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Cost Accounting Standard (CAS) 403 is one of the most consistently misunderstood standards within CAS.  Why?  Usually because it involves more than just the segment you reside in.  It requires cooperation and communication between parent entities and their  segments, government and commercial segments both.  The purpose of CAS 403 is simple,  “to establish criteria for allocation of home office expenses to the segments of the organization on the basis of a beneficial or causal relationship.”

Key Definitions for CAS 403

To understand CAS 403, it is fundamental to know how CAS defines a home office, an intermediate home office, and a segment.

A home office is an office responsible for directing or managing two or more segments of an organization. For example, a corporate headquarters. A home office usually performs management, administrative, and other back-office functions the benefit one or more segments.

An organization can also have intermediate home offices for each group within the organization that report to one common home office. For example, a company may have an ultimate parent organization that directs strategy of the business with core executive functions and similar.  And intermediate home offices may be back office support organizations that sit beneath the ultimate parent but still perform functions on behalf of multiple segments.

In order to properly comply with CAS 403, a complete cost accounting illustration is necessary to understand the big picture of who supports who and where they sit within the organizational and operating structure of the business.  Just getting this part right at the on-set is a significant advantage to complying with CAS 403, but also to understanding the best way to optimize cost allocations within your business.

A segment is “one of two or more divisions, product departments, plants, or other subdivisions of an organization reporting directly to a home office, usually identified with responsibility for profit and/or producing a product or service.”

CAS 403 focuses on how home office expenses must be allocated to segments, and/or intermediate home offices, as applicable.

Allocation Pool and Base Requirements

CAS 403 requires that home office expenses are allocated on the basis of beneficial or causal relationships.  The allocation methodology is hierarchial in nature, with direct allocations of home/intermediate home office costs being required to the maximum extent practicable. The concept of ‘direct allocation’ is not to be confused with the concept of ‘direct costs’.  Directly allocated simply means a cost is being assigned directly to the benefiting segment.

For example, if a home office is performing legal work on behalf of an individual segment, however it has responsibility for four (4) segments, the time spent on the matter can be directly identified, and hence directly allocated to the benefitting segment.  When direct allocation is not practical, home office expenses must be grouped into homogeneous expense pools and allocated subsequently.

Homogenous Expense Pools Prescribed by CAS 403

The following are the types of homogenous expense pools prescribed by CAS 403 that can be used:

  1. Centralized service functions
  2. Staff management of certain specific activities of segments
  3. Line management of particular segments or groups of segments
  4. Central payments or accruals
  5. Independent research and development (IR&D) costs and bid and proposal costs (B&P)
  6. Residual expenses

These are referred to as “functional allocations”.  The number of functional allocations an organization has usually depends on the variety and significance of service and management functions performed by the home office. But to avoid having too many groupings, as long as the pooled expenses can be allocated using the same allocation base (e.g., employee headcount), they can be included in the same home office expense pool.

CAS 403 Examples

CAS 403 provides illustrated examples of typical home office allocation pools and bases. For items one through five above, following are some additional examples.

Home Office Expense or Function Illustrative Allocation Bases
Human Resources Employee headcount, labor hours, payroll, number of hires
Information Technology Employee headcount, computer equipment nodes
Centralized warehousing Square footage, value of material, volume
Finance and accounting Operating revenue
Security Employee headcount, square footage

 

Lastly, if the home office costs cannot be allocated either directly or functionally then CAS provides for the remainder of costs to be treated as “residual expenses”.  Residual expenses are typically those that are not identifiable with specific activities of segments and cannot be more equitably allocated based on a functional allocation.

While it may be compliant to allocate residual expenses in different ways, the most common approach is the Three Factor Formula which is calculated by taking the arithmetical average of the following three percentages for the same period:

  1. Percentage of segment payroll dollars to total payroll dollars of all segments
  2. Percentage of segment operating revenue to total operating revenue of all segments
  3. Percentage of average NBV of the sum of segment tangible capital assets plus inventories to the total average NBV of such assets of all segments

Note that at certain size thresholds contractors are required to use the 3 Factor Formula.  Other contractors sometimes use sales as a simple residual allocation method when not required by CAS to use 3 Factor Formula.  Others still may find that a 2 Factor formula is most equitable given the nature of their business.  For example, it is not uncommon for some businesses to have highly variable fixed assets across their segments which may be distortive to the allocation method.

Best Practice Strategies

CAS 403 Challenges

The most common CAS 403 challenges we find working with contractors include:

While CAS 403 is a U.S. Government contract requirement, it’s allocation methodologies are highly leverageable by companies that understand them.  CAS 403 has its own dedicated audit program (DCAA > Customers > Guidance > Directory of Audit Programs)  that DCAA uses when auditing and findings within CAS 403 are some of the most common CAS audit findings.  While they can be a challenge, they can also be a way to ensure alignment between home office parents and their segments.  We have found the contractors with the most success with CAS 403 are those that have strong communication and alignment with their parent organizations.

Lastly, Home Office allocations require a Home Office Disclosure Statement.  For more information on preparing compliant Disclosure Statements, please visit:  DS Done -- CAS DS-1 Form completion application (rkiaccounting.com)

Cost Accounting Standards (CAS), promulgated by Part 30 of the Federal Acquisition Regulation (https://www.acquisition.gov/far/part-30#FAR_30_101), maintains specific requirements for a US Government Contractor when they apply to a US Federal Government Contract.

A CAS Covered Contract is one that meets specific qualifications that trigger CAS Coverage. The qualifications, exceptions, and other conditions that determine CAS Applicability, Coverage Type, and Disclosure Requirements can be confusing. Our blog post: What Are CAS Covered Contracts?  lists these qualifications and additional detail on the matter. To provide added clarity for the visual learner, we’ve put it all into one clean illustration:

Download the CAS Flowchart Here: CAS Applicability Flowchart.

 

Cost Accounting Standards (CAS) 401 and 402 are all about a U.S. Government contractor’s consistency in its cost accounting practices. While CAS 401 dictates the requirements for contractors to “bid, book, and bill” consistently, CAS 402 focuses on how a contractor ensures that contracts are not inequitably charged for similar costs incurred in like circumstances..

Cost Accounting Standards 401 – Consistency in Estimating, Accumulating and Reporting Costs.

The purpose of CAS 401 as stated: “is to ensure that each contractor’s practices used in estimating costs for a proposal are consistent with cost accounting practices used by [the contractor] in accumulating and reporting costs.”

In its simplest sense the federal government wants to ensure that a contractor can prove that the costs it estimates can, in some meaningful way, be tied to the actual costs they incur. Without this consistency, there is risk a contractor may estimate costs one way without any capability to evidence that their estimated costs were reasonable. An example follows:

Example: A contractor estimates engineering labor hours for five (5) separate engineering labor categories. However, the contractor does not separately track engineering labor hours for its employees in any of its books and records. In such a scenario, a contractor cannot demonstrate the actual number of hours incurred for the labor

CAS 401

categories that they estimated. The key question a contractor should ask themselves is “can I reproduce this cost estimate with actuals once the contract begins?”. Of significance in answering this question is the CAS definition for “accumulating costs”, as follows:

“Accumulating costs means the collecting of cost data in an organized manner, such as through a system of accounts.” (48 CFR 9905.501-30)

 

Cost Accounting Standards 401 Practice:

Please note that the definition provides for collecting cost data in an “organized manner”. That does not mean that you can’t have supplemental records that corroborate your cost estimates. Extending our example above for cost accounting standard 401, it’s possible the contractor does not differentiate its engineering labor in its General Ledger (G/L). However, it may well have work orders or project accounting records that provides such visibility.

There are even instances where a contractor may maintain the records outside its accounting software. Hence, the CASB DS-1 section 1.5.0 “Identification of Differences Between Contract Cost Accounting and Financial Accounting Records.” The federal government requirements understand that financial accounting and federal cost accounting are not one and the same.

The key is that they be equitable and reconcilable with the ability to reproduce actuals consistent with how you estimated. Best practice is certainly to have your financial accounting and federal cost accounting match one-to-one, but that’s not always practical. Understanding CAS 401 is key to how you establish your cost accounting and cost estimating practices. 

Cost Accounting Standards 402 – Consistency in Allocating Costs Incurred for the Same Purpose

The purpose of CAS 402 as stated: “is to require that each type of cost is allocated once and on only one basis to any contract or other cost objective.” Certain types of costs, such as project management, equipment, project accounting personnel, etc., are prone to inconsistent cost accounting practices where a federal contract may be charged twice for the same, or similar cost, without any additional benefit received.

They key words in Cost accounting standards 402 are 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.” This can be tricky given the innumerable circumstances in which a cost may be incurred (e.g., on-site, remote, etc.). An example follows:

Example: A contractor has a procurement department that supports all purchasing efforts, direct and indirect of the business. The department’s costs are included entirely in G&A. However, it has a new contract award that it bids procurement personnel as direct labor for.

This example is a classic CAS 402 example. The obvious conclusion is that this is a CAS 402 non-compliance because a federal contract would be incurring cost directly for the direct labor of the new procurement individual, as well as the G&A (which includes procurement personnel) resulting in double charging (bad words in government contracting!). Are there examples by which this may be compliant? Beauty is in the eye of the beholder.

Some contractors may be able to demonstrate that the nature of the procurement is different. Perhaps its local procurement overseas whereby they’re purchasing small dollar items for contract-specific needs. This may not in and of itself make it ‘unlike’, but it might. There are many variables to properly defining each cost as direct or indirect.

The question we most often ask a way of translating this is “Is the contract benefitting from both the direct activity and the indirect activity?” This might not answer the question completely, but it’s a start. CAS 402 is one of the most common, if not the most common CAS non-compliance during CAS audits.

Benefits of CAS 401 and CAS 402 Compliance

Complying with CAS 401 and CAS 402 have benefits to contractors that can significantly impact their bottom lines. CAS compliance can lead to:

A CASB Disclosure Statement is a form whereby a US Government Contractor discloses its cost accounting practices, for which it is required to demonstrate CAS compliance for the life of its active CAS (Cost Accounting Standards) covered awards. The CASB Disclosure Statement, otherwise known as DS-1, has a very rigid format with eight different parts:

Each part has numerous sections called items which vary in applicability to the contractor, depending on the contractor’s cost accounting practices. While each item is generally constituted by selection boxes and multiple-choice questions, certain responses require the contractor to detail information in longer narrative form, on “continuation sheets”.

When is a CASB Disclosure Statement Required?

The requirement to submit a CASB Disclosure Statement depends on the CAS covered contracts a contractor maintains. In a nutshell, CAS is applicable to individual contracts and the applicability of CAS is triggered based on dollar thresholds. Whether or not CAS is applicable to a given contract is determined by the contract type, the size of the business receiving the contract, and the amount awarded. A CASB Disclosure Statement is required if Full-CAS coverage applies to a contractor. [Click here] to learn more about types of CAS coverage and CAS applicability.

Any CAS-covered contract of $50 million or more requires a Disclosure Statement prior to the contract award. CASB DS-1 should not be submitted prior to Full-CAS coverage applicability. The solicitation usually provides clarification on when exactly the Disclosure is required. Typically, if the requirement is in the solicitation, and it is the Contractor’s first Disclosure, then submission is due at the time of the proposal.

If a CAS-covered contract under $50 million is awarded, and the Contractor received net CAS-covered awards in the prior accounting period totaling more than $50 million, then the Contractor is required to file a Disclosure Statement prior to the contract award. However, if the award is within the first 90 days of the proceeding accounting period, then the contractor is not required to file until the end of the 90 days. If a contractor anticipates future Full-CAS coverage, it is prudent to have the Disclosure Statement prepared and ready (i.e., not submitted to the Government).

CASB Disclosure Statement Adequacy and Compliance

When a CASB Disclosure Statement is required, it must be submitted to the Contracting Officer (CO) and the Cognizant Federal Agency Official (CFAO). All Disclosure Statements will be reviewed and audited based on two major factors (1) adequacy, and (2) compliance.

CASB Disclosure Statement Adequacy

The adequacy of a CASB Disclosure Statement is determined by how the DS-1 is formatted and filled out based on the applicability of the 19 Cost Accounting Standards to the contractor. For example, if a contractor accumulates Home Office expenses and allocates such expenses to various business segments, but it does not complete Part VIII of the Disclosure Statement, the Disclosure Statement would be deemed inadequate.CAS Disclosure statement

Ensuring adequacy on a CASB Disclosure Statement is not easy, and it can be a grueling process to pass adequacy with DCAA. DCAA’s adequacy checklist evaluates the DS-1 for completeness and proper formatting, oftentimes resulting in many rounds of back and forth before a Disclosure Statement is accepted for audit.  This erodes auditor confidence and burns costly time on behalf of the Government and the contractor.

Our experience suggests that at least 50% of inadequacies can be avoided simply by filling the DS-1 out with all the required information in proper format.  As a result, we designed a proprietary software – CASB DS-Done – to facilitate an adequate Disclosure Statement.  The software is built with control integrity to hit on all the required fields and continuation sheets with user-friendly prompts avoiding the countless hours of formatting and inadequacy rejections.  [Click here to learn more about DS-Done].

Contractor Compliance With Disclosed Accounting Practices and Procedures

The Defense Contract Audit Agency (DCAA) maintains eight types of noncompliance based on CASB rules, regulations, and standards, and FAR Part 31:

  1. Disclosed practices not compliant with CAS;
  2. Disclosed practices not compliant with FAR;
  3. Actual practices of estimating costs not compliant with CAS;
  4. Actual practices of estimating costs not compliant with FAR;
  5. Actual practices for estimating costs not compliant with the practices disclosed in the Disclosure Statement;
  6. Actual practices for accumulating or reporting costs not compliant with CAS rules and regulations;
  7. Actual practices for accumulating or reporting costs not compliant with FAR; and
  8. Actual practices for accumulating or reporting costs not compliant with the practices disclosed in the Disclosure Statement.

What Are the Penalties of CASB Disclosure Statement Inadequacies or Noncompliance?

Inadequate formatting of CASB DS-1 greatly hampers the progress of a contractor’s Government Contracts program from an operational, accounting, and billing standpoint. To ensure all contract estimates, procurements, and billings are conducted properly under CAS rules, regulations, and standards, and FAR part 31, the accounting practices of Full-CAS covered contracts or companies/business segments are audited via initial Disclosure Statement audit.

Such audits will only be initiated once the CFAO has deemed the CASB DS-1 to be adequate. Delays in Disclosure Statement adequacy translate to delays in Disclosure Statement audits, and delays in Disclosure Statement audits degrade both contractor and Government confidence in the contractor’s cost accounting reliance.  It can also result in delayed contract award, in addition to unnecessary resource consumption on both parties to resolve inadequacies that can be avoided with upfront diligence.

Penalties for Noncompliance

Depending on the nature of the non-compliance there can be a variety of penalties for noncompliance. In its simplest sense, the U.S. Government will be entitled to repayment of any material non-compliance if it resulted in increased cost to the Government. If the CFAO determines that noncompliance is material, the contractor is required to submit a description of any accounting practice change needed to bring the practices into compliance, which the auditor will review for adequacy and compliance. If the proposed change is both adequate and compliant, the contractor must submit a cost impact detailing the effect the non-compliance had on all effected CAS covered awards.

The CFAO will evaluate the cost impact and if the result was increased cost to the Government, the CFAO will administer contract and/or billing adjustments, plus applicable fines and interest to repay the amounts due as a result of the noncompliance. Noncompliant cost impacts take time to develop, negotiate, and are a significant burden and expense to both the contractor and the Government to administer. It can require going back years into your historical contract and accounting records to obtain the necessary information to perform a cost impact analysis.

Adding to the risk of CAS non-compliances is the risk of perceived, or actual, False Claim Act (FCA) allegations from the customer.  In many instances, the U.S. Government customer may assert that the contractor was aware, or should have been aware, of the non-compliance and, as such, the Government is entitled to False Claim damages up to treble damages.  In short, CAS non-compliances only come in 2 varieties:  bad and worse.

“CAS noncompliance” is among the short list of bad words you never want associated with your organization; right along with false claims and defective pricing – words that often get attached to CAS noncompliance if the Government feels the noncompliance was purposeful.  Be diligent upfront and ensure you can demonstrate compliance with CAS.

 

Defining CAS Coverage and What Constitutes a CAS Covered Contract

In its simplest sense, a CAS covered contract is any U.S. Government contract that does not meet an exemption from the Cost Accounting Standards (CAS) and includes the CAS clause (FAR 52-230-2 Cost Accounting Standards). While that sounds simple, what is not is navigating whether a contract meets CAS exemptions, and if it does not, knowing which CAS coverage is applicable to the contract; modified CAS or full CAS.

CAS applicability is one of the most common challenges faced by a growing U.S. Government contractor. Once a contractor has triggered CAS through the award of CAS covered contracts, its compliance profile changes significantly with increased cost accounting requirements and audit interest from the Defense Contract Audit Agency (DCAA).

Compliance with CAS can be complex and confusing to many Contractors, so it is crucial for Contractors to understand CAS applicability and determine whether they have any CAS Covered Contracts. It is also crucial, based on the type of CAS Coverage, to understand CAS implications in their organization. Many contractors lack the formal procedures and internal controls to effectively track their US Government Contract awards against CAS Coverage. This can result in major compliance challenges downstream that are expensive to untangle.

CAS Applicability & Exemptions

CAS is applicable to negotiated contracts greater than $2M, unless the contract meets one of the following CAS exemptions:

The trigger contract often results in contractors amassing multiple CAS covered contracts. Losing track of which contracts are subject to CAS and which are not is significant, as the U.S. Government has certain rights under CAS covered contracts that it does not under non-CAS covered contracts. This includes retroactive price adjustments should a contractor not comply with CAS.

CAS Coverage – Modified vs. Full CAS Coverage

Modified CAS Coverage is triggered when a contractor receives a CAS Covered Contract greater than $7.5M but less than $50M in its current cost accounting period. Modified CAS Coverage requires the contractor to comply with four of the 19 standards (CAS 401, 402, 405, and 406).

Full CAS Coverage, which requires compliance with all 19 standards, is triggered when either:

A.     A contractor receives a CAS covered award over $50M in the current cost accounting period; OR

B.     A contractor received an accumulation of CAS covered awards in the previous cost accounting period that total $50 or more.

As required by cost accounting standards, a CASB disclosure statement is required if full CAS coverage applies (and in some cases, modified coverage). CAS Disclosure Statements are a form whereby a contractor discloses its cost accounting practices, for which it is required to demonstrate compliance throughout the life of its active CAS covered awards.

CAS Exemptions Flowchart

A CAS coverage flowchart that illustrates applicability, coverage, exemptions, and CAS disclosure statement requirements can be found here.

A common misconception held by many contractors is that a contractor is either CAS-covered or not CAS-covered. While a simple way to think of it, it is important to recognize that CAS applies at a contract level, not at a contractor level. Every U.S. Government contract should be evaluated on its date of award to determine if and how CAS applies.

How Long Does CAS Coverage Last?

The CAS applicability on the date of the contract award is the applicability for the life of the contract. Hence, some contractors can have a combination of exempt, modified CAS, and full CAS covered contracts.

The CAS status of a contract or subcontract remains the same throughout its life. For example, if a contractor holds a contract subject to Modified CAS Coverage, and then receives a contract subject to Full CAS Coverage, the initial contract does not become subject to Full CAS, and remains subject to Modified CAS.

Making Cost Accounting Practice Changes Under CAS

Once CAS is triggered, contractors must monitor its cost accounting practices for any changes as they require disclosure to the U.S. Government pursuant to FAR 52.230-3 Disclosure and Consistency of Cost Accounting Practices. Contractors that fail to realize this significant requirement, applicable under both modified and full CAS covered contracts, may make a change that results in increased cost to the U.S. Government for which it will not pay.

Generally, the U.S. Government will not pay increased costs due to changes in a contractor’s cost accounting practices. One of the easiest, and expensive, ways to get in trouble with CAS covered contracts is to make changes to cost accounting practices that seem benign but change the way the U.S. Government participates in cost. Examples of common changes in cost accounting practice that are natural for a contractor but impact cost allocation include:

Impact on CAS Covered Contracts

All changes to cost accounting practice are likely to result in some cost impact to CAS covered contracts. Changes to cost accounting practice require disclosure prior to adopting them. In most instances the U.S. Government will require a contractor to submit a cost impact proposal, either through a Detailed Cost Impact (DCI) or General Dollar Magnitude (GDM).

Not realizing this requirement can result in significant cost impacts to the U.S. Government whereby a contractor may have to pay large sums of money back to the U.S. Government for years of undisclosed changes in cost accounting practice. This is a massive difference from commercial and non-CAS covered contracts. In its simplest sense, once a contractor is CAS covered, it really needs cooperation in order to change its cost accounting practices.

Monitor Your Contracts and Protect Your Organization!

If you are a contractor, it is important to evaluate every award for CAS applicability and maintain a CAS tracker so that you know the CAS applicability at the contract level. And it is something every executive team, not just accounting and contracts, needs to be familiar with. Changes in organizations bring changes to cost accounting; and those changes need to be considered prior to making the change. If the entire organization is not aware of these risks, it can easily result in changes that cost the contractor money.

Need Help Becoming CAS Compliant?

Ready to navigate the complexities of CAS coverage with confidence? At RKI, we specialize in providing comprehensive guidance and support for all your CAS-related needs. From understanding the nuances of modified and full CAS coverage to ensuring full compliance with cost accounting standards, our team is here to help. Don't let the intricacies of CAS applicability overwhelm you. Contact RKI today for expert assistance and protect your organization from costly compliance pitfalls. Get in touch now and take the first step towards seamless CAS management.

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