*This is Part 3 of a 6-part blog. Each part addresses the fundamental requirements and techniques for application related to the standard, and provides specific examples.
- Part 1 addressed the overall purpose of the standard, as well as the requirements/techniques for application related to direct costs.
- This Part 2 addressed the requirements/techniques for application related to indirect cost pools.
- This Part 3 addresses some of the requirements/techniques for application related to allocation bases.
- Part 4 will address the requirements/techniques for application related to allocation bases not addressed in Part 3 of this blog.
- Part 5 will address special allocations.
- Part 6 will address pre-determined indirect rates.
Background: This standard provides the criteria for the accumulation of indirect costs, including service center and overhead costs, in indirect cost pools. It also includes guidance relating to the selection of allocation measures based on the beneficial or causal relationship between an indirect cost pool and cost objectives. The standard covers the allocation of indirect costs for indirect cost pools other than those covered by CAS 403 (allocation of home office expenses to segments); CAS 410 (allocation of G&A expenses), and CAS 420 (allocation of “Bid & Proposal” and “Independent Research & Development” costs).
- In accordance with CAS 418.50(d), indirect cost pools that include a material amount of the cost of management or supervision of activities involving direct labor or direct material must be allocated on the basis of direct labor hours or direct labor dollars unless the indirect cost pool meets one of the following exceptions at CAS 418.50(d)(2):
A. The cost pool is comprised predominately of facility related costs such as depreciation, maintenance, and utilities, in which case a machine-hour base is appropriate;
EXAMPLE: A contractor has a machine overhead pool that is responsible for managing the employees that work on the company’s 100 fabrication machines and for maintaining the operations of those machines. There is a material amount of direct labor costs incurred by the employees that work on the fabrication machines. The contractor groups all of the costs of managing and maintaining the machines in a single homogeneous overhead pool. For FY 2014, the costs of the machine overhead pool were comprised of the following:
|Activity||FY 2014 Cost|
|Supervision & Management||$ 300,000|
|Indirect Labor (Other than Supervision & Management)||$1,000,000|
The contractor selects an allocation base comprised of fabrication machine hours. Since there is a material amount of direct labor costs associated with the activity being managed, and the cost pool is comprised primarily of facility related costs, use of this allocation base is in compliance with CAS 418.
B. There is a common production of comparable units, in which case a units-of-production base is appropriate;
EXAMPLE: A contractor has a line overhead pool that accumulates the indirect costs associated with managing the production of garments. The assembly line has 75 employees that charge most of their time as direct labor, and also uses a large dollar amount of materials. While the contractor produces many different types of garments, the basic manufacturing and production lines are predominately the same. About 90 percent of the production line is identical for all of the garments. The remaining 10 percent differs to allow for production of the unique qualities of the different garments. An analysis shows that the difference in the production costs for the 10 percent is not material. The line overhead pool is therefore determined to be homogeneous and the contractor includes all overhead costs associated with producing the garments in the line overhead pool. The contractor selects the total number of garments produced as its allocation base (a units-of-production base). This is in compliance with CAS 418, since there is a material amount of direct labor costs associated with the activity being managed and there is a common production of comparable units.
C. The activity being managed or supervised is a material related activity, in which case a material cost base is appropriate.
EXAMPLE: A contractor has a material processing department. The nature of the contractor’s business requires that large amounts of material be delivered to various locations for use on contracts. When a contract requires a materials delivery, a group of employees process the order and deliver the materials. The cost of these employees is charged direct to the contract for which the materials will be used. The material processing pool includes the costs of supervising and managing these employees, as well as the cost of operating and maintaining the equipment (e.g., cranes and forklifts). The contractor selects materials cost as the allocation base. This is in accordance with CAS 418. There is a material amount of the cost of management or supervision of activities involving direct materials and the activity being managed/supervised is related to materials.
- As previously noted, in accordance with CAS 418.50(d), indirect cost pools that include a material amount of the cost of management or supervision of activities involving direct labor or direct material must be allocated on the basis of direct labor hours or direct labor dollars unless the indirect cost pool meets one of the following exceptions at CAS 418.50(d)(2). Assuming none of these exceptions apply, when selecting between a direct labor dollar and direct labor hour base, CAS 418.50(d)(2)(i) requires that the base selected be the one that, in the aggregate, is more likely to vary in proportion to the indirect costs being allocated.
EXAMPLE: A contractor has a manufacturing overhead pool. The pool includes supervision of the manufacturing department. The manufacturing department is comprised of assemblers, welders, riveters, fabricators, and painters. The welders are paid substantially more than the others, and the assemblers are paid substantially less. The fabricators also earn more than the assemblers, riveters, or painters (but not as much as the welders). The contractor produces a variety of items. Some of the items require significant welding, while others require none. Also, some items may require fabrication and/or riveting, while others will not. The contractor proposes to use a direct labor hours allocation base. This is in noncompliance with CAS 418. The contractor must use a direct labor dollars allocation base. The activities in the pool (assembling, welding, riveting, fabricating, and painting) vary closer in proportion to direct labor dollars than direct labor hours (e.g., there is a significant difference in the hourly rate for welding activities than there are for assembling activities).
EXAMPLE: A contractor has an assembly line that produces both commercial and Government vehicles. When the vehicles exit the assembly line, they are sent to the painting department. The time required to paint the commercial vehicles is significantly different from the time required to paint the Government vehicles. The painting department consists of 100 employees and 8 supervisors. Each of the 100 employees is interchangeable, i.e., they work on both Government and commercial vehicles. The supervision and management costs of the painting department are material. The contractor has a painting overhead pool that is comprised of the indirect costs of the painting department including the management and supervision, supplies, utilities, and paint. The contractor allocates the costs of the painting department to the vehicles based on direct labor dollars. This is in noncompliance with CAS 418. The activities in the pool (supplies, utilities, and paint) vary closer in proportion to direct labor hours than direct labor dollars (the longer it takes to paint a vehicle, the more supplies, paint, and utilities required to perform the work).
- In accordance with CAS 418.50(d)(3), indirect cost pools that include material amounts of the cost of management or supervision of activities involving direct labor or direct material costs must be allocated to:
- Final cost objectives;
- Goods produced for stock or product inventory;
- Independent research and development costs;
- Bid and proposal costs;
- Cost centers used to accumulate costs identified with a process cost system (i.e., process cost centers);
- Goods or services produced or acquired for other segments of the contractor and for other cost objectives of a business unit; and
- Self-constructed, fabrication, betterment, improvement, or installation of tangible capital assets.
EXAMPLE: Segment R has a machining department. The contractor has a machining overhead pool that includes only the indirect functions related to the activity of the machining department. The machining department does a significant amount of work for other segments of the company. Segment R must include this work in the allocation base of the machining overhead pool.
- In accordance with CAS 418.50(e), indirect cost pools that do not include a material amount of the cost of management or supervision of activities involving direct labor or direct material must be allocated on the basis of resource consumption taking into consideration the following criteria:
A. A measure of resource consumption must be used as the allocation base if it is available and practical to ascertain (CAS 418.50(e)(1)).
EXAMPLE: A contractor operates a machine that uses a special brand of very high expensive fuel to operate which the contractor buys in large quantities because the machine requires a substantial amount of the fuel to operate. The machine provides a unique fabrication and weld for five unique Government and two unique commercial products. The machine requires about two hours of calibration before it can be used on a particular product. Thus, the machine is generally used for a minimum of eight hour increments on a particular product. The contractor is able to determine the amount of fuel used each time the machine operates on a particular product. The contractor has an indirect cost pool that is comprised solely of the cost of the fuel. The contractor uses gallons of fuel expended as the allocation base for the pool. This complies with CAS 418, since (1) the activity being managed does not involve material amounts of direct labor or direct material, and (2) fuel is an appropriate measure of resource consumption.
B. If a measure of resource consumption is unavailable or impractical to ascertain, the output of the activities of the indirect cost pool must be used as the allocation base (CAS 418.50(e)(2)(i)).
EXAMPLE: Business Unit P has a facilities management department that manages the three buildings owned by the contractor. The costs of this department are accumulated in a facilities management pool. The pool is comprised of indirect labor, depreciation, utilities, and supplies. The contractor is unable to ascertain the consumption of resources in relation to the use of the facilities by individual cost objectives. The contractor therefore selects an allocation base of square footage, which represents the output of the activities. This complies with CAS 418 because (1) the activity being managed does not involve a significant amount of direct labor or direct material, (2) resource consumption is impractical to ascertain, and (3) square footage is an appropriate measure of the output of facilities management.
C. When the allocation base is the output of activities and the basic unit of output does not reflect the proportional consumption of resources, the output measure must be modified or more than one output measure used to reflect the resources consumed by the activity (CAS 418.50(e)(2)(ii)).
EXAMPLE: A contractor has a reproduction department. The department produces both color and non-color copies. The department also produces bound and non-bound copies. The contractor selects an allocation base of number of pages produced. The allocation base is modified such that the number of pages produced for allocation base purposes is increased by 25% for color copies (the additional estimated cost of producing a color copy) and 10% for binding (the additional estimated cost of binding). This allocation method is in compliance with CAS 418 since (1) the activity being managed does not involve a significant amount of direct labor or direct material, (2) resource consumption is impractical to ascertain, and (3) a single output measure (number of copies) does not reflect the proportional consumption of resources and therefore must be modified to reflect the resources consumed by the activity.
D. If neither resources consumed nor output of activities can be measured practically, a surrogate that varies in proportion to the services received must be used to measure the resources consumed (CAS 418.50(e)(3)).
EXAMPLE: A contractor has a material handling overhead pool. The functions in the pool include the processing, inspection, and transfer of materials. The contractor is unable to ascertain the resources consumed or the output produced. The contractor therefore selects materials cost as the allocation base. This is in accordance with CAS 418.