Cost Accounting Standard 409 - Preambles

Preamble A

Preamble to Original Publication, 1-29-75

The following is the preamble to the original publication of Part 409, 40 FR; 4259, Jan. 29, 1975.

The Standards on Depreciation of Tangible Capital Assets being published today is one of a series being promulgated by the Cost Accounting Standards Board (CASB) pursuant to sec. 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.

On February 27, 1973, the Board promulgated a Standard on Capitalization of Tangible Assets. At that time the Board described its work to date in the area of fixed asset accounting including studies of practices used for both capitalization and depreciation. The responses to an issues paper and a questionnaire which were used in the development of the capitalization Standard were also useful in the development of the Standard being promulgated today. A preliminary draft of the Cost Accounting Standard on Depreciation of Tangible Capital Assets was widely distributed in March 1973 for informal comment by interested parties. The Board’s further consideration of the issues related to depreciation has been significantly enhanced by the responses received from well over 100 respondents to that informal proposal.

The Board’s research into fixed asset accounting practices included a survey of 107 profit centers selected to be representative of the diversity of firms to which Cost Accounting Standards apply. Reports on their fixed asset accounting practices and statistical information for a five-year period were received and analyzed. The Board was assisted in its deliberation by information available from the 1960 Treasury Department Survey which provided the data base for the “Asset Guideline Lives” used in Revenue Procedure 62-21 and data developed in an accounting research study performed for the American Institute of Certified Public Accountants.

A proposed Cost Accounting Standard dealing with depreciation was published by the Board on June 11, 1974 (39 FR 20505). After reviewing the responses to that publication, the Board revised its proposal. The revised version was published in the Federal Register for October 3, 1974 (39 FR 35678). The Board supplemented both Federal Register publications by sending copies of the Federal Register material directly to organization and individuals who were expected to be interested. The Board receive almost 200 responses to the June 11 and the October 3 proposals. Comments were received from individual companies, Government agencies, professional associations, industry associations, public accounting firms, universities, and individuals. All of these comments have been carefully considered by the Board. In addition, the Board invited representatives of Government agencies, professional accounting and industry association; and defense contractors to attend Board meetings and discuss their views on the significant issues concerning depreciation practices in Government contract costing. The Board takes this opportunity to express its appreciation for the helpful suggestions and criticisms which have been furnished. The comments furnished by organization and individuals have resulted in many changes in the Standard.

The comments below summarize major issues discussed by respondents in connection with both preliminary publications. They explain the major changes which have been made since the June 11 proposal.

(1) Economic Impact of the Standard

Many of the comments on June 11 and October 3 proposals were concerned with the economic impact of the Standard. They cited such concerns as delays in cash flow, impact of inflation, incentives for modernization, and administrative cost of additional recordkeeping requirements.

The Board’s consideration of each of these primary concerns is dealt with in detail in other sections of these prefatory comments. The Board has recognized the potential overall impact of the Standard as expressed in the comments received and has endeavored to establish the needed guidance on depreciation accounting with as little disruption as possible to contractors and current contractual relationships.

The Standard provides for a phasing in of requirements over a period of time so that the principal impact of the Standard will be a number of years in the future. The Standard applies only to assets acquired by a contractor after the beginning of its next fiscal year after receipt of a CAS-covered contract. If the Standard were to become effective six months after submission to Congress, application of any provisions of the Standard to any newly acquired assets would be delayed more than six months from date of promulgation and for most contractors at least 12 months.

The Standard provides for a two year period to develop records on past experience to support estimates of service lives. The same period could be used to develop any necessary changes in accounting for fixed asset lives. The two-year period begins after required compliance with the Standard, and, therefore, most contractors would have at least three years in which to apply the recordkeeping provisions for newly acquired fixed assets.

For those contractors who use the two-year period to develop new estimated service lives, the effect of the use of those new estimates would begin on assets acquired in the fourth year after submission of this Standard to Congress. In the fourth year and the next several years thereafter the impact of changes in cash flow because of changes in service life estimates would be minimal, since the difference in cash flow each year is the difference between depreciation amounts under the old and new estimates of service life for the newly acquired assets. The total impact on cash flow of changes in estimates of service life would not occur until the full cycle of asset replacement is completed. In addition, the impact of the rules on accounting for gain or loss would only begin to take place where new assets acquired after compliance with the Standard would be sold or otherwise disposed of and such impact will be many years in the future.

It is the Board’s opinion that the immediate economic and administrative impact of the Standard is minimal and will, over time, provide for a more appropriate recognition of cost accounting considerations distinct and apart from profit level determinations for defense contract cost and pricing actions.

(2) Need for a Standard

The accounting profession has established general principles to govern depreciation accounting. These broad principles require that depreciation practices be systematic and rational. Accountants consistently urge that the estimates of service lives used for depreciation should be realistic. These broad goals are almost universally agreed upon.

Some Commentators suggested that the Board should not promulgate any Standard dealing with depreciation because the applicable principles have been well established as a part of generally accepted accounting principles. These same commentators also argue that procurement regulations have allowed contractors to rely on depreciation practices found to be acceptable for other purposes; they believe that contract costing should continue to rely entirely upon the depreciation practices used for Federal income tax and for financial reporting purposes pursuant to the current procurement regulations. The Board believes, however, that depreciation charges based entirely on income tax and financial reporting practices do not necessarily assure reasonable representation of the costs of the services provided on Government contracts.

Various mathematical formulas have been suggested to represent the typical patterns of consumption of services over the lives of assets. Certain of these methods of depreciation have been incorporated into the Internal Revenue Code as acceptable for Federal income tax purposes. These same methods have, in general, been accepted as systematic and rational and therefore within the scope of generally accepted accounting principles. The Board finds that there has been a range of choice as to depreciation methods available for contract costing, without adequate criteria for the choices made.

The Treasury Department and Internal Revenue Service have established guidelines for determination of estimated periods of useful service. These guideline periods are said to be based on observed industry experience, but lives shorter than the averages experienced were established so that most companies would experience longer actual asset utilization periods than the permitted tax lives. Tax accounting lives for an industry are, therefore, not good representations of expected actual asset utilization periods for many individual contractors within that industry.

The Board’s research has indicated that the asset lives and depreciation methods selected by defense Contractors under existing regulations may result in an unduly accelerated allocation of depreciation to the final cost objectives of earlier cost accounting periods in the life of a tangible capital asset. Contractor representatives have expressed the view that the choices are typically appropriate in view of the uncertainties of Government contracting. These uncertainties, however, have not precluded utilization assets well beyond the short estimated service lives based on the IRS guideline periods. Other commentator were concerned that any Standard which would restrict cash flow would adversely impact profits. The Board has determined that a Cost Accounting Standard is needed to provide more assurance that depreciation cost identified with performance of negotiated defense contracts are appropriately measured. Consideration of risk and capital investment in the determination of the adequacy of profits is a policy question for the procuring agencies and not a cost accounting problem.

(3) Method of Depreciation

Many of the comments received on depreciation method center on whether accelerated methods or straight-line methods are more appropriate for contract costing purposes. The Board, however, believes that no particular method is necessarily appropriate for all contract cost accounting situations. The Board is establishing criteria by which the method or methods appropriate in the specific situation can be determined.

Both the June 11 proposal and the October 3 revision provided that the method selected “shall reflect the expected consumption of services in each accounting period.” This basic goal generally recognized as appropriate. Commentators have raised question relating to the practical aspects of compliance with the basic goal. What kind of evidence should be available to support a selection of a depreciation method? In the absence of authoritative criteria for selection, contractors have had no need to support their choices, nor have they accumulated much experience in collecting evidence relevant to the consumption of services. Thus a requirement for support of accelerated methods is seen by some as a prohibition of the use such methods. However, the proposed made no distinction between an accelerated method or the straight, method of depreciation in determining the quantity and quality of supporting evidence. The Board’s proposals included descriptions of the technique which should be used to determine appropriate methods for depreciation. The Board recognized the difficulty which might be experienced by contractors attempting to demonstrate the appropriateness of their choices. The Board’s proposals included, therefore, the provision that the method of depreciation used for financial accounting purposes should generally be acceptable for contract costing.

Representatives of the accounting profession pointed out that there is strong economic motivation to choose rapid depreciation write-off techniques where cost is the basis for pricing and reimbursement, as in the defense contracting environment. They say that this same motivation may not apply to external financial accounting for the same companies. Accordingly, they expect that any Cost Accounting Standard which required that, in order to use a technique for contract costing, a company must use the same technique for financial accounting, might create an incentive to modify financial accounting practices solely for the purpose of obtaining an advantage in contract pricing. Because of these considerations the Board would prefer not to base its criteria primarily on practices used for external financial reporting. Most commentators have asserted that the depreciation methods now in use for external reporting purposes are appropriate methods for contract costing, too. The Board believes that this is generally true, and it further recognizes that a requirement to change to a particular depreciation method might result in significant cost to many contractors. In the belief that the methods selected as appropriate for financial accounting are usually intended to approximate the actual consumption of services, the Board has provided for continuance of those methods where this is a reasonable assumption. Therefore, in the October 3 proposal the word “reasonably” was used to modify the requirement that the method of depreciation reflect the expected consumption of services; this provision is continued in the Standard being promulgated today. In those few cases where existing methods used for financial accounting purposes are obviously poor representatives of the expected pattern of consumption, and in any case when the contractor proposes to change methods, the choice should be made on the basis of a reasonable expectation of the future pattern of consumption of services in accordance with the criteria provided in this Standard.

It has been asserted that some-assets purchased for Government contract purposes are used on an intermittent basis with periods of use and periods of nonuse following one another in a pattern that fits neither the classical accelerated nor straight-line models and that does not conform with the active-standby dichotomy. “The pattern of consumption of services” for such an asset is difficult to determine either prospectively or historically and is not necessarily dependent solely on use.

In circumstances such as the foregoing, it is not the intent of the Board to introduce uncertainty into contract negotiation and settlement by encouraging challenge of contractors’ depreciation methods. If the method selected is also used for external financial reporting Q’Bd(sic) is acceptable for income tax purposes, the Board’s expectation is that it will be accepted.

(4) Service Lives

Depreciation is to be charged during the period of estimated usefulness of a tangible capital asset. Some commentators have expressed concern lest the Board not give appropriate recognition to the importance of possible obsolescence in estimating the period of usefulness. The Board recognizes that for many contractors the likelihood of obsolescence is an important factor in estimating the period of usefulness, and has so provided in the Standard.

The June 11 proposal provided that estimated service lives used for financial accounting, where such lives reasonably represented expected usefulness, were to be used for contract costing. However, several commentators expressed concern that the requirement to use financial accounting lives would continue to influence the motivation of some financial reporting entities to select for financial accounting purposes those practices which would be most advantageous for other purposes. The Board’s research showed that defense contractors often used minimum lives permitted for tax purposes for financial accounting rather than lives based on actual experience. Therefore, the October 3 revised proposal placed the primary reliance for estimation of service lives on records at of the age of assets at disposal or withdrawal from active use. The proposal is further provided that the historical data would be a baseline for estimates of useful life which could be adjusted or based on expected changes in physical or economic lives.

Contractors commenting on the October 3 proposal pointed out that they have not been required to have records which would show the retention periods of assets. Therefore, while most contractors have the basic information from which they could determine typical asset retention periods, few contractors have made analyses or summaries of the information available. Furthermore, they stated that contractors did not have records reflecting the withdrawal of assets from active use. The contractors expressed the opinion that to develop such records would be costly. The Standard has been modified to provide that the development of records of asset withdrawal from active use be at the option of the contractor; however, it should be pointed out that such records could be additional support to reduce historical asset lives.

The Standard also provides a two-year period for the development of analyses of historical asset lives. The Board believes the two-year period should provide adequate working time to develop such analyses. The Standard does not prescribe the nature of the analyses which should be performed, nor does it prescribe the number of prior years to be analyze or the extent of support necessary; it recognizes that the adequacy of records depends upon individual need and circumstances. The Board believe that most contractors have adequate records on asset retention. Estimates of experienced lives can be developed from these existing records on the basis of samples. Statistical sampling from existing records or judgmental samples with analyses to support a large portion of the dollar amounts involved may allow reasonable estimates in many cases with a relatively small sample. The Board expects that contractors will develop sufficient data support the lives used and that procurement agencies will enforce this requirement in a reasonable manner.

Several commentators criticized October 3 proposal on the basis that it would engender disagreements about the impact of the physical and economic factors recognized as appropriate to consider in relating actual past experience to expected future usefulness. The Board, in effect, places a burden of proof on the contractor who proposes that expected changes in physical and economic factors should be used to justify any specific reduction in estimate from that supported by his records.

The Board recognizes that many contractors would still be concerned not only about the concept of developing service life estimates from records of actual use but also about the risk of disagreements related to the appropriate adjustments to be made in relating actual past experience to expected future usefulness. The Board believes that procurement agencies generally recognize the significance of the physical and economic factors listed in the Standard. The Board encourages the procurement agencies to provide written guidance for use by field personnel, with the goal of making an effective transition from amortization periods derived from tax regulations those based on reasonable estimates actual useful service. The staff of the Board will participate, if requested, the development of appropriate guidance to field personnel.

(5) Reliance on Internal Revenue Service

Many commentators throughout the Board’s research process in the development of this Standard, have suggested that the Board should rely on the experience accumulated by the Internal Revenue Service. Under this general approach the Board would be expected to concede that there is so much uncertainty about depreciation that auditors should not ask for support of estimates from individual contractors, but should accept for contract purposes the operation of a broad band of averages which have been developed for other purposes but which do deal with the same depreciation practices. The Board has recognized that contract costing often deals with the same expenditures and the same problems of allocation to time periods as are of interest in income tax accounting. Tax regulations, however, are intended to achieve a variety of social goals quite foreign to the purposes of contract costing. In this regard, the “Asset Guideline Periods,” first established in 1962, were based on write-off periods substantially shorter than actual average experienced lives and these periods were subject to further reduction under the “Asset Depreciation Range System” in 1971.

In addition, tax assessment and collection are continuous so that, except for differences in tax rates, shifts of income or expense from one year to another generally do not have a significant effect on total tax paid over a period of time. However, similar shifts of cost from one year to another could have a decided impact on the costs chargeable to the Government on contracts with it.

The Board has considered very seriously the issues which are related to its decision not to rely solely or necessarily on IRS regulations with respect to depreciation. Early versions of this Standard placed some reliance on IRS regulations. However, spokesmen for contractors criticized the specific techniques used, including the difficulty of using lives shorter than those permitted by IRS, while representatives of the accounting profession tended to encourage less reliance on IRS in any way. The Standard now being promulgated continues to make limited use of IRS regulations for estimating service lives where more pertinent information is not available.

(6) Beginning and Ending Periods

Several commentators expressed concern that the proposed Standard (both the June 11 and October 3 versions, which were alike in this regard) would not permit accounting conventions to be used for the beginning and ending periods of asset use. The Standard permits the application of conventions (such as the half-year convention) where reasonable in the circumstances and consistently followed. The Board sees no need for change in this respect.

(7) Asset Groups

Some commentators felt that the June 11 proposal implied a desire by the Board for depreciation accounting on an asset-by-asset basis. The Board does not intend to force any changes in decisions reasonably made with respect to accounting in terms of groups or of individual assets. Since depreciation is largely based on the application of estimates, when groups are used the estimates are intended to represent the average or typical experience for all individual assets in the group. The October 3 proposal was modified to make clear the Board’s acceptance of grouping practices in accounting for assets and in determining applicable depreciation lives and methods. The Standard permits accounting for assets either individually or in any reasonable grouping, provided that the accounting treatment is consistently applied.

(8) Use Rates

In its June 11 proposal, the Board pointed out that the proposed Standard is expected to be applied by contractors in situations where depreciation cost is a factor in determining equitable charging rates to be used as a basis for contract costing. For example, the development of rate schedules for construction plant and equipment and ownership costs for comparison to lease or rental costs would be accomplished in conformance with the requirements of the proposed Standard. The proposed Standard also would have been required to be used by educational institutions in a determining amounts to be compensated for use of buildings, capital improvements and equipment.

University commentators stated that few colleges and universities recognize depreciation in their accounting records. Replacement of capital assets is often handled by special appropriations or by bequests and other contributions. Federal Management Circular 73-8 has provided for use allowances as recognition for the employment of capital assets on contract work.

A number of commentators have pointed out that many educational institutions prefer the current use allowance system even though they recognize that conventional depreciation accounting would result in higher recognized costs. The most important reason stated is that the administrative cost and effort involved in establishing depreciation accounts would be significant.

These comments have been persuasive. Universities who choose not to incur the additional administrative expense should have an acceptable alternative basis for reimbursement for the use of tangible capital assets. The Standard has been modified to provide that it does not apply where FMC 73-8 use allowances are a part of contract costs. However, the Standard does apply whenever depreciation accounting is used by an educational institution for a covered contract.

(9) Residual Value

Several commentators expressed concern that the proposed Standard defined “residual value” even though the only available numeric value during the service life of an asset is that for “estimated residual value.” The wording in the definition has been modified to clarify the Board’s recognition of this point.

The proposal included permission to disregard minor residual values (those-under ten percent of capitalized cost) in determining a schedule of depreciation charges -- until the net book value approaches the residual value. Some commentators suggested that residual values be ignored completely. Others suggested that they be permitted to depreciate beyond actual residual values because of practicality considerations.

The Board has several times expressed its belief that the administration of Cost Accounting Standards should be reasonable and not seek to deal with insignificant amounts of cost. (See, for example, the March 1973 “Statement of Operating Policies, Procedures and Objectives.”) Except for depreciable real property, there would usually be little improvement in the accuracy of cost measurements if estimates of minor residual values were explicitly considered in establishing amounts to be depreciated. However, the Board continues to believe that the magnitude of the expected residual value should be considered for each asset or for each group. If the estimate is greater than ten percent of capitalized cost or if it is applicable depreciable real property it should be deducted from the capitalized amount determining the depreciable cost. The Standard has been modified to clarify the applicability of the ten per cent materiality rule to personal property only.

The June 11 proposal prohibited the charging of any depreciation amount which would reduce book value below residual value. Where fixed asset accounting is by groups, this provision was not intended to require separate identification of the book values and residual values of individual assets. For individual assets, where actual residual values are not material, the Board does not intend that such material amounts be identified. The criterion of materiality applies to all Board promulgation’s, and therefor the Board does not believe it necessary to restate it in every circumstance.

(10) Gain or Loss

Both the June 11 and October 3 proposals required that gain or loss on disposition of tangible capital assets be assigned to the cost accounting period in which disposition occurs. A number of commentator suggested that gain or loss on disposition, as an adjustment of depreciation previously recognized, should be assigned to the cost accounting period; and cost objectives to which the depreciation had been charged. This suggestion is conceptually sound but impractical to apply. The records necessary to identify prior depreciation charge would be difficult to maintain. In addition, where losses occur on disposition, application of the cost to prior periods and cost objectives would often be precluded because applicable contracts may have been closed or funding for the additional cost may not be available. Accordingly, the Board believes it would be fair to both contractors and the Government to adjust for gain or loss in the current cost accounting period.

Commentators suggested that if adjustment is to be made in the current cost accounting period, it should be made to some general indirect cost pool so that adjustments could be absorbed by all work of the period. The Board believes, however, that -- to the extent practical -- adjustments should be made to the same cost accounts to which the depreciation cost of the asset had been or would have been allocated in that cost accounting period. To the extent that depreciation cost is assigned to individual departments or cost centers, so should the adjustments to depreciation resulting from the disposition of assets.

Commentators expressed the opinion that gains on disposition of assets in today’s economy are often the result of inflation and not adjustments of depreciation expense. The Board recognizes that assets held for long periods, especially real property, may be disposed of for amounts in excess of net book value. The gain may have been caused by any of several factors, including the rising general price level. In some situations it may be arguable that the gains should not be considered as corrections to previous depreciation charges. The Board and others in the accounting profession are examining new techniques to deal with accounting for inflation. However, accounting for cost on an historical basis is now generally accepted and until the new techniques are developed and accepted, the Board does not see a practical way to differentiate those gains deemed by some to be based on inflation from those resulting from excessive depreciation charges. Because the Standard applies only to assets acquired after the date when the Standard must first be followed by a contractor, the impact of the Standard on recognition of gains or losses in some years in the future. At that time it is expected that guidance will be available on the appropriate treatment for price-level changes reflected in gains or losses from disposition of fixed assets.

Current procurement regulations of Government agencies are not consistent in their provisions for gains and losses. A number of commentators were apparently unaware of this diversity; they encouraged the Board to leave the present situation alone. The existing procurement regulations have been carefully considered and the Board believes that contract cost determinations will be improved by more uniform treatment of such gains and losses.

Several commentators were concerned that the treatment of gain or loss from involuntary conversion, while in agreement with the Federal income tax treatment, differed from the generally accepted financial accounting practice. The Standard has been changed to permit the contractor to use either basis in accounting for involuntary conversions.

(11) Original Complements

The Standard on Capitalization of Tangible Assets defined and required the capitalization of original complements of low-cost equipment. There has been some controversy over the appropriate write-off technique for such capitalized amounts. Informal staff proposals require amortization over the life of the complement, or of the asset for is which it has been required, were challenged by contractors as being unreasonable. The Board recognized the intensity of this feeling and the June 11 proposal included a provision developed specifically to assign such costs among cost accounting periods.

Some commentators pointed out that the June 11 proposal for amortization of original complements would have required a practice which is not at all common and would be difficult to implement.

The provisions of the proposal were, modified for the October 3 version to require simply that an original complement be treated as a tangible capital asset, and that the basic requirements of the Standard be applied to it. Thus, the costs of each original complement would be amortized over its period of expected usefulness, and in accordance with its pattern of expected usage, either separately or as a part of an appropriate group. Comment received on the October 3 version have a suggested some misunderstanding of the principle involved. Some additional language has been added to the illustration on depreciation for original complements in 409.60(c) to further clarify the principle that an original complement is a single asset and not group of individual items.

(12) Retroactive Impact of Changes

The Board called attention, in the June 11 publication, to the conflict between some aspects of Opinion No. 20 of the Accounting Principles Board and the treatment proposed, in 409.50(i), for changes made in depreciation accounting during the service life of an asset. The position proposed by the Board, that of making changes applicable prospectively only, was approved by most of those who commented on the point. A very few commentators asked that the Board agree with the financial accounting principle and insist upon retroactive impact, even though this would require reopening settled contracts. The Board was not convinced that any improvement in costing accuracy resulting from reopening settled contract would merit the obvious administrative inconvenience involved. The Standard is, therefore, not changed in this regard.

(13) Service Center Costs

The June 11 proposal provided that when depreciable assets are part of an organizational unit whose costs are charged to users on the basis of service, the depreciation cost of such assets should be included as part of the costs of the organizational unit. A number of commentators expressed concern that the Standard might be thought to require the assignment of building depreciation separately to each organizational unit which occupied a building, even though the applicable building depreciation might be only a very minor part of the total organizational unit cost. If an organizational unit occupies a entire building, and the depreciation cost of that building is significant and can practicably be identified, that building depreciation cost should be included as a cost of the organizational unit for assignment to cost objectives on the basis of service. If, however, the total depreciation cost of a building, which is allocable to a number of cost objectives, is accounted for as indirect cost and its allocation on that basis would not materially distort the measurement of costs to a benefiting cost objective, little point would be served by insisting that each organizational unit receive a specific charge for building depreciation.

Several commentators were concerned that the paragraph on service centers might restrict the base or bases used for charging service center costs to other cost objectives. Nothing in that paragraph is intended to limit or prescribe the base or bases used for charging service center costs.

(14) Cost of Capital

Many commentators have pointed out that the requirements to be imposed by the Standard may result, on assets acquired after the effective date, in less depreciation charged in earlier years of asset life. The resultant slowdown in recovery of funds could, they pointed out, have an adverse impact on the profitability of defense contracts. Many of the comments seek to justify rapid write-off as a partial offset to the costs of capital actually involved but not directly recognized in contract pricing.

The purpose of this Standard is to provide a better measurement and a location of depreciation cost. Accounting practices used for these functions should be justified on the basis their effectiveness for such measurement and allocation. They should not be justified on the basis of problems identified with other aspects (e.g. profitability) of defense contracts.

The Board has no authority to extend itself into the area of profitability of defense contracts. This is a matter for the procuring agencies. In this regard, current procurement regulations provide guidance with respect to negotiating proposed profits; this guidance includes some implicit recognition of the cost of capital. The Board believes that accounting for the costs of capital and determining equitable measures of profit are issues separate from depreciation accounting and these issues cannot be resolved effectively by adoption of any particular depreciation practices.

(15) Modernization and Public Policy

Many commentators have pointed out, throughout the process of developing this Standard, that no Cost Accounting Standard should be adopted if it would interfere with public policy to encourage investment in facilities which might provide a more modern, more effective industrial mobilization base. The Board favors appropriate improvements in the physical facilities used in performance of negotiated defense contracts; its purpose however does not include such public policy decisions as the introduction or continuation of incentives to encourage investment in certain classes of assets. This Standard is being promulgated for the purpose of improving the measurement and allocation of depreciation on acquired assets. The Board does not believe that this purpose is inconsistent with or a deterrent to effective plant modernization.

(16) Inflation Accounting

Some commentators were concerned with the effect of inflation in depreciation accounting. They suggested that this Cost Accounting Standard should provide for the use of replacement cost or current value rather than historical cost as the basis for determining depreciable amounts. Present Government procurement regulations as well as financial and tax accounting are based on historical costs. Current inflationary trends, however, suggest that more attention should be given to the impact of inflation on established accounting concepts.

The Financial Accounting Standards Board (FASB) is considering this subject. The FASB issued an Exposure Draft on “Financial Reporting in Units of General Purchasing Power” on December 31, 1974. The CASB is also studying the subject.

The cost impact of this Standard for most contractors is some years in the future. The Standard is required to be followed by contractors at the start of their next fiscal year after receipt of a covered contract requiring compliance with this Standard. The Standard provides for a two-year period after required compliance to accumulate necessary supporting records. The requirement of the Standard for determining lives applies only to new assets acquired after the necessary records are available. Therefore, for most contractors implementation of the requirements of life determination will apply only to new assets acquired in accounting periods beginning January 1, 1978, or later.

The Board sees this Standard as establishing proper techniques for the measurement and allocation of depreciation expense. The Board believes, therefore, that this Standard can properly be promulgated at this time. The subject of inflation accounting concerns not only depreciation cost but all costs, and will be dealt with as part of the studies now in progress by a both the CASB and the FASB.

(17) Costs and Benefits

Comments received on the June 11 and October 3 proposals indicated that there would be substantial administrative cost entailed in complying with this Standard. Part of the increased cost is attributed to required changes in accounting practices; a greater part is alleged to be related to increased controversy over the acceptability of current and proposed depreciation methods and lives.

A number of the administrative problems described in the comments have been reduced or eliminated by changes to the Standard. The requirement for recordkeeping, however, has not been eliminated. As discussed above, the Board recognizes that for some companies additional cost will be incurred to implement this aspect of the Standard. Also as discussed above, there may be some one-time analytical effort during the next two years to develop starting estimates of actual retention periods. The Board believes that these administrative costs, when reasonably managed in light of the purpose to be served, are warranted by the likelihood of better measurement of depreciation cost than has previously been available.

The Standard does not prescribe uniform accounting treatment. It enunciates principles and criteria for the implementation of these principles, which will achieve a practical degree of increased uniformity and consistency in fixed asset depreciation accounting techniques. In some cases, as for the determination of estimated service life, the Standard requires the establishment of records to achieve a better measurement of cost based on the manner in which contractors manage their fixed assets.

The benefits to be expected are better accounting for depreciation cost and enhanced ability to meet the responsibilities of the Government and of defense contractors to properly account for the expenditure of public funds. The Board recognizes that some additional costs will be incurred in obtaining compliance with this Standard. The benefits to be obtained are substantial, and the Standard contributes to fulfilling the Board’s obligation to seek improved accounting for defense contracts.

• • • •

There is also being published today (40 FR 4259) an amendment to Part 400, Definitions, to incorporate in that part terms defined in 409.30(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 409.10. This amendment was part of a publication which added 331.30 (b)(3). Only the portion of the preamble which describes the revision to 409.10 is printed here. The remainder of the preamble appears as preamble K of the supplement to Part 331.

In the Federal Register of February 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.