*This is Part 1 of a 3-part blog. Each part addresses the fundamental requirements and techniques for application related to the standard, and provides specific examples.
- This Part 1 addresses the basic requirements/techniques for allocating home office expenses to segments
- Part 2 will address the requirements/techniques for allocating home office residual expenses to segments.
- Part 3 will address special allocations of home office expenses to segments.
Background: To provide criteria for allocating home office expenses to the segments of an organization based on the beneficial or causal relationships between the expenses and the receiving segments (CAS 403-20(a)).
What it covers:
- The allocation of home office expenses to segments of the organization (CAS 403-20(a)).
What it does not cover:
- The accounting treatment of the home office expenses after they have been allocated to the segments, i.e., how segments allocate the home office expenses to contracts. This is covered by CAS 410 and 418.
- The allocation of IR&D/B&P from the home office to segments. This is covered by CAS 420.
Basic Allocation Requirements/Techniques for Allocating Home Office Expenses to Segments
- In accordance with CAS 403-40(a)(1), home office costs must be allocated on the basis of the beneficial or causal relationship between supporting and receiving activities.
EXAMPLE: A contractor has three segments. The home office performs the materials inspection function for each of these segments. Segment X performs mostly service contracts with very little material costs. Segments Y and Z are manufacturing operations that utilize large quantities of materials. The contractor allocates the cost of the materials inspection function to segments on the basis of segment direct labor dollars. This practice is in noncompliance with CAS 403, since there is no beneficial or causal relationship between the direct labor dollars incurred by a segment and the materials inspection function. The contractor could correct this problem by using number of purchase orders, dollar value of purchase orders, or some other base that represents a beneficial or causal relationship between the inspection function and the utilization of that function by Segments X, Y, and Z.
- CAS 403-40(a)(1) requires that home office expenses be allocated directly to segments to the maximum extent practical.
EXAMPLE: A contractor performs building cleaning services for Segments M, N, and O. Segment M is in Ohio, Segment N is in Texas, and Segment O is in Georgia. The contractor groups the entire cost of the cleaning services in a single pool and allocates the costs on the basis of total square footage of all buildings occupied by Segments M, N, and O. This is in noncompliance with CAS 403, since it is practical for the contractor to directly allocate the costs of the cleaning services directly to each of the segments.
- Under CAS 403-40(a)(1), expenses that are not directly allocated shall be grouped in logical and homogeneous expense pools
EXAMPLE: A home office performs the payroll and software development functions for both of its segments, Segments H and I. Segment H is a service industry in which almost all employees have their own computer workstation and utilize the computer on a daily basis. Segment I is a manufacturing operation in which only about one in ten employees use a computer, and only about one in fifteen have their own computer workstation. The contractor groups the payroll and software development functions in a single pool and allocates the pool to the segments based on number of employees. This practice is in noncompliance with CAS 403 because payroll and software development do not have the same relationship to the segments. Payroll is related based on number of employees while software development is based on number of computers (or some other measure of computer usage).
- CAS 403-40(a)(2) states that no segment shall have allocated to it as an indirect cost any costs incurred for the same purpose that has been allocated directly to that or any other segment. This prevents double counting of home office expenses
EXAMPLE: The home office performs a security function for Segments A, B, and C. The purpose of the security function is the same for all Segments. During FY 2002, the total costs of the security function were $100,000. The home office determined that $40,000 of this $100,000 was for security at Segment C, and directly allocates this $40,000 to Segment C. The remaining $60,000 ($100,000 less the $40,000) is accumulated in a home office expense pool that is allocated on the basis of total personnel in Segments A, B, and C. This practice is in noncompliance with CAS 403, since Segment C is receiving costs incurred for the same purpose (the security costs) as both a direct and indirect allocation. The contractor could either (1) directly identify the security costs of Segment C and exclude Segment C from the allocation of security cost to Segments A and B, (2) directly identify security costs to each of the Segments, or (3) indirectly allocate all security costs to Segments A, B, and C (assuming a proper allocation base is utilized).
- In accordance with CAS 403-40(b)(1), CAS 403-50(b)(1), and CAS 403-60(a), centralized service functions shall be allocated on the basis of the service furnished to or received by each segment.
EXAMPLES OF POSSIBLE ALLOCATION BASES FOR CENTRALIZED SERVICE FUNCTIONS:
|CENTRALIZED SERVICE FUNCTION:||EXAMPLES OF POSSIBLE ALLOCATION BASES:|
|Personnel administration||Number of personnel; labor hours; payroll; number of hires.|
|Data processing services||Machine time; number of reports.|
|Centralized purchasing and subcontracting||Number of purchase orders; value of purchases; number of items.|
|Centralized warehousing||Square footage; value of material; volume.|
|Company aircraft service||Actual or standard rate per hour or per mile; passenger mile; or similar unit.|
|Central telephone service||Usage costs; number of instruments.|
- In accordance with CAS 403‑40(b)(2), CAS 403-50(b)(1)), and CAS 403-60(b), staff management shall be allocated to segments over a base representative of the total activity being managed. In addition, as stated at CAS 403‑40(b)(3), CAS 403-50(b)(1)), and CAS 403‑60(c), line management must be allocated to segments using a base representative of the total activity of such segments.
EXAMPLES OF POSSIBLE ALLOCATION BASES FOR STAFF MANAGEMENT AND LINE MANAGEMENT:
|MANAGEMENT FUNCTION:||EXAMPLES OF POSSIBLE ALLOCATION BASES:|
|Personnel management||Number of personnel; labor hours; payroll; number of hires|
|Manufacturing activities||Manufacturing cost input; manufacturing direct labor.|
|Engineering activities||Total engineering costs; engineering direct labor; number of drawings.|
|Material/Purchasing activities||Number of purchase orders; value of purchases|
|Marketing activities||Sales; segment marketing costs.|
- In accordance with CAS 403‑40(b)(4) , CAS 403-50(b)(1), and CAS 403-60(c), central payments or accruals which cannot be identified specifically with individual segments shall be allocated using an allocation base representative of the factors on which the total payment is based
EXAMPLES OF POSSIBLE ALLOCATION BASES FOR CENTRAL PAYMENTS OR ACCRUALS:
|MANAGEMENT FUNCTION:||EXAMPLES OF POSSIBLE ALLOCATION BASES:|
|Pension expenses||Payroll or other factor on which total payment is based.|
|Group insurance expenses||Payroll or other factor on which total payment is based.|
|State and local income taxes and franchises taxes||Any base or method which results in an allocation base that equals or approximates a segment’s proportionate share of the tax imposed by the jurisdiction in which the segment does business, as measured by the same factors used to determine taxable income for that jurisdiction.|
- CAS 403-50(b) (2) states that when neither activity nor output can be practically measured, a surrogate for the beneficial or causal relationship must be selected. The surrogate used should generally measure the activity of the segments receiving the service.
EXAMPLE: For employees that retired prior to FY 2011, Contractor P provided post-retirement health benefits. Contractor P does not provide post-retirement health benefits for employees that retire after FY 2011. Contractor P assigns these post-retirement health benefits on a pay-as-you-go basis, i.e., the contractor records the costs at the time the contractor makes payments to the employee or health provider. For FY 2014, the post-retirement health benefits totaled $50 million. Contractor P has three segments. An analysis of the average number of retirees that worked in each segment shows that the average age of the retirees in each segment is similar. In addition, each year the contractor does an analysis of the number of retirees from each segment to determine the allocation of post-retirement benefits. For FY 2014, the analysis shows the following:
|Segment||Number of Retirees||Percentage of Total|
Based on the above data, the contractor allocates the $50 million of post-retirements for FY 2014 to each of the segments using number of retirees from each segment as the surrogate, computed as follows:
|Segment||Percentage of Total Retirees||Amount Allocated to Segment|
|A||20%||$10 Million($50 million x 20%)|
|B||50%||25 Million($50 million x 50%)|
|C||30%||15 Million($50 million x 30%)|
The contractor’s use of number of retirees as a surrogate is in compliance with CAS 403, since it generally measures the activity of the segments receiving the service (or in this case the prior activity of the segments that generated the current service).
- In accordance with CAS 403-50(a)(1), separate expense groupings are required for each home office pool. However, it is not necessary to separately allocate each expense grouping if they have a common allocation base.
EXAMPLE: The home office expenses of Contractor X include personnel administration and personnel management. The contractor allocates personnel administration based on number of personnel and also allocates personnel management based on number of personnel. Contractor X must maintain an expense grouping for personnel administration, and a separate expense grouping for personnel management. However, the contractor may include these costs in a single pool that is allocated based on number of personnel.
- In accordance with CAS 403-50(a)(2), all segments must be included in the base for each expense that is to be allocated unless (1) a particular segment(s) did not receive any benefit from, or contribute significantly to, the cause of the expense to be allocated and (2) the segments that are included in the base did receive significant benefits from or contribute significantly to the cause of the expense to be allocated.
EXAMPLE: For Contractor Q, the home office does the payroll function for Segments 1, 2, and 3. Segment 4 does its own payroll function. Contractor Q includes Segments 1, 2, and 3 in the allocation base for allocating the costs of processing payroll, but excludes Segment 4. This is in compliance with CAS 403, since Segment 4 does not receive any benefit from or contribute significantly to the home office payroll function, and Segments 1, 2, and 3 all do benefit from the home office payroll function.