Cost Accounting Standard 410 - Preambles

Preambles to Cost Accounting Standard 410 - Allocation of Business Unit General and Administrative Expenses to Final Cost Objectives

Preamble A - Preamble to Original Publication, 4-16-76

The following is the preamble to the original publication of Part 410, 41 FR 16141, Apr. 16, 1976, as corrected at 41 FR 22241, June 2, 1976.

The Standard on Allocation of Business Unit General and Administrative (G&A) Expenses to Final Cost Objectives being published today is one of a series being promulgated by the Cost Accounting Standards Board (CASB) 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. Preliminary work on the development of this Standard was based in part on the “Report on The Feasibility of Applying Uniform Cost-Accounting Standards to Negotiated Defense Contracts,” which cited the allocation of G&A expenses as one of the most frequently encountered problems in the area of allocation of indirect cost.

Another basis for the early work in this area was the absence of a requirement in procurement agency regulations dealing specifically with the allocation of business unit G&A expenses. Up to now, practices related to the allocation of G&A expenses have been covered by general provisions dealing with allocability and indirect costs. These provisions do not include criteria for the selection of allocation practice in given circumstances. The Board undertook research with the view that a Cost Accounting Standard on this subject should increase the likelihood of achieving objectivity in the allocation of G&A expenses to final cost objectives and comparability of cost data among contractors in similar circumstances.

Early research included an extensive review of available literature including decisions of contract appeals boards and courts. A preliminary analysis of accounting for the allocation of G&A expenses was made and significant issues were identified. A research questionnaire based on these issues was distributed on July 28, 1972; it was designed to solicit a sample of existing practices used for the allocation of G&A expenses and the reasons supporting existing practices. Responses were obtained from 65 sources.

After evaluation of the responses to the questionnaire, the Board developed a preliminary research draft of the Standard which was widely distributed, on December 13, 1973, to obtain informal comment and to ascertain the cost impact of adoption of the Standard as proposed. The Board’s further consideration of the issues related to the allocation of G&A expenses has been enhanced by almost 100 responses to this preliminary proposal.

A proposed Standard was published in the Federal Register of September 24, 1974, (39 FR 34300). After reviewing the responses to that publication, the Board revised its proposal. As part of its research in preparing the revised proposal, the Board surveyed, as described below, a number of companies who use a cost of sales base to allocate G&A expenses. The revised proposal was published in the Federal Register of September 9, 1975, (40 FR 41801). As part of the comments with the September 9, 1975 publication, the Board stated that it was particularly interested in receiving comments on the alternative methods for the proposed requirement for the transition from a cost of sales base for allocation of the G&A expense pool to use of a cost input base. Respondents were specifically asked to comment on the administrative cost and effort entailed by each of the alternatives and to indicate their preference between the alternatives. The Board supplemented both Federal Register publications by sending copies of the Federal Register material directly to organizations and individuals who had expressed an interest in the work of the Board.

The Board received a total of 136 responses to both Federal Register publications; 65 to the September 24, 1974 proposal and 71 to the September 9, 1975 proposal. Responses were received from individual companies, Government agencies, professional associations, industry associations, public accounting firms, universities and others. The Board takes this opportunity to express its appreciation for the helpful suggestions and criticism which have been furnished. The comments furnished by organizations and individuals have resulted in a number of changes in the Standard.

The comments below summarize the issues discussed by respondents in connection with both proposed Standards. They incorporate the still relevant portions of the comments which accompanied the September 24, 1974 publication. The comments also explain the major changes which have been made to the prior proposals.

1. -- Selection of an Allocation Base for the G&A Expense Pool

Allocation Relationship

Commentators expressed the view that the choice of an allocation relationship between the G&A expense pool and final cost objectives is arbitrary; particularly, the selection of any single allocation base is arbitrary. Commentators also took the position that the G&A expense pool cannot be allocated on a demonstrable beneficial or causal relationship, that G&A is not specifically relatable to all costs, nor does it bear any relationship to cost objectives or any particular final cost objectives. Other commentators stated that the selection of the cost input base must be based on the assumption that G&A is caused by cost input. The commentators with reference to the Martin-Marietta case, ASBCA 14159, March 16, 1971, noted that the decision in that case rejected this position.

While some commentators on the September 9, 1975 publication supported the choice of cost input, others agreed with the views expressed above. The Board has concluded that the expenses in the G&A expense pool are the expenses of the general management and administration of a business unit as a whole: that the allocation base chosen should be one which measures the total activity of the business unit during a cost accounting period and not just some part of total activity and that a cost input base accomplishes this objective.

Cost of Sales Survey.

Shortly after the initial Federal Register publication, the Board surveyed segments of a number of companies who use a cost of sales base to allocate G&A expenses. The survey was designed compare the results of using a cost of sales base with the results of using a cost input base to allocate these expenses. Responses were received from 91 segments. The results of the survey established that in the case of individual segments the use of a cost of sales base as compared with a cost input base can result in a significant difference in the G&A rate and in the allocations of G&A expenses to final cost objectives.

For example, one of the segments in the survey had a G&A rate based on cost of sales of 8.0 percent. When that segment used a total cost input rate, its G&A rate for the same period was 10.4 percent or a 30 percent difference. A change to a total cost input rate would have resulted in substantially different allocations of G&A expense to that segment’s final, cost objectives.

Some commentators were critical of the Board’s using a single year as the basis for the survey. These commentators noted that there could be isolated instances where the use of a cost sales base would not produce equitable results. However, they noted that over time a cost of sales base will give equitable costing results.

For a cost of sales base to provide an equitable allocation consistent with that of an allocation to the total activity of a business unit during a cost accounting period, a contractor’s mix of work between Government and commercial, types of contracts and the level of G&A expenses would have to remain constant over many periods. In this regard, the cost of sales survey demonstrated that in any given period, one period being selected, the use of a cost of sales base can result in significant differences in the allocation of G&A expenses to final cost objective as compared with the results obtained using a cost input base.

Cost of Sales Base

A number of commentators suggested that the use cost of sales as a measurement of the allocation base for the G&A expense pool should be permitted. Commentators asserted that this base has long been used for the allocation of the G&A expense pool and is consistent with generally accepted accounting principles and the concept of period costs. The Board’s position is that the measurement of a cost of sales base is representative, in part, of the productive activities of prior periods and subject to fluctuations which can distort the allocation of G&A expense to activities of the current period. Although the measurement of cost of sales is based on a recorded date of sale, that is not necessarily an index of the activities of a period.

Under current regulations as interpreted by the Armed Services Board Contract Appeals, the use of a cost sales base will not result in an equitable allocation of G&A expenses where there are significant changes in the mix of business or significant changes in the beginning and ending inventory balances. The Board has considered the existence of these past disputes and cases involving the use of a cost of sales allocation base. In given circumstances, due to the definition and accounting for sales under various types of contracts, the cost of similar types of productive activities may be treated differently in terms of the measurement of a cost of sales allocation base. The use of a cost of sales base can result in unwarranted shifting of costs between different types of final cost objectives.

Therefore, the Board has concluded that the use of a cost of sales base is inappropriate for establishing the proper cost of final cost objectives within a cost accounting period.

Cost Input Base

Commentators took the position that the use of a cost input base would violate generally accepted accounting principles used for financial accounting purposes because G&A expenses are most commonly viewed as a period cost and not allocated to production nor inventoried. The use of a cost input base would result in inventorying G&A expenses for contract costing purposes. Further, commentators asserted that there is no beneficial or causal relationship between the G&A expense pool and cost input, cost objectives or specific final cost objectives.

The logical extension of this argument is that these expenses should not be allocable to Government contracts. If no beneficial or causal relationship can be established then there should be no recovery, because for a cost to be attached to cost objectives some beneficial or causal relationship should exist.

There are a number of firms which inventory G&A expenses on Government contracts for financial disclosure purposes. Moreover, the IRS and the SEC have recognized that in some instances G&A expenses are being applied to the inventory of Government contracts, and the G&A expense pool allocation remains in the inventory of these contracts at the end of the accounting period. While the Standard does not require that G&A expense be inventoried for financial reporting purposes, the inventorying of G&A expenses on Government contracts has been an acceptable accounting procedure for financial reporting as well as for filing with the SEC. Under current IRS regulations, G&A expenses may be allocated to inventory.

The Standard being promulgated today is based on the concept of full-costing of final cost objectives. For Government contracting purposes, both direct and indirect costs, including G&A expenses, are allocable. Thus, for contract costing purposes, the concept of period expense is inapplicable. The Board has concluded that there is a beneficial or causal relationship between G&A expenses and all of the final cost objectives of a cost accounting period. Therefore, these costs are allocable to such final cost objectives.

Commentators also asserted that the Standard was unduly rigid because it permitted only one base for the allocation of the G&A expense pool. The Standard is not limited to the use of one allocation base; rather, the scope of the base, the measurement of total activity, is limited to cost input as this is the measure of the total activity of the business unit. The Standard provides that the measure of cost input best representing the total activity of the business unit during cost accounting period is to be the one chosen as the base. The Standard includes criteria for determining the cost input base which will best measure total activity. The criteria are provided so that the allocation base for the G&A expense pool can be selected giving consideration to the differing circumstances of individual business units.

Commentators expressed a variety of views concerning the criteria for the selection of a cost input allocation base. Some commentators noted that the criteria included the necessary guidance and means for selecting the base. Others expressed concern that the criteria for selection of a particular cost input base were not clear and could lead to disputes. Some commentators expressed the view that the inclusion of value-added and single-element allocation bases was redundant. Also, a contractor should be required to demonstrate that the use of a total cost input base would not result in an appropriate allocation before the use of one of the other bases was permitted. Other commentators stated that explicit inclusion of direct labor hours and direct dollars serves to clarify the Standard. Commentators suggested that the selection criteria should be modified to remove any bias favoring a total cost input base.

The Board has recognized the merit of the numerous comments and suggestions received during the research process. The Standard has been modified to clarify the criteria for the selection of an allocation base in a particular circumstance.

Under the Standard, only a cost input base may be used. Three cost input bases have been provided and criteria have been established for selection of the appropriate base. The individual circumstances of a given business unit must be analyzed, and the cost input base that best represents the total activity of that business unit would be the base selected. The Board’s research indicates that generally total cost input, because it is a broad measure of all of the work done and includes all of the costs allocable to the contracts of the period, will be a measure that is representative of the total activity of the cost accounting period.

In this context the term “total activity” refers to the production of goods and services during a cost accounting period. This scope of activity is selected in light of the fact that the purpose of this Standard is to provide guidelines for the allocation of expense to all of the work of a given cost accounting period.

Commentators questioned whether other indirect costs not part of cost of goods sold, such as unallowables and nonoperating expenses, should be part of the measurement of cost input. These commentators took the position that such costs should not be part of cost input. Commentators pointed out that there could be an inconsistency in the cost input bases used by various contractors depending on whether costs such as selling costs or IR&D and B&P costs were included in the G&A pool or excluded from the G&A pool and included as part of the cost input base. Commentators also questioned whether costs such as service center costs and intersegment transfers should be included in the cost input base for the allocation of the G&A expense pool.

The cost input base has been selected as the measure of the total activity of the work performed during the cost accounting period. Therefore, it is appropriate that the costs of all activities, functions, materials, services, etc., allocable to final cost objectives during a cost accounting period be included in the total cost input base for that period. This relationship is based on the scope of the G&A expenses which represent the cost of the general management and administration of the business unit as a whole. For example, where a total cost input base has been selected, all significant costs other than the costs included in the G&A expense pool should be included in the base. The Board is aware that there can be a difference in the allocation bases used depending upon the treatment of selling costs and IR&D and B&P costs. This result occurs from the Board’s accommodation of existing practices for accounting for selling costs and IR&D and B&P costs within the structure of this Standard. The Board has specifically required the inclusion of these costs in the cost input base in 410.50(f). The illustrations concerning the accounting for these indirect costs as part of a cost input base have been revised to clarify the required treatment.

Commentators suggested that minor variations from the specific bases presented should be allowed. The Board points out that the Standard requires that the allocation base selected should include all significant elements of cost input necessary to represent the total activity. If in a given circumstance, the exclusion of a particular item does not invalidate the chosen base’s representation of total activity this is acceptable under the Standard. The Board notes that these are the kinds of decisions which involve consideration of the individual circumstances of a business unit; accordingly the Standard provides the opportunity for the exercise of judgment in these situations.

Commentators noted the Standard lacks an explicit consistency requirement for the use of the cost input base selected. It was pointed out that allocation bases once selected are then used for considerable periods of time, usually as long as the underlying economic circumstances do not change. In this situation the selected base would remain representative of the total activity of the business unit. The Board does not intend to change this practice. In fact, the Board notes that in concert with Cost Accounting Standard 401, the selection of the allocation base for the G&A expense pool should provide the basis for allocation of that pool until such time as the basic economic circumstances change. The Standard has been modified to require that the base selected should be one that measures activity of a typical cost accounting period.

Commentators were uncertain as to the relationship of cost input to the purchase of raw materials inventory and to Cost Accounting Standard (CAS) 404 -- Capitalization of Tangible Assets. To help clarify the relationship of this Standard to the purchase of raw material inventories and to CAS 404, an illustration has been added. Cost input is basically a measure of the costs and expenses allocated to production of goods and services during a cost accounting period. The illustration has been revised to make clear that items purchased for raw material inventory which have not been committed or used in production during a cost accounting period would not be part of the cost input base for that cost accounting period. As to the acquisition costs of assets constructed or fabricated by a contractor, CAS 404 and the Standard must be read together. The requirements of CAS 404 provide that those G&A expenses which are identifiable with the constructed asset and are material in amount shall be allocated to the cost of the asset. CAS 404 also provides that the cost of constructed assets that are identical with or similar to the contractor’s regular product shall include a full share of indirect costs -- thus, the costs of these assets will be included in the cost input base.

2. -- A Transition Provision

Some commentators suggested that to avoid disputes and inequities the Board should provide a specific method of transition for any contractor that is required to change from a cost of sales or sales base to a cost input base. In the September 9, 1975 publication, the Board proposed alternative transition. Methods X and Y as a means of avoiding potential disputes and minimizing the administrative cost of implementing the change from a cost of sales or sales base to a cost input base. Either of the proposed methods would have eliminated the major portion of potential equitable adjustments arising from compliance with the Standard.

Numerous comments regarding the equity administrative complexity, and costs of both X and Y were received. Some commentators asserted that Y was more equitable in that both CAS-covered and non-CAS-covered work would be treated alike, on the basis on which the work was negotiated. Others felt X was more equitable in that there would be less impact on non-CAS-covered work. Some commentators expressed the view that neither X nor Y was equitable in that both methods effectively repriced existing contracts by impacting, “squeezing down” the cost input rate on new contracts, and both methods would result in a deferral of recovery of G&A expenses.

While some commentators found one method less administratively complex than the other method, other commentators saw little difference in the administrative cost and effort required by either method. Most commentators expressed the view that either X or y would require some additional administrative effort and the generation of data not currently produced.

A number of alternative transition methods were suggested including:

(1) An option to use either X or Y,

(2) An option to use X or Y or switch over immediately,

(3) Neither X nor Y, but use equitable price adjustment,

(4) The use of a combination method involving the actual cost of sales and cost input rates for a period and some type of suspense account to prevent an over-recovery of G&A expenses.

In addition, commentators proposed a number of variations of these basic alternatives. The Board is persuaded, after reviewing all of the comments received on transition methods, that a variation of one of those methods favored by many industry associations and several defense contractors offers substantial promise for avoiding potential disputes and for minimizing the impact of shifting from a cost of sales or sales base to a cost input base. This transition method is set forth in 410.50(e) and Appendix A of the Standard. Business units required by the Standard to change from their present allocation base to a cost input base are not required to use this transition method; rather, a business unit has the option of choosing this transition method or proceeding with an immediate change over to a cost input base and seeking adjustment under the equitable adjustment provision of the contract clause.

Use of the optional transition method will, in the Board’s opinion avoid the need to use the equitable adjustment provision of the contract clause to reprice prime contracts an subcontracts of business units using this technique. The Board believes that this procedure is appropriate for this Cost Accounting Standard.

It is the Board’s view, however, that for most Standards the impact of changes in cost accounting practice required by new Cost Accounting Standards will be accommodated by price adjustments for covered prime contracts and subcontracts through the equitable adjustment provisions of the contract clause.

For any business unit which chooses not to use the transition method set forth at 410.50(e) and Appendix A, the contractual provision requiring appropriate equitable adjustment of the prices of affected prime contracts and subcontracts will, of course, be implemented with consequent adjustment of the price of such contracts and subcontracts. The optional transition method provided in 410.50(e) and Appendix A permits a business unit whose disclosed or established cost accounting practice was to use a cost of sales or sales base -- and which is performing work on final cost objectives which came into existence prior to the date the business unit must first allocate its cost in compliance with the requirements of this Standard -- to allocate the G&A expense pool to these cost objectives using a cost of sales or sales base. These final cost objectives often include:

(1) Government contracts which contain the CAS clause;

(2) Government contracts which do not contain the CAS clause;

(3) Contracts other than Government contracts, or customer orders awarded, prior to the date the business unit must first allocate its cost in compliance with the requirements of this Standard; and

(4) Production not specifically identified with contracts or customer orders under production or work orders existing prior to the date on which a business unit must first allocate its cost in compliance with this Standard and which are limited in time or quantity.

Production under standing or unlimited work orders, continuous flow processes and the like, not identified with contracts or customer orders, are to be treated as final cost objectives awarded after the date on which a business unit must first allocate cost in compliance with the requirements of this Standard.

The business unit will allocate its G&A expense pool to those final cost objectives which arise on or after the date on which a business unit must first allocate costs in compliance with the requirements of this Standard using a cost input base calculated in compliance with 410.50(d).

A business unit will use the transition method until all pre-existing final cost objectives using the cost of sales or sales base are completed. At that time the business unit will be using and will continue to use a cost input base selected in accordance with the requirements of 410.50(d) to allocate the G&A expense pool to all CAS-covered contracts.

In order to prevent possible windfalls and to provide equity to both parties to applied to the inventory suspense account must be established. The amount of the inventory suspense account shall be the beginning inventory of contracts subject to the CAS clause of the cost accounting period in which a business unit must first allocate costs in accordance with the requirements of this Standard. The G&A expense allocation rate to be applied to the inventory suspense account is the cost of sales rate for that first accounting cost period.

The suspense account will be amortized in any cost accounting period subsequent to the last cost accounting period in which final cost objectives negotiated by using a cost of sales or sales base are still being performed and in which the amount of the ending inventory of contracts subject to the CAS clause for that cost accounting period is less than the amount of the inventory suspense account. The G&A expense pool of that cost accounting period shall be reduced by the difference between the inventory suspense account and the ending inventory of contracts subject to the CAS clause of that cost accounting period times the cost of sales rate applicable to the inventory suspense account.

The Standard must be followed after the start of a contractor’s next fiscal year after January 1, 1977. This long lead time provides both the Government and contractors an opportunity to prepare appropriate administrative procedures for using this transition method.

3. -- Definition of G&A Expense

G&A Expense

Some commentators expressed the view that the definition was consistent with their current practice; others were concerned that the definition of G&A expense was narrower than those definitions currently in use, and the result might be excessive fragmentation of existing G&A expense pools to remove insignificant items.

Board research indicates that while accountants are in agreement about the general character of G&A expenses, practice has resulted in the cost of a variety of functions and expenses being included in the G&A expense pool. As a result, from the early stages of this project onward, the Board has seen a need to provide a definition of G&A expense in order to bring some uniformity to this area of accounting. Commentators expressed concern about problems involving the classification of those persons and functions of top level management that are concerned with both the overall planning and administration of a business unit and the direction of a particular function. Some commentators suggested that top level management people could keep time records, and split their costs between the G&A expense pool and the administration of the function which they are directing. While this may be appropriate in some circumstances, the Board believes the determination of the content of the G&A expense pool and the identification and classification of expenses in a particular circumstance must be based on judgment giving consideration to the characteristics of the individual business units. Similarly, the distinction between those expenses which are other indirect costs, including manufacturing overhead and those which are G&A expenses must be based on the individual circumstances using the guidelines provided in the Standard and the definition.

The definition has been revised to provide guidance for making those decisions. The definition now requires that for an expense to be classified as G&A expense, it must be incurred for the management and administration of the business unit as a whole. Further, the definition specifically excludes from G&A expense those management expenses whose beneficial or causal relationship to cost objectives can be more directly measured by a base other than a cost input base representing the total activity of a business unit during a cost accounting period.

Commentators indicated concern and expressed some confusion regarding the interaction of the definition of G&A expense and the requirements of 410.40(d). Commentators were uncertain as to if and when expenses which do not meet the definition of G&A expenses contained in the Standard should be removed from the G&A expense pool. The Board has revised 410.40(d) to clearly express the Board’s intent that those expenses which do not meet the definition of a G&A expense and whose beneficial or causal relationship to business unit cost objectives is best measured by base other than a cost input base representing the total activity of a business unit during a cost accounting period should be removed from the G&A expense pool.

Materiality

With respect to the questions about materiality, 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.” The Board has considered the comments concerning the potential problems that could arise without a clearer statement of materiality related to the composition of the G&A expense pool. The Board believes in this instance a significance test will be particularly useful and the Standard has been appropriately modified (410.50(c)).

Accounting for Specific Items of Expense in the G&A Expense Pool. Commentators also expressed concern about the treatment of specific items of expense that are sometimes found in the G&A expense pool. In particular, commentators expressed concern over the treatment of selling and marketing costs, independent research and development (IR&D) costs and bidding and proposal (B&P) costs. Commentators questioned whether under the Standard these costs were G&A expenses to be included in the G&A expense pool.

The Board recognizes that at the present time selling costs (marketing or selling costs) may constitute a significant amount of cost and are accounted for in a variety of ways. Some account for selling costs in a separate cost pool while others include selling costs as part of the G&A expense pool.

Contractors who have included selling costs in a cost pool separate and apart from the G&A expense pool may continue that practice or may change and include selling costs in their G&A expense pool. Further contractors who will have to change the allocation base used for the G&A expense pool and who have in the past included selling costs as part of the G&A expense pool may account for selling costs by establishing a separate cost pool for the selling costs and using the allocation base they previously used for their G&A expense pool. Where selling costs are accounted for in a cost pool separate and apart from the G&A expense pool and are allocated using a different allocation base, they shall become part of the cost input base used to allocate the G&A expense pool. Also, the Board notes that the current ASPR provision related to the accounting for IR&D and B&P cost requires that generally the allocation of these costs shall be on the same basis as the contractor’s allocation of his G&A expense pool, although these expenses are not termed G&A expenses. Under the provisions of this Standard, business units which have included IR&D and B&P costs in their G&A expense pool may continue to do so. Those business units which choose to use the optional transition method in 410.50(e) and in which the IR&D and B&P costs remain in the G&A expense pool will account for these costs as follows:

(a) During the transition period, those business units which were using a cost of sales or sales base will continue to use that base to allocate the G&A expense pool to final cost objectives which were in existence as of the date the business unit must first allocate its costs in accordance with the requirements of this Cost Accounting Standard.

(b) During the transition period and subsequent to that time, the G&A expense pool would be allocated to new contracts subject to the CAS clause using a cost input base as required by 410.50(d).

As a result of the current ASPR provision, a business unit which is required under this proposed Standard to change the allocation base used for its G&A expense pool could, because of the ASPR requirements, also be required to change the allocation base for IR&D and B&P. For those contractors who include IR&D and B&P in their G&A expense pool, this change in the business unit’s method of accounting for IR&D and B&P costs, however, would be subject to the transition provision of the proposed Standard, and would only affect allocation of these costs to contracts awarded on or after the date on which a business unit must first allocate its costs in accordance with the requirements of this Standard.

Commentators expressed the view that since IR&D, B&P costs, and selling cost could become part of the allocation base for the G&A expense pool it might lead to the concept that these costs are final cost objectives themselves and should receive an individual allocation of G&A expense. As was stated in the Prefatory Comments to the September 9, 1975 publication, the Board is currently working on projects involving IR&D, B&P and selling costs. The Board at this time does not require changing the accounting for these costs. However, where these expenses are treated separately and apart from the G&A expense pool they shall become part of the allocation base used to allocate the G&A expense pool to final cost objectives and are not to be treated as individual cost objectives in and of themselves.

The illustrations concerning the accounting for costs which are removed from the G&A expense pool and the accounting for IR&D and B&P costs and selling costs have been clarified in response to comments received.

Expenses Transferred from the G&A Expense Pool

Commentators expressed the view that those items which will be taken out of the G&A expense pool and transferred to the benefiting segment for which they were incurred, are not really G&A expenses of the segment but are G&A type expenses. These expenses come out of the pool and are transferred in what may be described as a purification of the G&A expense pool before it is allocated. The Board agrees with this position, but does not believe an amendment of the Standard is necessary.

4. -- Use of Memorandum Records

Some commentators urged that the Standard specifically permit the use of memorandum records for the allocation of G&A expenses to final cost objectives. The Board notes that even in the absence of this Standard, many contractors now use memorandum records to perform the allocation of G&A expenses for purposes of Government contracts, because in their formal records they do not make an allocation of G&A expenses to contracts or they do so on a different basis. The Board sees no need to disturb the practice of using memorandum records for the allocation of G&A expenses to final cost objectives.

5. -- Allocation of Home Office Expenses to Final Cost Objectives

Commentators expressed concern about the handling of home office expenses which are received by a segment as residual expenses under CAS 403 or as a lump sum which is not designated as a particular type of expense. The Standard now provides explicitly that individual handling of various types of home office expenses would be required only where a separate allocation of expenses is received from a home office, and where the amount of the allocated expense is significant.

Other commentators suggested that in given circumstances a different allocation base than the allocation base used for the allocation of home office expense to the segment may be appropriate for the allocation of home office expense to final cost objectives of the segment. The Standard does not require that the same base be used for the allocation of home office expenses to final cost objectives of the segment as was used for the allocation of home office expenses to the segment. The Standard requires establishment of a beneficial or causal relationship between the cost objectives and the expense wherever separate and significant allocations of home office expenses are received by a segment. It may be appropriate to use a different allocation base for the allocation of home office expenses received by a segment than the allocation base used to allocate home office expenses to the segment.

A number of commentators state that allocations of home office expenses, either in total or part, are the type of expenses which should be accounted for as period expenses and should not be inventoried nor should these allocations be part of a cost input base for the allocation of the G&A expense pool as they are not part of the activity being managed. The Standard provides that certain allocations of home office expenses are always to be included in the G&A expense pool. Allocations of certain other types of home office expenses, where they are separately received and significant in amount, may or may not be included in the segment’s G&A expense pool. The Standard provides that these costs shall be allocated to cost objectives of the segment based on the beneficial or causal relationship between the cost objectives and the expense. As such, where a beneficial or causal relationship between these expenses and cost objectives the segment can be established, these expenses shall be included in cost objectives other than the segment’s G&A expense pool. Where a beneficial or causal relationship for the expenses is not identifiable with other cost objectives of the segment then the expense would be included in the G&A expense pool.

The total cost of a final cost objective is made up of a variety of cost and expenses incurred in different manners and at different times. The functions and services represented the allocation of home office expense is recognized, for contracting purposes, as part of the total cost of final cost objectives. As such, these costs are not unlike the other costs incurred in the effort to produce the final cost objectives. These costs shall become part of the appropriate cost input base selected to allocate the G&A expense pool. The illustrations have been revised to clarify that a segment must receive the home office expenses as a separate allocation if the requirements of 410.50(g)(2) are to be applicable.

6. -- Allocation of G&A Expenses to Special Contracts

Commentators suggested that the special allocation provision be stated in terms of class of contracts or types of situations. If the G&A expense pool meets the requirements of the Standard, the existence of a need for special allocation to a class of contracts or type of situation would indicate that the allocation base being used is not representative of the total activity of the business unit during a typical cost accounting period. The Standard is designed to provide consistent accounting treatment for all contracts, except for a particular contract or other final cost objective, which is an exception to a business unit’s normal operation.

The cost input allocation base for G&A expense is a broad measure which is normally representative of the total activity of a business unit during a cost accounting period. Thus, for a given final cost objective to qualify for special treatment, the difference in its beneficial or causal relationship to G&A expense as compared with the relationship of other final cost objectives to G&A expenses should be one which is apparent and capable of being supported. The provision of the Standard calls for the exercise of judgment; nonetheless, the Board believes a materiality criterion based on a measure of significantly different benefits is proper for use in evaluating and establishing a separate and exceptional allocation to a given final cost objective.

7. -- Miscellaneous

Some commentators stated that the Standard should provide for the allocation of G&A expenses to intermediate cost objectives, such as service centers and other overhead pools. Their position was based on the concept that in various types of full-cost responsibility accounting systems, all costs are allocated to cost objectives for more accurate costing and control purposes. A few commentators stated that for certain management expenses within the G&A expense pool they are able to determine a discrete beneficial or causal relationship between these expenses and the cost objectives of the business unit. Therefore, these expenses are allocated on a separate allocation base to the cost objectives of the business unit.

Where a beneficial or causal relationship between certain management expenses and business unit cost objectives can be determined using an allocation base other than the base used for the G&A expense pool, then by definition, these management expenses are not G&A expenses and should be excluded from the G&A pool. Where a beneficial or causal relationship other than one based on a broad measure of total activity can be determined, generally the resulting allocation represents improved contract costing. However, for those expenses which are in the G&A expense pool, the Board’s research indicates that the beneficial or causal relationship between these expenses and business unit activities of a cost accounting period is such that if they are allocated to intermediate cost objectives the allocation to final cost objectives could be significantly distorted.

Some commentators took the position that G&A expenses should not be allocated to stock or product inventory items. Other commentators suggested that the cost input of stock or product inventory items should be included in the G&A allocation base only in the cost accounting period when these items are used. The Board has taken the position that work on stock or product inventory 1 items represents part of the productive activity of the business unit for a cost accounting period, and therefore, these items should receive an allocation of G&A expenses.

The Board has recognized the administrative difficulties that can arise as a result of inventorying G&A expenses on these items for contract costing purposes and at the same time complying with requirements of generally accepted accounting principles for financial reporting. The Board has concluded that a practical solution to this circumstance is provided by the accounting treatments set forth in the Standard. A contractor can include G&A expense with the inventory cost of these items for contract costing purposes and provide his own procedure for complying with generally accepted accounting principles. Alternatively, contractors who do not include G&A expenses in the inventory cost of these items in order to conform with generally accepted accounting principles, are permitted to apply G&A expenses using the G&A rate of the period in which the items are issued.

In either situation, the cost of stock or product inventory items is to be included in the computation of the allocation base in the year produced. The Board believes this procedure will provide the appropriate determination of the G&A rate for each year, and the difference in the G&A rate applicable to final cost objectives by using the G&A rate of the year in which the items are issued rather than manufactured will not be significant.

The illustration dealing with the timing of inclusion of stock or product inventory cost input in the allocation base has been revised to make clear that stock or product inventory items cost input is to be included in the year in which the cost input is incurred.

Commentators suggested that a transition provision be provided for other types of changes, e.g., changing from a value-added cost input base to a total cost input base, or removing an item of expense from the G&A expense pool, required for compliance with the Standard. The Board recognizes that a variety of changes may occur as individual business units take action necessary to comply with the Standard. The Board believes that the equitable adjustment provision of the CAS contract clause provides the best means of handling the variety of changes which may take place.

Commentators suggested that some type of exemption threshold for this Standard should be adopted. It was suggested that the threshold could be based on either total sales to the Government by a business unit or corporate entity or Government business stated as a percentage of total business. The Board is currently studying the question of whether an exemption from its regulation could be appropriately based on the proportion of total business which a contractor does with the Government. Pending the results of that study, the Board does not believe that a percentage-of-sales exemption in individual Standards is appropriate.

Cost-Benefit. Section 719(g) 50 U.S.C.App. 2168(g), as amended provides “In promulgating such standards and major rules and regulations for the implementation of such standards, the Board shall take into account, and shall report to the Congress in the transmittal required by Section 719(h)(3) hereof, the probable costs of implementation, including inflationary effects, if any, compared to the probable benefits, including advantages and improvements in the pricing, administration and settlement of contracts.”

In a draft of the proposed Standard that was distributed for comment, the Board specifically requested commentators to provide data on the administrative costs of compliance with that proposal. In the second publication of the proposed Standard, the Board made the same request for data to indicate the administrative costs of compliance with Alternative X or Alternative Y. Of the 165 comments received only two comments on the draft proposal and one comment on the second publication provided quantitative data. Many comments received indicated that there would be some administrative costs incurred in complying with this Standard. As indicated above, a number of the potential administrative problems described in the comments have been reduced or eliminated by changes to the Standard being promulgated today. Moreover, the practices of many contractors already conform with all or some of the provisions of this Standard.

Commentators indicated that part of the increased administrative cost is attributed to the transition to a cost input allocation base for those business units currently using a cost of sales allocation base. Another part of the increased administrative cost for these same business units is attributed to the accounting for the G&A expense allocated to ending inventory. The Board recognizes that these administrative costs will arise in some cases.

Among the benefits which the Board believes will be derived from use of this Standard No. 410 are a more equitable treatment of all costs incurred during a period, in terms of the G&A expense pool allocation to final cost objectives; improved measurement of the cost of final cost objectives; a reduction in disputes through the establishment of criteria for evaluation and selection of the allocation base for the G&A expense pool; increase in the likelihood of achieving objectivity in the allocation of G&A expenses to final cost objectives; and an increase in comparability of cost data, among contractors in similar circumstances.

The Board concludes that the costs anticipated for administrative compliance with this Standard when reasonably managed in light of the purposes to be served are outweighed by the probable benefits expected to be derived from its use.

As required by section 719(g) 50 U.S.C.App. 2168(g), as amended, the Board has evaluated the potential inflationary effect of this Standard. The Board has concluded that any inflationary effect of this Standard will be insignificant.

Effective Date

The availability of the transition method to contractors who choose to use it requires especial care in complying with the effective date and application provisions of the Standard. The following comments are offered to illustrate those provisions. The comments assume that the contractor has a January 1 fiscal year; contractors with different fiscal years would of course apply the requirements of the Standard using different dates appropriate to their own fiscal year. For those contractors using a cost of sales base, having a fiscal year beginning on January 1, and electing to use the transition method provided in Appendix A, all contracts entered into prior to January 1, 1978, would be accounted for using the contractor’s cost of sales base in accordance with the cost accounting practice previously disclosed or established. Contracts entered on or after January 1, 1978, should be accounted for using a cost input base in accordance with the requirement of 410.50(d). The transition period would begin January 1, 1978, and continue until all contracts entered into prior to January 1, 1978 are completed. This situation is illustrated in Appendix A, Illustration 1.

Under certain circumstances, a contractor who has been using a cost of sales base must be presumed, during the time between the effective date of this Standard and the date when it becomes applicable to him, to have elected to use the transition method provided in 410.50(e). These circumstances arise when

(1) the contractor proposes to receive an award of a contract priced by use of a cost of sales base for the entire contract and

(2) the period of performance specified or anticipated for the contract extends beyond the date when the Standard becomes applicable to the contractor. Contracting agencies should take appropriate action to advise the contractor that consistent with the concepts of Part 401, Cost Accounting Standard -- Consistency in Estimating, Accumulating and Reporting Costs, his decision to price the proposal entirely by use of a cost of sales base is deemed an election to operate under the transition method prescribed in 410.50(e) when this Standard becomes applicable to him.

Those contractors using a cost of sales base, having a January 1 fiscal year, and electing to proceed with a complete change-over to a cost input base on January 1, 1978, would have to be careful to comply with Standard 401 in making proposals for those contracts which will span part or all of the period October 1, 1976, through December 31, 1977, and cost accounting periods beginning January 1, 1978, and thereafter.

The proposal should indicate that the cost of sales base will be followed until the date when the requirements of this Standard must be followed; at that later time, the practice required by this Standard, a cost input base, should be proposed to be used as the contractor’s practice for the remaining life of the contract.

To illustrate, assume a contractor having a January 1 fiscal year currently allocates G&A expense using a cost of sales base. When the contractor makes a proposal for a contract which will be entered into after October 1, 1976, and prior to January 1, 1978, his proposal must recognize that his G&A expense pool will be allocated by using a cost of sales base from the date of the contract through December 31, 1977, and by using a cost input base thereafter.

The Board expects that this Standard will become effective on October 1, 1976.

There is also being published today an amendment to Part 400, Definitions, to incorporate in that part terms defined in 410.30(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 410.70. This amendment was part of a publication which added 331.30(b)(3). Only the portion of the preamble which describes the revision to 410.70 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.