fixed, but costs are not. By agreeing to a settlement price the parties take the risk that actual costs allocated to that contract might be higher or lower than expected. However, the Board finds no need to specify how variances are to be accounted for in this Standard. Normally, the expected variances will be estimated to be minor in amount, or the parties will not agree on the settlement price. Also, the manner of accounting for the actual variance should be agreed upon by the contractor and the Administrative Contracting Officer. If the amount is negligible, it may be agreed that it should be absorbed by other cost objectives of the period. In any event, the Board believes that this is a matter of contract administration and negotiation.

(4) Terminations

A few commentators recommended that guidance be provided in 406.50(c) for the treatment of unabsorbed overhead and continuing overhead charges allocable to contract terminations. The Board has noted the possible need for Cost Accounting Standards on termination costs and delay claims, situations in which the problems of unabsorbed overhead and continuing overcharges frequently arise, and has initiated research projects on those subjects. At this time, the Board sees need to disturb the expectations of the parties to a contract with respect the absorption of overhead assigned cost accounting periods (normally fiscal years) by cost objectives of those same periods, whether or not those cost objectives exist throughout an accounting period.

(5) Applicability of the standard both direct and indirect costs

One commentator recommended that the Standard be applied only to indirect costs. The Standard does apply both direct costs and indirect costs those terms are defined in 4 CFR Part 400. However, this Standard also includes provisions with specific applicability only to indirect cost pools. The Standard does not require that direct costs be allocated in the same manner as indirect costs. For example, it does not require that direct costs be annualized or averaged for purposes cost allocation. Direct costs, however are often used in establishing allocation bases for a period; therefore, they must be assigned and accounted for as costs of the particular cost accounting of periods to which they are application. Consistency in making adjustments both direct and indirect costs for purposes of determining the total costs allocable to the cost objectives of a cost accounting period is an important objective of this Standard.

(6) Permitting the use of periods less than a Year

A few interested parties recommended that the Standard permit the use of a period shorter than a fiscal year when, for example significant contract was begun or concluded during a fiscal year. No one advanced any criteria for determining when to use a short period or how to apply it, even after specific requests for such suggestions. The only rationale advanced for using less than an annual period in such circumstance was the assertion that a short period might be employed to arrive at “more equitable allocations,” or to avoid inequitable burdens on other cost objectives. In view of the vagueness of the criterion of “equity,” the possible effect of changing the risks assumed by the respective parties at the time of contracting, the possible impact on matters of cost allowability and contract administration and negotiation responsibilities, and the continuance of disputes and disagreements over the equity of a short period in particular circumstances, the Board has concluded that the Standard should not authorize the use of a short period except for allocating the costs of an indirect function which exists for only a part of a cost accounting period and for establishing a transitional period when a change of fiscal year occurs.

As published this Standard precludes either party to the contract from insisting upon a short period in order to maximize or minimize cost recoupment. It precludes, for example, the calculation of overhead rates after-the-fact for alternative application on the basis of either the fiscal year or the period of performance, and the consequent polarization of the positions of the parties as to which period is appropriate or “equitable” when there is a substantial difference between these rates. The Board believes that this Standard will significantly enhance fairness and objectivity in this regard.

(7) Equitable adjustments

One professional accounting organization requested that a specific provision be added whereby an equitable adjustment would be made where the contract cost was affected by a change in the contractor’s fiscal year and the change in the fiscal year was adopted for financial accounting and income tax purposes as well as for contract cost accounting. The principal argument advanced for this position is that “there seems to be no valid reason why a contractor should necessarily suffer and the Government should necessarily benefit in such a circumstance.” In the illustration in 406.60(c), the Board noted that under this Standard, a change in the fiscal year data is a change in accounting practices, and that an adjustment of the contract price might therefore be required in accordance with the adjustment provisions of the contract clause set out at 4 CFR 331.50. Those provisions do contemplate that no change in disclosed or established cost accounting practices, other than changes under paragraph (a)(4)(A) of the clause, may result in an agreement whereby costs paid by the United States are increased. The Board recognizes that a contractor may change his fiscal year ending date for substantial business reasons, and has illustrated this possibility in the Standard. A change in fiscal year may not have any cost impact. Where it does, the Board believes that it would be improper for the Government to agree to pay increased costs caused by a voluntary change in accounting practices, no matter how valid and unrelated to cost recovery the motives of the contractor for making the change in this fiscal year ending date may have been. A new paragraph (f) in 406.50 makes it clear that a change in the contractor’s cost accounting period is a change in accounting practices for which an adjustment in contract prices may be required in accordance with paragraph (a)(4)(B) of the contract clause set out at 4 CFR 331.50.

(8) Choice of transitional period

A public accounting firm suggested that it might help to avoid disagreements if the Standard made it clear as to the permissible choices in selecting the transitional period other than a year whenever a change of fiscal year occurred. This suggestion has been adopted in the new paragraph (f) of 406.50.

(9) Applicability to Renegotiation Board

One commentator noted that the Renegotiation Board, a “relevant Federal agency” under Pub.L.91-379, defines the term “fiscal year” to mean the taxable year of the contractor or subcontractor under Chapter I of the Internal Revenue Code, and that it has been the Renegotiation Board’s practice to renegotiate a contractor on the same basis as the contractor reports for Federal income tax purposes. Hence, it was recommended that, especially because of 406.40(a)(2) and 406.50(d) of the Standard, the Renegotiation Board be exempted from the application of the Standard.

The Board’s research confirms the possibility that a few contractors may use cost accounting periods which are different from their tax years. In most cases, however, there will be no conflict. Where there are differences, any use of a cost accounting period or fiscal year which is not identical with the period used for Federal income tax reports will involve reconciliation’s by the taxpayer. Contractors who presently use “model years” for their cost accounting periods now file reports with the Renegotiation Board on a taxable year basis. The Board finds no need to disturb this practice, and has provided a new 406.40(a)(4) to acknowledge it as an exception. The Board believes that the Standard is, however, otherwise applicable, and that there is no need for an exemption.

(10) Comparing benefits and costs

The Board concludes that this Standard as published herein has, for most contractors and for the Government, almost no cost impact. The only contrary expressions received in response to our requests have been answered by the changes described above. One major Defense agency expressed concern that the Standard might result in higher cost allocations to its contract insofar as it did not permit the use of short periods. While this may be true the Standard might also yield lower cost allocations to Government contracts as a result of the requirement to use a full fiscal year. No estimate of the amount of any shifts in cost allocations was provided. Because of the different circumstances of each application of the requirement, both increases and decreases in cost allocations can be expected.

The Board concludes that significant benefits, far outweighing any costs of implementation, will be realized from the promulgation of this Standard. Such benefits include reduction of disagreements and disputes; increase consistency, fairness, and objectivity and improvement of estimates for proposals.

(11) Effective date

It is anticipated that the effective date in 406.80(a) may be July 1, 1974.

There is also being published in this document an amendment to Part 400, Definitions, to incorporate in that part the term “fiscal year” defined in 406.30 of the Standard.

Preamble B

Preamble to Document Published 6-8-78

The document published on June 8, 1978 at 43 FR 24819, revised 406.10. This amendment was part of a publication which added 331.30(b)(3). Only the portion of the preamble which describes the revision to 406.10 is printed here. The remainder of the preamble appears as preamble K of the supplement to Part 331.

• • • •

In the Federal Register of February 15, 1977 (42 FR 9391), the Board proposed to amend section. 10, General Applicability, of standards 401 through 409 to conform these section to the general applicability section it appears in standard 410 et seq. No comments were received on this proposed amendment. The Board considers this change to be appropriate and is amending standards 401 through 409 as set forth below.