FAR – Appendix (Continued) Cost Accounting Preambles and Regulations*

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FAR – Appendix (Continued)
Cost Accounting Preambles and Regulations*

Preambles to the Cost Accounting Standards, Related Rules and Regulations, and the FAR System

Part I
Preambles to the Cost Accounting Standards Published by the Cost Accounting Standards Board

Preambles to Cost Accounting Standard 401,
Consistency in Estimating, Accumulating and Reporting

Preamble A
Original Publication of Part 401, 2-29-72

Preamble to the original publication of 4 CFR Part 401, 37 FR 4139, Feb. 29, 1972. Because that publication also added 4 CFR Parts 331, 351, 400, and 402, material relating to those parts has been omitted. It appears in the Supplements to those parts.

General Comments.

The purpose of the regulations promulgated today by the Cost Accounting Standards Board is to implement section 719 of the Defense Production Act of 1950, as amended, 50 U.S.C.App. 2168, which provides for development of Cost Accounting Standards to be used in connection with negotiated national defense contracts and for disclosure of cost accounting practices to be used in such contracts. The Board believes the materials being promulgated today constitute a significant initial step toward accomplishing one of its major objectives -- improved cost accounting and the proper determination of the cost of negotiated defense contracts. The regulations spell out contract coverage (Part 331), disclosure requirements (Part 351), a compilation of Definitions (Part 400), and two Cost Accounting Standards, one calling for consistency in estimating, accumulating, and reporting costs (Part 401), and the other calling for consistency in allocating costs incurred for the same purpose (Part 402).

Development of the material being promulgated today began many months ago with extensive research. It included examining publications on the subject, conferring with knowledgeable representatives of various Government agencies, Government contractors, industry associations, and professional accounting associations, and identifying and considering all available viewpoints. From this research, the initial versions of the material now being published were developed. As a part of the continuing research effort, these initial drafts were sent to 81 agencies, associations, and Government contractors which had expressed interest in assisting the Board in its work, and their comments were solicited. Some national defense contractors field-tested the material to see how it would apply to and affect their operations and advised the Board of their findings. In each step of the research process, the Board and its staff have urged and received active participation and assistance by Government, industry, and accounting organizations. Their cooperative efforts contributed in large measure to the exposure draft published in the December 30,1971, Federal Register for comment.

To better assure that all who might want to comment had an opportunity to do so, the Board supplemented the Federal Register notice by sending copies of the Federal Register materials directly to about 175 organizations and individuals who had expressed interest or had provided assistance in the development of the published material. Also a press release was distributed announcing the publication, which resulted in numerous articles in journals. The Board availed itself of all opportunities to publicize the proposals and solicit comments on them.

Written comments in response to the published material were requested by February 4, 1972. Comments were received from 105 sources, including Government agencies, professional associations, industry associations, public accounting firms, individual companies and others. The Board appreciates the obvious care and attention devoted by commentators, and as will be seen below, the Board has greatly benefited from the comments received.

Many of the comments received were addressed to all parts of the proposed Board rules as well as to the question of public availability of the Disclosure Statements. All of the comments received have been carefully considered by the Board taking into account the requirements of section 719. Understandably, many of the comments were addressed to issues which recur in two or more of the proposed parts while others dealt only with specific sections. Comments which dealt with 11 general issues are discussed separately below followed by a section-by-section analysis of other comments. Appropriate changes have been made in the material promulgated based on the Board’s disposition of the comments received.

Those comments and suggestions received which are of particular significance are discussed below.

Section 401.20 Purpose.

Commentators stated that the purpose of the standards would require each contractor to revise his formal system of accounts in order to maintain them on a basis used for estimating Government contracts. The Board did not intend that requirement. The standard does not contain any requirement that a contractor must revise his formal system of accounts. Cost accounting records are supplemental to, and generally subsidiary to a contractor’s financial records. However, it is necessary that the cost accounting records be reconcilable to the contractor’s general financial records.

Two commentators believed that the term “practices” in the phrase “Practices used in estimating costs in pricing proposals” could be confused as including estimating techniques relating to quantitative determination as well as the cost accounting practices used in estimating. The Board does not agree, because nothing in the standard precludes the use of any quantitative estimating tools.

Section 401.50 Techniques for Application.

Several commentators believed there may be an inconsistency between the requirements of the standard and the ability to make changes to established cost accounting practices. The Board intends that compliance with respect to proposals shall be determined as of the award date of the contract or as of the date of final agreement on price if the contractor has submitted cost or pricing data pursuant to Pub.L.87-653. Modifications of established cost accounting practices for accumulating and reporting costs are permitted by other regulations of the Cost Accounting Standards Board without causing a violation of this standard. The Board has modified the standard to express these intentions.

Section 401.60 Illustration.

An illustration has been added to this section to emphasize a requirement of the standard that any significant cost must be accumulated and reported in sufficient detail to permit its comparison the estimates made therefor.

Effective Date and Application.

For the convenience of readers, the following summarizes the effective dates set forth in 331.8, 351.4(e), and Parts 400, 401, and 402, which were transmitted to the Congress on February 24, 1972, pursuant to section 719(h)(3) of the Defense Production Act of 1950 as amended. After the expiration of a period of 60 calendar days of continuous session following the date of transmittal to the Congress, the regulations herein promulgated shall take effect as set forth in those regulations, unless there is passed by the two Houses a concurrent resolution stating in substance that the Congress does not favor the proposed standards, rules, or regulations.

4. Any contractor having a contract awarded prior to July 1, 1972, which contains a clause which already incorporates requirements governing submission of Disclosure Statements and application of Cost Accounting Standards will be required to comply with the provisions of that clause. In this connection, such contractor and the respective contracting agencies whose contracts contain such a clause should review those contracts to determine whether negotiations should be instituted to make Parts 400 through 402 applicable to them.

Preamble B
Preamble to Amendments of 11-7-73

Preamble to revision of the definitions of “actual cost” and “Indirect cost pool” in 401.30(a)(2) and (4), published at 38 FR 30725, Nov. 7, 1973. Material referring to other parts of 4 CFR Chapter III has been omitted; it appears in the Supplements to those parts.

The purpose of this publication by the Cost Accounting Standards Board is to amend Parts 331, 351, 400, 401, 402, 403, and 404 of its rules and regulations. The amendments, which are minor clarifications to the regulations, were published in the Federal Register of September 5, 1973 (38 FR 23971). The amendments: * * * (c) modify certain definitions in Parts 400, 401, 402, 403, and 404 for the purposes of uniformity among the various parts. Only one comment in response to the September publication has been received by the Board. This expressed agreement with the proposed changes.

In view of the foregoing, the following amendments to the Boards regulations are being made effective November 7, 1973.

Preamble C
Amendment published 11-30-76

Preamble to the addition of Appendix -- Interpretation No. 1 added on Nov. 30, 1976, at 41 FR 52427.

Interpretation No. 1 to Part 401, Cost Accounting Standard, Consistency in Estimating, Accumulating and Reporting Costs, is being published today by the Cost Accounting Standards Board pursuant to Section 719 of the Defense Production Act of 1950, as amended. (Pub.L.91-379, 50 U.S.C.App. 2168.)

This Interpretation culminates extensive research over a period of several years on the subject of accounting for the costs of direct materials not incorporated in end items. This research indicated that, as a general rule, the cost of such materials is being allocated properly to cost objectives. Accordingly, the Board concluded that a Cost Accounting Standard on this subject was not warranted at this time. However, the research indicated that frequent questions were raised with respect to the requirements of Part 401 regarding consistency between estimating the costs of certain direct materials in pricing proposals and the accumulation and reporting of such costs. Thus, the Board concluded that it would be desirable to issue an Interpretation of Part 401 to address specifically the requirements regarding consistency between estimating and accounting for the costs of such direct materials.

Section 401.40 requires that a contractor’s “practices used in estimating costs in pricing a proposal shall be consistent with his cost accounting practices used in accumulating and reporting costs.” Many contractors estimate the cost of certain direct materials, such as materials that will be scrapped, as a percentage of basic direct material requirements or of some other base. A significant number of questions have been raised as to the cost accounting practices to be followed where the cost of such materials is estimated on the basis of percentage factors. The Interpretation being published clarifies the requirements of Part 401 in this regard.

A proposed Interpretation was published in the Federal Register of June 24, 1976, with an invitation to interested parties to submit written comments. The Board supplemented the invitation in the Federal Register by sending copies of the proposed Interpretation directly to over 1,000 organizations and individuals. The Board received 43 written comments, all of which have been carefully considered by the Board.

In addition to an evaluation of the written comments, conversations were held with thirteen of these commentators who indicated particular problems with the proposed Interpretation. The Board takes this opportunity to express its appreciation for the time and effort expended by those who met with the Board representatives or provided written comments.

Comments of particular significance with respect to the proposed Interpretation are discussed below.

1. -- Need for an Interpretation

Several commentators stated that as the Interpretation expands the scope and is not consistent with the intent of Part 401, which they say requires only a comparison of actual costs with estimated costs for direct material. They argued that the Defense Contract Audit Agency (DCAA) guidance to its field auditors in October 1973 satisfactorily explained the meaning of Part 401. In general, these commentators felt that an Interpretation to Cost CAS 401 was not needed.

The Board’s research indicates that an Interpretation is needed. Numerous and widespread questions have been raised concerning whether application of a percentage factor to a base as a means of estimating the costs of certain additional direct material requirements is in compliance with Part 401 when the contractor accumulates direct material costs in an undifferentiated account. The Board notes that a similar question with respect to direct labor is specifically addressed in Part 401. Section 401.60(b)(5). In that Illustration, the accumulation of total engineering labor in one undifferentiated account is not in compliance with Part 401 where the contractor estimates engineering labor by cost function. Part 401 does not, however, specifically address the consistency requirement for direct materials, nor did the DCAA guidance specifically cover this matter. Accordingly, the Board concludes that this Interpretation is needed. In view of the fact that the Interpretation clarifies what is already required by Part 401, the Board does not agree that it expands the scope of the Standard.

2. -- Materiality

A number of commentators maintained that the cost of the materials estimated by means of a percentage factor was usually insignificant. These commentators were concerned that extensive records or analyses would have to be developed for insignificant amounts. The Board, of course, has always been concerned about the question of materiality and is on record as stating that the administration of its rules, regulations, and Cost Accounting Standards should be reasonable and not seek to deal with insignificant amounts of cost. To assure the application of the materiality criterion in this instance, specific language has been introduced which provides that the Interpretation applies only where “a significant part of costs” is estimated by means of a percentage factor. Furthermore, the Interpretation being published today recognizes that the accounting requirements of Part 401 depend on “the significance of each situation.”

3. -- Estimating Technique Versus Practice

Several respondents were of the opinion that the proposed Interpretation was inappropriate because they felt that the use of percentage factors to estimate the cost of certain direct materials is an estimating “technique,” rather than an estimating “practice.” Thus, they contended, the Interpretation is improperly covering an area not subject to Part 401, i.e., “estimating techniques,” and would limit the use of estimating factors as quantitative estimating tools. Some of these respondents noted that the Board recognized the difference between techniques and practices in the prefatory comments to Part 401, as published in the Federal Register of February 29, 1972. In that publication, the Board noted the concern of some commentators that the term “practices” in the phrase “practices used in estimating costs in pricing proposals” could be confused as including estimating techniques relating to quantitative determinations. In response to those comments, the Board stated that “nothing in the Standard precludes the use of any quantitative estimating tools.”

The Board reaffirms this conclusion. However, the Board did not intend to deny all interest in practices so readily subject to abuse. There are cases in which contractor percentage estimates are not adequately supported either by data as to relevant past experience or in any other manner. In such cases, particularly, the Board feels that the use of a percentage factor as a means of estimating the costs of additional direct materials is an estimating practice which must be consistent with the practices used in accumulating and reporting costs.

4. -- Retroactivity

A few commentators were concerned about the possible retroactive application of this Interpretation. They noted that the requirement of Part 401, as interpreted, would apply as of the date a contractor was first required to use that Standard. The commentators were concerned that those contractors who have not accounted for material costs in accordance with the Interpretation could be held to have been in noncompliance with Part 401, and therefore subject to a downward price adjustment in accordance with paragraph a(5) of the Cost Account Standards clause (4 CFR 331.50). These commentators urged that the Interpretation be effective on a prospective basis only. Some of these commentators suggested that the substance of the Interpretation should be a new Standard, with the opportunity for an equitable adjustment under a(4)(A) of the Cost Accounting Standards clause.

As already noted, the Board has carefully considered whether the subject of the Interpretation should be encompassed in a new Standard. The Board has concluded that the accounting for direct material cost as explained by this Interpretation is required by Part 401 and therefore should have been accomplished as of the date that Standard first became applicable to a contractor. Nevertheless, the Board recognizes that there has been widespread uncertainty about the application of Part 401 in situations where certain material costs are estimated on the basis of percentage factors. In addition, the Board believes that the determination of the cost impact of a contractor’s failure in the past to follow Part 401 as interpreted would be extremely difficult. Under the circumstances, the Board believes that the effort to seek contract price adjustments as a result of this Interpretation would, in most cases, be counterproductive. Accordingly, the Board believes that, in most cases, the process of attempting to determine price adjustments as a result of the retroactive application of Part 401 as interpreted would not be warranted.

5. -- Cost Accounting Practices

The proposed Interpretation stated that contractors who use a percentage factor to estimate certain direct material costs for a contract must “for that contract” maintain an adequate record or prepare an analysis of the actual cost. A number of commentators understood this sentence to require the recording or analysis on a contract-by-contract basis of the actual cost of materials represented by an estimated percentage factor. Many of these commentators noted that it would be difficult, if not impossible, to comply with this requirement. Other commentators questioned what was meant by an adequate record or an analysis.

As noted above the use of percentage factors for estimating direct material costs is an estimating practice which, pursuant to Part 401, must be consistent with the cost accounting practices used in accumulating and reporting costs. The Board notes however that Part 401 neither prescribes nor precludes any particular cost accounting practice. The Board recognizes that the consistency requirement of Part 401, as it pertains to direct material costs, could be met in a variety of ways. The Board is therefore of the view that it would be neither appropriate nor practical to prescribe by means of this Interpretation the amount of detail in accumulating and reporting costs which is deemed to be consistent with the use of percentage factors in estimating costs. The Board believes that the amount of detail which should be maintained with respect to direct material costs is a matter which is best left for decision by the appropriate Government procurement authorities on the basis of facts and circumstances of each situation. The Interpretation being published today has been revised accordingly and all references to the type of records to be maintained or analyses to be performed have been deleted.

6. -- Application to Developmental and Research Type Contracts

Many commentators urged that this Interpretation not apply to developmental and research type contracts. They said that since only material issued to these kinds of contracts is charged to such contracts, there would be no overstatement of material costs. They urged further that it would be impossible to maintain actual cost records by contract to record the additional material required and that it was extremely difficult to estimate additional material requirements because of the lack of past experience. Also, the commentators contended that material requirements on such contracts were not significant. Other commentators suggested that this Interpretation should not apply to cost type contracts.

It appears that these comments were generated mainly by the impression that the proposed Interpretation required records or analyses to be maintained by individual contract. As noted above, the Interpretation has been revised to make clear that no particular record or analysis is required by Part 401. The requirement for consistency in estimating, accumulating and reporting costs, however, applies to all contracts. The fact that a development contract or cost-type contract is involved does not remove this requirement. The Board feels that the changes made in the Interpretation should serve to minimize the problems described by these contractors.

7. -- Application to Standard Cost Accounting Systems

Several commentators suggested that this Interpretation not apply to standard cost systems. They argued that costs are not accumulated by contract or product and, therefore, compliance with the Interpretation would require a complicated and expensive recording system. They felt further that in setting standards, they use past experience plus engineering adjustments and could be charged by the Government with the need to comply with the records requirement of the Interpretation for each of their Standards.

Contractors using standard costs for material must comply with Part 407, the Use of Standard Costs for Direct Material and Direct Labor, which addresses the accounting for direct material and variances from standard costs of material. In the opinion of the Board, these contractors will be in compliance with Part 401 as interpreted.

8. -- Application to Specific Factors

Various commentators inquired about the application of this Interpretation to certain specific factors used in estimating contract price proposals, not necessarily related to the cost of additional direct materials. Among the factors mentioned were those to provide for inflation, contingencies resulting from indefinite or incomplete bills of material, losses in common inventory accounts, and miscellaneous small parts and hardware items. As noted in the Interpretation, its need was prompted by questions about the use of percentage factors to estimate the costs of “additional direct materials”; i.e., generally those direct materials not incorporated in end items. Factors such as those used to provide for inflation or allowances for incomplete bills of material do not represent costs of “additional direct materials,” as that phrase is used in the Interpretation. In the opinion of the Board, this interpretation does not apply to the costs represented by such factors.

Factors used in a proposal to provide for inventory losses represent the costs of additional materials which are governed by this Interpretation. With respect to factors for small parts, the Board notes that in accordance with Part 401, 401.60, Illustrations, a practice of estimating an average cost for a minor standard hardware item is considered to be consistent with the practice of recording the actual costs of such items.

The amount of detail to be used in accumulating and recording such costs, however, is a matter to be decided in accordance with this Interpretation.

9. -- Application of Interpretation to Direct Labor

A number of commentators raised questions concerning the applicability of the Interpretation to direct labor. Several commentators said it should not apply to such labor but should be clearly limited to direct materials. One commentator felt that the Interpretation was equally applicable to direct labor and should so state.

As already noted in paragraph 1, above, Part 401 includes specific provisions on the consistency requirements regarding direct labor. Accordingly, the Board is of the opinion that no further specific coverage of direct labor is required in this Interpretation.

Preamble D
Preamble, to Document Published 6-8-78

The document published on June 8, 1978 at 43 FR 248 19, revised 401.10. This amendment was part or a publication which added 331.30(b)(3). Only the portion of the preamble which describes the revision to 401.10 is printed here. The remainder or 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.

Preambles to Cost Accounting Standard 402,
Consistency in Allocating Costs Incurred for the Same Purpose

Preamble A
Preamble to Original Publication of Part 402, 2-29-72

Preamble to original publication of 4 CFR Part 402, 37 FR 4139. Feb. 29, 1972. That publication also included the addition of 4 CFR Parts 331, 351, 400, and 401, and so material relating to those parts has been omitted. It appears in the Supplements to those parts.

General Comments.

The purpose of the regulations promulgated today by the Cost Accounting Standards Board is to implement section 719 of the Defense Production Act of 1950, as amended, 50 U.S.C.App. 2168, which provides for development of Cost Accounting Standards to be used in connection with negotiated national defense contracts and for disclosure of cost accounting practices to be used in such contracts. The Board believes the materials being promulgated today constitute a significant initial step toward accomplishing one of its major objectives -- improved cost accounting and the proper determination of the cost of negotiated defense contracts. The regulations spell out contract coverage (Part 331), disclosure requirements (Part 351), a compilation of Definitions (Part 400), and two Cost Accounting Standards, one calling for consistency in estimating, accumulating, and reporting costs (Part 401), and the other calling for consistency in allocating costs incurred for the same purpose (Part 402).

Development of the material being promulgated today began many months ago with extensive research. It included examining publications on the subject, conferring with knowledgeable representatives of various Government agencies, Government contractors, industry associations, and professional accounting associations, and identifying and considering all available viewpoints. From this research, the initial versions of the material now being published were developed. As a part of the continuing research effort, these initial drafts were sent to 81 agencies, associations, and Government contractors which had expressed interest in assisting the Board in its work, and their comments were solicited. Some national defense contractors field-tested the material to see how it would apply to and affect their operations and advised the Board of their findings. In each step of the research process, the Board and its staff have urged and received active participation and assistance by Government, industry, and accounting organizations. Their cooperative efforts contributed in large measure to the exposure draft published in the December 30, 1971, Federal Register for comment.

To better assure that all who might want to comment had an opportunity to do so, the Board supplemented the Federal Register notice by sending copies of the Federal Register materials directly to about 175 organizations and individuals who had expressed interest or had provided assistance in the development of the published material. Also, a press release was distributed announcing the publication, which resulted in numerous articles in journals. The Board availed itself of all opportunities to publicize the proposals and solicit comments on them.

Written comments in response to the published material were requested by February 4, 1972. Comments were received from 105 sources, including Government agencies, professional associations, industry associations, public accounting firms, individual companies, and others. The Board appreciates the obvious care and attention devoted by commentators, and as will be seen below, the Board has greatly benefited from the comments received.

Many of the comments received were addressed to all parts of the proposed Board rules as well as to the question of public availability of the Disclosure Statements. All of the comments received have been carefully considered by the Board taking into account the requirements of section 719. Understandably, many of the comments were addressed to issues which recur in two or more of the proposed parts while others dealt only with specific sections. Comments which dealt with 11 general issues are discussed separately below followed by a section-by-section analysis of other comments. Appropriate changes have been made in the material promulgated based on the Board’s disposition of the comments received.

Those comments and suggestions received which are of particular significance are discussed below.

Part 402 Title.

One commentator pointed out that the definition of the word “allocate” covered all of the actions encompassed by the word “charge” and, therefore, the title of the standard should be changed to delete the words “charging and.” The Board agrees and has made the appropriate change here and elsewhere throughout the standard.

Section 402.40 Fundamental Requirement.

A number of commentators suggested a change to the standard to eliminate the requirement that direct and indirect costs be consistently allocated to all final cost objectives. Making the standard applicable only to individual contracts would permit a choice to be made solely on the basis of short-term economic benefit; the Board therefore has not adopted the suggestion.

Section 402.50 Techniques for Application.

Several commentators noted that the standard discusses the required treatment of incurred costs but does not cover estimated costs. The Board intends that both types of costs be covered by the standard and has therefore added a new paragraph to this section to make that intention clear.

A number of commentators suggested that the concept of materiality be included in the standard to allow the handling of minor direct cost items as indirect costs similar to the treatment accorded materiality in current ASPR regulations. The Board agrees, and has included a materiality statement in this section.

Several commentators did not understand the relationship of this standard to the Disclosure Statement. (This relationship is set out in paragraph (b) of this section). The Board intends to allow the contractor to disclose the cost accounting practices and criteria appropriate to his own situation while at the same time imposing the requirement that he adhere consistently to the choices once made. The Disclosure Statement is the vehicle by which the contractor describes the criteria and circumstances which define costs which are or are not incurred for the same purpose.

Effective date and application. For the convenience of readers, the following summarizes the effective dates set forth in 331.8, 351.4(e), and Parts 400, 401, and 402, which were transmitted to the Congress on February 24, 1972, pursuant to section 719(h)(3) of the Defense Production Act of 1950 as amended. After the expiration of a period of 60 calendar days of continuous session following the date of transmittal to the Congress, the regulations herein promulgated shall take effect as set forth in those regulations, unless there is passed by the two Houses a concurrent resolution stating in substance that the Congress does not favor the proposed standards, rules, or regulations.

4. Any contractor having a contract awarded prior to July 1, 1972, which contains a clause which already incorporates requirements governing submission of Disclosure Statements and application of Cost Accounting Standards will be required to comply with the provisions of that clause. In this connection, such contractor and the respective contracting agencies whose contracts contain such a clause should review those contracts to determine whether negotiations should be instituted to make Parts 400 through 402 applicable to them.

Preamble B
Amendments Published 11-7-73

Preamble to revision of the definitions of “cost objective” and “indirect cost pool”, 402.30(a) (2) and (6); 38 FR 30725, Nov. 7, 1973. Material relating to other parts of 4 CFR Chapter III, published in the same document, has been omitted, and appears in the Supplements to those parts.

The purpose of this publication by the Cost Accounting Standards Board is to amend Parts 331, 351, 400, 401, 402, 403, and 404 of its rules and regulations. The amendments, which are minor clarifications to the regulations were published in the Federal Register of September 5, 1973 (38 FR 23971). The amendments: * * * (c) modify certain definitions in Parts 400, 401, 402, 403, and 404 for the purposes of uniformity among the various parts. Only one comment in response to the September publication has been received by the Board. This expressed agreement with the proposed changes.

In view of the foregoing, the following amendments to the Board’s regulations are being made effective November 7, 1973.

Preamble C
Amendment Published 6-18-76

Preamble to the addition of Appendix -- Interpretation No. 1 added on June 18, 1976 at 41 FR 24691.

Interpretation No. 1 to Part 402, Cost Accounting Standard, Consistency in Allocating Costs Incurred for the Same Purpose, is being published today by the Cost Accounting Standards Board pursuant to Section 719 of the Defense Production Act of 1950, as amended. (Pub.L.91-379, 50 U.S.C.App. 2168). The interpretation deals with the application of 402.40 of Part 402 to proposal costs. Section 402.40 provides that, “All costs incurred for the same purpose, in like circumstances, are either direct costs only or indirect costs only with respect to final cost objectives.”

A number of questions had been raised by both the Government and contractors as to how Cost Accounting Standard 402 is to be applied to the accounting for proposal costs and, particularly, as to whether all costs incurred in preparing proposals are incurred for the same purpose, in like circumstances. A proposed interpretation was published in the Federal Register of February 4, 1976, with an invitation to interested parties to submit written comments if the proposed interpretation did not respond fully, or did not respond clearly enough, to what the Board understood to be the questions which had arisen. The Board also supplemented the invitation in the Federal Register by sending copies of the proposed interpretation to several hundred organizations and individuals. The Board received 32 written comments from companies, Government agencies, industry and professional associations, and others. All of these comments have been carefully considered by the Board. The issues of particular significance which were discussed by respondents in connection with the proposed interpretation are summarized below, together with explanations of the changes made in the interpretation being published today. The Board takes this opportunity to express its appreciation for the helpful suggestions and criticisms that were received.

Preamble D
Preamble to Document Published 6-8-78

The document published on June 8, 1978 at 43 FR 24819, revised 402.10. This amendment was part of a publication which added 331.30(b)(3). Only the portion of the preamble which describes the revision to 402.10 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.

Preambles to Cost Accounting Standard 403,
Allocation of Home Office Expenses to Segments

Preamble A
Preamble to Original Publication, 12-14-72

Preamble to original publication of 4 CFR Part 403, at 38 FR 26680, Dec. 14, 1972.

The Standard on Allocation of Home Office Expenses to Segments is one of a series being promulgated by the Cost Accounting Standards Board pursuant to section 719 of the Defense Production Act of 1950, as amended, Pub.L.91-379, 50 U.S.C.App. 2168, which provides for the development of Cost Accounting Standards to be used in connection with negotiated national defense contracts.

Work on this Standard was initiated as the result of a variety of continuing problems between contractors and the Government concerning equitable allocations of home office expenses to segments involved in negotiated defense contracts. The problems include disagreements on:

The allocation of home office expenses to segments is not now specifically governed or guided by an authoritative accounting statement. Home office expenses allocated to segments and then to contracts can constitute an important element of total contract cost. The lack of authoritative standards to guide contractors, procurement officers, auditors, and others, provides a great potential for disagreement and controversy over contract costs. Assurance of equity in cost determinations and contract settlement is singularly lacking.

This Standard prescribes criteria for allocation of the expenses of a home office to segments of an organization. The criteria are based primarily on the beneficial or causal relationship between such expenses and the receiving segments. The Standard governs how a contractor may allocate expenses of its corporate headquarters to various divisions, subsidiaries, plants, or other subsidiaries of the corporation. The Board believes that application of this Standard will result in sound cost accounting and will provide a great degree of uniformity in the determination of costs of negotiated defense contracts.

Research establishes that some home office expenses are incurred for specific segments and can be assigned directly to them. Other expenses, not incurred for a specific segment, have clear relationships to two or more segments, relationships which are measurable with reasonable objectivity. A third type of home office expense possesses no readily measurable relationship to segments.

The Cost Accounting Standards Board finds that a Cost Accounting Standard to govern the allocation of home office expenses is desirable to reduce wasteful and expensive controversy and to obtain equity for the contracting parties. The Standard published today requires that those home office expenses incurred for specific segments are to be allocated directly to those segments to the maximum extent practical. Those that can be allocated to segments on the basis of objective measurable relationships are to be accumulated and allocated by means of logical and homogeneous expense pools established for this purpose. The remaining or residual home office expenses are then to be allocated as discussed below.

The Board expects that this Standard will operate to reduce residual expenses to a relatively minor amount and by this means also reduce controversy and inequity. Where this is the case, the Board sees no reason to require one particular technique to allocate these expenses. Accordingly, where residual expenses are no greater than a specified percentage of operating revenues, the Standard allows the use of any appropriate allocation technique. However, if residual expenses exceed such specified percentages, the Board believes that its objective of reducing controversy and avoiding inequity would best be served by selecting a single allocation technique to be used. Its research in this connection has led the Board to conclude that for this purpose, a three-factor formula is superior to other allocation bases and techniques for the allocation of residual expenses.

Early research on this Standard included an extensive review of available literature on the subject, a review of decisions of contract appeals boards and courts, and a study of home office management philosophy and operations of 40 companies representing a wide variety of industries.

This research led to the publication of a proposed Cost Accounting Standard in the Federal Register of June 30, 1972, with an invitation for interested parties to submit written data views, and comments to the Board. To better assure that those who had already expressed interest or provided assistance had an opportunity to comment, the Board supplemented the Federal Register notice by sending copies of the Federal Register materials directly to 196 organizations and individuals, of which 86 companies were invited to furnish the Board with estimates of any additional or reduced costs which could arise from the implementation of the Standard.

Responses were received from 130 sources, including individual companies, Government agencies, professional associations, industry associations, public accounting firms, and others. All of these comments and data have been carefully considered by the Board. Those comments which are of particular significance are discussed below together with an explanation of resultant substantive changes to the Standard as published in the Federal Register of June 30, 1972.

As will be seen from the following discussion, the Board was greatly benefited by the many comments it received on the Standard as published in the Federal Register of June 30, 1972. The Board takes this opportunity to express its considerable debt to those who devoted time and skill to assisting the Board in this endeavor and to thank the many companies and individuals involved.

Preamble B
Amendments, 11-7-73

Preamble to revisions of the definitions of “home office” and “tangible capital asset,” 403.30(a)(2) and (5), and editorial amendments to 403.50(c)(2) and 403.70, 38 FR 30725, Nov. 7, 1973. The document amended 4 CFR Parts 331, 351, 401, 402, and 404 as well as Part 403; material relating to those parts is omitted. It appears in the supplements to those parts.

The purpose of this publication by the Cost Accounting Standards Board is to amend Parts 331, 351, 400, 401, 402, 403, and 404 of its rules and regulations. The amendments, which are minor clarifications to the regulations, were published in the Federal Register of September 5, 1973 (38 FR 23971). The amendments: * * * * (c) modify certain definitions in Parts 400, 401, 402, 403, and 404 for the purposes of uniformity among the various Parts. Only one comment in response to the September publication has been received by the Board. This expressed agreement with the proposed changes.

In view of the foregoing, the following amendments to the Board’s regulations are being made effective November 7, 1973.

Preamble C
Amendments, 8-4-75

This publication, 40 FR 32747, August 4, 1975, revised 403.70(a) and made several amendments to Part 351. Only those portions of the preamble which describe the revision of 403.70(a) are printed here, although the complete preamble appears as preamble F of the supplement to Part 351. A correction to the language which amended 403.70 was printed at 40 FR 33819, August 12, 1975.

The purpose of this publication by the Cost Accounting Standards Board is to modify Part 351, Basic Requirements, of its rules and regulations and Part 403, Allocation of Home Office Expenses to Segments. A proposed modification to Part 351 was published in the Federal Register of April 3, 1975 (40 FR 14942). Twenty-seven sets of comments were received in response to that publication. After considering those comments, the most significant of which are discussed below, the Board is today publishing an amendment to its rules relative to the requirement for the submission of Disclosure Statements by defense contractors and subcontractors.

6. Applicability of CAS 403. A number of commentators noted that the April 3 proposal deleted paragraph 351.41 of the Board’s regulations. This paragraph restated the requirement that only companies that met the Disclosure Statement filing requirement for Federal fiscal year 1971 were required to comply with CAS 403, Allocation of Home Office Expenses to Segments. These commentators asked that the Board’s position be clarified as to whether or not any current revision to the Disclosure Statement requirement also changed the coverage of CAS 403. It was not the Board’s intention to broaden the coverage of CAS 403 at this time. The possibility of extending the coverage of that Standard is the subject of a separate study currently underway. To make the Board’s intention wholly clear, 403.70 of CAS 403 is being revised to state explicitly rather than by cross reference the continuing coverage of that Standard. This revision has no substantive significance whatever, but instead merely sets out specifically what was and continues to be the exemption from that Standard, which was before today accomplished by reference to 351.40 of the Board’s Basic Requirements. Contractors and subcontractors which together with their subsidiaries did not receive net awards of negotiated national defense prime contracts during Federal fiscal year 1971 totaling more than $30 million continue to be exempt from Standard 403.

Preamble D
Amendment Published 9-12-77

This document amended 403.70(a) and designated the existing text or 403.80 as (a) and added (b). The amendment was published at 42 FR 45625, Sept. 12, 1977 as a part of the publication which added Part 332 and amendments to Parts 331 and 351 of this title. The complete preamble appears on the supplement to Part 332.

Comments on Part 403

With respect to the amendment of Part 403, the November 30, 1976 proposal was to revise that Standard to make it applicable to any contract which was subject to Cost Accounting Standards generally. The amendment being promulgated today retains this concept. However, as recommended by a number of commentators, the Board deferred the promulgation of this amendment pending the amendments to Parts 331 and 351 and the addition of Part 332 discussed above.

The decision to extend the application of Part 403 to additional contractors was made on the basis of extensive research. This research included both those contractors who were already required to use Part 403 and those who were expected to use it as a result of this amendment. With respect to the current users, the Board is satisfied that this Standard has resulted in more equitable allocations, with little administrative effort in most cases. With respect to potential additional users, the research indicated that many of these would have to make few, if any, changes to comply with Part 403 and that the remainder could comply with little difficulty. The Board notes in addition, an independent study by the Conference Board which found that defense contractors who are using Part 403 for contract costing purposes are using the same allocation procedures for internal reporting purposes. According to the Conference Board, it was typical of these companies to allocate home office expenses on a blanket basis prior to the promulgation of Part 403. (Information Bulletin No. 17, February 1977.)

A number of commentators suggested various limitations for the application of Part 403. Some of these suggestions were expressed in general terms. Some of the commentators recommended, for example, that the requirement to use Part 403 should not be extended to “small contractors.” Alternatively or additionally it was recommended that Part 403 should not be required for a large contractor with little work subject to Cost Accounting Standards. More specifically, recommendations were received to exempt those contractors with less than 10 percent of their revenue from Government work. Others recommended that contractors who have less than $10 million in contracts subject to Cost Accounting Standards should be exempt. The Board believes that the recommendations of this nature have been accommodated to the extent desirable and practical by the amendments to Parts 331 and 351 and the addition of Part 332 being promulgated today. Accordingly, any further exemption from Part 403, specifically, is considered to be necessary.

In publishing the proposed amendment to Part 403 in the Federal Register of November 30, 1976, the Board stated that there is evidence that almost all contractors who were required to make significant changes in their allocation practices as a result of Part 403 did so without undue trouble or expense. Several commentators questioned the Board’s conclusion in this regard. The Board’s conclusion was based in part on Staff research in involving 147 home offices who now use Part 403 to allocate home office expenses. This research sought to determine, among other things, the administrative problems and expense involved in making allocations pursuant to Part 403. Government auditors reported that of the 147 home office only 4 had problems in developing the necessary data and that there was evidence of significant administrative costs at one of these four offices. In addition, evidence of significant administrative costs in making the allocations was found by the Government auditors at four other of the 147 home offices.

Some of the respondents who questioned the Board’s conclusions regarding administrative problems and expense referred to an industry report on the economic impact of Cost Accounting Standards as support for this position. These respondents variously referred the Board to those sections of the report which summarized

Two associations reported that, contrary to the Board’s findings, their member companies had experienced trouble and expense in complying with Part 403. These associations declined to identify the companies involved, the nature of the problems, or the amount of the expenses. Under these circumstances, there is no basis to alter the conclusion that contractors have been able to make changes required as a result of Part 403 without undue trouble or expense.

One commentator stated that it would not be desirable to make more contractors subject to Part 403 because he believes it to be defective, particularly with respect to its application to the allocation of state and local taxes. With respect to the application of the Standard to the allocation of state and local taxes specifically, the Board notes that it reached its conclusion on the basis of considerable research and extensive deliberation. Moreover, it has reexamined its conclusion, even after the promulgation of Part 403. Notwithstanding the views of the commentator, the Board continues of the view that the provision in question is proper. Accordingly, the Board does not agree that this Standard should not be extended to additional contractors because of the tax allocation provision.

Effective Date

The effective date of the regulations being published today is March 10, 1978. Pub.L.91-379 provides that regulations shall take effect not earlier than the expiration of the first period of sixty calendar days of continuous session of the Congress following the given date on which a copy of the regulations is transmitted to the Congress. The calendars of the Congress indicate that the required sixty days will not pass until some time in February 1978. Accordingly, March 10, 1978, has been selected to assure sufficient time for the regulation to lie before the Congress.

Preamble E
Preamble to Document Published 6-8-78

The document published on June 8, 1978 at 43 FR 24819, revised 403.10 and 403.70(b). This amendment was part of a publication which added 331.30(b)(3). Only the portion of the preamble which describes the revision to 403.10 and 403.70(b) are printed here. The remainder of the preamble appears as preamble K of the supplement of 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 for amending standards 401 through 409 as set forth below.

Preambles to Cost Accounting Standard 404,
Capitalization of Tangible Assets

Preamble A
Preamble to Original Publication of Part 404, 12-27-73

Preamble, Published at 38 FR 5318, Feb. 27, 1973, to the original Publication of this part.

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

Work preliminary to the development of this Standard was initiated as the result of recognition that the general subject of fixed asset accounting has been the source of continuing problems between contractors and the Government concerning equitable determinations of the costs attributable to performance of specific contracts. The problems include

Early research on this Standard included an extensive review of available literature on the subject and a review of decisions of contract appeals board and courts. A preliminary analysis of the entire topic of fixed asset accounting was made and a number of issues were identified; comments on this analysis were obtained in response an extensive mailing. After careful evaluation of the comments, the Board developed and circulated a questionnaire on tangible fixed asset accounting practices. The replies to the questionnaire were considered in the preparation of a preliminary draft of the Standard on Capitalization of Tangible Assets, which was, in turn, widely distributed for informal comment by interested parties.

The Standard now being promulgated is derived from the proposal which was published in the Federal Register for October 5, 1972, with an invitation for interested parties to submit data views, and arguments to the Board. The Board supplemented that Federal Register publication by sending copies of the Federal Register material directly to organizations and individuals who were expected to be interested. Responses were received from 107 sources, including individual companies, Government agencies, professional associations, industry associations, public accounting firms, universities, and others. All of the comments have been carefully considered by the Board.

Most of those who commented expressed general concurrence with the provisions of the proposal. Many of the contractors who commented indicated that their practices in most respects already complied with the Standard; most suggested that the proposal should be modified only in a few respects. The Board takes this opportunity to express its appreciation for the helpful suggestions and criticisms which have been furnished. Many companies and individuals have devoted significant talent and effort to the improvement of this Standard.

The comments below summarize the major issues discussed in connection with the October 5 proposal and explain the major changes which have been made.

Preamble B
Amendments, 11-7-73

This publication, 38 FR 30725. Nov. 7, 1973, amended 404.30(a)(4) by revising the definition of “tangible capital assets”.

The purpose of this publication by the Cost Accounting Standards Board is to amend Parts 331, 351, 400, 401, 402, 403, and 404 of its rules and regulations. The amendments, which are minor clarifications to the regulation, were published in the Federal Register of September 5, 1973 (38 FR 23971). The amendments:

(a) Renumber Parts 331 and 351 to facilitate insertion of future modifications those parts;

(b) clarify one section the contract clause at 331.5; and

(c) (modify certain definitions in Parts 400, 401, 402, 403, and 404 for the Purposes of uniformity among the various Parts. Only one comment in response to the September publication has been received by the Board. This expressed agreement with the proposed changes.

In view of the foregoing, the following amendments to the Board’s regulations are being made effective November 7, 1973.

Preamble C
Preamble to Document Published 6-8-78

The document published on June 8, 1978 at 43 FR 24819, revised 404.10. This amendment was part of a publication which added 331.30(b)(3). Only the portion of the preamble which describes the revision to 404.10 is printed here. The remainder of the preamble appears as preamble K of the supplemental 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.

Preamble D
Amendments Published 3-3-80

This publication, 45 FR 13721, Mar. 3, 1980, revised 404.40(b)(1) and 404.80(b) and amended 404.60(a)(1) introductory text, (a)(1)(i) and (ii).

Summary

Part 404 includes a requirement that defense contractors have written policies for capitalization of tangible assets. Each such policy must include a minimum acquisition cost criterion, which has not been allowed to exceed $500. The Standard is being amended to raise the limit to $1,000. The purpose of the change is to permit contractors to adopt practices appropriate in today’s economy.

Effective Date

December 20, 1980.

Supplementary Information

Preambles to Cost Accounting Standard 405,
Accounting for Unallowable Costs

Preamble A
Preamble to Original Publication, 9-6-73

Preamble to the original publication of Part 405. Sept. 6, 1973, at 38 FR 24195.

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

Work preliminary to the development of this Standard was started as a result of recognition of the continuing problem concerning the accounting treatment of unallowable contract costs. There has been a lack of uniformity or comparability in the cost accounting treatment accorded unallowable costs after specific determination of their unallowability. There have also been reported problems concerning the content of indirect-cost allocation bases where unallowable costs are involved. Further, there have been instances reported of inclusion of unallowable costs in the base for progress payment billings.

There is no present requirement in agency regulations for contractor identification of unallowable costs. As a result, reports prepared by Government auditors contain frequent references to costs which are known to be unallowable but disclosed only through an audit. The Board has concluded that the identification of costs determined to be unallowable should be the subject of a Cost Accounting Standard.

This Standard requires the identification of specific costs at the time such costs first become defined or authoritatively designated a unallowable. The Standard also establishes guidelines for the cost accounting treatment to be accorded such identified costs. The Board believes that application of this Standard will provide a greater degree of uniformity in the determination of costs of negotiated defense contracts.

Early research on this Standard included a review of available literature on the subject, a review of the decisions of contract appeals board and courts, and meetings with contractors and other organizations and individuals concerning their operations and philosophy relative to the treatment of unallowable costs.

This research led to the publication of a proposed Cost Accounting Standard in the Federal Register of March 30, 1973, with an invitation for interested parties to submit written data, views, and comments to the Board. To assure that those who had already expressed interest in the proposed Standard had an opportunity to comment, the Board supplemented the Federal Register notice by sending copies of the published material directly to several hundred organizations and individuals.

Responses were received from 67 sources, consisting of individual companies, Government agencies, professional associations, industry association, public accounting firms and others. All of these comments have been carefully considered by the Board. Those comments which are of particular significance are discussed below, together with an explanation of the changes made to the proposed Standard published in the Federal Register of March 30, 1973.

Government commentators generally regarded a requirement for identification unallowable costs as being reasonable and desirable as long as it recognized that there is room for agency judgment relative to the allowability of individual cost elements. The reaction from industry sources was generally in opposition to a Standard on this subject. The reaction from other commentators was mixed. The Board notes that in the comments by industry representatives are a significant number of admissions that at least some unallowable costs can be identified clearly in advance and, in fact, are so identified by many contractors.

The Board has greatly benefited from the many comments it received on the Standard as published in the Federal Register of March 30, 1973. The Board takes this opportunity to express its appreciation for the suggestions it has received, and for the time devoted to assisting the Board in this endeavor by the many companies and individuals involved.

1. -- General -- Need for a Standard.

Those who took specific exception to the need for or propriety of a Standard raised a number of issues. Following is a summary and discussion of each of the major issues raised:

(a) Existing procurement regulations and procedures are adequate to resolve what is essentially an administrative issue, and are more appropriately relied upon for accomplishing the stated purposes of the Standard.

(b) The published proposal constitutes an inflexible procedural requirement rather than a cost accounting standard; it deals with minutiae and will necessitate considerable additional accounting effort and record keeping.

(c) A standard requiring specific identification of unallowable costs will only lead to added controversy and impair the freedom of contracting parties to negotiate equitable treatment of costs.

2. -- Directly Associated Costs.

The published version of the proposed Standard defined a directly associated cost as, “Any cost which is generated solely as a result of the incurrence of another cost and which would not have been incurred had the other cost not been incurred.” It then provided, in effect, that directly associated costs of identified unallowable costs should be included with the unallowable costs with which they are associated, and be accorded similar cost accounting treatment. These provision of the Standard which were intended solely to cover costs which were incremental with respect to identified unallowable costs, drew comment from disparate sources. Those who disagreed with any attribution of nonallowability to costs which were not unallowable by nature but merely by association were opposed to the directly associated cost concept. Also, some of those favoring such attribution, while not opposed to the concept, interpreted the Standard as encroaching upon, or narrowing the application of, existing regulatory provisions governing cost disallowances, and expressed disagreement with the proposed coverage on this basis. After careful consideration of the comments on this issue, the Board has concluded that coverage in the Standard of directly associated costs is appropriate and necessary.

The Board notes that various regulatory provisions use such nondefinitive terms as “corollary administrative costs,” “related collection costs,” “related legal costs,” “incidental costs relating thereto,” “other related costs,” etc., in describing unallowable costs. In such cases, the Board considers that the identification and measurement of costs covered by these broadly worded provisions is a function of cost accounting, and therefore appropriate for coverage in this Cost Accounting Standard as directly associated costs.

In light of the above considerations, the Board has retained coverage of directly associated costs. The Board, however, recognizes that treatment of a cost as an unallowable directly associated cost in certain circumstances could result in double counting with respect to a class or category of costs included in an indirect-cost pool that will be allocated over a base containing the designated unallowable costs with which the cost in question is associated. In such circumstances, the Standard requires that the cost shall not be classified as a directly associated cost, but rather shall be retained in the indirect-cost pool and allocated through the regular allocation process.

3. -- Expressly Unallowable Costs.

The requirement in the proposed Standard for contractor identification of “cost which are patently unallowable” gave rise to expressions of concern on the part of number of respondents. These ranged from allegations of general impracticability of compliance to apprehensions that the lack of a clear definition would lead to overzealous implementation by auditors and contracting officers and to increased controversy.

Various alternative suggestions were made by commentators. One such suggestion was that identification be required only when there is mutual agreement on unallowable costs by the parties to a contract. This, however would be likely to minimize one of the benefits of the Standard; namely, the reduction of the time and effort spent in audit and negotiation covering cost whose nonallowability is obvious. Also, items requiring agreement are covered by other provisions of the Standard.

A second suggestion made by respondents was that this requirement be made applicable only to costs which the contractor considers or determines to be “patently” unallowable. This suggestion, however, is subject to obvious criticism that any requirement that would provide the party subject thereto with absolute freedom of choice as to what constitutes compliance would be of dubious effectiveness. The Standard, of course, clearly provides for the contractor to be the party having the primary responsibility of making the initial determination as to what costs incurred by him are obviously unallowable.

A third suggestion offered by respondents was that the Standard provide a definition, or examples, covering the costs which are considered to be “patently” unallowable. The Board felt that this suggestion had merit. Because of apparent confusion as to the usage of the term “patently,” the Board has substituted the word “expressly” in the Standard, and has included a definition of “expressly unallowable cost.” Most of the items cost that are of the type required to be accounted for as expressly unallowable are specified in agency procurement regulations (e.g., ASPR 15-205). It would not be practical to list the items of cost that may be made expressly unallowable under the special provisions of contracts. The Board, its definition of an “expressly unallowable cost,” has used the word “expressly” in the broad dictionary sense -- that which is in direct or unmistakable terms.

With regard to the stated concern about overzealous implementation auditors and contracting officers, the Board has previously stated that the administration of its rules, regulation, and Cost Accounting Standards should be reasonable. The Board anticipates that this rule of reason will be applied in the implementation of this Standard. Thus, where a good faith effort has been made by a contractor, in the development and implementation of his cost accounting rules, procedure and practices, to provide for identification of expressly unallowable costs, it is intended that inadvertent failure to properly classify a particular item of cost will not be regarded as noncompliance.

The Board has retained the requirement for contractor identification of costs which are unequivocally made unallowable by the express provisions of an applicable law, regulation or contract. The Standard, however, has been revised to make clearer the accounting distinction between costs which are either expressly unallowable or mutually agreed to be unallowable and costs which are designated as unallowable by the unilateral exercise of a contracting officer’s authority under contract disputes procedures. Solely for the purposes of this distinction, the provision in the revised Standard setting forth the identification requirement for expressly unallowable and mutually-agreed unallowable costs also specifies that these are costs which shall be excluded from Government-contract billings, claims, or proposals.

4. -- Indirect-Cost Allocation Bases.

By far the largest number of comments were addressed to the requirement in paragraph (c) of 405.40 of the proposed Standard, that unallowable costs shall be subject to the same cost accounting requirements as allowable costs in determining the content of cost-oriented bases for allocation of indirect costs. This is an issue which appears to have produced an almost complete polarization of the viewpoints of Government representatives and of the parties with whom they contract.

Current agency regulations (e.g. ASPR 15-203(c)) provide, in essence, that indirect-cost allocation bases should not be fragmented for purposes of removing individual elements therefrom. They therefore provide that unallowable costs in an allocation base shall “bear” their pro rata share of the indirect costs in the pool being distributed. The wording of these regulatory provisions has commonly been interpreted as meaning that the indirect costs shall assume the allowability status of the costs in the allocation base. Comments on this regulatory requirement, therefore, have centered on the issue of making otherwise allowable costs unallowable, rather than on the broader accounting principles that should govern cost allocation.

As previously indicated, the Board believes that the issues concerning cost allocation and those relating to cost allowance are distinct and separate. Allowability should not be a factor in the selection or in the determination of the content of an allocation base used to distribute a pool of indirect costs. The appropriateness of a particular allocation base should be determined primarily in terms of its distributive characteristics. Any selective fragmentation of that base which eliminates given base elements for only some of the relevant cost objectives would produce a distortion in the resulting allocations. The Board, therefore, is retaining the requirement that unallowable costs be subject to the same cost accounting principles as e those governing allowable costs.

When an item, activity, or function has been deemed unallowable by other relevant authority, the Board in this Standard has approached the determination of the costs related to the unallowable item, activity, or function in three stages: (a) Its direct cost, (b) its directly associated cost, and (c) the indirect costs allocable by means of a base containing such costs. This has been done because, while there is usually no question that the relevant authority intended that the direct cost (a) be disallowed, there may be questions as to whether costs (b) and (c) otherwise allowable, were intended to be disallowed. The latter two costs are therefore, required to be separately, identified and measured so that their allowability can be resolved through the procurement process.

In concluding that indirect-cost allocation bases should not be fragmented solely for purposes of removing unallowable base elements, the Board is not implying that the elimination of all or part of a base element for other of purposes is always inappropriate and inconsistent with sound cost accounting.

5. -- Contracting Officer Decision.

Many respondents questioned the requirement, in 405.40(a) of the proposed Standard, for identifying as unallowable those costs “designated as, unallowable as a result * * * of * * * a final decision of the contracting officer issued pursuant to contract disputes procedures.” Concern was expressed that this gave too much standing to the unilateral administrative decision of the contracting officer, and did not recognize contractors’ right of appeal to the boards of contract appeals and the courts.

The Board recognizes that legitimate disagreements over allowability often are not finally resolved by contracting officers’ decisions. The Board notes, however, that the Standard distinguishes between costs which are “expressly unallowable” and costs which are “designated as unallowable.” To further the distinction, and to remove a possible source of misinterpretation, the words “final decision” have been changed to “written decision,” to conform to wording in agency regulations governing dispute procedures. The Board believes that, although the written decisions of contracting officers pursuant to formal disputes clause procedures are subject to appeal and possible reversal, they nevertheless constitute authoritative designations, and represent the culmination of a process of audit and negotiation. Furthermore, they are binding on the parties to a contract until and unless changed on appeal. The Board, therefore, considers that any definitive designations of unallowable cost which are provided in the contracting officers’ written decisions warrant identification, and it has retained this requirement.

A further objection was raised by some commentators to the requirement, in paragraph (a) of 405.50 of the published proposal, for future recognition of costs identified as unallowable, or of other costs incurred for the same purpose in like circumstance. The observation was made that future circumstances might warrant different conclusions as to allowability.

The Board recognizes that identical costs may be unallowable under one set of circumstances, but nevertheless be determined to be allowable under different conditions, or as a result changed criteria. The Board, however, believes that specific designations of the allowability status of particular classes or categories of cost should be given consideration in the evaluation of any like costs which are governed by the same allowability criteria and which are incurred for the same purpose in like circumstances. The provisions in the Standard which reflect this viewpoint have been clarified.

The Board notes that the identification of costs covered by an adverse contracting officer decision will not prevent a contractor from continuing to claim such costs, where disagreement as to allowability continues. It serves merely to identify the costs special consideration, thereby helping to assure adequate reevaluations, and to promote resolution of the issues involved in the disagreement. Reversal of the contracting officer’s decision by a final appeals board or court ruling would, of course, relieve the contractor of any identification requirement under the Standard covering the costs involved in the ruling.

6. -- Accountability for Unallowable Costs.

A number of comments were received concerning what some writers interpreted as an unnecessary and improper requirement for detailed accountability covering costs which are absorbed by the contractor and therefore should not be of any legitimate concern to the customer. The Board does not intend requiring cost identification or cost allocation which is not relevant to the determination or Government contract cost. The Standard requires identification of unallowable costs only to the extent needed audit verification of the costs which are included in, or which provide backup support for, proposals, billings or claims. Appropriate revisions have been made in the Standard.

7. -- Colleges and Universities.

A number of comments were received from university officials expressing concern that, because colleges and universities contracting with the Government are subject to a different set of contract cost reimbursement principles than commercial organizations, and operate in a different accounting environment, the proposed Standard might present implementation problems if applied to these institutions. These comments have been carefully considered, and supplementary discussions have been held with some of the officials concerned.

On the basis of its analysis of the practices described by commentators as having been deemed acceptable in the past, and of the underlying principles and contractual requirements, the Board believes that the Standard, as revised, can be applied to colleges and universities without any disruption of practices which are acceptable under applicable laws and regulations.

Particular concern was expressed over what was reported to be a common situation, where certain costs, such as faculty salaries, are excluded from contract costs even though such costs may directly pertain to work performance which is an intrinsic part of the contract project. The Board notes that specific identification with, or allocation to, individual contracts and other final cost objectives is not required for costs which will not be included in, nor constitute pertinent backup support for, any proposal, billing, or claim. The Standard requires only that sufficient identification be provided to enable verification of the allocability status of unallowable costs and the accounting treatment actually accorded such costs. The Board, therefore, does not believe that any special provision is required covering the situation described.

8. -- Materiality.

A number of comments were received suggesting that the question of materiality be given more consideration in the Standard. The recognition of the materiality problem in paragraph (f) of 405.50 of the proposed standard was endorsed, but concern was expressed that limiting application to circumstances where there was a “low incidence of negotiated Government contracts relative to other types of work” would render the provision ineffective.

Several instances of potential problem areas were mentioned. One of these concerned the situation where corporate headquarters’ expenses are allocated to segments which are involved in a relatively insignificant volume of Government contract work. Another cited the case of a standard cost accounting system covering the manufacture of standard products which may incidentally be used as material or components contract work. A third referred to the problem of determining “true” cost of an individual product in a joint-product, joint-cost production situation. Further problem area is that involving determination of the share of indirect expense to be assigned as costs of a proscribed organizational or functional activity.

The Board recognizes that accounting for unallowable costs (which are themselves often determined only through negotiation) is an area where the question of materiality should be given special consideration. In providing this consideration, many factors should be taken into account. These include not only the materiality of the total unallowable costs, but also the materiality of the refinements in determinations of unallowable costs which might be achieved through requiring detailed application of the Standard, as contrasted with negotiating the agreements authorized under the proposed paragraph (f) of 405.50. The Board, accordingly, has revised the Standard to include an amended paragraph (c) which, “based upon considerations of materiality,” permits agreements that will satisfy the purpose of the Standard. The Board believes that, in applying the materiality provision of the revised paragraph (c), consideration should be given to the criteria listed in the section titled “Materiality” in the Board’s March 1973 “Statement of Operating Policies, Procedures and Objectives.”

9. -- Improperly Allocated Costs.

One commentator raised a question concerning the accounting treatment to be accorded costs which are disallowed because they are erroneously allocated to the contract under which they are claimed. The Board does not believe that the Standard needs to deal with accounting errors of this type. It is obvious that the accounting treatment to be accorded any item of cost should be determined by that cost’s correct positioning in the cost accounting structure.

10. -- Cost/Benefit.

Only limited comments were received on the subject of the implementation cost of the Standard, and several of these indicated only minimal impact. Of those claiming significant additional implementation expense, none provided any data as justification for the claim. The Board has concluded from its research that the Standard, as revised, constitutes a reasonable requirement, and that the costs of implementation will be minimal. The potential benefits to the audit and negotiation processes accruing from the increase in visibility and in uniformity of cost accounting treatment will be substantial and will greatly outweigh any added costs.

11. -- Effective Date and Application.

With respect to the date that this standard becomes effective, it is anticipated that its provisions will be applicable to all solicitations issued on or after January 1, 1974, which are likely to lead to contracts covered by Standards, rules, and regulations of the Cost Accounting Standards Board.

There is also being published today an amendment to Part 400.

Definitions, to incorporate in that part the words and phrases defined in 405.30 of the Standard.

Preamble B
Preamble to Document Published 6-8-78

The document published on June 8, 1978 at 43 FR 24819, revised 405.10. This amendment was part of a publication which added 331.30(b)(3). Only the portion of the preamble which describes the revision to 405.10 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 section 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.

Preambles to Cost Accounting Standard 406,
Cost Accounting Period

Preamble A
Preamble to Original Publication, 11-7-73

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

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

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

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

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

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

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

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

Preamble B
Preamble to Document Published 6-8-78

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

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

Preambles to Cost Accounting Standard 407,
Use of Standard Costs for Direct Material and Direct Labor

Preamble A
Preamble to Original Publication, 4-1-74

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

The Cost Accounting Standard on the Use of Standard Costs for Direct Material and Direct Labor published today is one of a Series being promulgated by the Cost Accounting Standards Board pursuant to Section 719 of the Defense Production Act of 1950, as amended, Pub L. 91-379, 50 U.S.C App. 2168, which provides for the development of Cost Accounting Standards to be used in connection with negotiated national defense contracts.

Work preliminary to the development of this Cost Accounting Standard was initiated as the result of the recognition that practices concerning the use of Standard costs for contract costing purposes have not been well defined in Government procurement regulations. The Board has undertaken research on this subject with a view that Cost Accounting Standards promulgated on this subject will provide better guidance in the use of Standard costs.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Preamble B
Preamble to Document Published 6-8-78

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

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.

Preambles to Cost Accounting Standard 408,
Accounting for Costs of Compensated Personal Absence

Preamble A
Preamble to Original Publication, 9-19-74

The following is the preamble to the original publication of Part 408, on Sept. 19, 1974, at 39 FR 33681.

The Cost Accounting Standard on Accounting for Costs of Compensated Personal Absence is one of a series being promulgated by the Cost Accounting Standards Board pursuant 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. This Standard deals primarily with the amount and time recognition of costs of compensated personal absence.

Work preliminary to the development of this Cost Accounting Standard was initiated as a part of the study of the larger subject of accounting for labor costs. The costs of compensated personal absence are an important element of labor costs, but under existing procurement regulations there is no assurance that the costs of compensated personal absence are assigned to the cost accounting period in which the related labor is performed and in which the related wage or salary cost are recognized. Because the volume and mix of contracts of a particular Contractor may vary significantly from period to period, the assignment costs to the proper cost accounting periods is important.

Early research on this Cost Accounting Standard included a study of available literature and relevant decision of boards of contract appeals a Courts. Initial meetings were held with major procurement agencies and with a number of Contractors, and certain issues were tentatively identified. The relationship of Government procurement regulations to Federal Income Tax laws which govern the accounting for costs of compensated personal a sense was explored. It was noted that the exact nature of the employer’s ability to employees under a specific plan was an important consideration in determining the income tax treatment which might be permitted. A review of Disclosure Statements file indicated a disparity in existing accounting practices.

A questionnaire and a statement issues were then sent to 117 companies, 40 Government agencies, and 53 others, including industry and professional associations, to obtain detail information, particularly in regard to benefit plans and the reasons for selecting a specific accounting method. Data on benefit plans and accounting practices were received from 68 companies and comments on the issues were received from 37 respondents. Analysis of the data and Comments indicated that the issue could be classified broadly into two group -- those relating to the amount and timing of recognition of costs of compensated personal absence and those relating to methods of allocation of these costs to cost objectives. Some problems were noted in connection with the charging of costs of compensated personal absence directly to final cost objectives at the time of payment; these have been addressed in the Standard. Detailed criteria for the allocation of costs of compensated personal absence are not included in this Standard. Additional study of other labor-related costs is being undertaken and when it has been completed such criteria may be provided.

Based on analysis of the responses to the questionnaire and issues paper and on further discussions, a preliminary draft Standard was developed and widely distributed for comment. Comments and suggestions were received from 87 respondents; these comments were considered in developing a revised Standard which was published in the Federal Register off March 4, 1974, with an invitation to interested parties to submit written views and comments to the Board. The Board also supplemented the invitation in the Federal Register by sending copies of that issue to several hundred organizations and individuals who had provided the Board with Comments or the earlier proposal or who had otherwise expressed interest in the proposal.

Following the Federal Register publication, the Board received 86 sets of written comments from companies, Government agencies, professional associations, industry associations, public accounting firms, universities, and others. All comments have been carefully considered by the Board and those addressing areas of 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 Of March 4, 1974.

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

Preamble B
Preamble to Document Published 6-8-78

The document published on June 8, 1978 at 43 FR 24819, revised 408.10 and 408.70. This amendment was part of a publication which added 331.30 (b)(3). Only the portion of the preamble which describes the revision to 408.10, 408.70 are 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.

Preambles to Cost Accounting Standard 409,
Depreciation of Tangible Capital Assets

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.

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.

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:

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:

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

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.

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.

Preambles to Cost Accounting Standard 411,
Accounting for Acquisition Costs of Material

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.

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.

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.

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.

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.”

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.

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.

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.

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.

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.

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.

Preambles to Cost Accounting Standard 412,
Composition and Measurement of Pension Cost

Preamble A
Original Publication, 9-24-75

The following is the preamble to the original publication of Part 412, 40 FR 43873, Sept. 24, 1975.

The Cost Accounting Standard on Composition and Measurement of Pension Cost is one of a series being promulgated by the Cost Accounting Standards Board pursuant to section 715 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. This Standard establishes the components of pension cost, the bases for measuring such cost, and the criteria for assigning pension costs to cost accounting periods.

As part of the Board’s early research relating to the subject of pension costs, it developed an Issues Paper in August 1973, and a preliminary draft Standard in September 1974. Both the Issues Paper and preliminary Standard were sent to a large cross-section of companies, Government agencies, industry and professional associations, actuaries, and other interested individuals. The Board received responses to these research papers which were useful in identifying the key issues involved in pension cost accounting and in developing a proposed Standard which was published in the Federal Register of May 5, 1975, with an invitation to interested parties to submit written views and comments to the Board. The Board also supplemented the invitation in the Federal Register by sending copies of the proposed Standard to several hundred organizations and individuals who had provided the Board with comments on the preliminary proposal or who had otherwise expressed interest in the subject of the Standard.

The Board received 80 sets of written comments from companies, Government agencies, professional associations, industry associations, public accounting firms, universities, actuaries and others in response to the Federal Register proposal. All of these comments have been carefully considered by the Board. The Board’s views on each of the major issues discussed by commentators are outlined below, together with explanations of the changes made in the Cost Accounting Standard being promulgated.

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

(1) Relationship to the Employee Retirement Income Security Act of 1974 and to Generally Accepted Accounting Principles

The Board received a variety of comments relative to the relationship between the proposed Standard, the Employee Retirement Income Security Act of 1974 (ERISA), and generally accepted accounting principles set forth in “Accounting for the Cost of Pension Plans,” Opinion No. 8 by the Accounting Principles Board (APB-8). Some stated that, with the enactment of ERISA, Congress has expressed its will relative to pensions and a Cost Accounting Standard on pension costs which is different than ERISA is unnecessary. Others stated that APB-8 is a viable and proven document which provides sufficient guidance for both financial accounting and cost accounting purposes. Others stated that the combination of ERISA and APB-8 provides all the guidance needed for cost accounting purposes. Still others stated that a Standard should be deferred until the Federal regulations required by ERISA have been promulgated, and/or the Financial Accounting Standards Board (FASB) completes its reevaluation of APB-8.

The purpose of the Board in promulgating this Standard is to establish the accounting bases for measuring the proper amount of pension cost to be assigned to cost accounting periods for subsequent allocation to negotiated Government contracts.

ERISA establishes, among other things, minimum funding standards for pension plans and provisions affecting deductibility of pension costs for tax purposes. Although there is some commonality between the funding provisions of ERISA and the provisions of the Standard, ERISA does not provide for the measurement of pension costs for assignment among cost accounting periods or for the subsequent allocation of such costs to contracts. Accordingly, the Standard contains requirements, not contained in ERISA, to accomplish these purposes. Nevertheless, on the basis of its research, the Board is confident that the Standard being promulgated is compatible with the requirements of ERISA, i.e., compliance with the provisions of the Standard does not violate the provisions of ERISA, although certain provisions of the Standard are more restrictive than is permitted by ERISA.

APB-8 provides criteria for accounting for the cost of pension plans for financial accounting purposes. The Board believes that certain of these criteria are not appropriate for Government contract costing purposes. For example, a fundamental concept of APB-8 is that the annual pension cost to be charged to expense for financial accounting purposes is not necessarily determined by the funding of a pension-plan. The Board believes that a requirement of law for annual minimum funding of pension costs on an irrevocable basis, is strong evidence that an obligation for at least such period.

The Board is aware of the FASB’s projects to establish financial accounting and reporting Standards for employee benefit plans and to reevaluate APB-8, as well as the need for the cognizant Government agencies to develop regulations relative to ERISA. It is our understanding that the FASB reevaluation of APB-8 is not likely to result in a Standard that would be applicable before the end of calendar year 1976. The Board believes however, that the issuance of a Cost Accounting Standard is needed promptly for contract costing purposes.

For example, there does not now exist any authoritative guidance which sets forth the components of pension cost that are properly includable and excludable for contract costing purposes. In addition, there are no existing criteria to resolve how the components of pension cost, once determined, shall be measured and assigned to cost accounting periods. The need for such measurement and assignment criteria for contracts is particularly critical because of the long-range projections used in computing pension cost and because the many techniques available for measuring and assigning such cost have significant impact thereon. The significant amounts involved in annual pension cost calculations, the changes in the mix of contractors’ Government and commercial business, and the settlement of individual contracts long before actual pension costs can be determined create a special need to provide criteria relative to the assignment of pension costs among cost accounting periods and the allocation of such costs to the cost objectives of the periods.

In developing the accompanying Cost Accounting Standard, the Board has attempted to stay within the general constraints of APB-8 and the funding provisions of ERISA. The Board recognizes that in the FASB’s reconsideration of APB-8, the FASB could make significant changes in the manner in which pension costs are to be treated for financial accounting purposes and that the FASB’s project on financial accounting and reporting for employee benefit plans may influence the conclusions reached in the reevaluation of APB-8. However, any such changes would be directed to external financial reporting and would not necessarily impact contract costing. The Board is also aware that Federal regulations which may be issued could conflict with a provision of this Standard. The Board maintains constant liaison with the FASB with regard to the two Boards’ respective responsibilities for developing Standards. It also maintains liaison with the legislative and regulatory bodies responsible for developing and administering ERISA. The Board will review whatever pronouncements these bodies may issue and will make whatever revisions to the Standard it deems appropriate for contract costing purposes.

(2) Need for Two Standards Relative to Pension Cost

Several commentators suggested that this Standard should deal not only with the composition and measurement of pension cost, but also with actuarial gains and losses 1 and the allocation of pension costs. The Board believes that the development of a separate Standard covering the latter two areas is advisable. First, the development of a single Standard would result in an extremely large and complex Standard that could create many problems in implementation and administration. For example, the Issues Paper developed by the Board set forth a total of 50 distinct accounting issues requiring resolution; the Standard being promulgated covers only 24 of these issues. In addition, the Board believes that the subjects covered by the two Standards are separable; a Standard can be issued relative to the composition and measurement of pension cost without creating a concurrent need for a Standard relative to the adjustment and allocation of such costs. Moreover, in computing actuarial gains and losses, it is necessary to determine how fund assets should be valued. APB-8 does not cover this aspect of pension cost accounting. In its project on accounting for pension funds, the FASB is endeavoring to specify the manner in which assets should be valued. The Board intends, as part of its continuing liaison with the FASB on this matter, to exchange research so that any possible differences in concept or approach could be minimized or eliminated entirely.

(3) Treatment of Actuarial Gains and Losses

The Federal Register proposal noted that an adjustment for actuarial gains or losses is a component of pension cost. Several commentators expressed concern over the Board’s intent. Some commentators interpreted the proposed Standard as requiring that actuarial gains and losses be spread over a number of years. Other commentators believed that the proposed Standard required the immediate recognition of actuarial gains and losses.

The Board emphasizes that the Standard does not delineate how actuarial gains and losses shall be accounted for at this time. The Standard being promulgated neither requires nor prohibits immediate recognition of gains and losses or the spreading of such gains and losses to future years. Therefore, actuarial gains and losses should be accounted for in accordance with pertinent laws and regulations, and should be consistently applied, Section 412.50(a)(5) has been amended to clarify this concept.

(4) Actuarial Cost Methods (See Note 2)

Many commentators expressed their concern over the section of the Federal Register proposal which limited acceptable actuarial cost methods to the accrued benefit cost method 3 or to a projected benefit cost method 4 which separately identifies unfunded actuarial liabilities 5 and actuarial gains and to losses. This section, in effect, ruled out be the use of an aggregate 6 cost method for measuring pension costs for negotiated Government contracts. Most of these commentators noted that ERISA and APB-8 permit these methods to be used.

The Board’s primary reason for prohibiting the use of an aggregate cost method in the proposed Standard was because such a method does not disclose actuarial gains and losses. Any method that does not disclose actuarial gains and losses impairs the ability to determine whether actuarial assumptions 7 are reasonable. Actuarial assumptions are significant underlying factors for determining the amount of pension costs to be assigned among cost accounting periods. It is only when such assumptions are visible that a determination can be made that they are reasonable. The most appropriate means for determining reasonableness is to compare assumed events with actual events.

Also, because most aggregate cost methods do not develop unfunded actuarial liabilities, the Government cannot ascertain the funding status a plan, i.e., whether it is excessively funded at any point in time. Consequently, the Government could be making larger reimbursements than is required to defray its fair share of pension costs incurred by contractors. Many of the comments received acknowledge that most aggregate cost methods do not disclose overfunded situations.

Nevertheless, the Board is impressed by certain of the views of commentators who advocate the use of an aggregate methods. The Board recognizes that aggregate methods are widely used and that they generally spread pension costs evenly and within the periods established in the Standard for amortizing unfunded actuarial liabilities. The Board also notes that commentators stated that a required change in actuarial cost methods may result in substantial actuarial fees and, in some cases, could result in contractors violating current labor commitments.

The Board’s solution to this problem was provided generally in several of the comments received. First, several commentators who recognized that aggregate cost method does not disclose the funding status of a plan, suggested that contractors using such cost method develop an alternative computation to determine such status. They pointed out that such a computation is required under the full funding limitation of ERISA and is often required by the IRS when it believes a plan may be overfunded.

Other commentators suggested that contractors who use an aggregate cost method provide supplemental information identifying actuarial gains and losses that have occurred and the extent to which such gains and losses have been amortized through subsequent pension contributions or offset by gains and losses in subsequent accounting periods. These commentators informed us that the incremental costs of providing such additional information would be relatively minor.

Accordingly, the Board has added a section, (412.50(b)(2)) which permits a contractor to use any projected benefit cost method if the contractor

The third requirement was added because the Board has tried unsuccessfully to ascertain criteria for determining the circumstances under which an aggregate cost method is a preferable method for assigning costs to cost accounting periods for Government contracting purposes.

Finally, to assure that the aggregate cost method used spreads pension costs within the time frames set forth in this Standard for other projected benefit cost methods, 412.50(b)(2) requires that such aggregate cost methods spread the cost of future pension benefits over the average remaining working lives of the work force.

(5) Actuarial Assumptions

A large number of commentators were concerned with the manner in which the Federal Register proposal dealt with actuarial assumptions. They were particularly concerned with that provision of the proposed Standard which stated that when an actuarial assumption differs significantly from historical experience, the contractor shall provide evidence supporting its conclusion that such experience is no longer appropriate. Most commentators who objected to this provision in the Standard interpreted it as requiring separate gain and loss analyses for each assumption each time an actuarial valuation is performed. They cited the large cost of performing such analyses and noted that ERISA merely requires that actuarial assumptions be reasonable “in the aggregate.”

Although the Board believes that the basis and rationale for each assumption should be made visible by contractors, it believes that the test of reasonableness of such assumptions should be applied to the end result. It is not the intent of the Board to require a separate gain or loss analysis for each assumption each time an actuarial valuation is made. Rather, the intent is that contractors not use an undocumented composite factor to a represent all assumptions used in measuring pension costs, as this practice would inhibit any evaluation of the reasonableness of individual assumptions as applied to future periods. Such evaluations may be necessary when assumptions, taken in the aggregate, are found to be unreasonable, as discussed below.

Once individual actuarial assumptions have been set forth by contractors, the Board believes that the validity of these assumptions can be evaluated by the overall results obtained. Therefore, the Standard provides that the validity of the assumptions used may be evaluated in the aggregate. However, if an actuarial valuation discloses that the assumptions were not reasonable in the aggregate, the Standard requires that the contractor shall identify the major causes for the resultant actuarial gains and losses and set forth the bases and rationale used for either retaining or revising each such assumption.

In order to recognize the long-term nature of pension plans, the Standard provides in 412.50(b)(5) that actuarial assumptions should reflect long-term trends, rather than short-term fluctuations. Also, the Standard does not specify how often determinations of actuarial gains and losses should be made. ERISA provisions require that such determinations be made not less frequently than once every three years except that more frequent determinations may be prescribed by regulation in particular cases, i.e., for plans which have sustained substantial gains or losses for several periods in succession. The Board believes that the ERISA requirements with respect to the frequency of determinations for gains and losses is equally appropriate for compliance with the provisions of the Standard at this time.

In addition to the foregoing, several commentators stated that the Standard should provide that the judgment of enrolled actuaries, as set forth in ERISA, should be determinate with respect to assumptions as well as other actuarial determinations. The Board recognizes the importance of the functions performed by enrolled actuaries with respect to actuarial determinations. However, contract terms are not imposed on actuaries; rather, it is the contractors who are parties to contracts with the Government and must bear the responsibility for compliance with the terms thereof.

(6) Calculations of Normal Cost (See Note 8)

The Federal Register proposal provided that the calculations of normal cost should be the sum of the calculations for the individual employees in the plan, except that homogeneous groupings and averages could be used if the results substantially agree with the results based on individual employee calculations. A number of commentators objected to this provision. They said that it would appear to require that two calculations be made in order to show that the use of groupings and averages gives results that agree with the results based on individual employee calculations. Some commentators stated that this requirement is unrealistic because actuaries frequently use aggregate calculations and that such aggregations can be tested against individual company or industry-wide experience. Other commentators stated that this provision would result in a single calculation for determining the assumed entry age of planned participants.

The comments received indicate that there are divergent opinions as to how normal costs shall be calculated under projected benefit cost methods. Nevertheless, the Board concludes that the methods commonly used would not materially affect the results of normal cost calculations. Accordingly, the requirement to compute normal costs on an individual basis for projected benefit cost methods has been deleted from the Standard.

The proposed Standard provided also that the calculation of normal cost shall be based on a percentage of payroll. Many commentators stated that this requirement does not recognize the fact that many pension benefits are not related to salaries. In order to accommodate these views, the Board has revised the Standard (412.50(b)(3)) to provide that the calculation of normal cost shall be based on a percentage of payroll for plans where the pension benefit is a function of salaries and wages and be based on employee service for plans where the pension benefit is not related to salaries and wages.

(7) Pay-As-You-Go Pension Methods (See Note 9)

Several commentators apparently assumed that the Federal Register proposal prohibited the recognition of pension costs of plans that provide benefits on a pay-as-you-go basis. One commentator stated that the Standard prohibited the recognition of the costs of pay-as you-go plans which are qualified for Federal income tax purposes.

The Board’s view, as expressed in the Federal Register proposal, is no to prohibit recognizing the cost of pension benefits provided on a pay-as-you-go basis. Rather, the Board’s intent is to specify how the cost of such benefits shall be measured and assigned among cost accounting periods. Moreover, the accounting treatment to be afforded to the costs of pay-as-you-go plans is not dependent on the Federal income tax status of the plan.

Accordingly, the Board has revised the provisions of the Standard relative to pay-as-you-go methods (412.50(b) (4)) and has added an illustration (412.60(b)(2)) to clarify its intent.

(8) Unallowable Pension Costs

The Federal Register proposal provided that the pension costs applicable to prior years that were disallowed in accordance with then-existing Government contractual provisions should be separately identified and eliminated from any unfunded actuarial liability being amortized pursuant to the provisions of the Standard. Several commentators stated that this provision is not equitable because ERISA requires that such amounts be funded.

The Board recognizes that all elements comprising an unfunded actuarial liability, including unallowable costs included therein, are required to be amortized pursuant to the funding provisions of ERISA. However, ERISA does not deal with contract costing and therefore does not deal with unallowable contract costs. The Board believes that for contract costing purposes, pension costs which were assignable to prior periods and which were specifically determined to be unallowable under then-existing contractual provisions should not be assignable to periods subsequent to the effective date of this Standard. It should be noted that the treatment of amounts funded in excess of the pension cost for a cost accounting period is separately covered in 412.50(c)(1).

(9) Amortization of Unfunded Actuarial Liabilities

The Federal Register proposal included a provision requiring contractors to establish and consistently follow a policy for selecting specific amortization periods for any unfunded actuarial liabilities. The proposed Standard stated that such policy should give consideration to the size and nature of unfunded actuarial liabilities. Several commentators stated that they did not believe that the size and nature of such liabilities should govern the choice of amortization periods. The Board’s intent was to permit contractors to establish different amortization periods for different types and sizes of unfunded actuarial liabilities. The Board still believes that contractors should be permitted to establish such different amortization periods. Accordingly, the Standard has been revised (412.50(a)(3)) to clarify that such determinations are permissive rather than mandatory.

(10) Interest Resulting from Delayed Funding of Pension Plans

The Federal Register proposal provided that if any portion of pension cost computed for a cost accounting period is not funded by the time established by the funding provisions of the plan, an interest equivalent on the amount not funded shall not be a component of pension cost of any other cost accounting period. Several commentators stated that this provision is inequitable because, in order for a pension plan to be viable, an amount equivalent to interest should be added to pension costs to compensate the fund for interest that would have been earned if the cost had been funded in a timely manner. Some commentators added that APB-8 requires that interest equivalents be added to pension accruals under such circumstances. Still others understood the proposed Standard to say that such interest equivalent is not a cost; they therefore disagreed with the proposed Standard.

The Board agrees that an interest equivalent should be recognized in order to determine whether the plan is properly funded. However, the Board believes that interest cost resulting from the delayed funding of a pension plan is a consequence of an investment decision and is, therefore, an investment cost rather than a component of pension cost. The interest was caused by a decision of management to use its funds for other purposes; in effect, management borrowed from the pension trust fund.

Several commentators stated that they compute pension cost at the beginning of a cost accounting period and add interest at the valuation rate to the normal cost to the date of funding. They questioned whether the Standard would prohibit this practice. The Standard being promulgated does not prohibit this practice: Provided, That funding is made by the end of the cost accounting period. Accordingly, the Board has amended 412.50(a)(7) to state that if any portion of the cost computed for a cost accounting period is not funded in that period an amount equivalent to interest computed on that portion beyond the end of that period shall not be a component of pension cost of the current or any future cost accounting period.

(11) Assignment of Pension Cost

Certain commentators expressed their disagreement with the sections of the Federal Register proposal dealing with the assignment of pension costs among cost accounting periods. The concept set forth in the proposal related in the assignment of costs to the validity of the liability for such costs. Commentators referred to the concept set forth in APB-8 that the accrual of pension expenses and the funding of pensions are not necessarily related. They stated that cost should be assigned to cost accounting periods irrespective of whether or when funded.

The Board believes that assigning pension costs to cost accounting periods on a cash basis is inappropriate from an accounting viewpoint and could lead to the improper assignment of pension costs among periods. The Board believes also that the concept which states that funding is unrelated to pension accruals is not appropriate for contract costing because, under such a concept, pension costs could be assigned to cost accounting periods and never be funded; yet such costs would be reimbursed by the Government.

The underlying concept of the Standard is that when a valid liability exists, the corresponding costs may he accrued irrespective of when the liability is liquidated. If the liability (to the pension fund or, for pay-as-you-go plans, to retirees) is not valid, it cannot be accrued; in order for it to be allocated to cost objectives of the current period, it must be liquidated (funded) in that period or within a reasonable period of time thereafter. In order to clarify its intent wit regard to the allocation of pension costs to cost objectives of individual cost accounting periods, the Board has revised the wording of 412.40(c) of the Standard.

In the Federal Register proposal, the Board noted that the requirement to fund a pension cost pursuant to ERISA made the liability valid and therefore made the cost assignable to the current period. Several commentators stated that ERISA permits such costs to be waived and funded over a 15-year period. They reasoned that under such circumstances it is no longer appropriate to assign such pension cost in the year for which such costs were computed. The Board believes that if the financial, position of a contractor is such that it requests and obtains such a waiver there is doubt as to validity of the liability and therefore of the cost incurred. Accordingly, it has amended the Standard to provide, in 412.50(c)(3), that if a contractor receives such a waiver the Pension costs shall be assigned to the cost accounting periods in which the funding of such cost takes place.

(12) Insured Plans

Several commentators stated that the section of the Federal Register proposal dealing with insured plans was confusing. They stated that the definition of a “separate insurance account” set forth in the proposed Standard conflicted with this section. Commentators stated that this section would seem to eliminate from the major requirements of this Standard various forms of insured plans such as deposit administration and immediate participation guarantee contracts.

The Board’s intent with regard to insured plans is to treat defined benefit plans10 funded exclusively by the purchase of individual or group permanent insurance contracts as defined-contribution plan11.

The Board’s view relative to such plans is consistent with ERISA whose minimum funding requirements are not applicable to these plans. All other insured pension plans are subject to the provisions of this Standard. The Board has revised 412.50(a)(8) accordingly and has eliminated the definition of separate insurance account.

(13) Definitions

The Board has received a significant number of comments relative to the definitions used in the Standard. Some commentators stated that the Board should use the definitions contained in ERISA. Others stated that the Board should use the APB-8 definitions. Still others recommended that the Board should establish a single glossary of actuarial terms.

The Board recognizes that a major problem in the field of pension accounting has been the use of various terms which have the same meaning. For example, the term “prior service costs” used in APB-8, “past service costs” used in ASPR, “accrued liability” used in ERISA, and “supplemental liability” used by many actuaries have virtually the same meaning. In researching the definitions currently in use, the Board noted that one factor seemed to prevail: The glossaries in use were tailor-made for the particular documents which applied to the terms. For example, the definitions in APB-8 were written in the context of the way in which the words were intended for use in that Opinion. Similarly, the definitions used in ERISA were fashioned to be in consonance with the specific provision of the Act. The Board’s primary objective in developing the definitions in this Standard is similar; the definitions should help provide a clear understanding of the concept used therein, while at the same time maintaining consistency with the thrust of the definitions used in APB-8 and ERISA.

The Board received some additional comments with regard to specific definitions set forth in the Federal Register proposal. One commentator expressed confusion at the terms “accrued pension liability” and “unfunded accrued pension liability” because the word “accrued” has a specific meaning in an accounting sense which is different than that intended in the Standard. The Board believes that this comment has merit and, accordingly, the Standard has been revised to use the terms “actuarial liability” and “unfunded actuarial liability.”

Other commentators requested elaboration of the definition of a pension plan. Specifically, they questioned whether the definition is applicable to execute compensation plans, excess benefit plans, and other plans that may not be “qualified” for Federal income tax purposes. The Standard provides the accounting treatment for the cost of all pension plans which fall within the definition of a pension plan. Such accounting treatment is not contingent on the manner in which IRS may categorize plans for income tax purposes.

Several additional commentators questioned that portion of the definition of a pension plan which states that benefits shall be paid for life or be payable for life at the option of the employee. They questioned whether a life income settlement for an employee would fall within the meaning of this definition. The Board believes that such a settlement is, in effect, equivalent to a payment for life and thus falls within the intent of the definition.

(14) Costs and Benefits

The anticipated benefits of this Standard are improved cost measurement and increased consistency and uniformity in accounting for pension costs and assigning such costs to cost accounting periods, leading to increased assurance that the measured and assigned costs will be allocated to the proper cost objectives, including Government contracts.

When the preliminary draft Standard on pension cost was submitted to a wide cross-section of companies and individuals, the recipients were specifically asked to comment on the costs of implementing the Standard. The overwhelming majority of the respondents stated that the incremental costs of implementation should be small. In commenting on the proposed Standard published in the Federal Register, several respondents stated that the prohibition against use of an aggregate projected benefit cost method and the requirement to make annual gain or loss analyses of each actuarial assumption would involve additional administration costs of any significance. Since the Board has essentially, eliminated these problem areas in this Standard, it believes that increased administrative costs occasioned by this Standard will be minimal. In summary, the Board believes that the benefits to be derived from this Standard clearly outweigh the costs of implementation.

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

There is also being published today an Amendment to Part 400, Definitions, to incorporate in that part terms defined in 412.30(a) of this Cost Accounting Standard.

Part 412 -- Cost Accounting Standard for Composition and Measurement of Pension Cost is added to read as Follows:

Preambles to Cost Accounting Standard 413,
Adjustment and Allocation of Pension Cost.

Preamble A
Preamble to Original Publication, 6-2-76

The following is the preamble to the original publication of Part 413, 42 FR 37191, July 20, 1977.

The cost Accounting Standard on Adjustment and Allocation of Pension Cost is one of a series being promulgated by the Cost Accounting Standards Board pursuant to section 719 of the Defense Production Act of 1950, 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.

This Standard is the second Standard dealing with pension costs. The first Standard, 4 CFR Part 412, establishes requirements covering the composition of pension cost and the bases to be used for measuring such cost. The Standard being promulgated today establishes the basis for assigning actuarial gains and losses to cost accounting periods and for allocating pension cost to segments of an organization.

As part of the Board’s early research relating to the subject of pension cost, it submitted an issues paper to a large cross-section of companies, Government agencies, industry and professional associations, actuaries, and other interested individuals. On June 18, 1976, this staff draft Standard sent to those interested parties who had expressed a desire to assist the Board in its research efforts. The responses to the staff draft Standard were considered in developing a proposed Standard which was published in the Federal Register of February 3, 1977, with an invitation to readers to submit written views and comments to the Board. The Board also supplemented the invitation in the Federal Register by sending copies of the proposed Standard to over 1,000 organizations and individuals.

The Board received 67 sets of written comments from companies, Government agencies, professional associations, industry associations, public accounting firms, actuaries, universities, and others in response to the Federal Register proposal. All of these comments have been carefully considered by the Board. The Board’s views on each of the major issues discussed by commentators are outlined below, together with explanations of the changes made to the proposed Cost Accounting Standard.

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

Preamble A
Preamble to Original Publication, 6-2-76 (Continued)

Preamble A
Preamble to Original Publication, 6-2-76 (Continued)

Preamble A
Preamble to Original Publication, 6-2-76 (Continued)

Preamble A
Preamble to Original Publication, 6-2-76 (Continued)

Preamble A
Preamble to Original Publication, 6-2-76 (Continued)

Preamble A
Preamble to Original Publication, 6-2-76 (Continued)

Preamble A
Preamble to Original Publication, 6-2-76 (Continued)

Preambles to Cost Accounting Standard 414,
Cost of Money as an Element of the Cost of Facilities Capital

Preamble A
Preamble to Original Publication, 6-2-76

The following is the preamble to the original publication of Part 414, 41 FR 22244, June 2, 1976.

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

Performance under negotiated contracts usually requires the use of facilities which represent significant contractor investments. Accounting principles applicable to financial reporting do not provide for any explicit recognition of the cost of capital committed to facilities. The Board has long been interested in identifying, as a contract cost, a part of the contractor’s total cost of capital. The Board distributed three research papers dealing with the cost of capital in connection with negotiated contracts. These mailings were in June 1974, April 1975, and December 1975. The responses received to all three of those research mailings were useful in the development of the proposal published by the Board on March 5, 1976 (41 FR 9562).

The Board supplemented that March 5 Federal Register request for comments by sending copies of the Federal Register material directly to organizations and individuals who were expected to be interested. The Board has received 82 comments on the March 5 proposal. All of these comments have been carefully considered. The Board appreciates the helpful suggestions and criticisms which have been furnished.

The comments below summarize the major issues discussed by respondents and the significant changes which have been made from the March 5 version of the proposed Standard.

A. -- General Comments

B. -- Content of the Standard

C. -- Administration

D. -- Applicability

E. -- Benefits and Costs

With respect to Cost Accounting Standards, the Board’s primary goal is to issue clearly stated Standards to achieve

Contract costs currently do not include any measurement of the cost of money, which is undeniably a cost related to contract performance. The result is that contract cost measurements have made no distinction between contracts with equal amounts of total incurred cost but with vast differences in amounts of facilities investment.

This Standard need have no impact in the aggregate prices paid by the Government but will reflect specific identifiable cost of money as an element of the cost of facilities capital in individual negotiated contracts. Previously, these costs presumably were reflected in nonidentifiable amounts in the profits or fees included in the total contract prices. By reflecting specific costs of money attributable to contractor investments in facilities, this Standard will provide for greater consistency in negotiating total contract prices. The Board understands that procurement agencies expect to take this Standard into account in their current reconsideration of pricing policies. The Standard also will assist the procurement agencies to discriminate more effectively between contracts in which the cost of money is significant and those in which it is not.

The Nation’s mobilization base depends on its facilities. These may be more effectively modernized because of the explicit cost recognition provided by this Standard, which will help to eliminate the existing disincentives which have hampered contractor investments in facilities. Also, to the extent that the Standard results in investment in cost-reducing equipment, the Government will be able to procure goods and services at lower prices.

Some commentators have suggested that the Board’s issuance of Cost Accounting Standard No. 409 caused the need for recognition of this element of cost of facilities capital, and that the Standard being promulgated should be judged in that context. The Board does not agree. The Standard on depreciation was justified by the need for improved criteria with respect to depreciation expense identified with contract performance. Some critics of that Standard argued, in effect, that it should not have been promulgated because, even though it would improve depreciation accounting, there were economic costs not yet being recognized, and that improper depreciation could be justified as an acceptable technique for meeting the economic need. The Board was not and is not persuaded by such reasoning.

The Board has considered the administrative costs related to implementation of this Standard. The most significant potential problems mentioned by commentators were related to features of the proposal which have been modified in response to those comments. The Standard as promulgated today is not expected to involve any significant administrative difficulty, either for contractors or for the Government.

In summary, the Board finds that the benefits of this Standard, which are significant, outweigh the costs, including any inflationary impact.

F. -- Miscellaneous

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 414.30(a) of this Cost Accounting Standard.

Preambles to Cost Accounting Standard 415,
Accounting for the Cost of Deferred Compensation

Preamble A
Preamble to Original Publication, 7-30-76

The following is the preamble to the original publication of Part 415, 41 FR 31797, July 30, 1976.

The Standard on Accounting for the Cost of Deferred Compensation being published today is one of a series being promulgated by the Cost Accounting Standards Board pursuant to section 719 of the Defense Production Act of 1950. as amended(Pub.L.91-379, 50 U.S.C.App. 2168), which provides for the development of Cost Accounting Standards to be used in connection with negotiated national defense contracts. This Standard provides criteria for the measurement of the cost of deferred compensation and the assignment of such cost to cost accounting periods.

Early research included an extensive review of available literature, the Disclosure Statements filed with the Board, and decisions of boards of contract appeals. This information was then supplemented by visits and mail solicitations to contractors in order to elicit more specific data concerning company deferred compensation plans.

In May 1975, a questionnaire/issues paper was sent to a wide mailing list soliciting responses to several basic issues identified in the Board’s early research. Seventy responses to the questionnaire/issues paper were received from interested parties, the majority of whom were companies that had deferred compensation plans. Based on the responses received, a preliminary draft Standard was developed in December 1975 and sent to a large cross section of companies, Government agencies, industry and professional associations, and other interested individuals. The Board received 53 responses to the draft Standard.

After several changes were made to the draft Standard, based on consideration of the comments made by respondents, a proposed Standard was published in the Federal Register of April 7, 1976, with an invitation to interested parties to submit written views and comments to the Board.

The Board received 34 sets of written comments from companies, Government agencies, professional associations, industry associations, public accounting firms and others in response to the Federal Register proposal. All of these comments have been carefully considered by the Board. The Board’s views on each of the major issues discussed by the commentators are outlined in the following sections, together with explanations of the changes made in the Cost Accounting Standard being promulgated.

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

Relationship of Standard to Current Procurement Regulations

Under current procurement regulations, deferred compensation is allocable as a cost of Government contracts only to the extent that such costs are deductible for the same fiscal year for Federal income tax purposes. A few commentators expressed concern that the proposed Standard would require the assignment of the cost of deferred compensation to a cost accounting period that would be different than that determined under the Internal Revenue Code for Federal income tax purposes.

Under the Internal Revenue Code, a deduction for tax purposes for the cost of many incentive or bonus type plans is not permitted until the deferred compensation is paid to the recipient. Under the Standard, however, the cost of deferred compensation is assignable as a contract cost in the period the contractor incurs an obligation to pay such cost which, for many deferred compensation plans, will be the period in which the award is made. (See 415.40(a).)

The Board has recognized that contract costing often deals with the same expenditures as are of interest in income tax accounting. 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. Similar shifts of cost, however, from one year to another could have a decided impact on the costs chargeable to Government contracts. This impact occurs because the mix of Government and commercial contracts often changes significantly from period to period. Therefore, the Board believes that application of the criteria provided in the Standard to assigns the cost of deferred compensation on an accrual basis of accounting is needed to better assure that such cost of deferred compensation will be assigned to appropriate cost accounting periods.

Allocability and Allowability of Contract Costs

Several Government agency commentators pointed out that under present procurement regulations deferred compensation is not allowable until the period in which paid. These commentators also noted that the cost of stock options, under present procurement regulations, is unallowable although these commentators generally recognized that the provisions of the Standard involve allocability, they questioned whether the Standard would encroach on the allowability prerogatives of the procurement agencies.

The Board believes that recognition of the cost accounting concept that all costs incurred in carrying on the activities of an enterprise are allocable to the cost objectives of the enterprise is essential to the maintenance of sound and consistent contract cost accounting. Cost Accounting Standards should result in determination of costs which are allocable to contracts and other cost objectives. The use of Cost Accounting Standards, however, has no direct bearing on allowability determinations.

Definition

A commentator was concerned that the proposed Standard may apply to the cost of some pension plans that are subject to Accounting Principles Board Opinion No. 8, Accounting for the Cost of Pension Plans, and that different measures of cost might result for the same plan from application of the proposed Standard and from application of APB Opinion No. 8. The commentator questioned whether an amount paid to an employee after retirement for a specified period of time, e.g., 10 years, would fall under the definition of deferred compensation as used in this Standard. If a payment for a specified period of time after retirement is, in effect, equivalent to a life income settlement, this payment falls within the definition of a pension plan as provided in Cost Accounting Standard 412, Composition and Measurement of Pension Cost. If the payment is not a life income settlement, it is not a pension plan and the award is covered under the definition of deferred compensation. The Board does not believe that the Standard being promulgated today applies to any pension plan covered under APB Opinion No. 8.

Determination of Obligation

One of the criteria contained in the Standard for determining whether a contractor has incurred an obligation for the cost of deferred compensation is whether or not there is reasonable probability that certain required conditions precedent will occur before an employee is entitled to receive the benefits (see 415.50(a)(5)). The proposed Standard stated that, in determining whether certain events are likely to occur, one of the factors to be considered was the reasonableness of the time interval between the award and the expected occurrence of the event. A few commentators suggested that the proposed Standard specify the length of time that would be reasonable. The Board does not believe that a particular time period can be specified to cover all circumstances. Each category of award must be analyzed on a case-by-case basis because there are several factors involved in determining whether employees should be entitled to receive the benefits of an award. Among the factors that should be considered, in addition to the time interval, are the employer’s experience with similar awards and other restrictive terms which may be involved in the terms of the award.

Since there are numerous factors to be considered, the Board has deleted from 415.50(a)(5) of the Standard mention of two specific factors in order not to give undue weight to these factors. In addition, the Board has added 415.50(a)(6) to make clear with respect to stock options, that an obligation is deemed to have been incurred only if there is a reasonable probability that the option ultimately will be exercised.

Future Service Requirements

Section 415.50(a)(3) provides, as a condition for the assignment of deferred compensation, that the amount of future payment be capable of being measured with reasonable accuracy. In this connection, several commentators suggested that this provision should override the provision for prorating the cost if future service is required. The commentators stated that the service to be rendered after the period of award does not influence the basis for the award. These commentators believe that if there is a strong likelihood that the recipients of the awards would remain with the company for the periods of future service then the costs should be charged in the year of award.

The Board does not agree that the reasonable accuracy of measuring the cost should override the appropriate assignment of the cost to the periods of current and future service based on the facts and circumstances of the award. The Board believes that, where future service is required, such compensation related to the service rendered in those future periods and therefore the related cost should be assigned to those periods. In this regard, the Board believes that the concepts embodied in Accounting Principles Board Opinion No. 12 Omnibus Opinion, are appropriate for contract costing. This Opinion states that “If elements of both current and future service are present [for deferred compensation awards], only the portion applicable to the current service should be accrued.” To make certain that this concept is clearly understood to be incorporated in the Standard being promulgated, a provision has been added to 415.50(a).

Variable Interest Rate

Several commentators expressed concern over a provision in the proposed Standard which stated that if the interest rate included in the award is not fixed at the date of award, the interest was to be assignable only to the periods in which the interest was paid. A few of these commentators stated that generally accepted accounting principles require that the estimated amount to be paid should be assigned in a systematic and rational manner. The commentators stated that, if the amount of interest is known in each period, it should be assigned in each such period.

The Board agrees that the variable interests amounts should be assigned to periods in a systematic and rational manner provided that the terms of the plan specify the basis under which variable interest amounts will be derived and the interest applied in each period is determinable at that time. Consequently, the Standard being promulgated today has been revised to provide in 415.50(d)(2), that variable interest included in awards shall be assigned in the same period as the principal of the award, provided that the rate is based on a specified index and is determinable in each applicable period. The Standard also provides that since the interest rate used at the time of the award is likely to vary from the actual rates in future periods, adjustments shall be made in any future period in which the variation in rates materially affects the cost of deferred compensation.

Section 415.50(d)(3) was added to the Standard to provide for those situations in which the interest rate was not based on a specified index or not determinable in each applicable year. In these situations, the present value of the principal amount of the award is assignable in the year of award and the interest cost is assignable to the period or periods in which the payments are made.

Forfeitures

Two commentators stated that the forfeiture provision should be expanded to recognize that losses on the initial payment for irrevocably funded plans, as well as earnings, may occur within the framework of such a plan. The Board had intended that both gains and losses be recognized and has changed the provision to clarify this point (see 415.50 (d)(7)).

Another commentator stated that the forfeiture provision should not include interest to the date of the forfeiture. The commentator stated that it seems inequitable to require that the value of the forfeiture be determined at a level which was not fully allowable as a cost during the accounting periods affected. The Board does not share the view that including interest in the credit for forfeitures is inequitable. The interest factor represents the time cost of money which the contractor should pay to the Government for having been provided with funds. The forfeiture is calculated to be the present value of the future benefit at the time of forfeiture and thus is equivalent in present value terms to the amount of deferred compensation that was originally assigned. However, as stated in the Standard, the failure of the recipient to voluntarily exercise a stock option is not considered a forfeiture.

The Standard has been amended to provide that if a recipient of an award of stock options voluntarily fails to exercise such options, such failure does not constitute a forfeiture. (See 415.50(e)(6).)

Stock and Stock Options

A few commentators cited the requirement of 415.50(a)(3) of the proposed Standard which provides that the amount of the future payment must be capable of reasonable estimation, and expressed their opinion that the value of award of contractor stock that is to be distributed in a future period or periods should not be assigned to any period prior to payment because the amount of payment to the employee cannot be reasonably estimated before that time.

The Board believes that the compensation cost of stock or stock option plans should be measured by the quoted market price of the stock at the measurement date less the amount, if any, that the employee is required to pay. Further, the measurement date for both stock awards and stock option plans should be the first date on which are known both the number of shares to be distributed and the option price, if any. These views are embodied in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, which already must be followed by contractors for financial reporting.

If the market price of the stock on the date of distribution is used, the Government, in effect, would be sharing in financial risk taking with the contractor. Subsequent fluctuations of the price of the stock should not influence the measurement of the award. However, the Board recognized that the proposed Standard was not consistent with respect to the measurement of the cost of stock and stock option. Consequently, 415.50(e)(1) has been changed to provide for the measurement of the cost of stock to be at the measurement date rather than the time an obligation was deemed to have been incurred.

In order to further clarify the Board’s intent, 415.50(e) had been revised to provide that the measurement of the award of stock, stock options, or other assets as set forth in the Standard shall be deemed to be a reasonable measure of the amount of the future payment.

Two commentators stated that the cost of stock options should be based on the value of the options on the date they are exercised.

Similar to the reasoning expressed above, the Board does not believe that it would be appropriate to base the cost of stock options on the value prevailing at the date of exercise. Stock options which are awarded at a value which equals the market value of the stock would involve no cost under the provisions of the Standard. However, if the award of stock options were based on their value at the date exercised, a cost of the award would have to be recognized by the Government even though the contractor could purchase an appropriate number of shares at the time of the award to defray any cost resulting from future increases in the market value of the stock. The Board believes, therefore, that stock options should be a measured at the date on which both the option price and the number of shares are established (see 415.50(e)(1)).

Several commentators suggested that the requirement for prorating the cost of stock options over the period of future service and taking the present value of the prorated cost should be eliminated because the price of the stock is the present value of the stock price. The Board agrees with these commentators. Consequently, the requirement for discounting the cost of stock options has been eliminated from the Standard.

Transition Provision

Several commentators suggested that a transition provision be included in the Standard to amortize costs of deferred compensation accumulated in periods prior to the promulgation of the Standard, but not previously charged to contract costs. Several of these commentators suggested various methods to amortize the recovery of all prior deferred compensation on an accelerated basis. Among the methods suggested was to charge all such prior costs in the period that the Standard became effective or to charge such costs over the remaining work life of the employee or five years, whichever is shorter. However, one commentator recommended that the Board use a suspense account, as used in Cost Accounting Standard 408, Accounting for Cost of Compensated Personal Absence. The use of a suspense account would delay recognition of the cost of deferred compensation awarded before the effective date of the Standard.

The procurement regulations for costs of deferred compensation awarded prior to the effective date of the Standard generally provide that such costs will be allocable in the period in which they are paid to recipients. The Standard being promulgated today would not disturb the contractual provisions applicable to such prior awards. The provisions of this Standard are applicable only to new awards of deferred compensation made on or after the date that the Standard becomes applicable to each contractor. The Board recognizes that there will be a minor budgetary increase required by the Government agencies until the prior deferred compensation awards are paid. However, for the majority of deferred compensation plans, the awards previously made will be paid out over a relatively short period of time, e.g., five years. Consequently, the Board believes that a transition provision is not necessary for the Standard being promulgated today.

Other Changes

The first illustration (415.60(a)) was changed to reflect the change in the provision regarding interest rates that are not fixed at the date of award. Other changes of a minor nature were made to various sections of the Standard for clarification.

Costs and Benefits

Section 719(g) of the Defense Production Act of 1950, as amended, provides “In promulgating such standard 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.”

Comments received in response to the Federal Register publication, as well as information obtained from contractors prior thereto, indicated that there would be minimal administrative costs entailed in complying with the Standard. One Government agency stated that additional administrative burden would be placed on the Government as a result of the conversion from a cash basis to the accrual method of accounting. The Board believes that any such additional administrative costs due to this conversion will be minimal. The Governmental agencies have always had the responsibility for reviewing the reasonableness of deferred compensation plans and evaluating the payments to assure that such payments coincide with the principal and interest provisions of the plan. The Board believes the main additional administrative cost involved is in reviewing the present value calculation and determining if the contract has incurred a valid obligation at the time the award is made.

Among the benefits which the Board believes will be derived from the use of this Standard is the assignment of the costs of deferred compensation to proper periods. Under the present regulations, the assignment of much of these costs is essentially on a cash basis. As a consequence, deferred compensation costs may have been incurred in much earlier periods than the periods in which they were recognized as incurred costs; in many cases, several years after the service has been rendered by the employee. Giving full consideration to all the relevant factors discussed herein, the Board believes the benefits to be derived from this Standard clearly outweigh any costs of implementation.

As required by section 719(g), the Board has evaluated the potential inflationary effect of this Standard. The Standard requires the use of present value techniques for the assignment of cost and incorporates a forfeiture provision with interest. The use of these techniques recognizes the time cost of money. In the long run, the cost to the Government should be essentially the same as that which would be incurred under a cash basis of accounting. For a majority of deferred compensation plans, moreover, the awards previously made will be paid out over a relatively short period of time, e.g., five years. The Board has concluded that there will be only a minor budgetary increase on the Government agencies until the prior deferred compensation awards are paid. Overall, however, any inflationary effect of this Standard will be minimal.

The Board expects that this Standard will become effective January 1, 1977.

There is also being published today an Amendment to Part 400, Definitions, to incorporate in that part terms defined in 415.30 of this Cost Accounting Standard.

Preamble B
Preamble to Revision of Section, 7-30-76 and 1-8-78

The following is the preamble to the revision of 415.80, published at 42 FR 18857, Apr. 11, 1977 and correctly reprinted at 43 FR 24821, June 8, 1978.

On July 30, 1976, a Cost Accounting Standard entitled Accounting for the Cost of Deferred Compensation was published in the Federal Register (41 FR 31797 et seq.). The effective date of the Standard was reserved in the July 30 publication. This final rule establishes the effective date.

Preambles to Cost Accounting Standard 416,
Accounting for Insurance Costs

Preamble A
Preamble to Original Publication, 9-20-78

The following is the preamble to the original publication of Part 416, 43 FR 42239, Sept. 20, 1978.

(1) Background

Work on a potential standard on accounting for insurance costs was initiated for a number of reasons; these included

A statement of issues related to accounting for insurance and a preliminary draft standard were developed by the staff and circulated to contractors, agencies, and others. Responses to these staff papers and to the Federal Register publications of October 5, 1977, and May 15, 1978, and information obtained in subsequent meetings with respondents and other interested persons were considered in developing the standard which is being promulgated today. Twenty-nine comments were received in response to the most recent Federal Register publication. All comments have been considered by the Board and those addressing areas of significance are discussed below, together with explanations of the changes made in the cost accounting standard being promulgated today from the proposal published in the Federal Register of May 15, 1978.

Ten respondents said that the proposed standard was acceptable as written, or they suggested only minor word changes.

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

(2) Coverage of Standard

One respondent said that the standard should be limited in its application to significant problem areas rather than treating all insurance and insurance-related costs in a general fashion. As stated in the prefatory remarks which accompanied the May 15, 1978, Federal Register publication, in its research, the Board did not find that accounting practices depended upon the type of risk or insurance. Therefore this standard, applicable to the major problems, is also appropriate for all other insurance.

One respondent suggested that the standard deal with the subject of premiums paid to “captive” insurers. The Board reiterates its belief, which it stated in the May 15, 1978, Federal Register publication, that the technique for accounting for premium costs should not be influenced by questions of the reasonableness of the amounts paid. Consequently, no change in this regard has been made in the May 15, 1978, proposal.

(3) Self-Insurance as a Cost

Three respondents suggested that the proposed standard failed to properly distinguish between self-insurance and the absence of insurance. The Board recognizes that there may indeed be differences in the amount of planning involved, but there is no difference in the principle applicable to cost measurement. “Absence of insurance” is in fact one kind of self-insurance. The respondents said that a contractor who does not purchase insurance or set up a funded reserve to cover possible losses does not incur a cost and that, in such situations, actual losses are a part of entrepreneurial risk taking and should come directly from profit. For the reasons set forth below the Board does agree.

A contractor who acquires assets is exposed to two types of risks static risks and dynamic risks. Static risks are the risks which are inherent in the ownership of the assets; dynamic risks result from the decision to utilize the assets for the production of specific goods or services. Static risks are the same for all owners of similar assets in similar circumstances; e.g., the risk that property of a given type in a given location will be destroyed or damaged. Consequently, they are normally predictable by mathematical methods and can be insured against. Dynamic risks are a function of managerial judgment, e.g., whether a Proposed product can be produced for a profit. Dynamic risks are not normally predictable or insurable; they generate a profit or loss, depending on management’s ability to forecast costs and markets; they are the true entrepreneurial risks. Static risks, because they can be measured, predicted, and quantified, are properly subject to treatment as costs rather than as entrepreneurial risks.

From a cost accounting standpoint, the decision to purchase insurance or self-insure is not one of cost versus no cost. Rather, it is one of certainty versus uncertainty. A contractor who self insures will be subject to cost variations in any short time period as compared to one who purchases insurance but in the long run their costs should be substantially the same and their product or service must be priced to cover the same long-term cost.

Whether a contractor should be required to make deposits in a fund to provide for replacement of assets in the event of loss is not a consideration in determining the costs of self-insurance.

(4) Accounting for Self-Insurance

When the business entity purchases insurance coverage from an underwriter, the cost to the business -- for the static risk -- is the premium. When the business entity does not purchase insurance, the best method of assignment of cost to current activities is matter of possible disagreement.

A contractor who self-insures can recognize the cost of self-insurance for product pricing purposes in either of two ways:

The proposals which were published in the October 5, 1977, and May 15, 1978, Federal Register included criteria for selecting between the two approaches to recognizing the cost of self-insurance. A charge which would represent the projected average loss was required except in those situations where the actual losses in a cost accounting period could be expected to serve as a good representative of the long-term average loss for that period. The recognition of actual losses, rather than the use of a predetermined charge, would be expected where many units are exposed to loss and the maximum loss related to any one unit would be relatively small. Examples are the losses falling within the deductible portion of the automobile collision coverage for a fleet of vehicles, the deductible portions of property and casualty coverage where the size of the deductible is nominal in relation to the total exposure to risk for that coverage, and the worker’s compensation claims of a large work force. There would be little point in calculating a special self-insurance charge in such circumstances.

The Board has decided to retain the requirement for the use of a self-insurance charge, as contained in the Federal Register proposal. A reasonable assignment of cost should be made to products of each period in which there is exposure to the risk. The cost of each loss should be allocated to all work accomplished in the facility where it occurred (and successor facilities over the life of the enterprise, not just to the work of the day, month, or year in which the loss happened to occur. This can be accomplished by charging each period with a self-insurance charge which is equal to the projected average loss.

The standard also retains the provision of the Federal Register proposals which permitted the recognition of actual losses in those limited circumstances, as described above, in which the actual losses in any cost accounting period may be expected not to differ significantly from the projected average loss for that period.

Several respondents were concerned as to the possible consequences if a self-insurance charge were to be made, and, subsequently, actual losses differed substantially from the projected average loss. The self-insurance charge is, of necessity, and estimate. If the estimate is made in a reasonable and supportable manner, then the fact that actual losses depart significantly in either direction from the projected average loss is not a basis for adjusting the costs of that cost accounting period. However, the standard provides that contractor’s actual loss experience shall be reviewed regularly and that self-insurance charges for subsequent periods shall reflect experience, as would premiums for purchased insurance. Similarly, if the situation were one in which it had been determined that actual losses were to be used because they were not expected to differ significantly from the projected average loss, and actual losses did, in fact, differ significantly, the actual losses would be nonetheless the measure of the cost.

(5) Limitation on Self-Insurance Charge

The proposals which were published in the Federal Register provided that the self-insurance charge plus insurance administration expenses could be equal to, but could not exceed, the cost of comparable purchased insurance plus the associated administration expenses. Several respondents saw this as a question of allowability. It is, however, not a limit on allowability; it permits the cost of comparable purchased insurance to be used as one means of estimating the projected average loss. The provision is intended to avoid the necessity of employing actuaries to perform computations which other actuaries have already performed for the insurance company in setting the premium. The standard has been modified to express this intention more clearly.

Other respondents were concerned that a company which calculated a self-insurance charge based on, say, a 5-year moving average of its own loss experience would encounter problems if it were to incur a large loss; this would raise its average above the cost of comparable purchased insurance and thereby preclude the recovery of the excess over time. Again, the Board intended the limitation to apply only where the cost of comparable purchased insurance is used as a convenient method of estimating the projected average loss. The standard specifically requires that the contractor’s own loss experience be reviewed regularly and that self-insurance charges for future periods reflect such experience in the same manner as would purchased insurance. It should be noted that the cost of future insurance premiums would also be expected to reflect, to some degree, the unfavorable loss experience of the contractor.

Several respondents were concerned that the standard would require them to obtain quotations for insurance premiums for comparison with proposed self-insurance charges, and they questioned the feasibility of obtaining such quotations. The standard only requires such a quotation if the self-insurance charge is to be estimated thereby; it would not be required if, for example, the charge were to be based only on a projection of the contractor’s own experience.

(6) Terminology

Several respondents suggested that in the definition of “actual cash value,” the phrase “replacement cost less depreciation” could lead to confusion because the type of depreciation intended thereby was not clear. The phrase was intended to imply replacement of the destroyed asset with one in the same physical condition. The definition has been modified to make this intention clearer.

One respondent suggested that the provisions of 416.50(a)(1)(v) relative to “insurance coverage on retired lives” should be applicable to all types of insurance, rather than being limited to life insurance. The Board intended that this phrase provide for all types of insurance for retired persons. The term “retired lives” has accordingly been replaced by the term “retired persons.”

Two respondents asked that the standard define or prescribe criteria for determining when a loss is considered to be “catastrophic” for purposes of home-office reinsurance agreements; they were concerned about after-the-fact disagreement as to whether a particular loss was “catastrophic” and thereby to be allocated in part to the home office, or “noncatastrophic” and to be absorbed entirely by the segment. The Board believes that what constitutes “catastrophic loss” depends on the individual circumstances of each contractor. The determination should be made at the time the internal loss-sharing policy is established and should be revised, as necessary, for changes in future circumstances. Obviously, a catastrophic loss would be one which would be very large in relation to the average loss per occurrence for that exposure, and losses of that magnitude would be expected to occur infrequently.

(7) Premiums and Refunds

The proposed standard provided that a premium refund or dividend would become an adjustment to the pro rata premium cost for the earliest cost accounting period in which the refund or dividend is actually or constructively received. However, the standard permitted the contractor the option of using estimated net premiums instead. One respondent suggested that the standard permit the shifting of adjustments to prior years for purposes of overhead analysis. This proposed change would not assure consistent measurement of cost; it has therefore not been adopted.

(8) Direct Charging of Premiums

Section 416.50(a)(1)(ii) provides that where insurance is purchased specifically for, and directly allocated to, a single final cost objective, the premiums need not be prorated. One respondent was concerned that if the final cost objective included requirements for two or more customers and the insurance premium were not prorated over the policy period, the cost might be charged only to the earliest units of production. They suggested that the provision be qualified by limiting it to only those final cost objectives which include requirements for a single customer. If the need for the insurance were to be occasioned by only one customer’s requirements, the cost should be allocated to only that customer’s units regardless of the production sequence. If the requirement is common to all customers’ units, it should be allocated to all units.

The accounting principle here is the same as the one for specialized materials, which are charged directly to a final cost objective at the time of acquisition. If costs within a final cost objective, either for materials or for purchased insurance, were to be inappropriately related among the customers whose work is accumulated in the same cost objective, the problem would not be one of allocating costs to that cost objective. Rather it would be a problem of the method of analyzing costs within that final cost objective, a subject not being dealt with here.

(9) Deposits and Reserves

Insurance agreements frequently provide for substantial amounts to be held by the insurer for various contingencies. Such amounts may be negotiated in advance or may represent the unrefunded excess of premiums over losses; in either event they are not arrived at by actuarial computations of known risks. The contractor typically retains a significant amount of interest in, and control over, such funds. FASB statement No. 5 provides that amounts which do not represent transfers of risk from the insured to the insurer are deposits and should be accounted for as such. The proposed standard required that anything which would be a deposit under that statement be treated as a deposit for contract costing purposes. In addition, the standard required that “reserves” held by the insurer for the account of the contractor would be regarded as deposits unless they met stated criteria.

These special criteria included a prohibition against recapture of the reserve or fund so long as any beneficiary remained alive. Two commentators urged that this test be modified. The Board intended to assure that the cost had indeed been incurred, but there was no intention to tie up excess reserves for long periods. The provision has been modified accordingly.

One respondent pointed out that group insurance carriers in recent years have required that premium stabilization reserves be established on medium-size experience-rated programs to smooth the experience so it will be similar to a large group. He said that the contractor has no more right to these reserves than the monthly premium he pays on the policy. He therefore suggested that the reserves required by the insurance carrier should not be required to be treated as deposits unless these reserves are treated as deposits for financial statement purposes. The Board does not agree; such reserves are negotiated amounts and the contractor does in fact have some influence over them. Cost measurement is improved if these amounts are treated as deposits until settled.

Some respondents previously pointed out that where a contractor changes from a pay-as-you-go program for retired persons to a pre-funded program, or initially establishes a pre-funded program, a liability arises to those employees who have already retired. The respondent suggested that the standard provide a transition mechanism to deal with the newly recognized liability. Therefore, the standard which was proposed in the May 15, 1978 Federal Register provided and the standard being promulgated today provides that, for a transition from a pay-as-you-go plan to a terminal funded plan, or on the initial establishment of a terminal funded plan, the actuarial present value of benefits applicable to employees already retired shall be amortized over a period of 15 years.

Two respondents inquired as to the Board’s reason for not providing a similar provision for transitions to fully prefunded level-premium or entry-age-normal plans. The actuarial premium computations for such plans implicitly allow for appropriate amortization of the liability for past service; therefore, an explicit provision for this purpose is unnecessary.

Two respondents asked for some liberalization of the 15-year amortization requirement; one suggested that the period be negotiable depending upon or the circumstances which occasioned the change, as for example, when a segment is abolished and many employees take immediate retirement. The 15-year period was chosen to be comparable to the amortization period for actuarial gains and losses contained in CAS 413. To permit the amortization period to be negotiated on a case-by-case basis would reduce uniformity. It might also create an incentive to make such changes at times when one of the parties could be expected to benefit. The Board does not accept the suggestion.

(10) Relationship to Other Standards

One respondent was concerned about the relationship of this standard to two other cost accounting standards, CAS No. 412, composition and measurement of pension cost, and CAS No. 415, accounting for costs of deferred compensation. The respondent was concerned especially about health insurance carried for retired employees of a contractor; he felt that there might be confusion as to whether such insurance should be considered a form of deferred compensation a part of a pension plan, or a part of an insurance program.

The Board believes that these standards provide ample criteria for determining which standard is applicable to any given cost. In particular, the question of whether a benefit, such as insurance provided to retired persons is an integral part of a pension plan and thereby governed by CAS No. 412 or is a part of an insurance program and thereby governed by CAS No. 416 is a question of fact in each given instance. Moreover, application of either standard to this element would result in substantially the same amounts of allocable cost.

(11) Amount of a Loss

The proposal which was published in the October 5, 1977, Federal Register provided, in part, that “the amount of an incurred loss shall be measured by the net book value of property destroyed.” A number of respondents disagreed with this provision and suggested that the proper measure of the loss was “fair value,” “replacement cost,” “replacement cost, net of depreciation,” and “replacement cost if replaced and net book value if not replaced.” After considering these comments, the Board concluded that the measure of the loss should be the economic value of the asset destroyed, and that this value was best described as “actual cash value”; consequently the May 15, 1978, Federal Register proposal incorporated “actual cash value”.

Three respondents have again asked that the standard recognize replacement cost as the measure of the loss on the grounds that the asset would probably be replaced with a new asset and that the cost of insurance premiums which would provide for replacement cost coverage would be allowable. The Board believes that the measure of the loss is the economic value of the asset destroyed, and this may bear little relationship to the economic value of the asset which is required to replace it. In this connection it should also be noted that CAS No. 409 requires the treatment of a gain on involuntary conversion of an asset as a recovery of past depreciation or alternatively, treatment as a reduction in the cost basis of the replacement asset. The Board has, accordingly, retained the use of “actual cash value” as one of the major measures of loss.

Contract audit agencies have reported that contractors sometimes charge the maximum potential loss for contract costing purposes but report a lesser amount for published financial statements; therefore, the proposed standard provided that where the amount of the loss is uncertain, the estimate of the loss shall be the amount includable in published financial statements. Three respondents suggested that this requirement be deleted because the amount reported for financial statement purposes might be too conservative. The Board continues to believe that the guidance contained in FASB statement No. 5 and interpretation No. 14 thereto permits an objective measure of the loss. The Board, therefore, retains the requirement.

One respondent was concerned about whether use of the term “incurred loss” in 416.50(a)(3) was intended to mean something other than an actual loss. The Board did not so intend; the term “incurred loss” has been eliminated.

Two respondents asked the Board to clarify the references to “publish financial statements” contained in the previously proposed standards. One of these respondents pointed out that not all published financial statements are necessarily prepared in accordance with generally accepted accounting principles; the other pointed out that a loss may be required to be reported in a published financial statement under conditions where it is not accruable therein as a liability. In order to clarify its intent, the Board has replaced the phrase “published financial statements,” whenever it appeared in the proposed standard, with the phrase “statements prepared in accordance with generally accepted accounting principles” and the standard now refers to the amount which would be “includable as an accrued liability” in such statements.

(12) Present Value of Future Losses

One respondent objected to the requirement for discounting amounts of losses to be paid in the future at a rate different from that contained in existing procurement regulations. As it stated in the prefatory remarks which accompanied the May 15, 1978, Federal Register publication, the Board believes that the additional computational effort involved in using a rate for contract costing different from that required by the various States is not warranted. Where no rate is prescribed by a State, the use of the rate determined by the Secretary of the Treasury pursuant to Pub.L.92-41, 85 Stat. 97, as required by the standard, is consistent with the Board’s requirement in CAS 415 to use that rate in discounting deferred compensation awards.

(13) Allocation of Insurance Costs From a Home Office to Segments

The October 5, 1977, proposal contained criteria for the allocation of insurance costs from a home office to segments. Various respondents questioned the need for such additional guidance on the grounds that the provisions of CAS 403 are adequate for this purpose. The Board concurred in this belief and omitted the related provisions from the May 15, 1978, proposal. Two respondents to that proposal suggested that the provisions of CAS 403 are too general and further guidance is needed to insure that such allocations will reflect significant differences in segment loss experience.

CAS 403 requires that home office expenses shall be allocated on the basis of the beneficial or casual relationship between supporting and receiving activities. Specifically, with respect to central payments or accruals made by a home office on behalf of its segments, CAS 403 requires that these shall be allocated directly to segments to the extent that they can be identified. CAS 403 provides further that payments or accruals which cannot be identified with individual segments are to be allocated by means of an allocation base representative of the factors on which the total payment is based. If there are significant differences in segment loss experience, then these differences would be identifiable and would be required by CAS 403 to be reflected in the allocation of the related home office premium cost or refund. The Board therefore continues to believe that additional guidance for such allocations in this standard is not necessary.

(14) Materiality of Losses and Insurance Administration Expenses

The standard permits a contractor to recognize immaterial amounts of self-insured losses and insurance administration expenses as part of other expense categories rather than as “insurance expense.” Two respondents were concerned that what is a “material” cost will be the subject of controversy.

The Board recognizes that some contractors may elect to purchase all of their insurance services from an insurance company or outside agencies; such services as claims processing or payment, risk analysis, loss prevention activities, etc. may be billed separately or included in the premium. Other contractors may elect to provide some or all of these services themselves. The standard recognizes this diversity of practice by stating, in 416.40, that the amount of the insurance cost is the sum of the projected average loss plus the insurance administration expenses.

Where a contractor purchases substantially all of its insurance service and the cost is included in the premium, the allocation of the costs of such services automatically follows the allocation of the premium. In such situations, if immaterial amounts of in-house costs, such as portions of various individuals’ salaries or allocable space costs, are not explicitly recognized as insurance administration expenses, the accuracy of cost allocation is not significantly impaired. On the other hand, if a contractor establishes a claim processing department to process group insurance claims for a large work force, and the costs of such a group are material, then the Board believes that uniformity will be better served by requiring that such costs be allocated in the same manner as the costs of the related insurance. The Board believes that its previous pronouncements on the subject of materiality will provide sufficient guidance.

(15) Renegotiation

One respondent was concerned that contractors will have difficulty in following the standard while reporting to the Renegotiation Board, which is bound by law to allow items in accordance with chapter 1 of the Internal Revenue Code. This concern applies both to the election to account for refunds, dividends, and additional assessments on the basis of estimated net premiums, authorized in 416.50(a)(1)(vi), and the use of a self-insurance charge in lieu of the recognition of actual losses. In both instances the standard could result in the recognition, as contract cost, of amounts which would not be recognized for tax purposes.

Other cost accounting standard have required the selection of specific cost measurement techniques from among the many which might have been available under the Internal Revenue Code. The respondent suggested that the proposal on insurance is different in that it can result in the use of a method of contract cost accounting which is not permitted for tax accounting purposes.

The Board recognizes that the Renegotiation Board is indeed bound by law to recognize those elements of cost which are identified in the Internal Revenue Code. Measurement of the amounts of such costs to be recognized in any particular period, however should be done in accordance with the best available accounting technique where this standard recognizes a self-insurance charge in lieu of actual losses, the Renegotiation Board will also obtain a better measure of contractual (sic) profits by following the standard than by following (sic) the tax measurement. The Renegotiation Board, as a relevant Federal agency can arrange for the application of the standard as it has for various others which have required reconciliation between tax reporting and contract costing. No exemption is, therefore being made for renegotiation.

(16) Records

A contractor who elects to make a self-insurance charge should be expected to provide sufficient documentation to support the amount of the charge. In addition, the standard requires that the contractor’s own loss experience be evaluated regularly. Finally, the standard requires the identification of losses to the segment in which they occur. While the cost of losses is already reflected in the contractor’s formal accounting records, the data on loss frequency, amount, and location which may be necessary to comply with the proposed standard may not be a normal part of such accounting records. The “records” provision of the standard recognizes both the need for such data and the probable memorandum nature of the records. The requirement to maintain such records was contained in the October 5, 1977, proposal but was inadvertently omitted from the May 15, 1978, Federal Register proposal. It has been reinstated in the standard now being promulgated.

(17) Illustrations

One respondent suggested that the dollar amounts used in illustrations were unrealistic and would serve as guidelines for unrealistic rulings in practice. As the Board has stated on previous occasions, the use of dollar amounts in illustrations is intended to improve the understandability of the illustration. Such dollar amounts are not intended to establish criteria for use in actual situations.

(18) Costs and Benefits

The Board’s objective, with respect to uniformity, is to achieve comparability among entities operating under like circumstances. As applied to the measurement of insurance costs, there should be similar reported costs where there are similar exposures to risk. The Board has recognized the need to provide guidance on the determination of contract charges under self-insurance programs, especially under circumstances where the likelihood is that actual losses in a given period will differ materially from the long-term projected average. This standard will provide for increased uniformity in this field.

Consistency pertains to the use, by any one entity, of cost accounting practices which permit comparability of contract results under similar circumstances over periods of time. The decision whether to purchase insurance or to self insure is comparable to a make or buy decision. A change in the method of providing for the risks (which risks continue unchanged) is not a change in circumstances of the sort which should destroy comparability over time. This standard provides the basis for consistency in measuring insurance costs even when there are shifts between purchased insurance and self-insurance.

Only three respondents suggested a that the implementation costs of the standard would be excessive or would exceed the benefits. One of these foresaw increased administrative costs but did not offer any specifics. The concerns of the others appeared to lie primarily in two areas -- the lack of a definition of “materiality” in relation to insurance costs and the lack of specific procedural guidance in estimating a self-insurance charge. They therefore anticipated increased disagreements. The board has provided remarks about materiality in various public pronouncements. The Board believes that these comments are sufficient and that the concerns in this regard are unwarranted.

A self-insurance charge is an estimate, and the Board has consistently refrained from dictating detailed estimating procedures. A contractor must, of necessity, estimate many costs, and the degree of sophistication and complexity of the estimating process is a matter for discussion between the contractor and procurement and audit personnel.

The standard provides for several methods of recognizing the costs of self-insurance. First, the contractor may recognize actual losses in those situations in which the distribution of actual losses may be expected to not differ significantly from the projected average loss. This is a matter which should be readily determinable from or the nature of the exposure to risk; this will normally be expected where there are many units exposed to loss and the potential loss per unit is low in relation to the total exposure, as, for example, with worker’s compensation group insurance, and deductible portion of property and casualty insurance which is nominal in relation to the total exposure. In most such cases, contractors already charge actual losses, so no change will be necessary. Second, the contractor may use the premium cost of purchased insurance for comparable coverage as the basis for the self-insurance charge. This method would be appropriate when, for example, the contractor proposed to substantially increase a deductible provision for property and casualty insurance; he might propose to make a self-insurance charge equal to the premium reduction for the decreased coverage. Only in the event that either of these two methods is appropriate would the contractor have to resort to the third method, that of actuarial review of his own or industry experience to develop a self-insurance charge. Under these circumstances, the board believes that the majority of contractors will already be in compliance with the proposed standard and the costs of compliance for the remainder should not be significant. Therefore, the standard should have no significant inflationary impact.

Four respondents suggested that, if the majority of contractors would not have to change in order to comply with the standard, then the problems were not sufficient to justify the standard. The Board recognizes that, although the insurance problems resolved by this standard are likely to be encountered only by a minority of contractors, when they are encountered they are of substantial importance and their resolution in a uniform and consistent manner will be beneficial in contract costing.

In summary, the Board finds that this standard will increase the uniformity and consistency of measurement of the cost of insurance related to negotiated defense contracts. The standard will eliminate, or materially reduce, the problems listed in the Board’s prefatory remarks with the May 15, 1978 publication. The Board finds that the costs of implementation will be slight and that there will be no inflationary impact

There is also being published today an amendment to Part 400, definitions, to incorporate in that part terms defined in 416.30(a) of this cost accounting standard.

Preambles to Cost Accounting Standard 417,
Cost of Money as an Element of the Cost of Capital Assets Under Construction

Preamble A
Preamble to Original Publication, 7-21-80

The following is the preamble to the original publication of Part 417, 45 FR 48574, July 21, 1980.

Summary

The Cost Accounting Standards Board is Promulgating Cost Accounting Standard No. 417, one of the series of Standards being issued pursuant to section 719 of the Defense Production Act of 1950, as amended (Pub.L.91-379, 50 U.S.C.App. 2168).

This Standard provides for the determination of an imputed cost of money to be included in the capitalized cost of acquisition of assets developed, fabricated or constructed for contractor’s own use. Application of this Standard will provide increased uniformity in accounting for the acquisition costs of assets.

Effective Date

December 15, 1980.

Supplementary Information

(1) Background

Cost Accounting Standard (CAS) 417 being promulgated today is based on the same concept as CAS 414, which provides criteria for the measurement and allocation of the cost of money as a part of the cost of tangible and intangible capital assets. CAS 417 provides guidance for the measurement of the cost of money as an element of the cost of capital assets under construction. A proposed Standard on this topic, designated CAS 421, was published in the Federal Register on January 4, 1980. The Board received 36 letters of comment on that proposal and takes this opportunity to express its appreciation for the many helpful suggestions and constructive criticisms that were received.

(2) Need for a Standard

Most commentators favored the January 1980 proposal. Those who opposed it did so on the basis that they did not favor Standard No. 414 and do not favor any extension of the principle of that Standard. The Board, in promulgating CAS 414, provided for an important element of contract cost, that of the cost of money related to investment in facilities used in contract performance. Contractor investments committed to facilities not yet in service involve a similar economic cost. The Board believes that this Standard is an appropriate extension of the concept.

(3) Proposals to Amend CAS 414

A number of contractors suggested that instead of capitalizing cost of money, it should be treated as a current cost and therefore an amendment should be made to CAS 414 to recognize this cost on current contracts. The Board believes that capitalization of cost of money, in contrast to the immediate recognition of cost of money as a contract cost, will place such costs on the same basis as other construction costs and thus provide for the total cost of new assets to be charged to output of the periods when they are used in the production of goods and services.

(4) Capitalization of Paid Interest

The proposed Standard No. 421 provided an option to capitalize either cost of money computed in accordance with the provisions of the Standard or the amount capitalized for financial accounting and reporting purposes pursuant to FAS No.34. This option was offered in order to simplify the record-keeping procedures as it would have enabled the contractor to avoid a duplicate set of records -- one for financial accounting and the other for Government contract costing purposes.

A number of Government agencies disagreed with this approach. It was pointed out that no true compatibility exists between FAS No. 34 and the proposed CAS 421 since the former specifically prohibits recognition of any type of imputed interest cost for capitalization purposes. It was also stated that the option to elect between the two methods of capitalization in the proposed. CAS 421 would lead to inconsistent capitalization practices among contractors. Furthermore, it was pointed out that paid interest is an unallowable cost under pertinent procurement regulations. One major agency pointed out that if the Standard were to allow the choice as proposed, any contractor making the election to capitalize interest actually paid “* * * will have such costs disallowed when included in depreciation subsequently claimed as a cost under Government contracts. Such disallowance would effectively nullify the option.

In view of these comments by Government procurement agencies the Board has concluded that it would be futile at this time to proceed with the unrestricted option that permits capitalization of the amount capitalized for financial accounting and reporting purposes. The Standard, as promulgated, permits only capitalization of cost of money computed in accordance with the provisions of this Standard, or the amount used for financial reporting where it is not a materially different amount.

(5) One-Year Limitation

The proposed Standard required that in order to capitalize cost of money the construction or fabrication effort must be sustained at least for one year. This provision was based on the belief that administrative costs would typically be higher than the benefits to be expected from capitalization of cost of money for minor projects. Numerous commentators pointed out that irrespective of any administrative costs the cost of money could be quite material on a project lasting less than a year. The Board agrees with this view and has eliminated the restriction on the length of the construction period. The Board expects that contractors will apply the Standard where the benefits to be derived from improved cost measurement and allocation can be expected to outweigh the costs of implementation.

(6) Computation of the Representative Investment Amount

Some commentators questioned whether there are any constraints imposed on the methods that may be used for determining the “representative investment amount.” The Standard specifies in 417.50(a)(ii) [previously designated as 421.50(e)] only that the method selected should give appropriate consideration to the “rate at which costs of construction are incurred.”

The wording in illustration 417.60(a) and (b) has been changed to demonstrate more clearly when the use of beginning and ending balances of cost accounting period is appropriate. If major fluctuations are expected in the rate of cost incurrence, averaging of balances for shorter time periods, such as months, is appropriate.

(7) Applicability

The proposed Standard was to be applied only to those assets on which construction began after the Standard became applicable. Several commentators pointed out the desirability of immediate application with respect to all assets under construction.

The wording in 417.80 has been changed to extend the coverage to all the assets under construction at the time when the Standard is first applied by the contractor.

(8) Costs and Benefits

The Board recognizes that there are economic costs related to a contractor’s investment in the construction period for assets subject to this Standard. The cost, even though imputed, is real and is relevant for the contract costing. It has heretofore not been part of contract costing. This Standard provides for its measurement and therefore will improve the quality of cost ascertainment on contracts where the assets are used.

Limitation on the option to use, for contract costing, the amounts capitalized under FAS 34 may impose certain administrative costs for some contractors. The Board is persuaded that these costs, in general, will not be significant, and they are surely out weighed by the benefit of more consistent contract cost measurement which will be derived from the operation of this Standard.

Title 4 CFR Chapter III is amended by adding a new Part 417 to read as follows:

Preambles to Cost Accounting Standard 418,
Allocation of Direct and Indirect Costs

Preamble A
Preamble to Original Publication, 5-15-80

The following is the preamble to the original publication of Part 418, 45 FR 31932, May 15, 1980.

Summary

The Cost Accounting Standards Board is promulgating today Cost Accounting Standard (CAS) 418, Allocation of Direct and Indirect Costs. It is one of a series of Standards the Board is issuing pursuant to Section 719 of the Defense Production Act of 1950, as amended (Pub.L.91-379, 50 U.S.C.App. 2168).

CAS 418 requires that costs be consistently classified as direct or indirect establishes criteria for accumulating indirect costs in indirect cost pools and sets forth guidance on allocating indirect cost pools. These topics are central to the Board’s mission to issue Standards to achieve uniformity and consistency in the cost accounting practices followed by defense contractors in estimating, accumulating and reporting costs of defense contracts.

Effective Date

September 20, 1980.

Supplementary Information:

Title 4 CFR Chapter III is amended by adding a new Part 418 to read as follows:

Preambles to Cost Accounting Standard 420,
Accounting for Independent Research and Development Costs and Bid and Proposal Costs

Preamble A
Preamble to Original Publication, 9-25-79

The following is the preamble to the original publication of Part 420, 44 FR 55127, Sept. 25, 1979.

Part II
Preambles to the Related Rules and Regulations Published by the Cost Accounting Standards Board

Preambles to Part 331,
Contract Coverage

Preamble A
Preamble to Original Publication, 2-29-72

The material set forth below is the preamble to the original publication of Part 331, February 29, 1972, at 37 FR 4139. For the preamble to the republication of Part 331 (November 7, 1973, 38 FR 37025), see preamble D of this Supplement. Portions of this preamble relating to Parts 351, 400, and 401 have been omitted; they can be found in the supplements to their respective parts. This preamble to the publication of February 29, 1972, is included as part of the administrative history of Part 331.

General comments. The purpose of the regulations promulgated today by the Cost Accounting Standards Board is to implement section 719 of the Defense Production Act of 1950, as amended, 50 U.S.C.App. 2168, which provides for development of Cost Accounting Standards to be used in connection with negotiated national defense contracts and for disclosure of cost accounting practices to be used in such contracts. The Board believes the materials being promulgated today constitute a significant initial step toward accomplishing one of its major objectives -- improved cost accounting and the proper determination of the cost of negotiated defense contracts. The regulations spell out contract coverage (Part 331), disclosure requirements (Part 351), a compilation of Definitions (Part 400), and two Cost Accounting Standards, one calling for consistency in estimating, accumulating, and reporting costs (Part 401), and the other calling for consistency in allocating costs incurred for the same purpose (Part 402).

Development of the material being promulgated today began many months ago with extensive research. It included examining publications on the subject, conferring with knowledgeable, representatives of various Government agencies, Government contractors, industry association, and professional accounting associations, and identifying and considering all available viewpoints. From this research, the initial versions of the material now being published were developed. As a part of the continuing research effort, these initial drafts were sent to 81 agencies, associations, and Government contractors which had expressed interest in assisting the Board in its work, and their comments were solicited. Some national defense contractors field-tested the material to see how it would apply to and affect their operations and advised the Board of their findings. In each step of the research process, the Board and its staff have urged and received active participation and assistance by Government, industry, and accounting organizations. Their cooperative efforts contributed in large measure to the exposure draft published in the December 30, 1971, Federal Register for comment.

To better assure that all who might want to comment had an opportunity to do so, the Board supplemented the Federal Register notice by sending copies of the Federal Register materials directly to about 175 organizations and individuals who had expressed interest or had provided assistance in the development of the published material. Also, a press release was distributed announcing the publication, which resulted in numerous articles in journals. The Board availed itself of all opportunities to publicize the proposals and solicit comments on them.

Written comments in response to the published material were requested by February 4, 1972. Comments were received from 105 sources, including Government agencies, professional associations, industry associations, public accounting firms, individual companies, and others. The Board appreciates the obvious care and attention devoted by commentators, and as will be seen below, the Board has greatly benefited from the comments received.

Many of the comments received or were addressed to all parts of the proposed Board rules as well as to the question of public availability of the Disclosure Statements. All of the comments received have been carefully considered by the Board taking into account the requirements of section 719. Understandably, many of the comments were addressed to issues which recur in two or more of the proposed parts while others dealt only with specific sections. Comments which dealt with 11 general issues are discussed separately below followed by a section-by-section analysis of other comments. Appropriate changes have been made in the material promulgated based on the Board’s disposition of the comments received.

Those comments and suggestions received which are of particular significance are discussed below.

1. Public availability of disclosure statement. In a special notice in the notice of proposed rule making, the Board sought comments to assist it in redetermination of whether Disclosure Statements submitted by defense contractors and subcontractors should be available to the general public, pursuant to the Public Information Section of the Administrative Procedure Act (5 U.S.C.552) or whether such information was properly within one of the statutory exceptions to the legal requirement for public availability.

2. Contractor-subcontractor relationships. Several commentators, stating that contractors cannot dictate the cost accounting practices of their subcontractors at any tier, urged that the Board not hold contractors responsible for increased costs to the United States arising from the failure of sub-contractors to follow Cost Accounting Standards or disclosed cost accounting practices. Several commentators also urged that the contractor not be subject to the possibility of a default termination by reason of the actions or inactions of any of its subcontractors at any tier. Finally, some commentators urged that the Board establish a novel concept of privity between the contracting agency and subcontractors with respect to any concerns stemming from Board rules, regulations, and Cost Accounting Standards.

3. Exemptions. Many commentators urged the Board to provide exemptions either to the requirement to file a Disclosure Statement or to both that requirement and the requirement to follow Cost Accounting Standards. Exemptions were urged for subcontractors below the first tier, subcontractors with small amounts of defense contracting business, producers of basic or raw materials, colleges and universities, construction contractors, firms which would qualify as small businesses, and others.

4. Applicability date of standards, rules, and regulations. A related issue raised by many commentators is a request that Cost Accounting Standards be made applicable 90 days after issuance or at the beginning of the contractor’s next fiscal year, whichever is later. In order to provide the maximum benefits from use of Cost Accounting Standards, the Board has decided not to adopt any rule which would automatically delay the effective date of Cost Accounting Standards beyond the dates contemplated in section 719(h). That section provides a minimum of 4 months notice from the date of promulgation, to contractor of the likely applicability of a Cost Accounting Standard. The Board regards this as an adequate time for companies to prepare for use of the standard. The Board nevertheless recognizes that certain standards by their nature may require deferring applicability to the beginning of a contractor’s fiscal year next following the effective date, and in such cases that applicability will be stated in the standards concerned.

5. Agency administrative responsibility. Many commentators, noting the Board’s statutory responsibility to promote uniformity and consistency in cost accounting practices used in defense contracting and subcontracting have suggested that uniformity would be promoted by giving the Board another single Federal agency the sole implementing responsibility respecting Board regulations. Thus, some commentators recommended that the Board itself issue regulations prescribing the frequency of submission of Disclosure Statements and where they must be submitted. Other commentators urged that the Board issue a single regulation prescribing exact methods by which increased costs to the United States will be determined. Other commentators urged that the Board prescribe methods by which advance agreements affecting more than one contract shall be made, some commentators urging that the Board itself make those agreements. Others urged that the Board rule that the contracting agencies must act to approve or disapprove Disclosure Statements within a stated period of time. And finally, some commentators urged that the Board itself be the sole agency to approve the cost accounting practices disclosed through submission of a Disclosure Statement.

6. Contract modifications. Several commentators have urged that negotiated contract changes and amendments over $100,000 to contracts which are themselves not subject to Board jurisdiction should not be covered. One commentator pointed out that in a long-term contract, most changes represent “instead of” type changes with cost of price adjustments only for the incremental effect of the change. This commentator stated that there is no practical way separately to identify these incremental costs.

7. Definitions. The Board is also persuaded of the value of one commentator’s suggestion that the Board provide a compilation of definitions of the words or phases defined in individual Cost Accounting Standards, making those definitions applicable to all such standards. Consequently, a new Part 400 has been added, and all terms defined in Parts 401 and 402 have been placed in it, although they also remain in the particular standards in which they are defined. As more standards are added, any terms defined in them will also be added to Part 400. However, terms defined in Parts 331 and 351 are not included in the glossary of definitions, nor are terms used in those parts necessarily to bear the meanings ascribed to those terms in Part 400.

8. Application to individual contracts. Several commentators urged that the Board adopt the date of final agreement on a negotiated price as a cut-off date for the disclosure of cost accounting practices. The Board has reviewed the merits of selecting that date rather than the date of award to establish the date as of which the contractor’s Disclosure Statement must accurately reflect his cost accounting practices, at least with respect to those contracts where cost or pricing data have been submitted pursuant to Pub.L.87-653. The Board has decided to use the date of final agreement on price, as shown on the signed certificate of current cost or pricing data, with respect to contractors who have submitted cost or pricing data, and to use the date of award of the contract for all other contractors. In addition, the Board has concluded that it is appropriate to use those dates to establish which Cost Accounting Standards shall be applicable to the proposal and to the contract at its inception. Appropriate changes in Parts 331, 351, and 401 have been made to reflect this decision.

9. Price adjustments. Many commentators stated that where a contractor’s departure from existing disclosed practices is occasioned by the contractor’s wish to adopt a newly issued Cost Accounting Standard for all contracts, the Government should be willing to provide upward price adjustment whenever an existing contract is rendered thereby more expensive to perform. The view was often expressed that contractors could not maintain one accounting practice for contracts subject to a particular Cost Accounting Standard, but a different practice for contracts not so subject; therefore, it was alleged, once a contractor had to adopt a standard for any one contract, he would of necessity adopt it for all contracts and amend his Disclosure Statement accordingly.

10. Materiality. The Board notes that many commentators urged that a concept of materiality be incorporated in the Board’s regulations, to the end that minimal or insignificant modifications of or failures to use disclosed cost accounting practices would not be subject to price adjustment.

11. Additional requirements by agencies. As a final general point, concern was expressed that Federal agencies might require submission of cost proposals in ways inconsistent with the cost accounting practices of some or all of the potential offerors. The Board recognizes that this has happened in the past, but it notes that Board rules, regulations, and Cost Accounting Standards are to be used by relevant Federal agencies as well as by contractors and subcontractors, and it believes that henceforth requests for proposals must be fully consistent with such rules, regulations, and standards, although of course the Federal agency may ask for supplementary information to accompany proposals if this is needed to meet the agency’s requirements.

Other Comments

Section 331.2 -- Definitions.

A few commentators recommended modifying the definition of “relevant Federal agency.” Their purpose was to assure that agencies such as the General Accounting Office and the Renegotiation Board were excluded from the definition of such agencies. Those recommendations have not been accepted, since the Board believes the General Accounting Office, the Renegotiation Board, and other agencies whose responsibilities include review, approval, or other action affecting national defense procurements are within the meaning of “relevant Federal agencies.”

One Federal agency urged that the definition of “national defense” be supplemented at the end by adding the phrase “including R.& D. and services.” The Board believes this addition unnecessary, in light of the definition at 331.2(b) of “defense contractor,” and the definition of “material” set out in 50 U.S.C.App. 2152 as including “technical information.” The Board, of course, agrees that contractors for research and development as well as other services are national defense contractors in light of these definitions.

Several commentators urged that the definition of “negotiated subcontract” at 331.2(f) be broadened to reflect what the commentators believed was the Board’s purpose in this definition, that of precluding jurisdiction over subcontracts made after adequate price competition. That is not the Board’s intention; instead, the Board intended to exclude from the term “negotiated subcontract” only a subcontract made under conditions which are as close to the conditions governing Federal advertised contracts as possible. Accordingly, the Board has not accepted these suggestions, but it has added language to clarify its intention.

In connection with this comment the Board notes that several commentators urged that the Board exempt altogether from its jurisdiction any contract made after adequate price competition. The Board believes that any such exemption would be unwarranted and undesirable in view of the legislative history of section 719.

Section 331.5 Contract clause. The major changes in the contract clause urged by commentators have already been discussed in points 2 and 9 of the discussion of general comments. Commentators raised a number of additional points with respect to this contract clause. A great many commentators objected to the provision in paragraph (e) for termination for default. Many commentators urged that the requirement to repay increased costs to the United States should be deemed the sole remedy for a refusal or failure to comply with the requirements of the contract clause. While that remedy may be adequate for almost all cases involving a failure to follow Cost Accounting Standards or disclosed cost accounting practices, it would not be adequate to meet other possible situations, where, for example, a contractor refused to make a post-award submission of a Disclosure Statement or refused to grant access to records as required by the contract clause. In view of the fact that breach of any of the requirements of this clause would be a breach of a material condition of the contract, the default clause generally applicable to performance of the contract provides adequate coverage. Consequently, the Board has deleted the specific termination language in this contract clause as requested by many commentators.

Some commentators urged deletion or modification of paragraph (c) of the contract clause, which the Board has not done, since that language is prescribed by section 719(j). Other commentators urged that the Board set forth a specific period during which contractor and subcontractor documents, papers, or records relating to compliance with Cost Accounting Standards must be retained. The Board believes that there is no need to do so, since the general records retention requirements of any particular contract will establish that period. One Federal agency requested that the disputes language in paragraph (d) be modified to accommodate that agency’s practice of permitting subcontractors to bring contract disputes directly to that agency’s Board of Contract Appeals. The Board has accepted this recommendation. Two Federal agencies recommended deletion of the definitions in this contract clause as unnecessarily duplicating 331.2. The Board agrees and has made the deletion, except that the definition of “negotiated subcontractor” has been retained in the contract clause for the convenience of contractors and subcontractors.

Other suggestions were received in which the Board was urged to modify other language in the contract clause which is taken directly from provisions in section 719. Preferring to use the statutory language, the Board has not accepted these suggestions. It has however, modified its proposal in paragraph (b) so as to adopt the statutory language, as urged by one commentator.

Section 331.6 Post award disclosure. Two Federal agencies urged that the contracting agencies be authorized to make awards whenever the head of the agency concluded that it was impractical to secure a Disclosure Statement from a contractor or from a subcontractor. Recognizing that any avoidable delays in making procurements are undesirable, the Board has accepted this recommendation. The Board does not expect that the authority thus provided to agency heads will be abused, and it will be informed of all actions taken pursuant to this authority.

Effective date and application. For the convenience of readers, the following summarizes the effective dates set forth in 331.8, 351.4(e), and Parts 400, 401, and 402, which were transmitted to the Congress on February 24, 1972, pursuant to section 719(h)(3) of the Defense Production Act of 1950 as amended. After the expiration of a period of 60 calendar days of continuous session following the date of transmittal to the Congress, the regulations herein promulgated shall take effect as set forth in those regulations, unless there is passed by the two Houses a concurrent resolution stating in substance that the Congress does not favor the proposed standards, rules or regulations.

1. The provisions of 331.4 are to be included in all solicitations issued on or after July 1, 1972, which are likely to lead to contracts covered by standards, rules, and regulations of the Cost Accounting Standards Board.

2. The provisions of 331.5 are to be included in all contracts resulting from solicitations covered by 1 above. In addition, these provisions are to be included in any other contract which is within the jurisdiction of the Cost Accounting Standards Board and which is awarded after October 1, 1972.

3. The provisions of Part 351 will be applicable to any contractor who submits a proposal which results in contracts containing the clause in 331.5 and whose net awards of negotiated national defense prime contracts during Federal fiscal year 1971 totaled more than $30 million. Contractors whose net awards were less than that amount may be required to complete or submit a Disclosure Statement as the Board announces extensions of this requirement to such contractors.

4. Any contractor having a contract awarded prior to July 1, 1972, which contains a clause which already incorporates requirements governing submission of Disclosure Statements and application of Cost Accounting Standards will be required to comply with the provisions of that clause. In this connection, such contractor and the respective contracting agencies whose contracts contain such a clause should review those contracts to determine whether negotiations should be instituted to make Parts 400 through 402 applicable to them.

Preamble B
Preamble to Amendment of 6-29-72

This amendment redesignated 331.3 as 331.3(a) and added a new 331.3(b). The preamble and amendment were published on June 29, 1972, at 37 FR 12784. Although Part 331 was subsequently republished and revised on November 7, 1973 (38 FR 30725), the preamble to the amendment of June 29, 1972, is included as part of the administrative history of the regulation.

The purpose of this publication by the Cost Accounting Standards Board is to adopt a modification to 331.3. Applicability, of its rules and regulations. The modification adopted today was initially published in the Federal Register of May 23, 1972 (37 FR 10454). Comments regarding that notice of proposed rulemaking were invited to be submitted to the Board by June 23, 1972.

The prescribed period has passed, and no comment opposing the proposed modification has been received. In view of this and for the reasons set forth on May 23, 1972, Federal Register, modification to 331.3 of the Board’s rules and regulations is adopted and made effective on July 1, 1972.

Preamble C
Preamble to Amendments of 2-13-73

This amendment adds a new paragraph (c) to 331.3, and deletes 331.6(c). The preamble and amendments were published on February 12, 1973, at 38 FR 4237. Although Part 331 was subsequently republished and revised on November 7, 1973 (38 FR 30725), the preamble to the amendment of February 12, 1973, is included as part of the administrative history of Part 331.

The purpose of this publication by the Cost Accounting Standards Board is to adopt a modification to Part 331, Contract Coverage, of its rules and regulations. The modification was published initially in the Federal Register of December 8, 1972 (37 FR 26127). Some of the material in the modification was also published in the Federal Register of October 6, 1972 (37 FR 21177). Comments regarding the publication on December 8 were invited to be submitted to the Board by January 15, 1973.

The Board received 14 comments from a wide range of commentators. The Board is grateful for their interest and takes this occasion to thank them for the comments.

One commentator urged the Board to require certain additional information to support waiver applications pursuant to paragraphs (1)(i), (1)(iii), and (2)(I) of 331.3(c). The Board agrees that such additional information will assist it in deciding whether to grant a waiver and therefore has adopted this proposal.

Two commentators urged that the signed, unequivocal statement by a proposed contractor or subcontractor that it refuses to accept a contract containing the Cost Accounting Standards clause might not be obtainable even when there has been such a refusal. The Board agrees and has consequently modified the requirement at 331.3(c)(1)(i) so that the agency’s statement of the fact of an unequivocal refusal, and of the contractor’s or subcontractor’s specific reasons therefor, will be sufficient to satisfy this requirement.

A commentator suggested that the Board provide for exemption from particular portions of the Cost Accounting Standards clause, as well as providing for exemption from all of it. The Board agrees that it is helpful to spell out such authority and has modified its proposal accordingly.

The Honorable Wright Patman, Chairman of the Committee on Banking and Currency of the House of Representatives, noting that any extensive use of the Board’s proposed authority could seriously weaken the objectives of section 719 of the Defense Production Act of 1950, as amended, requested that within 30 days after acting on any request for an exemption the Board transmit to him a full report of the exemption request and its action thereon. The Board is pleased to comply with this request. A similar report will also be submitted to the Chairman of the Committee on Banking, Housing, and Urban Affairs of the U.S. Senate.

Another commentator urged in the interest of assuring maximum access by the public and the Congress to the Board’s actions that requests for waivers be published in the Federal Register and that comments on them be solicited that the Board’s action on a request and an explanation of it be published in the Federal Register. and, finally, that notwithstanding any prior publication, that the Board include in its annual report to Congress a listing of every request for waivers received during the year, together with an explanation of the Board’s action granting or denying the request. This commentator, asserting that the Board does not have unlimited discretion to grant waivers or exceptions, urges that the standards the Board will apply in acting on requests for waivers be stated.

The Board adopts the suggestion that it include in its annual reports to Congress a listing of the requests it receives for waivers and its disposition of those requests. The Board, however, does not believe that it should publish a notice of requested waiver and solicit comments. As noted above, the Board will provide full information to the Congress and to the public through it reports on its actions on waivers. With respect to this commentator’s suggestion that the Board publish the criteria which it will use in acting on requests for waivers, the Board is satisfied that those criteria clearly are implicit in the information which the Board is requiring to be submitted in support of a request for a waiver.

Several commentators urged that the Board delegate its waiver authority to the procuring agencies, stating essentially that waivers could thus be granted more expeditiously. The Board has not accepted this suggestion, since it believes that it should retain control over a matter as important as a total exemption from the requirements of section 719 of the Defense Production Act of 1950, as amended, and also because the Board is convinced that its retention of its waiver authority will not unduly delay action on waiver requests. In this connection, the Board reemphasizes its comments published in the Federal Register for December 8, 1972 (37 FR 26127) that, “The Board *** is prepared to act promptly in response to requests for waivers but *** the Board’s ability to respond promptly will depend in very large measure on whether or not the agency’s request for a waiver is in full accord with the proposed requirements.” If experience shows that delegation of this authority is warranted, the Board will, however, reconsider this suggestion.

Some of these commentators also urged that the level of agency officials authorized to submit requests waivers to the Board be modified to include persons at levels of responsibility below those indicated in the Board’s proposal. The Board believe that the level proposed will not unduly burden the procuring agencies and will assure that any request for a waiver of the Board’s regulations will receive consideration at a very high level within the procuring agency before submission to the Board. It therefore, does not adopt this suggestion at this time, although it may reconsider this suggestion if experience warrants.

Some commentators urged the Board to expand its proposal to permit exemptions on broader bases, instead of confining the exemption authority to particular cases of demonstrated need. The Board does not accept this suggestion, since it does not anticipate wholesale or, indeed, even very numerous requests for waivers. Nevertheless, should a need for broader exemption action be justified, the Board can deal with that need under its authority in section 719(h)(2) of the Defense Production Act of 1950, as amended.

One commentator urged an outright exemption for both foreign and domestic concerns for work performed outside the United States, and other commentators urged the exemption, of all subcontracts performed in Canada. The Board has adopted neither of these proposals, since it believes that the arguments advanced for them are unpersuasive in light of the purposes of section 719. The Board believes, further, that the exemption authority being adopted today provides an adequate basis for waivers where they are appropriate.

A commentator is concerned that the phrase, “on a timely basis,” in 331.3(c)(1)(iv) and 331.3(c)(2)(ii), if given a narrow interpretation, might suggest that timeliness of delivery is the only condition for granting a waiver. That commentator points out that other conditions also may warrant consideration. The Board agrees with the commentator, but it does not believe that a modification of its proposal is necessary to avoid the narrow interpretation feared.

In the interest of clarity, the waiver provision in 331.6(c) is deleted from that section and transferred to 331.3(c).

The Board has revised its proposal as discussed above and has made minor technical improvements. The revised proposal is adopted today.

Preamble D
Preamble to Republication, 11-7-73

This publication (38 FR 30725. Nov. 7, 1973) revised and republished Part 331.

The purpose of this publication by the Cost Accounting Standards Board is to amend Parts 331, 351, 400, 401, 402, 403, and 404 of its rules and regulations. The amendments, which are minor clarifications to the regulations were published in the Federal Register of September 5, 1973 (38 FR 23971). The amendments:

(a) Renumber Parts 331 and 351 to facilitate insertion of future modifications to those parts;

(b) clarify one section of the contract clause at 331.5; and

(c) modify certain definitions in Parts 400, 401. 402, 403. and 404 for the purposes of uniformity among the various Parts. Only one comment in response to the September publication has been received by the Board. This expressed agreement with the proposed changes.

In view of the foregoing, the following amendments to the Board’s regulations are being made effective November 7, 1973:

Preamble E
Preamble to amendment of 9-19-74

This amendment revised paragraph (c)(4) of 331.30, and was published on September 19, 1974, at 39 FR 33681.

The purpose of this publication by the Cost Accounting Standards Board is to adopt a modification to Part 331, Contract Coverage, of its rules and regulations. The modification adopted today was initially published in the Federal Register of August 9, 1974 (39 FR 28645). Comments regarding that notice of proposed rulemaking were invited to be submitted to the Board by September 9, 1974.

The August 9, 1974, publication proposed an amendment to 331.30(c)(4) to permit, under certain circumstances, submission of waiver requests from a level below that of the agency head. No objection to the Board’s proposal has been made. Therefore, the proposal has been adopted for the reasons expressed in the August 9, 1974, publication.

Preamble F
Preamble to Amendments of 12-24-74

This document amended 331.30(a), added 331.30(b)(8), and amended 331.40 and 331.50. It was published Dec. 24, 1974, at 39 FR 44389. The purpose of this publication by the Cost Accounting Standards Board is to adopt modifications to Part 331, Contract Coverage, and Part 351, Basic Requirements, of its rules and regulations. These modifications will provide an exemption from Cost Accounting Standards Board requirements for certain national defense contracts and subcontracts of $500,000 or less.

Public Law 91-379 requires that Cost Accounting Standards must be used in all negotiated prime contract and subcontract national defense procurements with the United States in excess of $100,000, with certain stated exceptions. From time to time the Board refers to contracts subject to its rules and regulations as “covered contracts”. Section 719(h)(2) of Pub.L.91-379 authorizes the Cost Accounting Standard Board to prescribe rules exempting from its requirements such classes or categories of national defense contractors and subcontractors as it determines, on the basis of the size of the contracts involved or otherwise, are appropriate and consistent with the purposes sought to achieved by Pub.L.91-379. The Board has granted several exemptions to classes or categories of contractors and subcontractors and also has established a procedure under which waiver of the Board’s requirements may be granted for individual contracts.

A proposed exemption increasing the minimum contract amount requiring compliance with Cost Accounting Standards Board rules, regulation, and Standards from $100,000 to $500,000 was published by the Board on September 27, 1974 (39 FR 34669). The Board received 32 responses the September 27 proposal. Comments were received from individual companies, government agencies, professional associations, industry associations, public accounting firms, and individuals. All of these comments have been carefully considered by the Board, and the Board takes this opportunity to express its appreciation for the helpful suggestions which have been furnished.

The comments below summarize the major issues discussed by respondents in connection with the initial publication and explain the Board’s disposition of these issues.

Issuance of the exemption. Practically all the commentators expressed concurrence in the proposed exemption, giving either unqualified support or support with added comments that additional exemptions should also be considered. However, three commentators -- a consulting firm, a major aerospace company and a Government agency -- disagreed with the proposed exemption, stating that an increase in the threshold for compliance with CAS requirements was inconsistent with the Board’s objective of establishing uniformity and consistency among contractors doing business with the Government.

The Board agrees that the adoption of the proposed regulation will exempt a substantial number of contractor and subcontractors who otherwise would be covered, and consequently will permit such companies to follow accounting practices other than those set out in Cost Accounting Standards. However, the Board is aware that compliance with its rules, regulations and standards may involve additional administrative effort, particularly on the part of small companies, which may not be commensurate with the benefit to the Government or the contractor resulting from such compliance. The Board, after considering the efforts required by both the Government and its contractors to assure compliance on all covered contracts in excess of $100,000, is persuaded that maximum benefit to the Government with minimum cost can be achieved by limiting the mandatory application of its standards to contractors who receive awards which constitute a substantial majority of the national defense procurement dollars. As was stated at the time the proposed exemption was issued for comment, some 70 percent of the prime contractors of the Department of Defense did not receive one or more negotiated awards in excess of $500,000 in Fiscal Year 1973. Thus, only 30 percent, or approximately 750 prime contractors, who received contract awards totaling $20 billion, would continue to be covered. The exemption would remove coverage from only about 10 percent of the dollar value of annual DoD awards.

In view of the foregoing, the Board considers the proposed exemption increasing the minimum contract amount requiring compliance with the Cost Accounting Standards Board rules, regulations, and standards to be in keeping with the purposes sought to be achieved by Pub.L.91-379 and to be an appropriate exercise of the authority granted to the Board by section 719(h)(2) of that law.

Increase exemption on all contracts to $500,000. A number of commentators suggested that the $500,000 single contract threshold for compliance with Board rules, regulations, and standards be changed to exempt all contracts of $500,000 or less. Those giving reasons in support of this suggestion generally based their comments on simplification of administration. These commentators felt that it would be difficult for the Government or prime contractors, when awarding a prime contract or subcontract in excess of $100,000 to determine whether the contractor or subcontractor had in existence a prior $500,000 covered contract.

The Board, in proposing the $500,000 threshold, did so with the intent of exempting those companies which do not receive contracts in excess of $500,000 from the Government. However, it was decided in the interest of consistency in cost accounting practices that once a contractor had received a covered contract of that size, compliance with CASB rules, regulations and standards on contracts at the level established in Pub.L.91-379 was appropriate. This is also consistent with the desire expressed by contractors to follow a single set of accounting practices. Further, the requirement for coverage of contracts in excess of $100,000 where the contractor already has received a covered contract in excess of $500,000 will permit the small contracts to be available for equitable adjustment if subsequently issued standards should become applicable. Moreover, once the administrative effort has been expended to comply with standards for contracts in excess of $500,000, compliance with standards on contracts above the statutory threshold of $100,000 requires little added effort.

With respect to the commentators’ statements concerning the difficulties, when making an award exceeding $100,000, of determining whether a contractor or subcontractor had in existence a prior award exceeding $500,000, the Board feels that an administrative requirement can be established for obtaining this information. A similar requirement now exists concerning the disclosure statement, whereby contractors are required to submit a disclosure statement, state that they have previously filed a disclosure statement, or submit a certificate of monetary exemption. The Board feels that a similar requirement can be set concerning the $500,000 level. The Board is not persuaded that this matter would create problems of sufficient significance to eliminate coverage down to the $100,000 level.

In considering the advantages of the exemption as proposed compared to its assessment of the administrative difficulties foreseen by commentators, the Board is persuaded that its proposal relative to coverage of awards in excess of $100,000 should not be changed.

Exemption based on sales. A number of commentators urged that the Board establish an exemption based on sales, using either minimum annual dollar amount of sales to the Government, or Government sales as a percentage of total annual sales, or a combination of these two factors. The most frequently it suggested amount was $10 million of sales to the Government or Government sales amounting to 10 percent of total annual sales. The objective sought by these commentators was an exemption of those companies or business units whose sales to the Government constituted a reasonably small portion of their total annual sales and whose business was essentially commercially oriented. The Board has given lengthy consideration to the use of a sales basis for the establishment of a minimum threshold for compliance with its or rules, regulations and standards. It did not use that basis at this time due to the nature of the problems involved in administering an exemption based on sales. In either of the situations suggested by commentators, the representation concerning the amount of sales must be made by the contractor and subsequently verified by the Government. This verification would impose very substantial and time-consuming efforts on both the Government and the contractor. Particularly in the case of Government sales as a percentage of total sales, Government representatives would be placed in the position of examining a contractor’s total sales to including those made in its commercial business. Examination of a company’s records concerning its total sales is not presently performed by Government procurement activities and would present new and unique problems to both parties as well as requiring substantial additional effort on the part of Government representatives.

An exemption based on sales would require a measurement period during which a contractor’s status with respect to compliance with standard would be determined. Contracts under which sales were recorded during this period would not be subject to standards. If the volume of sales during the measurement period exceeded a stated threshold, a contractor would then be required to comply with standards under contracts received in subsequent periods. Thus, the contracts that brought the contractor under the Board’s rules would not be subject to standards, while those received at a later time would be.

The Board has decided that the administrative problems involved with an exemption based on sales should be considered before establishing such a threshold. The Board will continue to study these problems and investigate whether exemptions based on criteria other than a minimum contract amount would be appropriate and consistent with the purposes of Pub. 91-379.

Retroactivity. Several commentators requested that the Board modify proposal so as to provide retroactive exemption to existing contracts when the circumstances are such that the existing contracts would have been exempt if awarded after the effective date of the proposed regulation.

The Board has no authority to modify existing contractual agreements between the government procurement agencies and their contractors. However, the Board sees nothing inconsistent with its regulations or with Pub.L.91-379 in modification by the procurement agencies of contracts in this category, assuming of course that the Government receives adequate consideration for deletion of CAS requirements.

Increase minimum amount. A number of commentators recommended that the exemption proposed be increased to an amount greater than $500,000, the figure of $1,000,000 being frequently mentioned. The Board is not now prepared to raise further minimum contract amount required compliance with its promulgator. The Board, in studying an exemption based on minimum contract amount concluded that the $500,000 threshold was the most appropriate one for achieving its objectives, all factors considered. The Board will continue examine various limitations but considers that the threshold established in the proposed exemption best meets its requirements and obligations this time.

Effect of final payment under contracts subject to CAS clause. Several commentators urged that the exemption of contracts of $500,000 or less should not be dependent on the final payment on contracts which are subject to Board requirements, on the grounds that final payment can occur a substantial period of time after completion of work on a contract and that there are many technicalities in closing out a contract which do not involve cost accounting applications.

The Board considers this point to be well taken and has changed the requirement in 331.30(b)(8) where it first appears to “notification of final acceptance of all items or work to be delivered.” At that time it is considered that all direct costs will have been charged to the contract since all work will have been completed, and any further accounting transactions would be the result of adjustments not directly related to contract performance.

Reduction of contract price by exclusion of commercial items. Some commentators, in reading the introductory comments to the Board’s initial publication of this exemption, interpreted the phrase “minimum contract amount requiring compliance” in a manner not at all intended by the Board. These commentators interpreted this phrase to permit the price of a contract subject to standards to be reduced by the value of those individual contract items or subassemblies of final contract items whose prices could be considered to be “catalog” or “market” prices, if sold separately. They requested that the regulation be clarified to reflect their interpretation of the Board’s introductory comments.

Those requesting this clarification misunderstood the Board’s intentions. The Board does not intend that the price of a contract be adjusted to exclude the price of items or subassemblies which, if purchased separately, might be exempt from the Board’s promulgation’s. Consequently, the change in the regulation requested by commentators on this point would be completely inappropriate.

Definition of contractor. One commentator noted that the prefatory comments to the Board’s September 27, 1974, publication specifically mentioned the fact that receipt of a contract in excess of $500,000 by one business unit of a multi-unit company would not in itself require other units of the same company to follow Board requirements. This commentator requested that the definitions of “defense contractor” and “defense subcontractor” contained in 331.20 (b) and (c) be modified to reflect this intention by the Board.

As the Board stated in its September 27 publication, its contract requirements have been applied to business units, such as a profit center, division, subsidiary, or similar unit of a company, which perform the contract, even in those cases where the contract was entered into on behalf of the overall company rather than the business unit. This application of the Board’s requirements to a performing business unit is well established and unchallenged, and clarification of the definitions of “contractor” and “subcontractor” does not appear necessary.

Effective date. Several commentators raised questions concerning the effective date of the eligibility for this exemption in relation to awards received prior to January 1, 1975. Contractors who have received a prime contract or subcontract in excess $500,000 subject to cost accounting standards prior to January 1, 1975, and on which notification of final acceptance of all items or work to be delivered on that contract or subcontract has not been received, is a contractor who has “already received a contract or subcontract in excess of $500,000,” as that phrase is used in 331.30(b)(8). Therefore, today’s publication requires that a contractor meeting this test will be required to comply with standards on all covered prime contracts or subcontracts in excess of $100,000 received after January 1, 1975, under the provisions of 331.30.

Preamble G
Preamble to Amendments of 2-2-76

This amendment added paragraph (b)(9) to 331.30 and was published on February 2, 1976, at 41 FR 4809.

* Purpose. The purpose of this publication by the Cost Accounting Standards Board is to adopt a modification to Part 331, Contract Coverage, of its rules and regulations. This modification will provide a conditional exemption for contracts and subcontracts made with United Kingdom, firms for performance substantially in the United Kingdom. *

The Cost Accounting Standards Board is authorized by Pub.L.91-379 to prescribe rules and regulations exempting from its requirements such classes or categories of defense contractors or subcontractors under contracts negotiated in connection with national defense procurements as it determines, on the basis of the size of the contracts involved or otherwise are appropriate and consistent with the purposes sought to be achieved by the Act. Pursuant to this authorization the Board has issued a regulation, 331.30, Applicability, exemption and waiver, of Title 4, Code of Federal Regulations, which, among other things, establishes a procedure by which procuring agencies may request a waiver of the Board’s requirements for a particular contract or subcontract.

The Board from 1972 to date has granted 45 waivers requested by procuring departments and agencies. Of that number, 23 were for contracts or subcontracts to be performed by United Kingdom firms each of which is a defense supplier to the U.K. Government and also is essentially a sole source supplier for the particular item being purchased by the U.S. Department of Defense. The waivers granted to U.K. firms have been based in general on the urgency and essentiality of the procurements, which were reported to preclude any alternative to making the proposed awards. However, the U.K. firms were reported having objections to complying with the Board’s rules and regulations, on the grounds that their accounting practices have been approved by the U.K. Government, their major customer, and may not thereafter be changed without further approval. They were reported as stating that they cannot assume an obligation to comply with Cost Accounting Standards which could be in conflict with U.K. Government Accounting Conventions and the governmentally approved accounting practices for the individual firms.

In view of the recurrence of this position and the high proportion of waiver requests involving U.K. firms, the Board undertook discussions with the U.K. Ministry of Defence concerning the application of Cost Accounting Standards and the Board’s rules and regulations to firms which are U.K. defense contractors. As a result of these discussions it has been determined that U.K. defense contractor do disclose their accounting practice to the Ministry of Defence and that the Ministry of Defence approves companies’ practices which then cannot be changed without further approval. It has further been determined that Review Board for Government Contracts, whose chairman and member are nominated by the Government and industry and appointed by the Treasury, but which is established as an independent organization, among other duties periodically reviews and makes recommendations for change in U.K. Government Accounting Conventions. The Review Board has also issued or sponsored certain cost accounting standards for use by U.K. firms in contracting with the Ministry of Defence.

On November 17, 1975, the Board published for public comment in the Federal Register (40 FR 53271) a proposal for a conditional exemption for U.K. firms performing substantially in the U.K. Nine responses were received to that publication. Responses were received from government department, defense contractors, an industry association and two individuals. All of these comments have been considered by the Board, and the Board takes this opportunity to express its appreciation for the helpful suggestions which have been furnished.

The comments below summarize the major issues discussed by respondent to the initial publication and explain the Board’s disposition of these issues.

U.K. Government Accounting Conventions. Two United States Government departments were concerned that the reference in the proposed conditional exemption to the obligation of U.K. firms to disclose cost accounting practices which would be in accord with U.K. Government Accounting Conventions implied or could be understood to require that when matters mandated by the Conventions were in conflict with certain requirements of the Armed Services Procurement Regulation and Energy Research and Development Administration procurement regulations, the policies of the Conventions would prevail.

One of the departments pointed out that the Conventions permit reimbursement of four kinds of costs which are either by U.S. law or by U.S. procurement policy not allowable costs in U.S. contracts. These are entertainment expenses, product advertising certain donations and certain non-incurred capital costs. The Board recognizes that the Conventions deal broadly with matters which can be regarded as relating to both allocability and allowability of costs. They do indicate that in certain circumstances, the indicated costs are allowable costs under U.K. contracts. However, cost accounting practices covered by Disclosure Statements do not deal with the allowability of costs, only with their measurement and allocation. Where appropriate, a disclosed practice must result in measurement and allocation of a cost in accord with the Conventions; whether that cost is or is not allowed as a cost under U.S. contracts is a matter for agreement by the parties to the contract and is not affected by the requirement that disclosed cost accounting practices be in accord with the Conventions.

Secondly, the department points out that the profit formula used by the U.K. Government is different from the profit formula used in U.S. negotiated procurements. The U.K. profit formula, however, is not a part of the U.K. Government Accounting Conventions governing cost accounting practices, nor does the Disclosure Statement deal with policy on which profits are determined. Consequently, a requirement that disclosed cost accounting practices be in accord with the Conventions does not impinge on the authority of U.S. officials to prescribe policy for the determination of profits under U.S. prime or subcontracts.

Thirdly, the department notes that there are differences between the U.K. Government Accounting Conventions concerning independent research and development and the provisions in ASPR Section XV which are used for compliance with Pub.L.91-441. Pub.L.91-441 makes Department of Defense appropriations unavailable for payment of a contractor’s independent research and development or bid and proposal costs, unless the work which is paid for has a potential relationship to a military function or operation and unless other conditions are met. The most important of the other conditions is that there be an advance agreement with the contractor. What has been said above about the allowability of costs is applicable to this point also. Furthermore, nothing in the Board’s conditional exemption in any way controls the terms and conditions upon which the Department of Defense may agree in advance with a U.K. firm for the reimbursement to it of independent research and development and bid and proposal costs.

Additionally, the department notes potential differences in the treatment of depreciation costs under the Conventions and under the applicable ASPR requirements, unmodified by the Board’s Cost Accounting Standards. The comment does not specify, nor does the Board find, any significant differences at present. The Board does recognize that both the U.S. and U.K. Governments may modify their tax laws and their procurement regulations with an objective to encourage capital investment, and that differences could some day arise. In such case, the Conventions permit sufficient flexibility in individual cases to allow U.S. agencies to reach agreement with U.K. firms on appropriate annual depreciation costs.

Finally, this department has consistently requested unqualified waivers from the Board for use in its prime and subcontracts with U.K. firms. Such firms have in fact been required to follow U.K. Government Accounting Conventions on their work for the U.K. Government, and the department has been able to negotiate mutually agreeable prices for contracts with them despite this circumstance. Under the Board’s conditional waiver, the department will have the advantage of a Disclosure Statement from such firms, which could not have been available when an unconditional waiver was sought and which should be of material assistance in the negotiation and audit of new contracts.

The Board is glad that these questions were raised but does not believe it is necessary to modify its proposed conditional exemption to resolve them.

It is appropriate to note here that the Board has not specifically required access to records of U.K. firms by appropriate U.S. officials, as it might have done. Such a requirement appears unnecessary in view of the standard provisions for access to records contained in U.S. defense contracts and subcontracts for performance in the U.K. Access to records through such standard provisions in those contracts will be adequate to assure contractor compliance with the consistency requirement of the conditional exemption.

Another commentator opposed the proposal largely on the basis of his belief that the proposal would require adoption by U.S. price negotiators and auditors of the pricing practices followed by the U.K. Ministry of Defence. This belief appears to have been based on the reference in the proposal to U.K. Government Accounting Conventions. The Board sees nothing in the conditional exemption which would require U.S. negotiators to accept pricing practices contrary to U.S. procurement regulations and the agreements which U.S. negotiators reach with U.K. firms in the pricing of prime or subcontracts.

This commentator also indicated that not all U.K. firms which are U.S. prime or subcontractors are also suppliers to the U.K. Government. The Board agrees that this could be the case and believes that if so, it is not appropriate for the Board to require that all U.K. firms necessarily adopt the U.K. Government Accounting Conventions. It has consequently modified its proposal to provide that disclosed practices must be in accord with the Conventions only when the disclosing contractor is already required to follow the Conventions. Thus, certain U.K. firms may be subject to neither Cost Accounting Standards nor U.K. Government Accounting Conventions. In such cases, U.S. negotiators must use that firm’s Disclosure Statement in arriving at agreement on the cost accounting practices to be followed in contracts subject to the conditional exemption.

Retention of disclosure statements. A commentator pointed out that while the Board had proposed that Disclosure Statements submitted by U.K. firms be filed with the U.K. Ministry of Defence, the Board had not specified that the Statements would be retained in the Ministry. Since that was in fact the Board’s intention, the Board has adopted a modification to its proposal in order to make that intention clear.

Prime contractor-subcontractor relationships. Two matters relating to prime contractor-subcontractor relationships were raised. A commentator pointed out that a U.K. subcontract might be subject to price adjustment if the subcontractor changed its disclosed cost accounting practices during contract performance. In such a case, the Government’s action would presumably be to require a corresponding change in the cost or price of the prime contract. The Board agrees that this is so, and prime contractors may wish in the future, as some have done in the past, to obtain agreement with U.K. subcontractors for appropriate indemnification in the event the subcontractor’s change in practices cause a modification in the cost or price of the prime contract. The Board previously discussed this situation in its original publication of 4 CFR 331.50 and does not consider that specific language addressed to this matter is required to be included in the condition all exemption.

Another commentator stated that was confident that the Board did intend that the conditional exemption apply to U.S. subcontractors under prime contracts with U.K. firms a urged the Board to address this matter specifically. The Board’s proposal do not require any flow-down of the clause, “Consistency in Cost Accounting Practices”, from U.K. prime contractors to first tier or lower tier subcontractors. The Board may after experience in use of that clause is gained, reconsider this matter. In that case, the Board would then have to consider whether it would be appropriate for the Board to require that U.K. prime contractor be required to pass down to any subcontractor whether or not a U.S. subcontractor, a more extensive contractual obligation than is imposed on the prime contractor. For the time being, the Board notes the likelihood that U.S. subcontractors under U.K. prime contracts will already be subject to Cost Accounting Standards by reason of other covered prime or subcontracts which that firm has entered into. If this prior coverage has not taken place, the Board believes that the value of achieving coverage through a flowdown provision in a U.K. prime contract is too insignificant to justify the administrative complexities of such a provision.

Further exemptions for foreign suppliers. A commentator, not wishing to comment on the present proposal, nevertheless recommended that the Board exempt all foreign suppliers, on the ground that problems in the administration of the CAS clause are matters of contention and, in the opinion of the commentator, pose relatively greater difficulties in the administration of foreign contracts.

The Board has announced the establishment of projects to investigate the administrative concerns of this commentator and others, and if those concerns prove to be substantial, the Board will take appropriate action. In the more than four years during which the CAS clause has been required to be included in all appropriate foreign contracts and subcontracts, absent a waiver, the Board has heard of no problem in the administration of the clause which has posed any problem in foreign contracts.

Whenever the Board believes a waiver of the CAS clause for foreign firms has been persuasively proposed by a contracting agency, it will grant such a waiver, but the Board’s experience to date does not indicate to it any reason to consider a blanket waiver for all foreign prime contracts and subcontracts.

Miscellaneous comments. One commentator, from a major defense contractor, deserves note by the Board because of what the Board perceives to be major misconceptions and erroneous assumptions underlying the comment.

The comment opposed the proposal for a conditional exemption and favors an unqualified exemption. One reason given, to quote from this comment, is:

By requiring a contract clause which will provide for a penalty to be paid by the U.S. prime contractor in the event that a U.K. subcontractor fails to consistently follow disclosed cost accounting practices where such failure results in increased costs paid by the U.S. Government, is to impose on the U.S. primes an obligation so vague and impracticable as literally to be unique in the history of bilateral contracting.

The Board believes this comment is wholly inaccurate. First, the obligation to consistently follow disclosed or established cost accounting practices is not imposed by the Board’s current proposal -- it has been present in every U.K. prime contract or subcontract subject to the CAS clause. Secondly, exactly the same obligation of a prime contractor has existed for years with respect to every subcontract it makes which includes the CAS clause. The Board does not believe that the obligation arising under the conditional exemption is either vague or impracticable, and it knows it is not unique.

Additionally, this commentator with respect to the same obligation stated:

For the U.S. Government to impose such alien rules on the defense contracting community in the United Kingdom * * * where neither the Government of the United Kingdom nor the contractors have determined for themselves that there are benefits to the imposition of such punitive rules regarding accounting practices seems patently absurd. Further, to impose on the procurement process such a nebulous and onesided contractual requirement by the use of the regulatory procedures which will render the clause “mandatory and non-negotiable” is to express an unwarranted contempt by the United States for the standards and practices of business accounting and contracting procedures of the United Kingdom.

Apart from the commentator’s several adverse characterizations of the Board’s requirements, which are discussed generally below, this portion of its comment does not appear to recognize that the Board’s proposal was discussed with the U.K. Government and with representatives of the British defense industries. Through meetings in both Washington and London and through continuing, close consultations, the Board has confidence that its proposal has been carefully reviewed and discussed within the United Kingdom and that its adoption will be welcomed by the firms and governmental agencies affected by it. This careful consultation, and the Board’s subsequent proposal for a conditional exemption, arose out of the Board’s respect for, not its contempt of, the standards and practices of cost accounting in the United Kingdom.

Finally, this commentator expressed its view that there have been no discernible benefits whatever from the Board’s regulations and its further view that the Board has abundant evidence that its regulations requiring consistency in following disclosed cost accounting practices have resulted in “substantial impairment of the economy, efficiency, and effectiveness of procurement * * *. The commentator concluded this point by stating that since it regards the Board’s consistency requirement to be “unfair, unworkable and doubtfully enforceable”, it would use the proposed conditional exemption for U.K. firms only “with shame and reluctance.”

The Board has received reports from procurement agencies of major benefits stemming from use of its consistency requirements, and the Board believes that they have unquestionably, improved the economy, efficiency and effectiveness of procurement. The Board believes that those requirements are fair, workable and enforceable.

As noted above, the Board is currently investigating suggestions made by some U.S. defense contractors, including this commentator, to determine whether there are substantial problems in the administration of its requirements to follow disclosed accounting practices consistently. The commentator offers no information concerning any such problem, only its conclusion that the Board has acted wholly improperly in proposing the U.K. conditional exemption. The Board does not agree.

Costs and benefits. The Board discerns no significant cost or inflationary impact of the conditional exemption.

The benefits include a substantial reduction in the number of waiver requests for United Kingdom firms, while establishing a consistency requirement for all U.K. contractors which is necessarily lost when all Board requirements are waived.

A United Kingdom firm could find that its obligations to follow U.K. Government Accounting Conventions might require the firm to change a disclosed cost accounting practice. In such an event, the Board hopes the cost impact on U.S. contracts or subcontracts of any such change would be negotiated in advance of the effective date of a change to the Convention, so as to avoid the imposition of any interest charges on increased cost paid by the United States. The negotiation relating to a change in disclosed practices would be patterned on the similar negotiation required under Section (a)(4)(B) of the Cost Accounting Standards Clause.

In view of the foregoing, the following change to Part 331 of the Board’s regulations is being made effective February 2, 1976.

Preamble H
Preamble to Amendments of 9-12-77

The amendments to 4 CFR Part 331, 42 FR 45625, Sept. 12, 1977 were published as a part of the document which set forth the original 4 CFR Part 332 and amendments to Parts 351 and 403. The complete Preamble appears in the supplement to Part 332.

Small Business

Several commentators urged that all businesses which qualify as small business concerns under the rules and regulations of the Small Business Administration be exempted. The February 16, 1977 proposal would have provided such an exemption only for a small business which received less than $10 million in awards during its preceding fiscal year. Modified coverage would have been provided for other small businesses. Research indicates that there are very few companies which would fall into the category of small businesses receiving awards of $10 million or more. In the interest of using a single test, i.e., whether the contractor qualifies as a small business concern, rather than a dual test which would result only in a few small businesses being subject to modified coverage, the Board has adopted the recommendation to exempt all small business concerns. Research indicates that if this action had been applied to Federal Fiscal Year 1976 it would have resulted in exemption of 196 small business concerns which were doing business with the Department of Defense and which had $460 million of contracts of the type subject to Cost Accounting Standards. Consequently, on average, each small business concern would have a relatively small amount of covered contracts.

Other Categories

Various commentators renewed previous recommendations that the Board exempt other categories of contracts and contractors. The categories included colleges, universities, non-profit organizations, hospitals, and government-owned contractor-operated facilities. The Board has considered these recommendations and concluded that none of these categories should be exempted.

Effective Date

The effective date of the regulations being published today is March 10, 1978. Pub.L.92-379 provides that regulations shall take effect not earlier than the expiration of the first period of sixty calendar days of continuous session of the Congress following the date on which a copy of the regulations is transmitted to the Congress. The calendars of the Congress indicate that the required sixty days will not pass until some time in February 1978. Accordingly, March 10, 1978, has been selected to assure sufficient time for the regulation to lie before the Congress.

Preamble I
Preamble to Amendments of 10-5-77

This document added 331.71 and was published Oct. 5, 1977, at 42 FR 54254.

Summary. This modification of the Cost Accounting Standards Board’s rules and regulations provides criteria for determining the materiality of costs in given circumstances, in applying words or phrases of materiality used in Cost Accounting Standards, and to limit price adjustments to material amounts of cost.

Supplementary information. A discussion of the background and public comments received in response to the initial publication of these regulations and of the principal issues considered in preparing the final promulgation precedes the regulations.

The purpose of this publication by the Cost Accounting Standards Board is to adopt a modification to Part 331, Contract Coverage, of its rules and regulations. The modification will provide criteria for determining the materiality of amounts of cost in given circumstances. The Board initially considered publishing a definition of the terms “cost accounting practice” and “change to either a disclosed cost accounting practice or an established cost accounting practice” along with the modification dealing with materiality. That definition is being handled separately by the Board, however, and will be considered at a later date.

The Board is authorized by Pub.L.91-379 to prescribe rules and regulations for implementing Cost Accounting Standards. Pursuant to this authority, the Board is today issuing a modification to its regulations. Contractors and procurement agencies engaged in the implementation and administration of CASB rules, regulations, and Standards have recommended that the Board provide guidance concerning materiality in the administration of the Board’s rules, regulations, and Standards.

Representatives from various organizations affected by Standards have pointed out that guidance in this area will facilitate the implementation and administration of CASB pronouncements. A similar recommendation was also received by the Board at an Evaluation Conference in June 1975. The General Accounting Office’s Status Report on the Cost Accounting Standards Program -- Accomplishments and Problems (PSAD-76-154, Aug. 20, 1976), also referred to the need for guidance on this subject.

Research in this area included a review of data submitted by participants in the Evaluation Conference, an analysis of papers submitted by various contractors, professional groups, trade associations, and Government agencies, as well as a review of existing procurement regulations. and existing CASB promulgation’s. A Staff draft of an amendment dealing with materiality criteria and price adjustments was distributed on August 13, 1976. Responses from 53 sources contributed to the Board’s further consideration of the issues involved in this proposed amendment.

A proposed amendment to the Board’s regulations was published in the Federal Register on February 3, 1977 (42 FR 6591). A total of 45 responses were received from individual companies, Government agencies, professional associations, industry associations, universities, and others. The Board takes this opportunity to express its appreciation for the helpful suggestions and criticisms which have been furnished. The comments furnished by the organizations and individuals have resulted in a number of changes in the amendment being promulgated today. The following material summarizes the issues regarding materiality that were discussed by respondents in connection with the proposed modification and explains the changes made to the proposal published February 3, 1977. The still relevant portions of the comments which accompanied the February 3, 1977 publication have been incorporated in this material.

Materiality Criteria

Generally, commentators felt the proposed materiality criteria were a necessary, positive and useful step, However, some commentators suggested that the proposed criteria were not sufficiently specific and would not resolve the materiality questions that currently exist. Some commentator suggested that quantitative criteria be added to the proposed regulation others suggested that the criteria proposed were suitable.

At the present time, the Board is of the opinion that quantitative limits should not be established for materiality determinations. The essence of materiality criteria is to allow for the excise of judgment; and absolute dollar amount in one case may be material while in another case the same amount may be immaterial. Accordingly, quantitative limits have not been added to the proposed amendment.

The materiality criteria being promulgated are designed for use in a variety of situations and to resolve issue which have been raised by various sources, Cost Accounting Standards establish the cost accounting appropriate for the determination of contract costs. Departure from the requirements of these Standards may occur and the cost effects of such departure may be immaterial. The criteria serve to limit price adjustments to material amounts of cost. The regulation also describes the actions to be taken when immaterial amounts of cost are involved in noncompliance with Standards. The criteria for materiality are also to be used in applying words or phrases of materiality used in Cost Accounting Standards. In particular Standards, the Board will continue to give consideration to defining materiality in a specific manner as to either the entire Standard or any provision thereof, whenever it appears feasible and desirable to do so.

Administrative Costs

Commentators proposed that the administrative cost of processing a change in cost accounting practice to both the Government and the contractor should be one of the criteria used in determining materiality. The Board’s initial publication did not provide for consideration of these costs in determining materiality. Generally, such costs on the part of both the Government and the contractor are absorbed as part of their routine operations. On a conceptual basis, the determination of materiality should be made considering only the amount of costs affected by the proposed changes. As a practical matter, however, the administrative cost to process a contract price adjustment is a factor in a materiality decision.

The Board is persuaded that the administrative cost of processing a change in cost accounting practice should influence a decision as to materiality. For example, if it is estimated that costs would be changed by $10,000 through processing a change at a Government contractor administrative cost of $10,000, then processing the change would be nonproductive whether or not, considering all materiality factors, the estimated change in costs of $10,000 would be judged material. Accordingly, the Board has added a provision to this modification dealing with such costs.

Measurement of Cost Impact

Commentators suggested that the Board’s regulations provide that initially the determination of materiality should be done on a gross, overall, basis rather than on an in-depth cost impact study. These commentators asserted that a provision of this type would help to reduce the time and cost of evaluating and processing proposed changes which are judged to have an immaterial impact. Procedures for measuring and processing cost impact due to both changes in cost accounting practice and noncompliance’s with Cost Accounting Standards have been developed by the procurement agencies, and they now require an estimate of the general dollar magnitude of the change as a first step in the process. The Board encourages the use of the materiality criteria promulgated today in conjunction with the existing two-stage cost impact evaluation procedure provided in procurement agency regulations. The Board believes that the effective use of procedures established in agency regulations will accomplish the saving in time and cost desired.

Some Government commentators proposed that 331.71(b)(2) be deleted. They expressed the view that it dealt with administrative matters and not criteria for the determination of materiality. The question of both the contractor’s and the Government’s responsibility in situations where noncompliance with Cost Accounting Standards resulted in a cost impact which is immaterial has frequently arisen. The Board believes that the implementation and administration of cost accounting rules, regulations, and Standards will be facilitated by a statement of the Board’s position on this matter. Accordingly the Board believes that the section in question should be retained in its regulations.

Retroactive Application

Commentators expressed concern that 331.71(b)(2) would be applied retroactively to immaterial items. The language of this section requires that it be applied to the accounting period or for which the cost impact of a noncompliance becomes material and to succeeding cost accounting periods. In any cost accounting period prior to that, by reason of the provisions of this requirement, the cost impact of the noncompliance would have been determined to be immaterial. Thus, no contract modification was or is required.

Illustrations

The February 3, 1977, proposal contained two illustrations of the application of the materiality criteria. A number of commentators stated that the illustrations were too basic to be useful, and that the problems related to the determination of materiality are too numerous and too complex to be adequately illustrated in a regulation of this type. The commentators suggested that the illustrations be eliminated. The Board agrees, and has eliminated the examples in this section.

Preamble J
Preamble to Amendments of 3-10-78

The document published at 43 FR 9775, Mar. 10, 1978, added 331.20(h), (i), and (j), 331.50(a)(4)(C), 331.51, 332.50(a)(5),and 332.51, revised 331.50(a)(4)(B), and (d) introductory text and (d) (1) and (2), and amended Parts 351, 403, 406, and 409.

The purpose of this publication by the Cost Accounting Standards Board is to adopt a modification to part 331 Contract Coverage, and part 332 Modified Contract Coverage, of its rules and regulations. The Board is also withdrawing a proposal to modify 331.70. This modification being adopted will

The Board is authorized by Pub. 91-379 to prescribe rules, regulations, and modifications for implementing cost accounting standards. Pursuant to this authority, the Board is today issuing modifications to its regulations. Contractors and procurement agencies engaged in the implementation and administration of CASB rules, regulations, and standards have recommended that the Board provide guidance concerning the meaning of “cost accounting practice” and “change to either a disclosed cost accounting practice or an established cost accounting practice.”

Representatives from various organizations affected by standards have pointed out that guidance in the areas will reduce disagreement and facilitate the implementation and administration of CASB pronouncements. Similar recommendations were also received by the Board at evaluation conferences in June 1975 and October 1977. The General Accounting Office’s Status Report on the Cost Accounting Standards Program -- Accomplishments and Problems,” (PSAD-76-154, August 20, 1976), also referred to the need for guidance on these subjects.

Research in this area included review of data submitted by participants in the evaluation conference, an analysis of papers submitted various contractors, professional groups, trade associations, and Government agencies, as well as a review of existing procurement regulations, the Internal Revenue Code, Accounting Principles Board Opinion No. 20, and existing CASB promulgation’s, staff draft of amendments containing definitions of “cost accounting practice” and “change to either a disclosure cost accounting practice or an established cost accounting practice” distributed on August 13, 1976. Responses from 53 sources contributed the Board’s further consideration of the issues involved in these proposed amendments.

Proposed amendments to Board’s regulations were published the Federal Register on February 3, 1977 (42 FR 6591). A total of 45 responses were received from individual companies, Government agencies, professional associations, industry associations, universities and others. The proposed amendments were revise and republished for comment on October 21, 1977 (42 FR 56130) and included a proposed change to the CAS contract clause. A total of 40 responses were received to that publication.

The Board takes this opportunity to express its appreciation for the helpful suggestions and criticisms which have been furnished. These comments have resulted in a number of changes and improvements in the amendments being promulgated today. The following material summarizes the issues discussed by respondents in connection with the proposed modification and explains the changes made to the proposals published February 3 and October 21, 1977. The still relevant portions of the comments which accompanied the earlier publications have been incorporated in this material.

Definition of Cost Accounting Practice

The need for a definition of “cost accounting practice” has been raised by numerous inquiries from the field and by participants in the evaluation conferences. The Board agrees, and believes that a definition of this term can reduce disputes and contribute to increased uniformity in the administration of the CAS contract clause. A number of commentators expressed the view that the proposed definition was workable and useful as presented, would serve to reduce disagreements, and would facilitate the administration of cost accounting standards. Some said that the proposal, if adopted, would go a long way towards solving several problems identified in earlier written communications to the Board and oral presentations to the Board and its staff. Some encouraged the Board to promulgate the rule at an early date and commended the Board for taking a very significant step towards solving one of the troublesome and difficult areas of Cost Accounting Standards.

Other commentators suggested that the proposed definition went beyond the authority of the Board in that it included both the measurement of cost and the assignment of cost to cost accounting periods.

They asserted that these are financial accounting topics and are not within the realm of cost accounting. Still other commentators stated that the Board was dealing with detailed practices and procedures rather than Cost Accounting Standards and principles.

As early as March 1973, in the “Statement of Operating Policies, Procedures, and Objectives” and more recently in the May 1977, “Restatement of Objectives, Policies and Concepts,” the Board stated that Cost Accounting Standards will be established to define and measure cost, determine the cost accounting periods to which costs are assigned, and determine the manner in which costs are allocated to covered contracts. The Board has spoken directly to the measurement of cost in Cost Accounting Standards 404 and 412 and to the assignment of costs to cost accounting periods in Cost Accounting Standards 403, 409, and 412. The definitions being promulgated today are consistent with the Board’s authority and previously adopted view that cost accounting practices include measurements of cost, assignment of cost to cost accounting periods and allocation of costs to cost objectives. Questions have been raised as to whether the measurement of cost includes the determination of the price to be paid by the contractor for goods and services. From the beginning of the project to define a cost accounting practice, the Board has taken the position that the determination of the amount paid or a change in the amount paid for units of goods and services does not constitute a change in cost accounting practices. The definition has been revised to convey this concept more clearly.

With respect to commentators’ views on the difference between Cost Accounting Standards, principles, and practices, the Board’s 1973 “Statement of Operating Policies, Procedures, and Objectives” and the 1977 “Restatement” describe a Cost Accounting Standard as:

A Cost Accounting Standard is a statement formally issued by the Cost Accounting Standards Board that:

This position is similar to the approach the accounting profession takes in dealing with accounting principles for financial reporting. The Accounting Principles Board Opinion No of 20, Accounting Changes, states:

The term accounting principle includes not only accounting principles and practices, but also the method of applying them.

Thus, in line with previous statements, the Cost Accounting Standards Board reiterates its position that the terms “principles and practices” include methods and techniques. The Board’s position is consistent with Pub.L.91-379 and reflects one of the principal purposes of setting Standards, which is to measure the full cost of supplies and services acquired by the Government in a way that is fair to both buyer and seller.

Commentators also raised the question of what should be the required level of detail of a cost accounting practice. The issue is what is the appropriate and necessary level of accounting detail for effective implementation of Pub.L.91-379. For cost allocation purposes the Board has concluded that the level of detail should include not only the type of base, e.g., direct labor, but also the composition of that base, e.g., the elements of labor costs comprising the base. Similarly, the level of detail should include the types of indirect cost pools as well as the components or items of cost which make up those pools. As to measurement of cost, the level of detail includes identification of components of a particular item of cost and the basis on which cost is measured.

Definition of Change to Either a Disclosed Cost Accounting Practice or an Established Cost Accounting Practice

With respect to the February 3, 1977, proposed definition, commentators requested expansion of those changes in cost accounting practices which would not be subject to the provisions of paragraphs (a)(4) and (a)(5 of the Cost Accounting Standards contract clause (4 CFR 331.50). Commentators recommended that changes to improve management controls, accounting changes which the Government and contractors believe would be beneficial in the long run, and change due to changed business circumstance should be added to 331.20 as action which are not considered as a change in cost accounting practice for purposes of paragraphs (a)(4) and (a)(5) of the Cost Accounting Standard Contract Clause (4 CFR 331.50).

The Board notes that in a dynamic business environment it may be desirable to make changes of many types. These changes may include organizational changes, changes in the way work is performed, and changes in the product produced. There may be a Variety of reasons for these changes such as better managerial control, new technology, or changed business conditions.

These business changes by themselves are not changes in cost accounting practices. Such changes may, however, cause a change in a contractor’s cost accounting practices. In a circumstance where there is a change in cost accounting practice, the contractor and Government must take certain action under the provisions of the CAS contract clause. Only when the contracting officer does not make the required determination under the new 331.50(a)(4)(C) would contracts be amended to insure that the Government does not pay any increased cost as a consequence of the change.

The decision as to whether there is a change in cost accounting practice is made through an analysis of the circumstances of each individual situation based on the criteria being promulgated in these regulations.

It is to be expected that the accounting system must change betterments, improvements, modifications or alterations to the system are necessary to accommodate the business changes discussed above. The Board notes that Pub.L.91-379, in its provisions relative to failure of a contractor to follow consistently his disclosed practices, makes no distinction among the causes of changes in cost accounting practices. Thus, accounting changes of the types described by the commentators, which result in a failure of a contractor to follow consistently his previously disclosed or established practices, remain subject to the CAS contract clause (4 CFR 331.50). While a number of the suggestions made have been adopted and are discussed in the following material, the suggestions that changes in cost accounting practice due to changed circumstances or to improve management control be excluded from adjustment under the CAS contract cause have not been adopted by the Board. These types of changes are subject to review and agreement by the contracting officer and the contracts may be adjusted under new 331.50(a)(4)(C).

A number of commentators urged that changes resulting from issuance’s of the Financial Accounting Standards Board should also be excluded from paragraphs (a)(4) and (a)(5) adjustments. The legislative history leading to creation of the Cost Accounting Standards Board shows that standards and principles issued for financial accounting purposes were not deemed suitable for cost accounting for negotiated Government contracts. The Cost Accounting Standards Board views its own work as relating directly to the preparation, use and review of cost accounting data in the negotiation, administration and settlement of negotiated defense contracts. The Board is the only body established by law with the specific responsibility to promulgate Cost Accounting Standards and these Standards have the force and effect of law in the negotiation, administration and settlement of defense contracts.

The Board seeks to avoid conflict and disagreement with similar organizations having other responsibilities in the area of accounting Standards and through continuous liaison makes every reasonable effort to do so. The Board will give careful consideration to the pronouncements affecting financial reporting and in the formulation of Cost Accounting Standards it will take these pronouncements into account to the extent it can do so in accomplishing its objectives. Nevertheless, the nature of the Board’s statutory authority and its mission to establish Cost Accounting Standards for negotiated defense contracts is such that it must retain and exercise full responsibility for meeting its objectives. Accordingly, the Board has not adopted this suggestion.

Alterations Not Considered Changes in Cost Accounting Practices

The February 1977 proposed definitions specifically provided that certain contractor actions should not be considered as changes in cost accounting practices. These include the initial adoption of a cost accounting practice or the elimination of a cost accounting practice. A number of commentators expressed the opinion that the accounting treatment of a cost which up to a given point in time has been immaterial in amount and now becomes material in amount is a situation very similar to the establishment of a practice for the initial incurrence of a cost. They pointed out that Accounting Principles Board Opinion No. 20, Accounting Changes, treats this situation as a first time incurrence of a cost rather than a change in accounting principle or practice.

The Board has previously expressed the position that administration of the Cost Accounting Standards should be reasonable and not seek to deal with immaterial amounts of costs. In concert with this position, the Board in the October 1977 proposal modified 331.20(i) to provide that a change in its accounting for a cost which has previously been immaterial and now becomes material is not a change in cost accounting practice.

The alterations described above are not treated under the CAS contract clause as changes in cost accounting practices. They can, however, result in establishment of cost accounting practices. Where such is the case, the requirements of the CAS contract clause (4 CFR 331.50) will apply. The new practices must be followed consistently on all CAS contracts, Disclosure Statements updated where appropriate.

Subsequent Changes Under a Standard

The Board’s October 1977 proposal provided that when a Standard with which the contractor has complied subsequently requires the contractor to alter a cost accounting practice in order to remain in compliance, that alteration shall not be a change in cost accounting practice for purposes of paragraphs (a)(4) and (a)(5) of the CAS clause. Some commentators said that their proposal was inconsistent with the Board’s position in 4 CFR Part 403. Others said that unless a contract adjustment can be made under CAS regulations no acceptable adjustment mechanism was available. Most commentators generally felt that changes of this type should be dealt with under CAS regulations. The Board believes that this provision is not inconsistent with 4 CFR Part 403. In that Standard, the Board was limiting use of equitable adjustment to the first time that a particular allocation provision of the Standard was applied.

The Board recognizes the points made by the commentators, however, and has concluded that a change in cost accounting practice to remain in compliance with a Standard does not constitute a failure to comply with Cost Accounting Standards or to follow consistently disclosed cost accounting practices. Accordingly, the Board has deleted from the regulations being published today the provision excepting adjustments for subsequent changes under a Standard from being considered under paragraph (a)(4) of the Board’s regulations, because changes of this type will be covered by new paragraph (a)(4)C) of the CAS contract clause which calls for negotiation of an equitable adjustment. The Board also notes that contractors who have filed Disclosure Statements would be required to amend such Statements to describe the practices to be followed.

Change Compelled by Law or Regulation

A number of commentators urged the Board to delete the exception in its October 1977 proposal for price adjustments under cost accounting standards for changes compelled by law or regulation 331.20(i)(3). Some contended that all changes, regardless of motivation, should be considered for adjustment under the Board’s new proposed subparagraph dealing with changes agreed to by the parties. Other commentators urged the Board to remove the exception to preclude a contractor from experiencing a windfall or suffering a loss because of such changes. The Board agrees with the suggestions made to delete this paragraph, because the Board feels that all contractor proposed changes in cost accounting practice should be considered for contract adjustment. Therefore, contractor desiring to make a change in cost accounting practice for any reason must negotiate with the contracting officer under the appropriate paragraph of the CAS contract clause.

Should a situation arise where major changes in cost accounting practices would be required by contractors to comply with express provisions of law or regulation, the Board would seek to accommodate any such requirement by a change in its standards, rules or regulations.

The Board has deleted from these amendments the proposed 331.20(I)(3) which dealt with changes compelled by law or regulation.

Illustrations

Many commentators said that all or some of the illustrations should be deleted, while other commentators said they should be retained. The Board included the illustrations to demonstrate the application of the definitions in situations of the type which have been reported to the Board in the past.

The Board noted that some of the illustrations dealing with changes in organization were being misinterpreted. In effect, the commentators expanded the illustrations to include situations not set forth in the illustrations. The Board concluded that in view of the extent of misinterpretation, it would be questionable value to revise the illustrations to cover all the situations described by commentators. Accordingly, several illustrations dealing with accounting changes related to organizational changes have been deleted.

As the Board stated when the proposed definitions were published in February 1977, the accounting effects of any organizational change must be considered separately and a final decision concerning a change must be based on an evaluation of those effects. Thus, an organizational change per se is not a change in cost accounting practice. One must look at any accounting revision brought about for any reason, including one caused by a change in organization.

By including the illustrations the Board does not intend to imply that all possible situations are covered nor are the illustrations to be used as limitations for accounting changes. The Board believes that the changes made to this section are responsive to the statements made by commentators.

Contract Clause

The Board proposed in October 1977 that where the parties agree to a change in cost accounting practice they should negotiate an equitable adjustment for any cost impact on existing contracts. Most commentators agree with this proposal but some felt that the contracting officer’s agreement should not be necessary. Others urged the Board to state that a contracting officer’s disagreement with a change is subject to the disputes clause of the contract. Further, a number of commentators suggested that the new contract adjustment paragraph be renumbered (a)(4)(C) to avoid confusion with the preexisting numbering series. Finally, some commentators asked if the Board planned to make comparable revisions to its Part 332, Modified Contract Coverage.

The October 1977 proposal was in response to urging by both contractor and Government agency representatives to establish an alternative to paragraph (a)(4)(B) for adjusting contracts where both parties agreed that a change in cost accounting practice was desirable. Under that proposal, a method was established providing for equitable adjustment for these changes. The Board does not agree that contracting officer’s agreement is not necessary and remains convinced that Government agreement to the change is essential to protect the Government’s interests.

With respect to the treatment of a contracting officer’s disagreement with a proposed change in cost accounting practice under the disputes clause of the contract, the Board believes this should be determined under agencies’ general rules governing appeals from various types of decisions by contracting officers. Accordingly, the Board has not specifically provided for the application of the disputes clause in this situation.

The Board agrees with the suggestion concerning the renumbering of the paragraph dealing with equitable adjustments for changes in cost accounting practices agree to by the parties. The amendments being published today have that paragraph numbered (a)(4)(C). Designating the new paragraph as (a)(4)(C) eliminates the need to change citations in other subparagraphs in section 331 from those previously existing in CASB regulations.

With respect to the question concerning comparable revisions to Part 332, the new definitions and illustrations are incorporated in 332.20 by the existing cross reference to 331.20. The Board’s regulation concerning changes in cost accounting practices agreed to by the contracting officer will be incorporated in 332.50(a) and 332.51 by amendments being published today.

Increased Cost Paid

Commentators at the 1977 Evaluation Conference and respondents to e the February 3 and the October 21, 1977, proposals requested that the Board remove from its regulations the prohibition against increased costs paid because of changes in cost accounting practices 331.50(a)(4)(B)) and/or that the expression “increased costs paid” (4 CFR 331.70) be redefined to exclude fixed price contracts. The Board has established a priority project to perform a comprehensive review of Part 331 of its regulations including the treatment of increased costs paid.

Contracting Officer Determination

Many commentators objected to the Board’s including a requirement that contracting officers make a finding that a change is desirable and is not detrimental to the interest of the Government. Some claimed that such a requirement encroached on management’s prerogative to design an accounting system to meet its needs; others said the decision concerning changes was an administrative matter better left to the agencies. Others suggested that different terms be substituted for some of the words. Finally some commentators said that the Board should require only that agencies prescribe appropriate regulations for the use of the equitable adjustment provision for accounting changes agreed to by the parties.

The Board understands the concerns expressed by the commentators on this matter. It should be recognized, however, that the Board is proposing that equitable adjustments be negotiated for accounting changes not required by Standards. This type of Provision was requested by many contractors and Government agencies in the past. These groups insist that agreed-to changes should be allowed and the contractor should not be required to pay for any increased costs on existing contracts resulting from such desirable changes. The Board is responding to these requests by providing for equitable adjustments for those proposed changes with which the contracting officer agrees if he finds them to be desirable and not detrimental to the interests of the Government.

Management certainly can propose any changes it feels desirable for its own accounting system. If a change is not desirable from the Government point of view, the Board sees no justification for permitting the contractor to realize economic benefits on existing contracts from the change.

The Board’s regulation merely recognizes the contracting officer’s position and does not encroach on the administrative responsibilities of the procurement agencies. A contracting officer would routinely make certain that a contractor’s proposed change is not detrimental to the Government before agreeing to allow increases in contract prices.

Some suggested alternative words for “desirable” were: “Appropriate, warranted, equitable, fair or reasonable.” The Board concludes that all these tests are encompassed by the Board’s language. Accordingly, this statement has not been changed.

The Board expects administration agencies to publish regulations they feel necessary to define what they conclude is “desirable and is not detrimental to the interest of the Government.” Thus, the Board does not agree that it is getting involved in administrative matters. The Board agrees with the commentators who suggested that the second sentence of 331.51, which required that the contracting officer document the basis for his finding, be eliminated. The Board believes that the stated documentation requirement is redundant with other language in this subparagraph, and accordingly, that sentence has been eliminated.

Withdrawal of Proposed Alternative Method of Determining Increased costs

On December 29, 1976, a proposal was published in the Federal Register to amend 331.70(b) which, if adopted, would have permitted procurement agencies to use either an estimate-to-complete approach or an original-negotiation-data approach to determine increased costs paid by the United States. As proposed, agencies would have been authorized to use the estimate-to-complete method when negotiations had not been based on cost estimates or such estimates were not readily determinable by the procuring agency.

Most of the comments received expressed opposition to all or part of the proposal. Upon reexamining the subject in light of the comments received, the Board concludes that the proposed alternative method would not provide sufficient improvement in the administration of Standards to warrant its adoption. Additionally, none of the alternatives suggested by the commentators appears likely to benefit the procurement process materially. Accordingly, the proposal to amend 331.70(b), Contract Coverage, as published in the Federal Register of December 29, 1976, is hereby withdrawn. This subject will be considered in the Board’s comprehensive review of Part 331.

Costs and Benefits

The definitions promulgated today fill a void that had been recognized in numerous comments to the Board and the procurement agencies. The Board believes that the material being promulgated today is in keeping with its responsibility and authority as provided in Pub.L.91-379. The Board believes further that the appropriate use of the definitions can significantly reduce the time and effort involved in the administration of Cost Accounting Standards. The Board concludes, therefore, that there will be virtually no costs involved in implementing these regulations and that there will be significant benefits with no inflationary effects.

Miscellaneous Amendments

A number of miscellaneous amendments are being published today to conform language in certain paragraphs of Title 4 CFR Parts 351, 403, 406 and 409. These amendments add references to the new 331.50(a)(4)(C).

Effective Date

The following changes to the Board’s regulations are being made effective today, March 10, 1978.

Preamble K
Preamble to Amendments of 6-8-78

The document published as 43 FR 24819, June 8, 1978, added 331.30(b)(3) and revised 403.70(b), 408.70. and 410.70 and 415.80. Portions of this preamble relating to Parts 401 through 410 and 415 have been omitted; they can be found in the supplements to their respective parts.

The Cost Accounting Standards Board is authorized by Pub.L.91-379 to prescribe rules and regulations exempting from its requirements such classes or categories of defense contractors or subcontractors under contracts negotiated in connection with national defense procurements as it determines on the basis of the size of the contracts involved or otherwise, are appropriate and consistent with the purposes sought to be achieved by the Act.

The Cost Accounting Standards Board has been requested by several Federal agencies and by representatives of educational institutions to consider the extent to which its standards, rules, and regulations should apply to educational institutions that are subject to Federal Management Circular 73-8 or OMB Circular A-21 and to consider whether an exemption for such institutions from Board promulgation’s is appropriate. The Board had provided exemptions for them in certain specific standards where the application would not be appropriate.

On March 15, 1978, the Board published for comment in the Federal Register (43 FR 10699) a proposal to exempt most educational institutions. The exemption would not apply to contracts with federally funded research and development centers operated by such educational institutions. Forty-seven comments have been received, all of which favored the proposed action by the Board although some respondents requested minor changes and clarifications.

A few commentators expressed concern that an educational institution receiving a contract from the Government could apportion the contract effort between the university and the FFRDC to take advantage of differences in cost accounting required under CAS and under FMC 73-8. If this becomes a problem, the procuring agencies are able to take the necessary corrective action.

Several commentators noted that there could be some misunderstanding concerning the applicability of CAS 403 to the university which is functioning as a “home office” for an FFRDC. The Board intends that CAS 403 not be applicable to the university in this situation and minor changes have been made to the language to clarify its intent.

One commentator indicated that the definition of FFRDC is not meaningful and suggested that the Board list the criteria by which NSF designates an FFRDC. Since coverage is intended only for those organizations designated as FFRDC’s by the NSF based on whatever criteria they deemed appropriate, inclusion of their current criteria would not be useful. Accordingly no changes have been made in the definition included in 331.30(b)(3).

One commentator noted that the removal of current exemptions from CAS 403, 408, and 410 for FFRDC’s will require a transitional period. It is considered that the provisions of 403.70(a), 408.80, and 410.80 will furnish sufficient time for compliance by the FFRDC’s with those standards. Section 403.70(a) provides that a contractor, if not exempt, shall be required to comply at the start of his first cost accounting period following receipt of the award of a negotiated national defense contract making the standard applicable. A contract awarded after August 1, 1978, will make the standard applicable to a FFRDC. Consequently, a FFRDC must comply with CAS 403 as of the start of its next cost accounting period after receipt of a contract after August 1. Standards 408 and 410 apply in the same way. It is recognized that all FFRDC’s do not necessarily receive new contract each year and that annual funding may be by means of an amendment to an existing contract. Applicability would be at the start of a cost accounting period after receipt of a new contract or after receipt of the annual extension of an existing contract.

The Board having found the exemption appropriate and consistent with purposes sought to be achieved by Pub.L.91-379, is modifying its regulations as set forth below.

Preamble L
Preamble to Amendments of 11-14-78

The document published on Nov. 14, 1978 at 43 FR 52693 revised 331.30 (b)(5), (c)(1) and(c)(2).

The Cost Accounting Standards Board is today promulgating amendments to its regulations dealing with exemptions for contracts and subcontracts performed by foreign governments and foreign concerns. On July 31, 1978, the Cost Accounting Standards Board published a proposal under which contracts or subcontracts with foreign concerns could be exempted from certain individual standards if an authorized official of a relevant Federal agency determines that application of the standards to such contracts or subcontracts is inappropriate. The Board received 12 comments on the proposal.

One commentator opposed the proposal as unnecessary because the Board itself has authority to grant exemptions when such action is appropriate and asserted that delegation is undesirable because such decisions are too important to be delegated. The Board agrees that decisions concerning exemptions are important and has carefully considered the proposed action in the light of all comments and other available information. Based on that consideration the Board has concluded that it should grant a specific categoric exemption. Consequently no delegations are needed. Moreover because of the categoric exemption, the need to amend individual standards is obviated.

One government agency to whom delegation of authority was proposed noted that in implementing the delegation, one of the factors it would consider in determining whether the application of an individual standard is appropriate is the matter of sovereignty. Because of the action being taken today, there is no need to comment on the appropriate weight to be assigned to that factor.

Another commentator also discussed sovereignty and suggested that the United States has no legal right to impose the requirements of its laws and regulations on foreign contracts. To support this assertion, the commentator cited an official of the Department of Defense who attributed some of the difficulties in foreign procurements to the insistence upon contracts rather than general agreements. Whether a contract or some other instrument is used is something to be decided by other agencies of the government and not by the CASB. The Board has long recognized that its Standards are not applicable to noncontractual arrangements and agrees with the suggestion that if the procuring agencies used some noncontractual arrangement to transact business with foreign contractors, CAS would be inapplicable to the transaction. However, when the parties agree to use a negotiated national defense contract or subcontract as the vehicle for transacting business, the agreement must include the standards, rules, and regulations of the Board.

One commentator expressed the opinion that no substantial benefit would accrue to the United States under the limited exemption originally proposed but that a complete exemption from all Cost Accounting Standards Board requirements would be beneficial. Instead of the proposed exemption and delegation, that commentator recommended that all contracts and subcontracts with foreign firms and governments be exempt from all CAS requirements. The Board does not agree that a limited exemption would produce no significant benefits but that a complete exemption would. Significant benefits accrue to the United States Government from all standards, in part because each standard enhances the likelihood of achieving the goal of uniformity and consistency set forth in Pub.L.91-379. The Board believes that by exempting foreign contracts from some standards there is a detriment rather than a benefit insofar as the public law itself is concerned. Nonetheless the Board has been advised that the requirement to apply some standards has become a significant impediment to efficient, successful contracting with foreign concerns and foreign governments.

The exemption being granted today will remove that impediment while continuing to provide protection through the application of CAS 401 and 402. In addition, foreign concerns will still be required to file Disclosure Statements.

The requirements of CAS 401 and 402 are fundamental to any sound cost accounting program. In the Board’s view application of these standards is essential to provide some assurance that a contractor’s cost accounting practices are sufficient to provide reliable information on which to base the negotiation, administration, and settlement of contracts. Similarly, the requirement for disclosure which is also being continued unchanged, serves to assure that necessary information about cost accounting practices is available to the Government.

Several commentators recommended that in addition to contracts with foreign contractors, the Board should exempt contracts with foreign governments. The Board has concluded that this recommendation has merit and the exemption being promulgated today has been amended accordingly. Because the exemption established in 1972 for the Canadian Commercial Corp., an agency of the Canadian Government, is included in today’s exemption action, the 1972 exemption is being withdrawn.

One commentator suggested a need to define “foreign concerns” and another recommended that “performance” be defined. The term “foreign concern” has already been defined by the Board in 331.30(c)(2).

As to what constitutes “performance,” the Board believes that in general it encompasses the contractor’s activity under the contract up to the point of inspection and acceptance of the items called for by the contract. However, because of the complexity and variety of contracts, the Board believes that the contracting agency can best determine whether a specific contract is to be performed outside the United States.

A number of commentators suggested various changes in the delegation procedures proposed by the Board. Since the Board is withdrawing the delegation, there is no need to consider these suggestions.

One commentator suggested that the reference in 331.30(c) to the Assistant Secretary of Defense (Installations and Logistics) be changed to reflect organizational changes in the Department of Defense. This revision has been made.

Preamble M
Preamble to Revision, 9-18-80

The material set forth below is the preamble to the revision and republication of Part 331, September 18, 1980, at 45 FR 62011. This preamble to the publication of September 18, 1980, is included as part of the administrative history of Part 331.

Summary

On June 1, 1979, the Board published in the Federal Register proposed revisions to Parts 331, 332 and 351 of its regulations dealing with contract coverage and the filing of Disclosure Statements. Based on comments to its June 1 proposal, the Board made substantial modifications in the proposed revisions and republished the revised Parts again for comment on February 8, 1980. After considering the comments to the second publication and reviewing all suggestions from interested parties, the Board has determined that the revised regulations are ready for promulgation. It believes that the revised regulations will result in improved administration and will be more readily understood by parties subject to the regulations.

Effective Date

April 1, 1981.

Supplementary Information

In the Federal Register of June 1, 1979, (44 FR 31655) the CASB published for comment proposed revision to Parts 331, 332 and 351 of its regulations. The revisions were made for the purpose of simplifying these parts of the regulations and to modify them where experience indicated the changes would be desirable. Thirty-six responses were received by the Board to its request for comments.

The Board after consideration of the comments modified its proposed revisions and again published the revised parts for comment in the Federal Register of February 8, 1980 (45 8677). Twenty comments were received to the February publication. The Board wishes to thank all of the respondents for their constructive suggestions which were of substantial assistance to the Board in its review and revision of these parts.

In the February 8 proposal two areas of the regulations drew a substantial number of comments from the respondents, the exemption of firm fixed price contracts (FFPs) awarded without submission of cost data and the definition of “increased costs paid by the Government” as such may occur under FFPs after award. The Board’s views on these two areas and on other comments received are as follows:

1. Exemption. Commentators generally endorsed the Board’s proposal to exempt FFPs awarded without submission of any cost data. However, most commentators urged the exemption be expanded to require that cost data be certified or that the data have been relied on as the basis of price.

2. “Increased costs paid” under FFPs after contract award. In its February 8 proposal the Board deleted certain proposed revisions contained in its June 1, 1979 proposal concerning the adjustment of FFP contracts in view of the objections of most commentators to the proposed changes. The Board in its February proposal limited changes in the regulations affecting FFPs to a clarification in 331.70(b) concerning the measurement of increased costs paid by the United States under those contracts. The modified 331.70(b) paragraph was the subject of adverse comment by a majority of industry commentators who maintain that under FFP contracts once price is agreed to, there can be no increased cost paid by the U.S. attributed to any subsequent changes the contractor may make in its cost accounting practices.

(3) Modification of 331.70(f). One commentator suggested that 331.70(f) be modified to delete reference to “all affected contracting officers” and place the authority to effect agreement in the hands of one contracting officer delegated by affected agencies to handle CAS matters. In 331.70(e) the Board urged that the contracting agencies designate such an individual and generally agencies have done so. However, this is a voluntary action of the agencies and the Board is not in a position to make it mandatory.

(4) Statement on Fairness. One commentator requested the Board issue a statement on fairness in the application of its contract clause and related interpretations. The essence of the statement recommended would be that the results in any particular case arising from application of the Board’s Standards, rules and regulations must be deemed “fair” in some general undefined sense by the negotiating parties or the Board’s issuance may be disregarded. The Board’s Restatement of Objectives, Policies and Concepts contains a statement that a Standard is fair when, in the Board’s best judgment, it shows neither bias nor prejudice to either party. The Board views its rules and regulations on contract and price adjustments in the same light. In any given case, the results of contract pricing may ultimately be regarded as fair or unfair by either or both parties to the contract because, on a case-by-case basis, fairness is viewed from the personal vantage point of the particular party. It is impossible to adopt such a subjective criteria and have meaningful Standards. Consequently any attempt to define “fairness” in the context of individual contract negotiations is inappropriate.

(5) Miscellaneous. There were various miscellaneous comments and suggestions on the Board’s proposal to which the following comments are addressed:

Title 4 CFR Parts 331 and 332 are revised in their entirety and Part 351 is amended by revising 351.30, 351.40, 351.60, 351.70, 351.80, and 351.120 and by deleting and reserving 351.50 and 351.110 as follows:

Preambles to Part 332,
Modified Contract Coverage

Preamble A
Preamble to Original Publication 9-12-77

The material set forth below is the preamble to the original publication of Part 332, 42 FR 45625, Sept. 12, 1977.

Contract Coverage, Modified Contract Coverage, Basic Requirements And Cost Accounting Standards

This publication adds a new Part 332 and amends Parts 331, 351 and 403 of the Cost Accounting Standards Board’s rules, regulations and Standards. The proposal to add Part 332 and amend Parts 331 and 351 were published for comment in the February 16, 1977 Federal Register (42 FR 9389). The proposal to amend Part 403 was published for comment in the November 30, 1976 Federal Register (41 FR 52473). Appropriate periods for comment on the proposals were provided. Numerous and extensive comments were received concerning both proposals. The Board appreciates the interest expressed by the commentators and thanks them for their participation.

Comments of Parts 332, 331 and 351

General

Many commentators expressed general approval of the proposal to exempt certain businesses and provide modified coverage for others. Information available to the Board does not demonstrate that the benefits to be derived from applying all requirements to all contracts clearly outweigh cost of requiring such application, moreover the Board does not believe that many small companies with less sophisticated accounting systems and small accounting staffs can comply with the Board’s requirements without experiencing inordinate difficulty and some cost. Under these circumstances, the Board has concluded that it is appropriate to remove completely the obligation of small businesses to comply with Standards, rules, and regulations of the Board. In reaching this conclusion the Board has also given some weight to the belief expressed by a few commentators that the prospect of having to comply with Board requirements has caused some companies to avoid Government contracts.

As noted by some commentators who opposed the Board’s proposal, the granting of exemptions tends to reduce rather than increase uniformity of cost accounting practices because of the exemptions. In that sense the action may be viewed as not being in furtherance of that statutory goal which is set forth in Pub.L.91-379. It has long been recognized that uniformity is an extremely important objective of the Board’s actions. It is not, however, the only consideration. If there were any doubt on this point, the fact that the Law authorizes the Board to prescribe rules and regulations exempting contractors from its requirements should dispel that doubt. The Board believes that the action being taken is consistent with its statutory duties viewed as a whole even though uniformity among some business units will be reduced.

Threshold Determinations

Several commentators noted that the $10 million threshold provided in Part 332 would be based on all contracts subject to Cost Accounting Standards rather than being limited to national defense contracts and subcontracts. They noted that Pub.L.91.379 does not apply to nondefense contracts and that such contracts are subject to Board Standards rules and regulations only to the extent that the Administrator of General Services has extended coverage to it. Because of this they urged that the calculation be made only on the basis of national defense contracts and subcontracts. This recommendation has been adopted by the Board.

The proposal to exempt all contracts under $500,000 was viewed as generally desirable by many commentators. Some recommended that $1 million or more be established as the minimum coverage level. However, some commentators opposed exempting small contracts of a contractor required to follow Standards on large contracts. They contended that once the contractor has to establish practices in compliance with Standards, there is no additional burden involved in applying those practices to its small contracts. In any case it is unlikely that application of those practices could result in burdens that would be equal to those that would result from applying one set of cost accounting practices to large contracts and another set to small contracts. For this reason the Board has not adopted the proposal to exempt all contracts under $500,000. Instead the existing provisions providing for coverage of smaller contracts awarded to a business unit which has received an award of $500,000 or more are being retained.

One commentator noted that some contractors receive contract awards of $10 million or more every other year and few, if any, covered awards in the intervening years. The large contracts would not be subject to disclosure requirements or Standards under the February 16 proposal. The Board has remedied this problem by providing that any single contract award of $10 million or more is subject to all Standards and must be covered by a Disclosure Statement.

Small Business

Several commentators urged that all businesses which qualify as small business concerns under the rules and regulations of the Small Business Administration be exempted. The February 16, 1977 proposal would have provided such an exemption only for a small business which received less than $10 million in awards during its preceding fiscal year. Modified coverage would have been provided for other small businesses. Research indicates that there are very few companies which would fall into the category of small businesses receiving awards of $10 million or more. In the interest of using a single test, i.e., whether the contractor qualifies as a small business concern, rather than a dual test which would result only in a few small businesses being subject to modified coverage, the Board has adopted the recommendation to exempt all small business concerns. Research indicates that if this action had been applied to Federal Fiscal Year 1976 it would have resulted in exemption of 196 small business concerns which were doing business with the Department of Defense and which had $460 million of contracts of the type subject to Cost Accounting Standards. Consequently, on average, each small business concern would have a relatively small amount of covered contracts.

Other Categories

Various commentators renewed previous recommendations that the Board exempt other categories of contracts and contractors. The categories included colleges, universities, non-profit organizations, hospitals, and Government-owned contractor-operated facilities. The Board has considered these recommendations and concluded that none of these categories should be exempted.

Part 332 Eligibility

The February 16 publication would require that a contractor have less than $10 million in covered contracts and that the covered contracts be less than 10% of total sales to be eligible for Part 332. In discussing this provision some commentators proposed a wide variety of tests in lieu of the tests proposed in that publication. Some suggested using only a dollar test or only a percentage test rather than both. The amounts recommended ranged up to $100 million and 50 percent of total sales. Some suggested using sliding scales to determine eligibility. None of the suggested tests appear more likely to achieve the purposes of the Board than the test originally proposed. The Board has therefore retained its initial proposal.

Scope of Part 332

A number of commentators recommended that eligibility for Part 332 should result in complete exemption. Others recommended that requirement for compliance with Parts 401 and 402 be the only requirement and that the disclosure obligation be eliminated. The Board believes that substantial benefits may be derived by continuing to require compliance with Parts 401 and 402. There is nothing which suggests that compliance with the two Standards entails any significant cost. Consequently this requirement is being retained. According to information reported to the Board, adoption of Part 332 will relieve 264 segments of 131 contractors of the requirements to comply with all Standards but will remove only $405 million of contracts from full coverage.

Disclosure Statement Requirements

Many commentators suggested that preparation of a Disclosure Statement was burdensome. They also contended that in the situation where a large commercial contractor receives only a few small contracts containing a Cost Accounting Standards clause the need for a Disclosure Statement appears to be minimal. Some asserted that adoption of the proposal to require a Disclosure Statement for all covered contracts would reduce the number of companies that would accept contracts subject to the Board’s Standards, rules and regulations. The Board is persuaded that for the time being Disclosure Statements should not be required for all covered contracts. Accordingly it is not adopting the February 16 proposal. The Board is retaining the existing Disclosure Statement requirement provided in Part 351 except that a business unit will be required to submit a Disclosure Statement if it is a company or a segment of a company which received awards of national defense contracts subject to Cost Accounting Standards in excess of $10 million during its preceding cost accounting period rather than the preceding Federal fiscal year.

Revisions to Part 351

Part 332 and the amendments to Part 331 generally will result in annual determinations being made a contractor’s obligation to follow Standards and to submit Disclosure Statements. The determination will be made on the basis of sales and award data from the immediately preceding cost accounting period. The requirement to continue to submit a Disclosure Statement so long as the contractor has a contract subject to Cost Accounting Standards will no longer apply. Disclosure Statements must be maintained for and applied to only those contracts which were awarded during a cost accounting period which the contractor met the filing requirements of 351.40. Sections 351.40 and 351.50 have been revised to reflect this change.

Segments of Large Companies

A number of commentators sought to have small segments of large companies treated in the same way the small businesses are treated. In the view, small segments are competing the same environment as small business and are operating with essential similar capacity and resources. Therefore, such segments, they concluded should be subject to the same rules as small business. The Board does not accept this line of reasoning. Even those cases where a segment may appear to operate as a small business its status as a segment precludes it from being regarded in the same way. It has available to its capacities and resources of the company of which it is a part. Also the policy considerations of the Small Business Act has no applicability to segments of larger company. Further, as a practical matter, the rules already exist in the Small Business Administration for identifying small business concerns. There are no comparable rules for identifying small segments.

As indicated by the February 16 proposal the Board nonetheless recognizes that segments which are engage in primarily noncovered work should be eligible for modified coverage. This coverage is provided by Part 332. It will apply to segments which according to information submitted to the Board have average covered sales of approximately $1.4 million per segment. The relatively small amount of covered contract sales by each of these segments, the limited Government interest in the total business activity of the unit and the fact that the implementation and administration involves some cost lead to the conclusion that modified coverage is appropriate and sufficient to protect the interests of the Government.

Summary

The results of the Board’s adoption of Part 332 and amendment of Parts 331 and 351 are:

1. None of the Board’s requirement apply to a business unit unless it has received an award of at least one covered contract of more than $500,000 Thereafter covered contracts of more than $100,000 are subject to the Board’s requirements.

2. A Disclosure Statement must be submitted by any business unit receiving a covered contract if it is either a company which received net awards of negotiated national defense prime contracts and subcontracts subject to Cost Accounting Standards totaling $10 million or more in its preceding cost accounting period or a segment of such a company.

3. Contracts awarded to any business unit which received less than $10 million in awards of covered contracts in its preceding cost accounting period are subject to:

4. Any single award of a covered contract of $10 million or more is subject to all Standards and requires submission of a Disclosure Statement.

5. Contracts awarded to any business unit which received $10 million or more in awards of covered contracts during the preceding cost accounting period are subject to all Standards.

6. Notwithstanding the foregoing, all businesses which qualify as small business concerns under the rules and regulations of the Small Business Administration are exempt from all Cost Accounting Standards Board requirements.

Comments on Part 403

With respect to the amendment of Part 403, the November 30, 1976 proposal was to revise that Standard to make it applicable to any contract which was subject to Cost Accounting Standards generally. The amendment being promulgated today retains this concept. However, as recommended by a number of commentators, the Board deferred the promulgation of this amendment pending the amendments to Parts 331 and 351 and the addition of Part 332 discussed above.

The decision to extend the application of Part 403 to additional contractors was made on the basis of extensive research. This research included both those contractors who were already required to use Part 403 and those who were expected to use it as a result of this amendment. With respect to the current users, the Board is satisfied that this Standard has resulted in more equitable allocations, with little administrative effort in most cases. With respect to potential additional users, the research indicated that many of these would have to make few, if any, changes to comply with Part 403 and that the remainder could comply with little difficulty. The Board notes in addition, an independent study by the Conference Board which found that defense contractors who are using Part 403 for contract costing purposes are using the same allocation procedures for internal reporting purposes. According to the Conference Board, it was typical of these companies to allocate home office expenses on a blanket basis prior to the promulgation of Part of 403. (Information Bulletin No. 17, February 1977.)

A number of commentators suggested various limitations for the application of Part 403. Some of these suggestions were expressed in general terms. Some of the commentators recommended, for example, that the requirement to use Part 403 should not be extended to “small contractors.” Alternatively or additionally it was recommended that Part 403 should not be required for a large contractor with little work subject to Cost Accounting Standards. More specifically, recommendations were received to exempt those contractors with less than 10 percent of their revenue from Government work. Others recommended that contractors who have less than $10 million in contracts subject to Cost Accounting Standards should be exempt. The Board believes that the recommendations of this nature have been accommodated to the extent desirable and practical by the amendments to Parts 331 and 351 and the addition of Part 332 being promulgated today. Accordingly, any further exemption from Part 403, specifically, is considered to be unnecessary.

In publishing the proposed amendment to Part 403 in the Federal Register of November 30, 1976, the Board stated that there is evidence that almost all contractors who were required to make significant changes in their allocation practices as a result of Part 403 did so without undue trouble or expense. Several commentators questioned the Board’s conclusion in this regard. The Board’s conclusion was based in part on Staff research involving 147 home offices who now use Part 403 to allocate home office expenses. This research sought to determine, among other things, the administrative problems and expense involved in making allocations pursuant to Part 403. Government auditors reported that of the 147 home offices, only 4 had problems in developing the necessary data and that there was evidence of significant administration costs at one of these four offices. In addition, evidence of significant administrative costs in making the allocations was found by the Government auditors at four other of the 147 home offices.

Some of the respondents who questioned the Board’s conclusions regarding administrative problems and expense referred to an industry report on the economic impact of Cost Accounting Standards as support for this position. These respondents variously referred the Board to those sections of the report which summarized

Two associations reported that, contrary to the Board’s findings, their member companies had experienced trouble and expense in complying with Part 403. These associations declined to identify the companies involved, the nature of the problems, or the amount of the expenses. Under these circumstances, there is no basis to alter the conclusion that contractors have been able to make changes required as a result of Part 403 without undue trouble or expense.

One commentator stated that it would not be desirable to make more contractors subject to Part 403 because he believes it to be defective, particularly with respect to its application to the allocation of state and local taxes. With respect to the application of the Standard to the allocation of state and local taxes specifically, the Board notes that it reached its conclusion on the basis of considerable research and extensive deliberation. Moreover, it has reexamined its conclusions, even after the promulgation of Part 403. Notwithstanding the views of the commentator, the Board continues of the view that the provision in question is proper. Accordingly, the Board does not agree that this Standard should not be extended to additional contractors because of the tax allocation provision.

Effective Date

The effective date of the regulations being published today is March 10, 1978. Pub.L.91-379 provides that regulations shall take effect not earlier than the expiration of the first period of sixty calendar days of continuous session of the Congress following the date on which a copy of the regulations is transmitted to the Congress. The calendars of the Congress indicate that the required sixty days will not pass until some time in February 1978. Accordingly, March 10, 1978, has been selected to assure sufficient time for the regulation to lie before the Congress.

Preamble B

Preambles to Part 351,
Basic Requirements

Preamble A
Preamble to Original Publication, 2-29-72

The material set forth below is the preamble to the original publication of Part 351, February 29, 1972, at 37 FR 4139. For the preambles to the revision of Part 351 (October 4, 1973 and November 7, 1973), see preambles B and C. Portions of this preamble, relating to Parts 331, 400, and 401 have been omitted; they can be found in the supplements to their respective parts. This preamble to the publication of Part 351 is included as part of the administrative history of Part 351.

General comments. The purpose of the regulations promulgated today by the Cost Accounting Standards Board is to implement section 719 of the Defense Production Act of 1950, as amended, 50 U.S.C.App. 2168, which provides for development of Cost Accounting Standards to be used in connection with negotiated national defense contracts and for disclosure of cost accounting practices to be used in such contracts. The Board believes the materials being promulgated today constitute a significant initial step toward accomplishing one of its major objectives -- improved cost accounting and the proper determination of the cost of negotiated defense contracts. The regulations spell out contract coverage (Part 331), disclosure requirements (Part 351), a compilation of Definitions (Part 400), and two Cost Accounting Standards, one calling for consistency in estimating, accumulating, and reporting costs (Part 401), and the other calling for consistency in allocating costs incurred for the same purpose (Part 402).

Development of the material being promulgated today began many months ago with extensive research. It included examining publications on the subject, conferring with knowledgeable representatives or various Government agencies. Government contractors, industry associations, and professional accounting associations, and identifying and considering all available viewpoints. From this research, the initial versions of the material now being published were developed. As a part of the continuing research effort, these initial drafts were sent to 81 agencies, associations, and Government contractors which had expressed interest in assisting the Board in its work, and their comments were solicited. Some national defense contractors field-tested the material to see how it would apply to and affect their operations and advised the Board of their findings. In each step of the research process, the Board and its staff have urged and received active participation and assistance by Government, industry, and accounting organizations. Their cooperative efforts contributed in large measure to the exposure draft published in the December 30, 1971, Federal Register for comment.

To better assure that all who might want to comment had an opportunity to do so, the Board supplemented the Federal Register notice by sending copies of the Federal Register materials directly to about 175 organizations and individuals who had expressed interest or had provided assistance in the development of the published material. Also, a press release was distributed announcing the publication, which resulted in numerous articles in journals. The Board availed itself of all opportunities to publicize the proposals and solicit comments on them.

Written comments in response to the published material were requested by February 4, 1972. Comments were received from 105 sources, including Government agencies, professional associations, industry, associations, public accounting firms, individual companies, and others. The Board appreciates the obvious care and attention devoted by commentators, and as will be seen below, the Board has greatly benefited from the comments received.

Many of the comments received were addressed to all parts of the proposed Board rules as well as to the question of public availability of the Disclosure Statements. All of the comments received have been carefully considered by the Board taking into account the requirements of section 719. Understandably, many of the comments were addressed to issues which recur in two or more of the proposed parts while others dealt only with specific sections. Comments which dealt with 11 general issues are discussed separately below followed by a section-by-section analysis of other comments. Appropriate changes have been made in the material promulgated based on the Board’s disposition of the comments received.

Those comments and suggestions received which are of particular significance are discussed below.

1. Public availability of disclosure statement. In a special notice in the notice of proposed rule making, the Board sought comments to assist it in its determination of whether Disclosure Statements submitted by defense contractors and subcontractors should be available to the general public, pursuant to the Public Information Section of the Administrative Procedure Act (5 U.S.C.552) or whether such information was properly within one or the statutory exceptions to the legal requirement for public availability.

2. Contractor-subcontractor Relationships. Several commentators, stating that contractors cannot dictate the cost accounting practices of their subcontractors at any tier, urged that the Board not hold contractors responsible for increased costs to the United States arising from the failure of subcontractors to follow Cost Accounting Standards or disclosed cost accounting practices. Several commentators also urged that the contractor not be subject to the possibility of a default termination by reason of the actions or inactions of any of its subcontractors at any tier. Finally, some commentators urged that the Board establish a novel concept of privity between the contracting agency and subcontractors with respect to any concerns stemming from Board rules, regulations, and Cost Accounting Standards.

3. Exemptions. Many commentators urged the Board to provide exemptions either to the requirement to file a Disclosure Statement or to both that requirement and the requirement to follow Cost Accounting Standards Exemptions were urged for subcontractors below the first tier, subcontractors with small amounts of defense contracting business, producers of basic or raw materials, colleges and universities, construction contractors, firms which would qualify as small businesses, and others.

4. Applicability date of standards, and regulations. A related issue raised by many commentators is a request that Cost Accounting Standards be made applicable 90 days after issuance or at the beginning of the contractor’s next fiscal year, whichever is later. In order to provide the maximum benefits from use of Cost Accounting Standards, the Board has decided not to adopt any rule which would automatically delay the effective date of Cost Accounting Standards beyond the dates contemplated in section 719(h). That section provides a minimum of 4 months’ notice from the date of promulgation, to contractor of the likely applicability of a Cost Accounting Standard. The Board regards this as an adequate time for companies to prepare for use of the standard. The Board nevertheless recognizes that certain standards by their nature may require deferring applicability to the beginning of a contractor’s fiscal year next following the effective date, and in such cases that applicability will be stated in the standards concerned.

5. Agency administrative responsibility. Many commentators, noting the Board’s statutory responsibility to promote uniformity and consistency in cost accounting practices used in defense contracting and subcontracting have suggested that uniformity would be promoted by giving the Board or another single Federal agency the sole implementing responsibility respecting Board regulations. Thus, some commentators recommended that the Board itself issue regulations prescribing the frequency of submission Disclosure Statements and where they must be submitted. Other commentators urged that the Board issue single a regulation prescribing exact methods by which increased costs to the United States will be determined. Other commentators urged that the Board prescribe methods by which advance agreements affecting more than one contract shall be made, some commentators urging that the Board itself make those agreements. Others urged that the Board rule that the contracting agencies must act to approve or disapprove Disclosure Statements within a stated period of time. And finally, some commentators urged that the Board itself be the sole agency to approve the cost accounting practices disclosed through submission of a Disclosure Statement.

6. Contract modifications. Several commentators have urged that negotiated contract changes and amendments over $100,000 to contracts which are themselves not subject to Board jurisdiction should not be covered. One commentator pointed out that in a long-term contract, most changes represent “instead of” type changes with cost of price adjustments only for the incremental effect of the change. This commentator stated that there is no practical way separately to identify these incremental costs.

7. Definitions. The Board is also persuaded of the value of one commentator’s suggestion that the Board provide a compilation of definitions of the words or phrases defined in individual Cost Accounting Standards, making those definitions applicable to all such standards. Consequently, a new Part 400 has been added, and all terms defined in Parts 401 and 402 have been placed in it, although they also remain in the particular standards in which they are defined. As more standards are added, any terms defined in them will also be added to Part 400. However, terms defined in Parts 331 and 351 are not included in the glossary of definitions, nor are terms used in those parts necessarily to bear the meanings ascribed to those terms in Part 400.

8. Application to individual contracts. Several commentators urged that the Board adopt the date of final agreement on a negotiated price as a cut-off date for the disclosure of cost accounting practices. The Board has “reviewed the merits of selecting that date rather than the date of award to establish the date as of which the contractor’s Disclosure Statement must accurately reflect his cost accounting practices, at least with respect to those contracts where cost or pricing data have been submitted pursuant to Pub.L.87-653. The Board has decided to use the date of final agreement on price, as shown on the signed certificate of current cost or pricing data, with respect to contractors who have submitted cost or pricing data, and to use the date of award of the contract for all other contractors. In addition, the Board has concluded that it is appropriate to use those dates to establish which Cost Accounting Standards shall be applicable to the proposal and to the contract at its inception. Appropriate changes in Parts 331, 351, and 401 have been made to reflect this decision.

9. Price adjustments. Many commentators stated that where a contractor’s departure from existing disclosed practices is occasioned by the contractor’s wish to adopt a newly issued Cost Accounting Standard for all contracts, the Government should be willing to provide upward price adjustment whenever an existing contract is rendered thereby more expensive to perform. The view was often expressed that contractors could not maintain one accounting practice for contracts subject to a particular Cost Accounting Standard, but a different practice for contracts not so subject; therefore, it was alleged, once a contractor had to adopt a standard for any one contract, he would of necessity adopt it for all contracts and amend his Disclosure Statement accordingly.

10. Materiality. The Board notes that many commentators urged that a concept of materiality be incorporated in the Board’s regulations, to the end that minimal or insignificant modifications of or failures to use disclosed cost accounting practices would not be subject to price adjustment.

11. Additional requirements by agencies. As a final general point, concern was expressed that Federal agencies might require submission of cost proposals in ways inconsistent with the cost accounting practices of some or all of the potential offerors. The Board recognizes that this has happened in the past, but it notes that Board rules, regulations, and Cost Accounting Standards are to be used by relevant Federal agencies as well as by contractors and subcontractors, and it believes that henceforth requests for proposals must be fully consistent with such rules, regulations, and standards, although of course the Federal agency may ask for supplementary information to accompany proposals if this is needed to meet the agency’s requirements.

3. The provisions of Part 351 will be applicable to any contractor who submits a proposal which results in contracts containing the clause in 331.5 and whose net awards of negotiated national defense prime contracts during Federal fiscal year 1971 totaled more than $30 million. Contractor whose net awards were less than that amount may be required to complete or submit a Disclosure Statement the Board announced extensions of this requirement to such contractors.

4. Any contractor having a contract awarded prior to July 1, 1972, which contains a clause which already incorporates requirements governing submission of Disclosure Statements an application of Cost Accounting Standards will be required to comply with the provisions of that clause. In this connection, such contractor and the respective contracting agencies whose contracts contain such a clause should review those contracts to determine whether negotiations should be instituted to make Parts 400 through 402 applicable to them.

Preamble B
Preamble to Amendments of 10-4-73

These amendments (38 FR 27507, Oct. 4, 1973) added 351.41 and 351.50(c), and amended 351.70.

The purpose of this publication by the Cost Accounting Standards Board is to modify Part 351, Basic Requirements, of its rules and regulations. A proposed modification to Part 351 was published in the Federal Register of July 27, 1973 (38 FR 20101). That proposal was a revision of an earlier proposal published on May 21, 1973. Thirty-three sets of comments were received in response to the July publication and after considering those comments (discussed below), the Board is today publishing an amendment to its rules relative to the requirement for the submission of Disclosure Statements by defense contractors.

The Board’s July 27 proposal required that, in determining who must file Disclosure Statements, only negotiated contracts of the type which are subject to Cost Accounting Standards were to be considered. All commentators who dealt with this matter supported the proposal. The Board, therefore, in the amendments being published today, specifically limits the contract awards to be included in the computation of a contractor’s volume of defense contracts in determining whether the revised filing requirement has been met, to those of the type subject to the Board’s jurisdiction. The Board recognizes that Standards were not required in contracts in Fiscal Year 1972. In view of this, the amendment refers to “negotiated national defense prime contracts of the type which are subject to Cost Accounting Standards.” This filing requirement, therefore, includes all negotiated defense prime contracts in excess of $100,000 except those where the negotiated price is based on

The amendment being published today by the Board to reduce the dollar level above which filing of a Disclosure Statement will be required excludes from the computation the amounts of all subcontracts and those negotiated defense prime contracts not subject to Cost Accounting Standards. In view of this exclusion, the Board is providing that if the dollar volume of prime contract awards to be considered exceeds $10 million, the contractor will be required to submit a Disclosure Statement. Also, in computing the amount, the amendments require that contracts awarded in either Federal Fiscal Year 1972 or 1973 should be considered. Contractors who meet the threshold amount in either year would be required to file Disclosure Statements, effective April 1, 1974.

The Board believes that the inclusion of the amount of subcontract awards in the Disclosure Statement filing requirement would be appropriate because subcontracts, unless specifically exempt, are subject to the Board’s Standards, rules and regulations. The Board recognizes, however, that there is a lack of records relative to the nature of subcontracts awarded during fiscal years 1972 and 1973. Because of this, the Board concludes that it is inappropriate to include subcontracts in the determination of the threshold amount for filing Disclosure Statements at this time.

The amendments being published today thus limit consideration to the dollar value of prime contracts only. The Board wishes to point out, however, that future levels of the threshold amount may call for inclusion of the dollar value of subcontract awards in the calculation. Contractors are hereby advised that they may be required to determine the dollar value of negotiated defense subcontract awards subject to Cost Accounting Standards beginning with July 1, 1973. Contractors and subcontractors may find it advantageous to begin to identify and accumulate the value of such awards separately.

A major defense agency commented that reduction of the threshold at this time would be premature. It stated that a large number of Disclosure Statements would now be required from contractors less likely to have sophisticated accounting systems. Consequently, greater agency manpower efforts would be required to review them for adequacy. Also, the agency expressed concern with the upcoming work required for compliance reviews and the possibility of negotiation of price adjustments relative to Standards. Finally, it stated that a number of manpower spaces have already been provided in order to support Board requirements. The agency suggested that a threshold reduction be deferred until after July 1, 1974.

The Board believes that Disclosure Statements from “contractors less likely to have sophisticated accounting systems” would seem to be especially needed by the Government in order to know more precisely how such contractors account for their costs. Additionally, the Government has gained a great deal of experience in reviewing the Disclosure Statements already received, which should aid review of newly submitted statements on an expeditious basis. With respect to the potential workload required in compliance reviews, Government agencies have always had a responsibility for reviewing contractor accounting practices and the use of those practices for Government contract costing. The Disclosure Statement provides a benchmark which should facilitate such reviews in the future. Moreover, the Board is advised that most Disclosure Statements filed under the existing $30 million threshold have been reviewed for adequacy, and compliance reviews are now being made as a part of other routine audit work.

The need to provide manpower spaces to support Board requirements is to be expected. The advantages of the expanded disclosure requirement, however, are many. For example, another defense agency strongly endorsed the Board’s proposal to reduce the threshold because of the useful information provided in Disclosure Statements to contracting officers and auditors. Additionally, one agency previously reported to the Board that the Disclosure Statement has become a valuable tool in giving the negotiator more cost visibility while another referred to the Statement as a significant asset for use in reviewing contract proposals. After considering the agencies’ comments referred to above, the Board has concluded that a reduction in the threshold is desirable and within the capabilities of the agencies’ staffs to review the additional statements that would be submitted.

The Board’s July proposal included an effective date of January 1, 1974. The Board has concluded that additional time between the publication of these amendments and the effective date of the reduced threshold should be given to allow agencies to prepare fully to handle the additional volume of Disclosure Statements that will be submitted. Also, additional time will further assure that contractors meeting the new threshold requirement can complete the Disclosure Statement without interference with the prospective award of contracts. For these reasons, the amendments being published today require that contractors meeting the threshold must submit a Disclosure Statement in order to receive a covered contract after April 1, 1974.

Nine commentators urged the Board to provide an exemption for profit centers, divisions, etc., which are predominately commercially oriented and which have only a small dollar volume or percentage of covered defense contracts. The Board has announced that it is initiating a study to consider the establishment of a minimum dollar amount or percentage of covered contract effort below which contractors profit centers and divisions would be exempt from Board Standards, rule and regulations, including the disclosure requirement. In any case, the Board has concluded that $10 million in covered contracts on a company wide basis is a significant dollar volume and that it warrants establishment of the requirement for submission of a Disclosure Statement.

Two commentators objected to the establishment of an absolute dollar amount of awards as a basis for determining the requirement for filing a Disclosure Statement. They suggested that a percentage of overall business would be more appropriate. This kind of information is not available at the present time. In estimating the number of Disclosure Statements that would be submitted at any threshold amount, and relating that number of statements to the agency’s capability to process them, the Board uses statistics on contract awards maintained by defense agencies. Because of this, for the present the Board has retained the requirement to compute the threshold amount for filing a Disclosure Statement in terms of dollar volume of contract awards. The study discussed above may provide information to allow the Board to consider use of a percentage of covered contracts in relation to total business as a factor in setting future threshold requirements. While not specifically related to the Board’s proposal of July 27, 1973, the Board has received a number of oral inquiries concerning the intent of the second sentence of 351.120(d) of the Board’s regulations, which states:

Revised data for items 1.4.0 through 1.7.0, 8.1.0 and 8.2.0 must be submitted annually at the beginning of the contractor’s fiscal year.

The Board did not intend that the changes to these items should be considered in counting the number of changes which would necessitate the resubmission of an entire Disclosure Statement. This information, which relates to the volume of business, should be sent to the recipients of Disclosure Statements only on an annual basis and only if the responses to the items in the Disclosure Statement on file require a change. If on a year-to-year basis, the sales data remain such that the contractor would check the same box in the Disclosure Statement, the Board’s rules and regulations do not require resubmission of data concerning these particular items.

The Board’s July 27 proposal included a requirement that contractors were to submit a copy of their Disclosure Statement to the Board only after a determination of adequacy has been made of the Statement. All commentators who dealt with this point supported this proposal, and it is included in the amendment being published today.

Today’s publication is numbered in consonance with the new numbering system published on September 5, 1973, as part of the proposal set forth in 38 Federal Register 171 at page 23971 et seq. Pending adoption of the September 5, proposal, references to 331.60, 351.40, 351.50, and 351.70 refer to 331.6, 351.4, 351.5 and 351.7 respectively of the Board’s current rules and regulations. The new 351.41 will be located immediately after 351.4 which will become 351.40.

Preamble C
Preamble to Revision of Part 351, 11-7-73

This publication (38 FR 30725, Nov. 7, 1973) revised Part 351 in its entirety, with the exception of 351.41. 351.50(c) and the last sentence of 351.70.

The purpose of this publication by the Cost Accounting Standards Board is to amend Parts 331, 351, 400, 401, 402, 403, and 404 of its rules and regulations. The amendments, which are minor clarifications to the regulations, were published in the Federal Register of September 5, 1973 (38 FR 23971). The amendments:

In view of the foregoing, the following amendments to the Board’s regulations are being made effective November 7, 1973:

Preamble D
Preamble to Amendment of 12-12-73

This publication (38 FR 32460, Dec. 12, 1973) amended 351.140 and added a new 351.145.

The purpose of this publication by the Cost Accounting Standards Board is to modify Part 351, Basic Requirements, of its rules and regulations. A proposed modification to Part 351 was published in the Federal Register of September 17, 1973 (38 FR 26072). That proposal dealt with a Disclosure Statement form designed expressly for submission by colleges and universities. Comments were requested on that proposal from the general public.

Public Law 91-379 which applies to most negotiated defense prime contracts and subcontracts in excess of $100,000 requires that contractors shall disclose in writing their cost accounting practices. The Disclosure Statement form, CASB-DS-1 has been designed to facilitate the meeting of this requirement by contractors. Representatives of colleges and universities had expressed to the Board a desire to have a separate Disclosure Statement to cover their practices. Form CASB-DS-2, being published today, was devised for that purpose and incorporates terminology more commonly used by colleges and universities.

Comments on the September 17 proposal were received from 15 commentators, who offered suggestions for changing the proposed form to explain or further clarify the intent of the questions. Insofar as practicable, the Board has made changes to the college and university Disclosure Statement form to accommodate the suggestions made.

Colleges and universities required to submit Disclosure Statements after April 1, 1974, should use Form CASB-DS-2. Any college or university which has previously submitted a Disclosure Statement should use Form CASB-DS-2 for any amendments which are to be effective after April 1, 1974.

Preamble E
Preamble to Amendment Published 12-24-74

This publication revised 351.40(a) and amended 351.130. and was published on Dec. 24, 1974, at 39 FR 44389.

The purpose of this publication by the Cost Accounting Standards Board is to adopt modifications to Part 331, Contract Coverage, and Part 351, Basic Requirements, of its rules and regulations. These modifications will provide an exemption from Cost Accounting Standards Board requirements for certain national defense contracts and subcontracts of $500,000 or less.

Public Law 91-379 requires that Cost Accounting Standards must be used in all negotiated prime contract and subcontract national defense procurements with the United States in excess of $100,000, with certain stated exceptions. From time to time the Board refers to contracts subject to its rules and regulations as “covered contracts”. Section 719(h)(2) of Pub.L.91-379 authorizes the Cost Accounting Standard Board to prescribe rules exempting from its requirements such classes or categories of national defense contractors and subcontractors as it determines, on the basis of the size of the contracts involved or otherwise, are appropriate and consistent with the purposes sought to be achieved by Pub.L.91-379. The Board has granted several exemptions to classes or categories of contractors and subcontractors and also has established a procedure under which waiver of the Board’s requirements may be granted for individual contracts.

A proposed exemption increasing the minimum contract amount requiring compliance with Cost Accounting Standards Board rules, regulations and Standards from $100,000 to $500,000 was published by the Board on September 27, 1974 (39 FR 34669). The Board received 82 responses to the September 27 proposal. Comments were received from individual companies, government agencies, professional associations, industry associations, public accounting firms, and individuals. All of these comments have been carefully considered by the Board, and the Board takes this opportunity to express its appreciation for the helpful suggestions which have been furnished.

The comments below summarize the major issues discussed by respondents in connection with the initial publication and explain the Board’s disposition of these issues.

Issuance of the exemption. Practically all the commentators expressed concurrence in the proposed exemption, giving either unqualified support or support with added comments that additional exemptions should also be considered. However, three commentators -- a constituting firm, a major aerospace company and a Government agency -- disagreed with the proposed exemption, stating that an increase in the threshold for compliance with CAS requirements was inconsistent with the Board’s objective of establishing uniformity and consistency among contractors doing business with the Government.

The Board agrees that the adoption of the proposed regulation will exempt a substantial number of contractor and subcontractors who otherwise would be covered, and consequently will permit such companies to follow accounting practices other than those set out in Cost Accounting Standards. However, the Board is aware that compliance with its rules, regulations and standards may involve additional administrative effort, particularly on the part of small companies, which may not be commensurate with the benefit to the Government or the contractor resulting from such compliance. The Board, after considering the efforts required by both the Government and its contractors to assure compliance on all covered contracts in excess of $100,000, is persuaded that maximum benefit to the Government with minimum cost can be achieved by limiting the mandatory application of its standards to contractors who receive awards which constitute a substantial majority of the national defense procurement dollars. As was stated at the time the proposed exemption was issued for comment, some 70 percent of the prime contractors of the Department of Defense did not receive one or more negotiated awards in excess of $500,000 in Fiscal Year 1973. Thus, only 30 percent, or approximately 750 prime contractors, who received contract awards totaling $20 billion, would continue to be covered. The exemption would remove coverage from only about 10 percent of the dollar value of annual DoD awards.

In view of the foregoing, the Board considers the proposed exemption increasing the minimum contract amount requiring compliance with the Cost Accounting Standards Board rules, regulations, and standards to be in keeping with the purposes sought to be achieved by Pub.L.91379 and to be an appropriate exercise of the authority granted to the Board by section 719(h)(2) of that law.

Increase exemption on all contracts to $500,000. A number of commentators suggested that the $500,000 single contract threshold for compliance with Board rules, regulations, and standards be changed to exempt all contracts of $500,000 or less. Those giving reasons in support of this suggestion generally based their comments on simplification of administration. These commentators felt that it would be difficult for the Government or prime contractors, when awarding a prime contract or subcontract in excess of $100,000 to determine whether the contractor or subcontractor had in existence a prior $500,000 covered contract.

The Board, in proposing the $500,000 threshold, did so with the intent of exempting those companies which do not receive contracts in excess of $500,000 from the Government. However, it was decided in the interest of consistency in cost accounting practices that once a contractor had received a covered contract of that size, compliance with CASB rules, regulations and standards on contracts at the level established in Pub.L.91-379 was appropriate. This is also consistent with the desire expressed by contractors to follow a single set of accounting practices. Further, the requirement for coverage of contracts in excess of $100,000 where the contractor already has received a covered contract in excess of $500,000 will permit the small contracts to be available for equitable adjustment if subsequently issued standards should become applicable. Moreover, once the administrative effort has been expended to comply with standards for contracts in excess of $500,000, compliance with standards on contracts above the statutory threshold of $100,000 requires little added effort.

With respect to the commentators’ statements concerning the difficulties, when making an award exceeding in $100,000, of determining whether a contractor or subcontractor had in existence a prior award exceeding $500,000, the Board feels that an administrative requirement can be established for obtaining this information. A similar requirement now exists concerning the disclosure statement, whereby contractors are required to submit a disclosure statement, state that they have previously filed a disclosure statement, or submit a certificate of monetary exemption. The Board feels that a similar requirement can be set concerning the $500,000 level. The Board is not persuaded that this matter would create problems of sufficient significance to eliminate coverage down to the $100,000 level.

In considering the advantages of the exemption as proposed compared to its assessment of the administrative difficulties foreseen by commentators, the Board is persuaded that its proposal relative to coverage of awards in excess of $100,000 should not be changed.

Exemption based on sales. A number of commentators urged that the Board establish an exemption based on sales, using either minimum annual dollar amount of sales to the Government, or Government sales as a percentage of total annual sales, or a combination of these two factors. The most frequently suggested amount was $10 million of sales to the Government or Government sales amounting to 10 percent of total annual sales. The objective sought by these commentators was an exemption of those companies or business units whose sales to the Government constituted a reasonably small portion of their total annual sales and whose business was essentially commercially oriented. The Board has given lengthy consideration to the use of a sales basis for the establishment of a minimum threshold for compliance with its rules, regulations and standards. It did not use that basis at this time due to the nature of the problems involved administering an exemption based on sales. In either of the situations suggested by commentators, the representation concerning the amount of sale, must be made by the contractor and subsequently verified by the Government. This verification would impose very substantial and time-consuming efforts on both the Government and the contractor. Particularly in the case of Government sales as a percentage of total sales, Government representatives would be placed in the position of examining a contractor’s total sales including those made in its commercial business. Examination of a company’s records concerning its total sales is not presently performed by Government procurement activities and would present new and unique problems to both parties as well as requiring substantial additional effort on the part of Government representatives.

An exemption based on sales would require a measurement period during which a contractor’s status with respect to compliance with standards would be determined. Contracts under which sales were recorded during this period would not be subject to standards. If the volume of sales during the measurement period exceeded a stated threshold, a contractor would then be required to comply with standards under contracts received in subsequent periods. Thus, the contracts that brought the contractor under the Board’s rules would not be subject to standards, while those received at a later time would be.

The Board has decided that the administrative problems involved with an exemption based on sales should be considered before establishing such threshold. The Board will continue to study these problems and investigate whether exemptions based on criteria other than a minimum contracting amount would be appropriate and consistent with the purposes of Pub.L.91-379.

Retroactivity. Several commentators requested that the Board modify its proposal so as to provide retroactive exemption to existing contracts where the circumstances are such that these existing contracts would have been exempt if awarded after the effective date of the proposed regulation.

The Board has no authority to modify existing contractual agreements between the government procurement agencies and their contractors. However, the Board sees nothing inconsistent with its regulations or with Pub.L.91-379 in modification by the procurement agencies of contracts in this category, assuming of course that the Government receives adequate consideration for deletion of the CAS requirement.

Increase minimum amount. A number of commentators recommended that the exemption proposed be increased to an amount greater than $500,000, the figure of $1,000,000 being frequently mentioned. The Board is not now prepared to raise further the minimum contract amount requiring compliance with its promulgation’s. The Board, in studying an exemption based on minimum contract amount concluded that the $500,000 threshold was the most appropriate one for achieving its objectives, all factors considered. The Board will continue to examine various limitations but considers that the threshold established in the proposed exemption best meets its requirements and obligations at this time.

Effect of final payment under contracts subject to CAS clause. Several commentators urged that the exemption of contracts of $500,000 or less should not be dependent on the final payment on contracts which are subject to Board requirements, on the grounds that final payment can occur a substantial period of time after completion of work on a contract and that there are many technicalities in closing out a contract which do not involve cost accounting applications.

The Board considers this point to be well taken and has changed the requirement in 331.30(b)(8) where it first appears to “notification of final acceptance of all items or work to be delivered.” At that time it is considered that all direct costs will have been charged to the contract since all work will have been completed, and any further accounting transactions would be the result of adjustments not directly related to contract performance.

Reduction of contract price by exclusion of commercial items. Some commentators, in reading the introductory comments to the Board’s initial publication of this exemption, interpreted the phrase “minimum contract amount requiring compliance” in a manner not at all intended by the Board. These commentators interpreted this phrase to permit the price of a contract subject to standards to be reduced by the value of those individual contract items or subassemblies of final contract terms whose prices could be considered to be “catalog” or “market” prices, if sold separately. They requested that the regulation be clarified to reflect their interpretation of the Board’s introductory comments.

Those requesting this clarification misunderstood the Board’s intentions. The Board does not intend that the price of a contract be adjusted to exclude the price of items or subassemblies which, if purchased separately, might be exempt from the Board’s promulgation’s. Consequently, the change in the regulation requested by commentators on this point would be completely inappropriate.

Definition of contractor. One commentator noted that the prefatory comments to the Board’s September 27, 1974, publication specifically mentioned the fact that receipt of a contract in excess of $500,000 by one business unit of a multi-unit company would not in itself require other units of the same company to follow Board requirements. This commentator requested that the definitions of “defense contractor” and “defense subcontractor” contained in 331.20 (b) and (c) be modified to reflect this intention by the Board.

As the Board stated in its September 27 publication, its contract requirements have been applied to business units, such as a profit center, division, subsidiary, or similar unit of a company, which perform the contract, even in those cases where the contract was entered into on behalf of the overall company rather than the business unit. This application of the Board’s requirements to a performing business unit is well established and unchallenged, and clarification of the definitions of “contractor” and “subcontractor” does not appear necessary.

Effective date. Several commentators raised questions concerning the effective date of the eligibility for this exemption in relation to awards received prior to January 1, 1975. Contractors who have received a prime contract or subcontract in excess of $500,000 subject to cost accounting standards prior to January 1, 1975, and on which notification of final acceptance of all items or work to be delivered on that contract or subcontract has not been received, is a contractor who has “already received a contract or subcontract in excess of $500,000,” as that phrase is used in 331.30(b)(8). Therefore, today’s publication requires that a contractor meeting this will be required to comply with standards on all covered prime contracts or subcontracts in excess of a $100,000 received after January 1, 1975, under the provisions of 331.30.

Preamble F
Preamble to Amendments of 8-4-75

This publication (40 FR 32747, Aug. 4, 1975) amended 351.40 by revising (c) and adding (f); deleted 351.41; amended 351.50 by revising (a) and (c) and adding (d); and amended 351.120 by revising (d) and adding (e). A correction to the language which amended 351.40 appeared at 40 FR 33819, Aug. 12, 1975.

The purpose of this publication by the Cost Accounting Standards Board is to modify Part 351, Basic Requirements, of its rules and regulations and Part 403, Allocation of Home Office Expenses to Segments. A proposed modification to Part 351 was published in the Federal Register of April 3, 1975 (40 FR 14942). Twenty-seven sets of comments were received in response to that publication. After considering those comments, the most significant of which are discussed below, the Board is today publishing an amendment to its rules relative to the requirement for the submission of Disclosure Statements by defense contractors and subcontractors.

1. Fiscal Year Coverage. The Board’s April 3 proposal provided that any company which, together with its subsidiaries, received more than $10 million in prime contracts subject to Cost Accounting Standards in Government fiscal years 1974 or 1975 would be required to file Disclosure Statements. Board regulations now require the filing of Disclosure Statements on the basis of prime contracts awarded in fiscal years 1971, 1972 or 1973. There were no objections voiced by commentators to the inclusion of fiscal years 1974 and 1975 in the filing requirement. Accordingly, the amendments being published today require that companies who exceeded the threshold amounts in either of those fiscal years will be required to file Disclosure Statements.

2. Effective Date. The Board’s proposal established July 1, 1975, as the effective date for the requirement to include awards made in fiscal years 1974 and 1975. Most commentators pointed out that in view of the short time permitted between submission of comments on the proposal and the July 1 date, any company which met the new requirement would not have sufficient time to file a satisfactory Disclosure Statement to permit receipt of a covered contract. The Board agrees, and accordingly, the amendments being published today establish an effective date of January 1, 1976, for the new requirement. Thus, any company which, together with its subsidiaries, received more than $10 million in prime contract awards subject to Cost Accounting Standards in Government fiscal years 1974 or 1975 must submit a Disclosure Statement in order to receive a covered national defense contract after January 1, 1976.

3. Inclusion of Subcontracts. The Board’s proposal required that beginning with Federal fiscal year 1976 (July 1, 1975-June 30, 1976) companies would be required to include, in addition to prime contract awards, the value of subcontract awards received subject to Cost Accounting Standards in their computation to determine if they must file Disclosure Statements. Beginning with that fiscal year and for all subsequent fiscal years, the Board’s proposal stated that any company which, together with its subsidiaries, received more than $10 million in prime contract awards and subcontract awards subject to Cost Accounting Standards would be required to file Disclosure Statements.

4. Change in Fiscal Year Period. Several commentators noted that the Federal Government is changing the dates of its fiscal year following Federal fiscal year 1976. The new fiscal year period will be from October 1 through the following September 30. The period July 1, 1976, thru September 30, 1976, will be known as Federal fiscal period 197T. These commentators asked whether or not contracts awarded in that period should be included in some way with a normal fiscal year’s contract awards. The Board feels that it is not desirable to upset the regular twelve-month fiscal year computation period and accordingly has concluded that contracts awarded in that three-month period need not be included by companies in determining the value of contract awards received in fiscal year 1976 or any subsequent fiscal year.

5. Previously Announced Filing Requirements. The Board’s proposal included a requirement that any company which has submitted or was required to submit a Disclosure Statement to the Government under the previously announced filing requirements by virtue of having received a covered contract shall remain subject to those requirements so long as it has any contract subject to Cost Accounting Standards. The proposal also required that Disclosure Statements from those companies on file with the Government must be maintained in a current form by those companies. There were virtually no comments received on this requirement. The amendments being published today contain that requirement as set out in the April 3 proposal.

6. Applicability of CAS 403. A number of commentators noted that the April 3 proposal deleted 351.41 of the Board’s regulations. This paragraph restated the requirement that only companies that met the Disclosure Statement filing requirement for Federal fiscal year 1971 were required to comply with CAS 403. Allocation of Home Office Expenses to Segments. These commentators asked that the Board’s position be clarified as to whether or not any current revision to the Disclosure Statement requirement also changed the coverage of CAS 403. It was not the Board’s intention to broaden the coverage of CAS 403 at this time. The possibility of extending the coverage of that Standard is the subject of a separate study currently underway. To make the Board’s intention wholly clear, 403.70 of CAS 403 is being revised to state explicitly rather than by cross reference the continuing coverage of that Standard. This revision has no substantive significance whatever, but instead merely sets out specifically what was and continues to be the exemption from that Standard, which was before today accomplished by reference to 351.40 of the Board’s Basic Requirements. Contractors and subcontractors which together with their subsidiaries did not receive net awards of negotiated national defense prime contracts during Federal fiscal year 1971 totaling more than $30 million continue to be exempt from Standard 403.

7. Amendments to Disclosure Statements. The Board’s April 3 proposal also included revised procedures for handling changes to the Disclosure Statement. Contractors would be required to submit only the Disclosure Statement pages on which changes have been made. All commentators supported these revised procedures and they are being published today as part of the Board’s regulations.

8. Computation of Dollar Amount of Contract Awards. A number of commentators asked that the Board clarify its intent as to which contracts should be included in the computation of the dollar amounts. The Board feels that covered contracts awarded in any fiscal year in which the computation is being made should be included. This would mean that for all of fiscal year 1974, negotiated defense prime contracts in excess of $100,000 would be included by a company in determining if it met the requirement to file a Disclosure Statement. For the first six months of fiscal year 1975 all covered contracts in excess of $100,000 would be included in the figure for that fiscal year. For the balance of fiscal year 1975 only those awards which are subject to Standards would be included. This means that if a company was not performing under a covered contract exceeding $500,000 at January 1, 1975, and did not receive an award exceeding that amount in the last six months of the fiscal year, then only the covered contracts received in the first six months would be included. Only those companies which received an award of $500,000 or more in the last six months of the year would add up their covered contracts, including those subsequently awarded in amounts of $100,000 or more, to arrive at the total amount awarded in that period, to be added to the total for the first six months.

9. Summary of Disclosure Statement Filing Requirements. The Board has amended the requirement for filing Disclosure Statements a number of times. As a convenience to those affected by CAS, there follows a tabulation showing these requirements.

10. Modification. The modifications being adopted today are limited to those areas in which the Board considers clarification or changes warranted at the present time. From time to time the Board may announce further changes in the criteria for applicability of the disclosure requirement.

The following modifications to Part 351 of the Board’s regulations are being made, effective August 1, 1975, in view of the foregoing.

Preamble G
Amendment Published 9-12-77

The material set forth below is the preamble to the revision or 351.40(e) and (f). This preamble was part of a document which also set forth amendments to Parts 331, 332 and 403. The complete preamble to appears in the supplement to Part 332.

Disclosure Statement Requirements

Many commentators suggested that preparation of a Disclosure Statement was burdensome. They also contended that in the situation where a large commercial contractor receives only a few small contracts containing a Cost Accounting Standards clause the need for a Disclosure Statement appears to be minimal. Some asserted that adoption of the proposal to require a Disclosure Statement for all covered contracts would reduce the number of companies that would accept contracts subject to the Board’s Standards, rules and regulations. The Board is persuaded that for the time being Disclosure Statements should not be required for all covered contracts. Accordingly it is not adopting the February 15 proposal. The Board is retaining the existing Disclosure Statement requirement provided in Part 351 except that a business unit will be required to submit a Disclosure Statement if it is a company or a segment of a company which received awards of national defense contracts subject to Cost Accounting Standards in excess of $10 million during its preceding cost accounting period rather than the preceding Federal fiscal year.

Revisions to Part 351

Part 332 and the amendments to Part 331 generally will result in annual determinations being made of a contractor’s obligation to follow Standards and to submit Disclosure Statements. The determination will be made on the basis of sales and awards data from the immediately preceding cost accounting period. The requirement to continue to submit a disclosure Statement so long as the contractor has a contract subject to Cost Accounting Standards will no longer apply. Disclosure Statements must be maintained for and applied to only those contracts which were awarded during a cost accounting period in which the contractor met the filing 351.40. Sections 351.40 and 351.50 have been revised to reflect this change.

Effective Date

The effective date of the regulation being published today is March 10, 1978. Pub.L.91-379 provides that regulations shall take effect not earlier than the expiration of the first period of sixty calendar days of continuous session of the Congress following the date on which a copy of the regulations is transmitted to the Congress. The calendars of the Congress indicate that the required sixty days will not pass until some time in February 1978. Accordingly, March 10, 1978, has been selected to assure sufficient time for the regulation to lie before the Congress.

Part III
Preambles Published Under the FAR System

Preamble A to 30.404,
Capitalization of Tangible Assets

This final rule, in Federal Acquisition Circular (FAC) 84-38, revises 30.404-40(b)(1), 30.404-60(a)(1), and 30.404-60(a)(1)(i).

Summary

Section 30.404 requires that contractors have written policies for capitalization which must include a minimum acquisition cost criterion of $1000. The standard is being amended to raise the threshold to $1500. The purpose of the change is to permit contractors to adopt practices appropriate in today’s economy.

Effective Date: The effective date of this modification is September 19, 1988.

Background

Supplementary Information. The CAS Board established the minimum acquisition cost criterion for capitalization at $500 when it originally promulgated CAS 404 in 1973. The Board’s initial $500 limitation encompassed the practices of 97 percent of the companies whose Disclosure Statements were filed with the Board. In the promulgation comments to the Standard, the Board recommended that the special limits in the standard “. . . may need to be reviewed in the future. . . (and will be revised) promptly if developments warrant a change.”

On March 3, 1980, the Board did revise the limitation upward to $1000 as it recognized that circumstances had changed significantly since the promulgation of Standard 404. The Board found that the performance of several official indices showed increases from 60 to 80 percent, and a survey of companies not influenced by the limitation of Standard 404 showed a significant number using $1000 as the minimum criterion for capitalization.

The impact of inflation has continued over the 7 years since 1980, although at a lower level. Indices from the Commerce Department for the implicit price deflators on nonresidential structures and machinery and equipment showed increases from 30 to 35 percent over the period 1979 through 1985. When applied to the current $1000 criterion, this yields values from $1300 to $1350. In addition, economic projections showed inflation levels rising slightly from 1986 through 1989. Consequently, this change increases the minimum acquisition cost criterion for capitalization of tangible capital assets to $1500 to cover both actual and projected price increases.

The amendment which is now being promulgated is derived directly from the proposed rule which was published in the Federal Register on July 9, 1986 (51 FR 24971), with an invitation for interested parties to submit comments.

Four letters of comment were received on the July 9, 1986, proposal. Only one letter directly addressed the appropriateness of the proposed revisions to 30.404. That comment stated that inflation should not be the motivating factor in determining significant costs for capitalization, but rather materiality of the cost should be the factor in determining significance.

The CAS Board’s comments in the CAS 404 preamble and its action to increase the capitalization threshold based upon inflation, discussed above, indicate that the Board considered the materiality and significance of asset acquisition cost to be directly related to the level of prices in the economy. The Defense Acquisition Regulations Council and the Civilian Agency Acquisition Council agree with the CAS Board’s outlook on this matter and expect the increase in capitalization threshold provided in this modification to 30.404 will be beneficial to Government contract costing by not requiring capitalization of assets that are of insignificant value.

Preamble A to 30.416,
Accounting for Insurance Costs

This final rule, in Federal Acquisition Circular (FAC) 84-38, revises 30.416-50(a)(3)(ii).

Summary

FAR 30.416-50(a)(3)(ii) revisions delete the requirement to use state rates in discounting certain self-insured losses to present value.

Effective Date: The effective date of this modification is September 19, 1988.

This modification shall be followed by each contractor on or after the start of its next cost accounting period, beginning after receipt of a contract to which this modification is applicable.

Background

Supplementary Information. Section 30.416 provides that the amount of insurance cost to be assigned to a cost accounting period is the projected average loss (PAL) for that period plus insurance administration expense in that period. The PAL is either the insurance premium, where the risk of loss is covered by the purchase of insurance, or a self-insurance charge, where the exposure to risk is not covered by the purchase of insurance. Where it is probable that the actual amount of losses will not differ significantly from the PAL, the actual amount of losses may be considered to represent the PAL for the period as the self-insurance charge.

In self-insurance, when the actual amount of losses is being used to represent the PAL, contractors are to discount those losses to present value, where payments to the claimant will not take place for over a year after the loss occurs. If a state provides a discount rate for computing lump-sum settlements, 30.416 requires that the state rate be used for computing present value. Otherwise, the Pub.L.92-41 Treasury rate is to be used. The differing rates specified by the states, and the lack of specified rates in some states, result in inconsistent treatment of self-insurance charges on defense contracts.

The purpose of requiring a present value computation for contract cost accounting purposes is to recognize the time value of money for funds advanced to and used by the contractor for extended periods before being disbursed. The Pub.L.92-41 Treasury rate is generally specified for this purpose. The majority of state laws covering worker’s compensation insurance specify a rate in the range of 3-6 percent. The use of a low rate results in a larger settlement than would use of a current money market rate. The purpose of low state rates is to discourage lump-sum settlements. This purpose is unrelated to that of fair valuation for contract cost accounting purposes. The use of state rates may produce inaccurate measures of present values and will most certainly create inconsistencies in the pricing of contracts due to the lack of consistent determinations of present values. Consequently, the proposed rule, published in the Federal Register on July 8, 1986 (51 FR 24788), deleted the reference to state discount rates at 30.416-50(a)(3)(ii) and required use of the Pub.L.92-41 Treasury rate in all cases.

Four comments were received in response to the proposed rule. None of the comments directly challenged the appropriateness of the proposed revision. Therefore, no changes were made to the proposed rule as a result of the public comments.


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