For most Government contractors, the Federal Acquisition Regulation (FAR) is common knowledge. FAR 31.205, Contract Cost Principles and Procedures – Selected Costs, is a first stop when regulatory clarity is needed for a cost that may or may not be allowable. When unsure if a cost is allocable (which can be a more intimidating question), though, contractors typically refer to CAS, codified into FAR in 48 Code of Federal Regulations (CFR) Chapter 99. This is where a much thornier question is often explored: Which of your costs belong to which cost objectives?
Whether your company is required to follow modified CAS (only CAS 401, 402, 405, and 406) or all 19 standards, ensuring compliance with CAS is no easy feat. It requires a three-way match between the standards, the contractor’s disclosed practices, and its actual practices. Keeping all three in alignment minimizes audit exposure and optimizes your practice. Here we survey some common CAS pitfalls and key CAS concepts.
The explanations and examples given here offer only a sampling of common issues. An in-depth review of all 19 standards, and the rules that surround their application and disclosure, would occupy its own course. Nonetheless, these extracts should address some of the major concerns that drive CAS.
CAS 402 requires 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.” In theory, this is one of the more straightforward standards. If you have a cost in an indirect pool, don’t include anything like it as a direct cost if incurred for a similar circumstance. The opposite is also true. If you have a cost counted as direct, don’t include like costs in an indirect pool if incurred for a similar circumstance. When initially adopting cost accounting practices, it is unlikely that a contractor will incorporate non-compliance with CAS 402 into its policies and procedures.
The difficulty often arises down the road when a new contract makes a change of practice appear reasonable. Here’s an example. As a standard practice, Company A includes its direct labor personnel travel in its overhead pool. A newly-awarded contract pertains to work at a distant location and will require a substantial amount of those same personnel traveling back and forth. Given the circumstances, it seems sensible to charge travel to this contract directly – it’s large enough and it’s easily traceable to this one contract. Unfortunately, using both practices in parallel runs afoul of CAS 402 since the travel costs are “incurred for the same purpose, in like circumstances.” Either the old practice must be carried forward and all travel remain as indirect charges, or Company A must submit a revised Disclosure Statement and remove this type of cost from its overhead pool for allocation to Government contracts.
In contrast to CAS 402, CAS 403, which relates to the allocation of costs from intermediate and home offices to segments, is demanding in both design and in practice. The standard requires that centralized costs be allotted in three steps: first, directly to the benefiting segments to the maximum extent practical, second, in “logical and homogeneous pools,” and third, in a residual pool where the costs benefit the entire organization. The goal of this standard is to leave as little as possible in the residual pool – to move costs incurred by home offices into more granular pools and to assure costs are being absorbed by those contracts with which they bear the clearest causal-beneficial relationship.
Other than minimizing residual pool expenses, the most challenging concept contractors wrestle when designing a CAS 403-compliant cost accounting system is determining the appropriate basis for their homogeneous pools. What is the best representative metric for the “total activity being managed” by your HR function? Payroll, perhaps? Head count? Arguments could be made for either. For a centralized service like IT, what is the best measure of the service “furnished to or received by” each segment? Cases can be made for square footage, units of output, head count (again), number of service tickets processed, etc. Those are dissimilar bases, but they all bear some relationship with the costs being incurred. And threading that needle is not always straightforward. Unfortunately, we often see contractor’s resorting to what is easiest to apply – not what is the most equitable allocation knowing what is driving the cost to the segment or business unit.
Finally, CAS 405, which deals with unallowable costs, is somewhat simpler than CAS 403. But parts of it are still ripe for misapplication. The basics of the standard are simple enough. Contractors must separately identify and accumulate costs that are unallowable either under FAR or through agreement. Costs must also be “incurred for the same purpose under like circumstances.”
The area where misapplication happens is generally “directly associated” costs. Directly associated costs are those that are “generated solely as the result of the incurrence of another cost,” and importantly, CAS 405-40(a) states that unallowable costs “including costs mutually agreed to be unallowable directly associated costs, shall be identified and excluded from any billing.” The litmus test for direct association is simple – would Cost A have been incurred if Cost B, which is unallowable, had not been incurred? If the answer is no, Cost A is unallowable, too.
For example, let’s say a contractor’s employee is attending a conference and the employee’s time at the conference has been deemed unallowable. After separately identifying and accumulating the costs for that time, it’s easy to overlook the directly associated costs – the per diem, the airfare, the lodging, and other costs that are unallowable because they were incurred as a result of the original unallowable cost (i.e., the labor). Or, perhaps a contractor has several meetings with outside counsel about a reorganization and the legal costs are unallowable under FAR 31.205-27. There will likely be other G&A costs incurred because of those meetings. Those, too, must be excluded from billings as unallowable because they are directly associated with unallowable legal fees.
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