Cost Accounting Standard 407 - Preambles

Preamble A

Preamble to Original Publication, 4-1-74

Following is the preamble to the original publication of Part 407, on April 1, 1974, at 39 FR 11869.

The Cost Accounting Standard on the Use of Standard Costs for Direct Material and Direct Labor published today is one of a Series being promulgated by the Cost Accounting Standards Board pursuant to Section 719 of the Defense Production Act of 1950, as amended, Pub L. 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 Cost Accounting Standard was initiated as the result of the recognition that practices concerning the use of Standard costs for contract costing purposes have not been well defined in Government procurement regulations. The Board has undertaken research on this subject with a view that Cost Accounting Standards promulgated on this subject will provide better guidance in the use of Standard costs.

Because the subject of Standard costs is extremely complex, the Board has elected to address this subject in phases. The Cost Accounting Standard being promulgated covers the use of Standard Costs for direct material and direct labor; the use of Standard costs for Service centers and the use of Standard costs for overhead represent two other phases of this subject that are currently under research.

Early research on this Cost Accounting Standard included a study of available literature on the subject and of relevant decisions of boards of contract appeals and courts. Following this study, several issues were identified. A review of Disclosure Statements on file suggested that standard costs are in use by a large number of defense contractors. In an effort to learn the reasons underlying the use or non-use of standard costs for contract costing purposes, and to gain a better understanding of the standard-cost practices by companies in different industries, the Board developed and circulated a questionnaire on the use of standard costs. Selected respondents of this questionnaire were then visited for further discussion. Information derived from replies to the questionnaire and from visits suggested the complexity of the subject and the desirability of addressing it in phases. Accordingly, in the preparation of a preliminary draft, the subject was limited to the use of standard costs for direct material and direct labor. This preliminary draft was widely distributed for comment. Incorporating many comments thus received, a revised proposal was drafted and published in the Federal Register of November 21, 1973, with an invitation for interested parties to submit written views and comments to the Board. The Board also supplemented the invitation in the Federal Register by sending copies of that issue directly to Several hundred organizations and individuals who had expressed an interest in the proposal or who had provided the Board with comments on the earlier proposal.

These direct and public invitations for comments resulted in the Board’s receiving 47 sets of written comments from individual companies, Government agencies, professional associations, industry associations, public accounting firms, universities, and others. Some of these commentators also supplemented their written comments with discussions at individual or group meetings. All of these comments and views have been carefully considered by the Board. Those issues that are of significance are discussed below, together with an explanation of the changes made in the Cost Accounting Standard being promulgated from the proposal published in the Federal Register of November 21, 1973.

The Board wishes to take this opportunity to express its appreciation for the helpful suggestions and constructive criticisms it has received, and for the time devoted to assisting the Board in this endeavor by the many organizations and individuals involved.

1. Management Uses of Standard Costs

Several commentators emphasized the value of information generated from the use of standard costs for management-control purposes and urged the Board to retain these control features. The Board agrees with this view and has consequently modified the proposed standard to better assure that its use will be fully compatible with the use of standard costs for management-control purposes.

2. Exclusion of overhead and service centers in the Cost Accounting Standard

A few commentators expressed the view that the Cost Accounting Standard being promulgated should be broadened to include the treatment of overhead and service centers. The Board believes that the Cost Accounting standard being promulgated may be used effectively without such broadening. Further, because the use of standard costs for overhead and for service centers involves different issues, the Board believes that this Cost Accounting Standard should be promulgated as is.

3. Coverage of this standard

Many commentators suggested that the proposed standard did not clearly state that the use of standard costs for Government contract costing purposes is at the option of a contractor; they recommended various changes in wording to make this point clear. The Board has accommodated this suggestion by appropriate modifications in 407.40.

4. Use of the term production unit

Many commentators expressed a need for a better understanding of the meaning and significance of the term production unit. As defined in 407.30(a)(7), a production unit is a grouping of activities which either uses homogeneous inputs of direct material and direct labor or yields homogeneous outputs. Where a grouping of activities meets either one of these two criteria, it is the proper level at which to accumulate standard costs of direct material and direct labor and to accumulate variances related thereto. Since variances are allocated on the bases of costs and statistics of each production unit, homogeneity of standard costs of direct material an direct labor would assure that data thus accumulated would be appropriate as bases for allocating variances to cost objectives. The concept of homogeneity embodied in the term production unit, then, would permit contractors a degree of flexibility in setting and revising standards based on individual needs and circumstances and still provide for the proper cost assignment of variances.

To further clarify the intended meaning and purpose of a production unit, the Board has added an illustration as 407.60(b).

5. Homogeneous grouping of material

A few commentators suggested that the concept embodied in the term homogeneous grouping of material be enunciated. The Board agrees; accordingly, the Board has added a statement under 407.50(b)(2) and an illustration as 407.60(d).

6. Cost accounting period

Quite a few commentators felt that relating the establishment of standards to cost accounting period, which is the subject of a Cost Accounting Standard (4 CFR Part 406), is both undesirable and unnecessary, in view of the differences in industry practices and management needs for establishing and using standards; they urged the Board to reconsider. Upon reconsideration the Board finds this argument persuasive. The Board has revised 407.50(a)(1), which provides that a contractor shall state the period during which Standards are to remain effective.

7. Interim revision of standards

Many commentators stated that, to maintain comparable information to management-evaluation purposes, revising standards during a cost accounting period is undesirable and counterproductive; they suggested the deletion of this provision. The Board finds this suggestion persuasive; accordingly, the Board has deleted this provision from the Cost Accounting Standard being promulgated.

8. Procedural details

Several commentators felt that the proposed Cost Accounting Standard contained too much procedural detail. The Board does not share this feeling. This Cost Accounting Standard, in addressing itself to the entire process of standard cost accounting for direct material and direct labor and to alternatives in each step of the process, necessitates attention to a great many issues. The Board feels that the provisions of this Cost Accounting Standard only reflect the complexity of the subject matter and the diversity of practices being addressed.

9. Recording allocation of variances in books of account

A few commentators misconstrued the proposed Cost Accounting Standard and thought that certain provisions required the recording of variance allocations in formal accounting records; they urged the Board to permit the use of adjustments based on memorandum worksheets for covered contracts. To avoid this misconstruction, the Board has made appropriate revisions in the Cost Accounting Standard being promulgated by using the term books of account to mean formal accounting records, and by adding 407.50(e) to specifically permit the use of memorandum worksheet adjustments.

10. Adjustment of material-price variance recognized at the time of purchase

Several commentators objected to a provision whereby material-price variances, recognized at the time purchases of material are entered into books of account, are allocated between items introduced into production units and items remaining in ending purchased-items inventory. They argued that this provision does not conform to their practices, particularly where the allocation of unfavorable variances would increase inventory carrying values, and that the provision infringes upon financial accounting.

In all its research, the Board gives extensive consideration to existing contractor practices. In this instance, however, the practices advocated by those contractors are likely to create inequities and are without adequate conceptual support. As to the second argument, the Board believes that this provision, which concerns the proper allocation of material-price variances between reporting periods for cost accounting purposes, is compatible with objectives of financial accounting. In view of these considerations, the Board has retained this provision in 407.50(b)(3).

11. Annual allocation of variances

Quite a few commentators felt that a provision that permitted the allocation of variances not more frequently than once each cost accounting period does not reflect industry practices and management needs. The Board finds this argument persuasive. Accordingly, a provision that permits the allocation of variances more frequently than annually has been added under 407.50(d)(1).

12. Five percent materiality criterion

Many commentators to the proposed Cost Accounting Standard objected to the inclusion of a 5 percent materiality criterion as a basis for determining whether variances are allocated to cost objectives or are included in indirect cost pools for subsequent allocation. Several of the commentators felt that the materiality criterion was arbitrary; others felt that it would delay the process of allocation where it is undertaken monthly; and still others felt that it could result in inconsistencies.

The Board’s early research showed that a majority of respondents had variances below 5 percent, and quite a few experienced variances below 2 percent. Later, an overwhelming majority of those commenting on a preliminary draft of this Cost Accounting Standard, which contained a 2 percent materiality criterion, suggested that a materiality criterion set at 5 percent would be reasonable.

The intent of the materiality provision was to permit contractors to use a simpler method of allocation of variances where the amount was below the 5 percent level. Nevertheless, the Board is persuaded by the comments received, and has deleted this provision from the Cost Accounting Standard being promulgated. In its stead, the Board, in 407.50(b)(4) and (d)(2), provides that, where variances are immaterial, such variances may be included in appropriate indirect cost pools for subsequent allocation.

13. Cost/benefit

As to benefits, this standard provides needed criteria which the Board believes will improve cost measurement and will result in more equitable assignment of contract costs. As to costs, the Board anticipates little or no cost of implementation by those contractors who are currently using standard costs: the Standard permits contractors to choose from many recognized standard cost practices. Consequently, the Board believes that the benefits to be derived by this standard clearly outweigh any costs of implementation.

The Board expects that the effective date of this Cost Accounting Standard will be October 1, 1974. There is also being published today an amendment to Part 400, Definitions, to incorporate in that part terms defined in 407.30(a) of this Cost Accounting Standard.

Preamble B

Preamble to Document Published 6-8-78

The document published on June 8, 1978 at 43 FR 24819. revised 407.10. This amendment was part of a publication which added 331.30(b)(3). Only the portion of the preamble which describes the revision to 407.10 is printed here. The remainder of the preamble appears as preamble K of the supplement to Part 331.

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In the Federal Register of February 16, 1977 (42 FR 9391), the Board proposed to amend section 10, General Applicability, of standards 401 through 409 to conform these sections to the general applicability section as 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.