*This is Part 2 of a 3-part blog. Each part addresses the fundamental requirements and techniques for application related to the standard, and provides specific examples.
- Part 1 addressed the basic requirements/techniques for allocating home office expenses to segments.
- This Part 2 addresses 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.
Allocating Home Office Residual Expenses to Segments
- CAS 403-40(c)(1) requires that a contractor’s residual expenses be allocated to all segments by means of a base representative of the total activity of such segments, unless the amount of the residual expenses exceeds the CAS 403 threshold requirement. In addition, in accordance with CAS 403-40(c)(2) and CAS 403‑50(c)(1), if the amount exceeds the CAS 403 threshold requirement, the contractor must allocate the residual expenses using the three-factor formula. This threshold requirement is exceeded when the amount of residual expenses for the contractor’s prior fiscal year (excluding any unallowable costs) exceeds the amount obtained by applying the following percentages to the aggregate operating revenue of all segments for such previous year:
- 3.35 percent of the first $100 million;
- .95 percent of the next $200 million;
- .30 percent of the next 2.7 billion; and
- .20 percent of all amounts over $3 billion.
EXAMPLE: During FY 2013, the contractor had $500 million in sales, with residual expenses (excluding unallowable costs) totaling $7 million. To determine if the contractor meets the threshold requirement, the following computations are necessary:
| 3.35 % of the first $100 million | $3.35 million (.0335 x $100 million) |
| .95 % of the next $200 million ($100-$300 million) | $1,90 million (.0095 x $200 million) |
| .30% of the next $200 million ($300-500 million) | $.60 million (.0030 x $2.7 billion) |
| Total | $5.85 million (3.35 million + 1.90 million + .60 million) |
The total residual expenses of $7 million exceed the threshold of $5.85 million. The contractor must therefore allocate these residual expenses using the three factor formula.
- As specified at CAS 403-50(c)(1), the three-factor formula is the average of the following three percentages for the contractor’s fiscal year:
(1) The percentage of segment payroll dollars to total payroll dollars of all segments;
(2) The percentage of the segment’s operating revenue to the total operating revenue of all segments. The operating revenue of any segment shall include amounts charged to other segments and shall be reduced by amounts charged by other segments for purchases.
(3) The percentage of the average net book value of the sum of the segment’s tangible capital assets plus inventories to the total average net book value of such assets of all segments. Property held primarily for leasing to others is excluded from the computation. The average net book value is the average of the beginning book value and the ending book value for the fiscal year.
EXAMPLE: During FY 2013, the contractor had the following data:
| Segment | Percentage of segment payroll dollars to total payroll dollars for all segments | Percentage of segment operating revenue to total operating revenue for all segments | Percentage of segment average net book value to total average net book value for all segments |
| D | 35% | 24% | 31% |
| E | 22% | 17% | 42% |
| F | 43% | 59% | 27% |
| Total | 100% | 100% | 100% |
Based on the above data, the amount of residual expenses to be allocated to segments is computed as follows:
| Segment D | Segment E | Segment F | Total | |
| % of segment payroll dollars to total payroll dollars for all segments | 35% | 22% | 43% | 100% |
| % of segment operating revenue to total operating revenue for all segments | 24% | 17% | 59% | 100% |
| % of segment average net book value to total average net book value for all segments | 31% | 42% | 27% | 100% |
| Total of Segment Percentages | 90(35 + 24 + 31) | 81(22 + 17 +42) | 129(43 + 59 + 27) | |
| Average of Segment Percentages | 30%(90/3) | 27%(81/3) | 43%(129/3) | 100% |
Based on the above computations, residual expenses will be allocated as follows:
- Segment D will receive 30% of the total residual expenses;
- Segment E will receive 27% of the total residual expenses; and
- Segment F will receive 43% of the total residual expenses.