Cost Accounting Standard 411 - Preambles

Preamble A

Preamble to Original Publication, 5-5-75

The following is the preamble to the original publication of Part 411, 40 FR 19425, May 5, 1975.

The Standard on Accounting for Acquisition Costs of Material 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 resulted from the absence of a requirement in agency regulations that the same costing method be used for similar categories of material within the same business unit and that the method be consistently applied. The Board undertook research with a view that a Cost Accounting Standard on this subject might improve cost assignment and cost measurement in accounting for acquisition costs of material.

Early research included an extensive review of available literature and a review of decisions of boards of contract appeals and courts.

A preliminary analysis of material accounting concepts was made and a number of issues were identified; comments on this analysis were obtained from interested persons. After evaluation of all of the issues, the Board developed and circulated preliminary research drafts of Standards which were widely distributed for informal comment and to ascertain the cost impact of adoption of the Standard as proposed.

Suggestions and comments were received from 70 respondents; these comments were considered in developing a revised Standard which was published in the Federal Register of November 26, 1974, with an invitation for interested parties to submit written views and comments to the Board. The Board supplemented that Federal Register publication by sending copies of the Federal Register material directly to organizations and individuals who had provided the Board with comments on the earlier proposal or had otherwise expressed an interest in the proposal.

Responses were received from 86 sources including individual companies, Government agencies, professional associations, industry association, public accounting firms, universities, and others. All of these comments have been considered by the Board and those addressing areas of particular significance are discussed below, together with explanations of the changes made in the Cost Accounting Standard being promulgated from the proposal published in the Federal Register on November 26, 1974.

The Board takes this opportunity to express its appreciation for the helpful suggestions and criticisms which have been received, and for the time devoted to assisting the Board in this endeavor by the many companies and individuals involved.

1. Need for a standard

Many comments were received questioning the need for a Standard in this area. Suggestions were received that because Disclosure Statements at present deal with this subject matter, the Board should accept them in place of a Standard. Other commentators contended that Standard 402, Consistency in Allocating Costs Incurred for the Same Purpose (4 CFR Part 402), dealt with any problems encompassed by this Standard. Some commentators argued that current practices concerning material costs used on Government contracts are well defined, of long duration, and are continually monitored by the Government. Others contended that inventory costing methods are covered by generally accepted accounting principles (GAAP) and, for this reason the Board should not issue a Standard on this subject.

With respect to the makeup of the draft Standard itself, some commentators said it was too broad, while others said it was too detailed and procedural. Some commentators stated that any Standard in this area should deal with direct materials only and should not contain any reference to indirect materials.

The Board has considered the arguments raised above as well as other facets of this particular subject matter. After studying this matter further, the Board has concluded that a Standard dealing specifically with accounting for the acquisition costs of material is needed to complement the Disclosure Statement and Cost Accounting Standard Contract Clause requirements, and to provide consistency in the application of material costing methods. Further, the Board believes that issuance of a Standard may be entirely appropriate even if the Standard does no more than establish as a Cost Accounting Standard the currently prevailing procurement regulations dealing with the allocation of costs to cost objectives. Accordingly, the Board is promulgating today a Standard, appropriately revised in light of the comments received, dealing with Accounting for Acquisition Costs of Material.

2. Inventory costing methods

The draft Standard published in the Federal Register on November 26, 1974, provided for the use of three inventory costing methods and asked commentators to identify any other methods they believed should be acceptable, for contract costing purposes, along with a justification and criteria for the use of such methods. Many commentators expressed the view that the last-in, first-out (LIFO) inventory costing method, under which the recent costs of material are allocated to cost objectives and the older costs are allocated to material remaining in inventory, should be permitted. Some commentators noted that LIFO should be allowed because it is acceptable to the Internal Revenue Service and the Securities and Exchange Commission, and because it is a recognized method for valuing inventory under generally accepted accounting principles and it is acceptable for other purposes. Other commentators expressed the view that the LIFO method results in a better matching of current costs with current revenues thereby reducing the “inventory profits” that develop during inflationary periods.

The purpose of this Standard is to provide for better allocation and measurement of material costs as they relate to specific contracts. The accounting practices used to achieve this purpose should be justified on the basis of their effectiveness for such allocation and measurement. They should not be justified solely on the basis that they are practices acceptable for tax and financial reporting purposes. Further, generally accepted accounting principles do not specify the details of cost allocations to particular contracts but are concerned with reporting the financial results of operations of the company as a whole.

The Board realizes LIFO is considered by some as a partial answer to accounting for the impact of inflation. The Board has noted however, that most of the companies that recommended that the LIFO method be permitted for contract costing purposes charge almost all of their material to contracts at the time the material is acquired or produced. The direct allocation of the costs of materials to contracts tends to counter the effects of inflation since the current cost of the material is charged against the contract. Moreover, few of these companies use LIFO for material that is issued to contracts from inventory.

The Board believes that accounting for the impact of inflation should be the subject of a separate Standard. The Cost Accounting Standards Board is currently conducting research into this subject. The Board did not include LIFO as a permitted inventory costing method in the draft Standard because contractors which currently follow LIFO for Government contracts use it in a manner which does not permit systematic and rational identification of the cost of material issues to specific cost objectives. The Board believes such identification is essential in cost accounting for Government contracts. Accordingly, while the Board has included the LIFO inventory costing method as a permitted method in the Standard being promulgated today, it has also included a requirement that the costing method used be applied in a manner which results in systematic and rational costing of issues of material to specific cost objectives.

The costing of such issues to cost objectives must be reasonably current; it would not appear rational to hold in abeyance for months, pending a LIFO determination, the cost of materials issued to a Government contract.

3. Direct charging of material

The proposed Standard included a provision whereby the cost of a category of material could be allocated directly to a cost objective provided the cost objective is specifically identified on the purchase order at the time of purchase or on the work order at the time of production of material and provided there is no established material inventory account for that category of material. Some commentators felt that contractors should be permitted to allocate the cost of material directly to a contract without the identification requirement. A greater number of contractors supported the identification requirement provided by the Board. These commentators felt that if identification with the end use was feasible, direct allocation should be permitted.

Most commentators objected to the prohibition of direct allocation if a material inventory account existed. They complained that this requirement forced the contractors to stock material at their own expense. They said this requirement would discourage purchase of material in economical lots. Commentators also pointed out that this requirement would make off-site shipments uneconomical, and would adversely affect contractors’ compliance with requirements in other Standards concerning their price proposals.

The Cost Accounting Standards Board favors the direct identification of costs where possible. The Board stated in its “Statement of Operating Policies, Procedures and Objectives” (March 1973):

As an ideal, each item of cost should be assigned to the cost objective which was intended to benefit from the resource represented by the cost or, alternatively, which caused the incurrence of the cost. To approach this goal, the Board believes in the desirability of direct identification of costs with final cost objectives to the extent practical. The Board recognizes the need for care in application of the concept of direct identification of costs with final cost objectives * * *

In furtherance of this objective, the Board has concluded that the specific identification of the end use of a category of material at the time of purchase or production should remain a requirement for the direct allocation of the cost of material. The Board is persuaded, however, that the existence of a material inventory account should not prohibit the direct allocation of the cost of material, and the Standard being promulgated has been revised to delete that prohibition. If contractors have previously established material inventory records for categories of material, however, the Standard does not require any change in this practice.

4. Cost of material

The draft Standard provided that material costs should be the acquisition cost of material adjusted to the extent practical by extra charges paid or discounts and credits received. Many commentators objected to this provision since they said that it is not in accordance with the practices currently followed by most companies. They argued that they charge many of the types of adjustment items referred to above to an indirect cost account and distribute those costs to all material on a base that they say is now acceptable to the Government. They also allege that there would be considerable work involved in identifying these kinds of additional charges with the individual purchases of material and to then spread the charges against the categories of material being purchased.

The Board intended this requirement to define broadly the net acquisition cost of material. This provision has been retained in the Standard being promulgated. A section has been added to the Standard stating that where it is not practical for a contractor to handle charges and credits as set out above, the contractor may provide for the consistent inclusion of such charges or credits in an appropriate indirect cost pool.

5. Definitions

Many comments were received on several of the definitions included in the draft Standard. Most commentators raised questions about the definitions of “Category of Material” and “Material Inventory Account.”

Some commentators concluded that “Category of Material” would include items such as lubricants, paper, ink, towels, and items of that type. The Board intended that material such as this could be handled as provided under 411.40(c) of the promulgated Standard which permits the cost of material to be allocated, under certain conditions, to an indirect cost pool for distribution to cost objectives.

Other commentators felt that the requirement that a category of material be comprised of identical or interchangeable units would be unduly restrictive. Their contention was that the different, individual items of material would have to be considered as separate categories of material. The Board intended its definition to be read in this way. It was not meant that all sheet steel, for example, should be considered as a single category of material. Most contractors would maintain separate inventory records of different sizes and thicknesses of sheet steel. Each of these would be a category of material.

Many of the comments concerning the definition of “Material Inventory Account” indicated that commentators assumed the Board was talking only about general ledger or subsidiary ledger accounts. Such is not the case. The Board was referring to any record used for accumulating the cost and quantity of material for subsequent issue to one or more cost objectives. The records the Board had in mind could include card files, computer data, bin tags, or other forms of detailed information used in the company’s system of accounting for receipt in and issue of material recorded as an asset.

Many commentators objected to the inclusion of the word “quantity” and the word “cost” in the definition of material inventory account. Some said they maintained records of either cost or quantity only. It was not the Board’s intention that each record must show both cost and quantity. The word “quantity” has been deleted from the definition. The records referred to are those used to accumulate the cost of materials for allocation to specific cost objectives.

The Board has concluded that the definition of “Category of Material” as presented in the draft Standard published on November 26, 1974, should be retained. The reference to “Material Inventory Account” has been deleted and the term “Material Inventory Record” substituted. Several words in this definition have been changed to make it more clear that the Board is referring to any records maintained in support of general ledger or subsidiary ledger financial accounts.

6. Need for written policies

Many commentators said that a requirement for written policies should be deleted from this Standard. They contended that such a requirement was not in accordance with their understanding of what Cost Accounting Standards should cover. They felt the Board was becoming too deeply involved in procedural details with such a requirement.

Contractors who have submitted Disclosure Statements felt that such submission should exempt them from a requirement for written policies. They contended that in responding to the Disclosure Statement, they were, in effect, setting forth their written policies and practices. During the Board’s development of the Disclosure Statement, many contractors suggested that a Disclosure Statement such as the Board had designed was not justified because they said they had accounting manuals and similar written documents which set forth their accounting practices. They contended further that these manuals and similar written documents were available to Government auditors and provided sufficient information concerning the contractor’s accounting practices. Although these manuals could not be used to fulfill the disclosure requirement, the Board recognizes that these are the kinds of documents that should contain written policies that are needed to permit effective implementation of this Standard. The Board also notes that many companies which are subject to Cost Accounting Standards are not required to file Disclosure Statements.

Some commentators questioned whether there would be a need for written policies for each category of material. Certainly the Board does not intend that this be the case. It is expected that contractors will have written policies establishing criteria which would apply to all of their material transactions.

Other commentators concluded that the written policies were listed as a requirement by the Board solely for the Government’s use in determining compliance with the Standard. The Board feels that written policies and practices are beneficial as evidenced by the many companies which have them.

7. Applicability of standard to indirect material

The draft Standard provided a means by which a category of material used solely in performing indirect functions or which is not a significant element of production costs could be handled through an indirect cost pool rather than accumulated in a material inventory record. There was a further requirement that when quantities of such material were not consumed in a cost accounting period and were estimated to be significant in total costs, the cost of such material was to be established as an asset at the end of the period.

Many commentators stated that the Standard should not deal with indirect materials, while a few questioned the use of an indirect cost pool for allocating the cost of such material. Other commentators stated that many contractors generally do not maintain inventory records of such material and that the provision set forth in the first sentence of the preceding paragraph was necessary, otherwise the Standard might present major problems for contractors. Most of those commenting on this point recommended the retention of this provision.

Many commentators disagreed with the requirement to establish remaining material of this type as an asset at the end of the period. Some commentators felt that this requirement contradicted the first part of the provision. They argued that if the material was not a significant element of production cost and thereby was permitted to be allocated to an indirect cost pool, it did not seem logical to require that any amounts of such material should be established as an asset at the end of the period. They stated that if this situation occurred, then presumably the material should not have been charged to cost objectives through an indirect cost pool.

These commentators apparently misinterpreted the Board’s intention. The draft Standard referred to the value of unconsumed material to be set up as an asset, not the amount charged to an indirect cost pool during the cost accounting period. The provision deals with significant amounts of unconsumed material of this type remaining at the end of the period.

Another commentator stated that the expensing of indirect supplies has long been a generally accepted practice and, if consistently applied, would not result in inequities in contract costing as long as unconsumed amounts do not fluctuate significantly from year to year. Other commentators were concerned that the use of the word “significant” would generate endless disputes with Government auditors since such a determination is subjective and no definition of that word was included in the Standard.

After considering all the comments the Board has received on this point, it has decided to retain the provision allowing the use of an indirect cost pool for allocation of the cost of material of the type described in this provision of the Standard. The Board is also persuaded that when quantities of such indirect material are not consumed in a cost accounting period and the excess of the ending inventory over the beginning inventory is estimated to be significant in relation to the total cost included in the indirect cost pool, the cost of such unconsumed material is to be established as an asset at the end of the period. The setting up of this material as an asset is to be accomplished by reducing the indirect cost pool by a corresponding amount.

On numerous occasions the Board has stated that it agrees that the administration of its rules, regulations, and Standards should be reasonable and not seek to deal with insignificant amounts of cost. Because of this, the Board does not believe it essential to define the term “significant” as used in this provision of the Standard. Generally accepted accounting principles, as stated in the American Institute of Certified Public Accountant’s Accounting Research Bulletin No. 43, recognize that the term “inventory” includes goods to be consumed directly or indirectly in operations, such as supplies.

The aforementioned requirement has therefore been retained in the Standard being promulgated.

8. Transfers of material

The draft Standard contained a requirement that a transfer of the cost of material from one cost objective to another was to be made at the same cost that was allocated to the initial cost objective or at the current market value. Many commentators objected to this provision on the grounds that it would be extremely difficult to identify the cost that was allocated to the initial cost objective. They contended that this requirement would also generate disagreements with Government auditors as to whether or not initial cost information was, in fact, available. Also, some commentators felt that determination of current market value would be a difficult and time consuming chore.

While not agreeing or disagreeing with the commentators’ statements, the Board has concluded that the transfer of material is of sufficient significance to warrant consideration as a subject for a separate Standard. The Board has initiated a research project to consider what factors affect the cost of transfers between cost objectives and between organizations. For this reason, the provision concerning cost of transfers of material between cost objectives has been deleted from this Standard.

9. Periodic vs. perpetual inventory accounting

The published draft Standard contained a provision permitting either periodic or perpetual inventory accounting procedures. This was coupled with a requirement that the period for periodic inventory accounting should not be longer than one quarter of a year. It was further stated that these provisions were not intended to establish a requirement regarding the taking of physical inventories.

Many commentators stated that this provision appeared to contain contradictory statements since the periodic inventory accounting method normally requires a physical inventory when the inventory value is established. They further said that as they understand that provision, they would be required to take physical inventories quarterly, which they felt was unnecessarily frequent.

The Board was referring to the period involved for the establishment of costs of material issues, not to the taking of physical inventories. It is the Board’s intention that costing of material issues should be on a current basis. To achieve this goal, the Board has inserted a requirement in the Standard that the inventory costing method used is to be applied in a manner which results in systematic and rational costing of issues of material to specific cost objectives.

10. Costs and benefits

Few comments were received on the subject of implementation costs of the Standard. This Standard has, for most contractors, almost no cost. It does require written policies; most contractors already have such policies. A few contractors, however, may have to establish or modify inventory policies; for these contractors there may be minimal costs.

The Board believes that this Standard will result in improved understanding of the requirements involved in accounting for acquisition costs of material during the negotiation and audit of contracts and these potential benefits will outweigh any costs of implementation.

11. Other comments

The published draft Standard contained a provision excepting small quantities of material used for purposes such as prototype and developmental work from the definition of an established material inventory account. While only a few commentators offered comments on this provision, in view of the revisions being made to the Standard as set out above, this provision has been deleted from the Standard.

A number of commentators raised questions concerning the potential conflict between requirements of this Standard and those set out in Standard 407, Use of Standard Costs for Direct Material and Direct Labor (4 CFR Part 407). The Board recognizes the nature of the potential conflict described by the commentators, but feel that an inventory costing method using standard costs in accordance with the requirements of Standard 407 would meet the inventory costing requirements of this Standard.

Section 411.10, General Applicability, has been shortened and simplified from the material under this section appearing in earlier promulgated Cost Accounting Standards. The earlier material was a restatement of the statutory requirements of Pub.L.91-379. The Board believed it was helpful to repeat this material to assist users of the Standards. However, the Board has from time to time provided for certain exemptions from the requirements to follow Cost Accounting Standards, and these exemptions were not recognized in the “applicability” sections of earlier Standards. The Board believes that the shortened material in 411.10, referring users to the Board’s detailed regulations, will provide users with helpful information on general applicability.

There is also being published today an amendment to Part 400, Definitions, to incorporate in that part terms defined in 411.30(a) of this Cost Accounting Standard.