*This is Part 4 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.
- Part 3 addressed the requirements/techniques for application related to allocation bases (with the exception of the allocation of indirect cost pools that benefit each other, which is addressed in Part 4 of this blog).
- This Part 4 addresses the requirements/techniques for application related to allocation bases for the allocation of indirect cost pools that benefit each other.
- 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).
Allocation Bases (Allocation of Indirect Cost Pools That Benefit Each Other)
- In accordance with CAS 418.50(d)(4), the allocation of indirect cost pools that benefit one another shall be accomplished by use of either of the following methods:
1. Cross-allocation (reciprocal) method (CAS 418.50(d)(4)(i)).
EXAMPLE: A contractor has two indirect cost pools, a General Overhead and a Facilities Management Overhead Pool. The General Overhead Pool is allocated on the basis of total labor dollars, while the Facilities Management Overhead is allocated on the basis of square footage occupied. The contractor uses a cross-allocation method for allocating costs. The data for FY 2012 is shown below (in $000):
|Indirect Cost Pool||FY 2012 Costs (000,000)|
|Cost Objective||FY 2012 Square Footage Occupied (000)||FY 2012 Total Labor Dollars(000)|
To use the reciprocal method, an equation for each pool needs to be developed. The amount of costs to be allocated from a particular pool to the cost objectives is equal to the amount of costs in that pool plus the amount of costs that will be allocated to it from the other pool. For example, the amount of the Facilities Pool to be allocated is equal to the $15 in the facilities pool plus 10% of the General Overhead Pool (the facilities overhead pool will receive 10% of the General Overhead Pool costs because it had 10% of the total labor dollars). This equation can be written as follows (F is the Facilities Pool and G is the General Overhead Pool):
F = $15 + .10G
Similarly, the amount of the allocation of the General Overhead Pool to cost objectives is equal to the $40 in the General Overhead Pool plus 20% of the General Overhead Pool (the General Overhead Pool will receive 20% of the Facilities Pool Costs because it had 20% of the total square footage). This equation can be written as follows:
G = $40 + .20F
Now there are two equations that must be solved simultaneously. This is done by making one of the variables the same in both equations. One way to do this is to multiply the second equation by 5, as shown below:
5 (G) = 5 ($40 + .20F)
5G = $200 + F
Now we have the following two equations:
0 + 5G = 200 + F
15 + .10G = 0 + F
If we now subtract the first equation from the second we get the following:
0 + 5G = 200 + F
15 + .10G = 0 + F
-15 + 4.9G = 200 + 0
Now basic algebra will find the value of G as shown below:
-15 + 4.9 G = $200 + 0
-15 + 15 + 4.9G = 200 + 15 + 0
4.9G = 215
4.9G/4.9 = 215/4.9
G = 215/4.9
G = 43.877
Now we substitute G into one of the equations as follows to find F:
15 + .10 G = F
15 + .10(43.877) = F
15 + 4.3877 = F
19.3877 = F
Based on the above calculations, we now need to allocate the following to Contracts X and Y based on their participation in each pool:
Facilities Pool $19.3877 (20% to Contract X and 60% to Contract Y)
General Overhead Pool $43.877 (30% to Contract X and 60% to Contract Y)
The allocation to the contracts is shown below:
|Contract||Facilities Pool||General Overhead Pool||Total Allocation|
|X||$3.88(20% x $19.3877)||$13.16(30% x $43.877)||$17.04|
|Y||$11.63(60% x $19.3877)||$26.33(60% x $43.877)||$37.96|
- Sequential method (CAS 418.50(d)(4)(ii)).
EXAMPLE: A contractor has three indirect cost pools, Computer Overhead, Facilities Management, and General Overhead. The Computer Overhead is allocated on the basis of computer hours used, the facilities management on the basis of square footage occupied, and the general overhead on the basis of total labor dollars. The contractor uses a sequential method of allocation. The established practice of the contractor is to allocate the Computer Overhead first, followed by the Facilities Management, and then the General Overhead. The costs of each indirect cost pool for FY 2012 are shown below:
|Indirect Cost Pool||FY 2012 Costs|
The data for the computer hours used, square footage occupied, and total labor dollars for each of the cost objectives is shown below:
|Cost Objective||FY 2012 Computer Hours||FY 2012 Square Footage Occupied||FY 2012 Total Labor Dollars|
|Computer Overhead||——–||20,000||$ 1,000,000|
|Facilities Management||10,000||——–||$ 2,000,000|
Using the sequential method, the contractor begins by allocating the computer overhead, which is comprised of the following hours in the base:
|Cost Objective||FY 2012 Computer Hours|
The contractor therefore allocates the costs of the computer overhead pool as follows:
|Cost Objective||FY 2012 Computer Hours (A)||Total Hours (B)||% of Total Hours(C=A/B)||Total Computer Overhead Costs||Allocation of Computer Costs|
|Facilities Management||10,000||200,000||5%||$5,000,000||$ 250,000|
|General Overhead||20,000||200,000||10%||$5,000,000||$ 500,000|
After allocating the costs of the Computer Overhead Pool, the contractor next allocates the costs of the Facilities Management Overhead Pool. The data for computing the allocation of the facilities management pool is as follows (Note that the 20,000 square feet occupied by the computer overhead pool is not included in computing the allocation of the Facilities Management Pool when the sequential method is used):
|Cost Objective||FY 2012 Square Footage Occupied|
The contractor therefore allocates the costs of the facilities management pool as follows (Note that the total facilities management cost is $15,250,000, which represents the facilities management cost pool of $15,000,000 plus the $250,000 allocation from the computer overhead pool):
|Cost Objective||FY 2012 Square Footage (A)||Total Square Footage (B)||% of Total Square Footage(C=A/B)||Total Facilities Management Costs||Allocation of Facilities Management Costs|
|Contract A||120,000||300,000||40%||$15,250,000||$ 6,100,000|
|Contract B||150,000||300,000||50%||$15,250,000||$ 7,625,000|
|General Overhead||30,000||300,000||10%||$15,250,000||$ 1,525,000|
After allocating the costs of the Computer Overhead and Facilities Management Pools, the contractor then allocates the costs of the General Overhead Pool. The data for computing the allocation of the General Overhead Pool is as follows (Note that the $1,000,000 of labor costs for the Computer Overhead Pool and the $2,000,000 of labor costs for the Facilities Management Pool are not included in the data used to allocate the General Overhead Pool when the sequential method is used):
|Cost Objective||FY 2012 Labor Dollars|
The contractor therefore allocates the costs of the facilities management pool as follows (Note that the total cost to be allocated for the general overhead pool is $42.025,000, which represents the initial amount of $40,000,000, plus the $500,000 allocation from the computer overhead pool and the $1,525,000 allocation from the facilities management pool):
|Cost Objective||FY 2012 Labor Dollars (A)||Total Labor Dollars (B)||% of Total Labor Dollars(C=A/B)||Total General Overhead Costs||Allocation of General Overhead Costs|
3. Any other method that results in an allocation that approximates those achieved by either the cross-allocation or sequential method (CAS 418.50(d)(4)(iii)).
EXAMPLE: The contractor has two overhead pools, Assembly Overhead and Fabrication Overhead. The contractor uses an allocation method that is different from both the cross-allocation and sequential methods. For FY 2012, a comparison of the results derived using contractor’s method and the sequential method is shown below:
|Cost Objective||Total Allocation of Assembly and Fabrication Overhead Pools Using Contractor’s Allocation Method (A)||Total Allocation of Assembly and Fabrication Overhead Pools Using Sequential Allocation (B)||Difference(A – B = C)|
|Contract M||$ 100,000||$ 101,021||$(1,021)|
|Contract O||$ 200,000||$ 198,984||$ 1,016|
|Contract P||$ 400,000||$ 398,222||$ 1,778|
|Contract Q||$ 617,000||$ 615,999||$ 1,001|
|IR&D/B&P||$ 423,000||$ 425,774||$ 2,774|
The difference between the two methods is not materially different for any particular cost objective (the largest difference for any particular cost objective is $2,774). Therefore, for FY 2012, the contractor’s allocation method is in compliance with CAS 418. Note that the contractor will need to show that the impact is immaterial each fiscal year in which the alternate method is used. This does not have to be done by a detailed analysis if there is another method that will sufficiently show that the difference is immaterial.
- In accordance with CAS 418.50(d)(5), when the activities represented by an indirect cost pool provide services to two or more cost objectives simultaneously, the cost of such services shall be prorated between or among the cost objectives in reasonable proportion to the beneficial or causal relationship between the services and the cost objectives.
EXAMPLE: A contractor whose main office is located near Washington, D.C. maintains a corporate aircraft. The cost of aircraft is allocated to cost objectives on the basis of miles flown. The contractor has numerous contracts, including Contracts E, F, and G. The managers of Contracts E, F, and G jointly attend a meeting in San Francisco via the corporate aircraft. The total roundtrip mileage is 4,500 miles. In determining the amount of miles in the allocation base for each cost objective, the contractor divides the mileage equally among the three managers, i.e., 1,500 miles goes to Contract E, 1,500 miles to the Contract F, and 1,500 miles to Contract G. This practice is in compliance with CAS 418, since the cost of the services (corporate aircraft) was prorated between the cost objectives in reasonable proportion to the beneficial or causal relationship.