1. Overview of Accounting Requirements in Government Contracting
Warren Stoker
Vice President, Government Liaison & Business Process Controls,
Textron Inc.
University of Texas at Arlington
CPA Day – August 20, 2015

2. Learning Objectives
Identify how certain U.S. Government (USG) acquisition policies drive associated accounting practices
Identify specific USG Contract types requiring unique accounting practices
Identify reasons supporting the requirement for these accounting practices
Review examples of the required accounting practices
Provide sources for additional information

3. Applicable Regulations
Federal Acquisition Regulation (FAR)
FAR is codified in Title 48 of the United States Code of Federal Regulations
FAR and its agency supplements have “the force and effect of law,” see Davies Precision Machining, Inc. v U.S., 35 Fed. Cl. 651 (1995).
Nearly all government agencies are required to comply with the FAR.

4. Significant FAR Parts
FAR part 12 describes policies and procedures unique to the acquisition of commercial items. It implements the Federal Government’s preference for the acquisition of commercial items contained in Title VIII of the Federal Acquisition Streamlining Act of 1994 (Public Law  ) by establishing acquisition policies more closely resembling those of the commercial marketplace and encouraging the acquisition of commercial items and components.

5. Significant FAR Parts
FAR Part 15 describes policies and procedures governing competitive and noncompetitive negotiated acquisitions.
Part 16 – Types of Contracts – describes type of contracts that may be used in acquisitions and when the various types should be used. Common contract types used by DOD are Fixed Price, Cost Reimbursement, Cost + award fee, and Cost + incentive fee among others.

6. Significant FAR Parts
Part 30 – Cost Accounting Standards (CAS) Administration - describes policies and procedures for applying CASB rules and regulations to negotiated contracts.
Part 31 – Cost Principles and Procedures – for the pricing of contracts, subcontracts and modifications to contracts and subcontracts when ever cost analysis is performed, and the determination, negotiation, or allowance of costs when required by a contract clause.

7. DoD FAR Part 15 vs. Commercial Acquisition Process
The primary driver relative to DoD vs. Commercial acquisition process is based on the consumer and market relationship.
In commercial markets, consumers typically have many similar products from which to choose (i.e., Ford, GM, Honda, Toyota, etc.).
The consumer makes their choice based on need and available data, including price.
Generally, Price is the primary consideration.

8. DoD FAR 15 vs. Commercial Acquisition Process
DoD acquisitions generally start with issuance of a Request for Proposal (RFP). These proposals will often include the technical requirements that DoD specifies to meet their need (i.e., an aircraft that can fly x mph at x altitude for x period of time with a payload capacity of x). Due to the limitations of companies that are able to comply with security and system requirements for this type of contracting, the list is typically short, and may even be a sole source
Generally, Costs are the primary consideration.

9. Types of Costs - Direct Cost
Direct Cost - any cost that is identified specifically with a particular final cost objective. Direct costs are not limited to items that are incorporated in the end product as material or labor. Costs identified specifically with a contract are direct costs of that contract All costs identified specifically with other final cost objectives of the contractor are direct costs of those cost objectives
Examples of Direct Cost
Program Specific Cost
Direct Labor
Engineering
Manufacturing Assemblies

10. Types of Cost - Indirect Cost
Indirect Cost - any cost not directly identified with a single final cost objective, but identified with two or more final cost objectives or with at least one intermediate cost objective.
FAR Subpart 2.1
Examples of Indirect Cost
Accounting
Audit
Indirect Labor
Office Supplies
Human Resource Support
Information Technology Support

11. How Indirect Costs are Reported to the Government
Primary Documents the Vendor provides to the USG:
Disclosure Statement – details the manner in which corporate office costs are accumulated (by pool) and subsequently allocated (over base) based on a causal/beneficial relationship as defined in the FAR and DFARS.
Incurred Cost Submittal – Provides the USG with the total corporate cost for the prior year (less those determined to be unallowable, unallocable, or unreasonable) in accordance with the Disclosure Statement.

12. How Indirect Costs are Reported to the Government
Forward Pricing Rates – a forecast of costs for the current year plus three years into the future. These rates are utilized for estimating cost for future USG contracts and would be included with proposals.
Forward Pricing Rate Agreement – formalized agreement between the contractor and the Government defining the rate package (i.e., any escalation factors, assumptions, etc. used in the forecast.)

13. FAR Part 31 Identifies Covered Costs
Cost Type
FAR Reference
Public Relations and Advertising Costs *
Bad Debts
Bonding Costs
Compensation for Personal Services
Contingencies
Contributions or Donations *
Cost of Money
Depreciation
Economic Planning Costs
Employee Morale, Health, Welfare, Food Service, and Dormitory Costs and Credits *
Entertainment Costs *
Fines, Penalties, and Mischarging Costs
Gains and Losses on Disposition or Impairment of Depreciable Property or Other Capital Assets
Idle Facilities and Idle Capacity Costs
Plant Reconversion Costs
Precontract Costs
Professional and Consultant Service Costs
Recruitment Costs
Relocation Costs
Special Tooling and Special Test Equipment Costs
Taxes

14. FAR Covered Costs (cont.)
Cost Type
FAR Reference
Termination Costs
Independent Research and Development and Bid and Proposal Costs
Insurance and Indemnification
Interest and Other Financial Costs
Labor Relations Costs
Lobbying and Political Activity Costs
Losses on Other Contracts
Manufacturing and Production Engineering Costs
Material Costs
Organization Costs
Plant Protection Costs
Patent Costs
Trade, Business, Technical and Professional Activity Costs
Training and Education Costs
Travel Costs *
Costs Related to Legal and Other Proceedings
Research and Development Costs
Goodwill
Costs of Alcoholic Beverages *
Asset Valuations Resulting from Business Combinations

15. Cost Criteria
In accordance with FAR certain criteria must be met in order to charge costs to the USG.
Costs must be Allowable, and
Costs must be Allocable,
Pursuant to guidance in FAR Part 30 – Cost Accounting Standards (CAS).

16. Allowability of Cost
Cost is allowable only when the cost complies with all of the following requirements:
Reasonableness
Allocability (Costs can be allocable but Unallowable)
Standards promulgated by the CAS Board, if applicable, otherwise relevant US GAAP (Generally Accepted Accounting Principles)
Terms of the contract
Any limitations set forth in this FAR Subpart
Even if a contract is not CAS covered, Allowable/Unallowable determination must be made
Inconsistent treatment of cost may result in a portion of cost being questioned as unallowable
Contractors are responsible for maintaining adequate cost documentation records in order for the cost to be considered allowable

17. Unallowable Cost Review and Removal
Direct cost (i.e., manufacturing assembly) are charged directly to the contract
Indirect costs (i.e., accounting labor, office supplies) must be “cleansed” before being charged
In a government contracting environment unallowable cost must be removed before costs are charged to the US Government in the Incurred Cost Claim for the year
Cost Incurred
Unallowable Cost Removed
Allowable, Indirect Costs Built into Claim
Cost charged to the US Government

18. Allocability of Cost
A cost is allocable if it is assignable or chargeable to one or more cost objectives on the basis of relative benefits received or other equitable relationship. Subject to the foregoing, a cost is allocable to a Government contract if it
Is incurred specifically for the contract
Benefits both the contract and other work, and can be distributed to them in reasonable proportion to the benefits received
Is necessary to the overall operation of the business, although a direct relationship to any particular cost objective cannot be shown

19. Cost Accounting Standards (CAS)
CAS are mandatory for use, as applicable, by the prime contractors and subcontractors of all executive agencies in estimating, accumulating, and reporting costs, and settlement of disputes concerning, all negotiated prime contract and subcontract procurements with the United States Government that are in excess of $650,000 and not exempted by CAS Board regulations

20. CAS Sections
401 Consistency in Estimating, Accumulating, and Reporting Costs
402 Consistency in Allocating Costs for the Same Purpose
403 Allocation of Home Office Expenses
404 Capitalization of Tangible Assets
405 Accounting for Unallowable Costs
406 Cost Accounting Period
407 Standard Costs
408 Costs of Compensated Personal Absence
409 Depreciation of Capital Assets
410 Allocation of G&A
411 Accounting for Acquisition Costs of Material
412 Composition and Measurement of Pension Cost
413 Adjustment and Allocation of Pension Cost
414 Cost of Money as an Element of the Cost of Facilities Capital
415 Accounting for the Cost of Deferred Compensation
416 Accounting for Insurance Costs
417 Cost of Money as an Element of the Cost of Capital Assets Under Construction
418 Allocation of Direct and Indirect Costs
419 Reserved
420 Accounting for IR&D and B&P Costs

21. CAS 401: Consistency in Estimating, Accumulating and Reporting Costs
Purpose
To ensure that the contractor’s practices used in estimating costs for a proposal are consistent with cost accounting practices used to accumulate and report costs
Basic requirements
Classification of elements or functions of costs as direct or indirect
The indirect cost pools to which each element or function of costs charged or proposed to be charged
Methods of allocating indirect costs to the contract

22. CAS 401: Consistency in Estimating, Accumulating and Reporting Costs
Estimating System
Accounting System (incl. Billing, Labor, etc.)
Earned Value Management System
Purpose
To ensure that the contractor’s practices used in estimating costs for a proposal are consistent with cost accounting practices used to accumulate and report costs
Basic requirements
Classification of elements or functions of costs as direct or indirect
The indirect cost pools to which each element or function of costs charged or proposed to be charged
Methods of allocating indirect costs to the contract

23. CAS 402: Consistency in Allocating Costs for the Same Purpose
No final cost objective shall have any cost allocated as an indirect cost, if other costs incurred for the same purpose, in like circumstances, have been included as a direct cost of that or any other final cost objective, and vice versa
Basic requirements
Equally applicable to estimates of costs to be incurred as used in contract proposals

24. CAS 405: Accounting for Unallowable Costs
Purpose
To facilitate contract negotiation, audit, administration and settlement
Basic Requirements
Costs expressly unallowable, or mutually agreed to be unallowable, shall be identified and excluded from any billing, claim, or proposal
Costs which become designated as unallowable as a result of a CO’s written decision pursuant to disputes procedures shall be identified if included or used in the computation of any billing, claim, or proposal
Costs directly associated with unallowable costs that would not have been incurred if not for the incurrence of the unallowable costs are also unallowable
Costs of any project not contractually authorized shall be accounted for in a manner which allows ready separation from costs of authorized projects
Where unallowable costs are normally part of a base(s) for the allocation of indirect expenses, the unallowable costs shall remain a part of the base(s)

25. CAS 407: Standard Costs Purpose Basic Requirements
To improve cost measurement and cost assignment for contractors that choose to use a "standard" type accounting system
Basic Requirements
Standard costs may be used for estimating, accumulating, and reporting costs of direct material and direct labor when:
Standard costs are entered into the books of the account
Standard costs and related variances are appropriately accounted for at the level of the production unit
Practices regarding the setting and revising of standards, use of standard costs, and disposition of variances are stated in writing and are consistently followed

26. CAS 410: Allocation of G&A Expense
Purpose
To provide criteria for the allocation of business unit G&A expenses to business final cost objectives based on their beneficial or causal relationship
Basic Requirements
Business unit G&A expenses shall be grouped in a separate indirect cost pool which shall be allocated only to final cost objectives
The G&A expense pool shall be allocated by means of a cost input base which best represents the total activity of a typical cost accounting period (i.e., total cost input, value-added cost input, or single element cost input)
Home office expenses received by a segment shall be included in its G&A expense pool (exceptions apply)
Any costs that do not satisfy the definition of a G&A expense can remain in the G&A pool unless they can be allocated on a beneficial or causal relationship best measured by a base other than cost input

27. CAS 418: Allocation of Direct and Indirect Costs
Purpose
To improve classification of costs as either direct or indirect and as such
To provide criteria for accumulating indirect cost into cost pools
Basic Requirements
Indirect costs shall be accumulated in homogeneous cost pools
Pooled costs shall be allocated to cost objectives in reasonable proportion to the beneficial or causal relationship as follows:
If cost pool costs consist of material amounts of management or supervision costs, the pool shall be allocated to a base representative of the activity being managed or supervised.
If management or supervision costs are not significant, the pool shall be allocated based on resource consumption measure

28. CAS 420: Accounting for IR&D and B&P Costs
Purpose
To improve cost allocation of Internal Research & Development (IR&D) and Bid & Proposal (B&P) costs
Basic Requirements
IR&D and B&P costs shall be tracked by individual project
The IR&D and B&P cost pools shall consist of project costs and other allocable costs except G&A
The IR&D and B&P cost pools of a home office shall be allocated to segments based on a beneficial or causal relationship
The IR&D and B&P cost pools of a business unit shall be allocated to the final cost objectives of that business unit based on a causal/beneficial relationship
IR&D and B&P costs incurred in a cost accounting period shall not be assigned to any other period (exceptions apply to IR&D)

29. Costs Must Also Be Determined Reasonable
A cost is reasonable if, in its nature and amount, it does not exceed that which would be incurred by a prudent person in the conduct of competitive business. What is reasonable depends upon a variety of considerations and circumstances, including
Whether it is the type of cost generally recognized as ordinary and necessary for the conduct of the contractor’s business or the contract performance
Generally accepted sound business practices, arm’s-length bargaining as well as Federal and State laws and regulations;
The contractor’s responsibilities to the Government, other customers, the owners of the business, employees, and the public at large
Any significant deviations from the contractor’s established practices

30. Additional Definitions
Actual Costs - (except for Subpart 31.6) amounts determined on the basis of costs incurred, as distinguished from forecasted costs. Actual costs include standard costs properly adjusted for applicable variances
Allocate - to assign an item of cost, or a group of items of cost, to one or more cost objectives. This term includes both direct assignment of cost and the reassignment of a share from an indirect cost pool
Cost Objective - (except for Subpart 31.6) a function, organizational subdivision, contract, or other work unit for which cost data are desired and for which provision is made to accumulate and measure the cost of processes, products, jobs, capitalized projects, etc.
Expressly Unallowable Cost - a particular item or type of cost which, under the express provisions of an applicable law, regulation, or contract, is specifically named and stated to be unallowable
Indirect Cost Pools - (except for Subparts 31.3 and 31.6) groupings of incurred costs identified with two or more cost objectives but not identified specifically with any final cost objective
Profit Center - (except for Subparts 31.3 and 31.6) the smallest organizationally independent segment of a company charged by management with profit and loss responsibilities

31. Additional Resources Code of Federal Regulations
Title 41 of the United States Code
Federal Acquisition Regulation (FAR)
Defense Federal Acquisition Regulation Supplement (DFARS)
Defense Contract Management Agency (DCMA)
Defense Contract Audit Agency (DCAA)