RGCI-The Perils of Cost Accounting Practice Changes

Previously, we discussed how a company ends up with CAS covered contracts.  This month we are going to talk about some of the further fun with CAS.  We recommended preparing a CAS Disclosure Statement soon after emerging from small business status, but you need to remember to take a close look at your accounting structure first, because once you are CAS-covered, it becomes harder and more costly to change.  This is because of the rules related to cost accounting practice changes.  If you change your cost accounting practices, you must determine the cost impact of the change on your existing CAS-covered contracts.  In this article we are going to illustrate how a minor change can result in costing you big money.  While doing so, we will learn the related language.

What is a Change in Cost Accounting Practices?

This has been the subject of much debate and much litigation over the year, but the basic definition is that it is a change in one of the following:

  • the measurement of costs
  • the assignment of costs to cost accounting periods or
  • the allocation of costs to cost objectives

Measurement of Costs

An example of a change in the measurement of costs would be changing from a depreciation policy that says the useful life of assets must be greater than one year to be capitalized and depreciated to a policy that extends this useful life to two years before capitalization.  The most frequent reason for a change like this would be acquisition by or merging with another entity.  In that case, if the policies differ, one entity will have to change.

Assignment of Costs

Changing inventory methods from LIFO to FIFO could change the amount of costs charged to cost of goods sold from one year to the next, thus changing the assignment of costs to cost accounting periods.

Allocation of Costs

Changing from a total cost input (TCI) base to a value added (VA) base for general and administrative (G&A) expense pool is probably the most common change in the allocation of costs to cost objectives.  This often occurs when a labor-intensive contractor is awarded a contract or contracts that will use extensive materials and subcontracts.  Continuing to use a TCI base would spread a disproportionate share of the G&A expense to the material intensive contracts.

When is a Cost Accounting Practice Change not a Cost Accounting Practice Change?

  1. Initial adoption of a cost accounting practice when a function is created and the first time that cost is incurred is not considered a cost accounting change. For example, if a company receives a contract which requires them to paint a product and they have never had a point shop before, setting up a paint shop overhead rate would not be a change in cost accounting practice. 
  2. If a cost had previously been immaterial, but now becomes material, changing the practice for this cost would not be a cost accounting practice change.
  3. The partial or total elimination of a function or cost is not a change in cost accounting practice. Closing the paint shop that I no longer needed is not a cost accounting practice change.
  4. When the change is related to an external restructuring where the practice is compliant and there are two-to-one savings to the Department of Defense due to the restructuring (see DFARS 231.205-70).

What are the Different Types of Cost Accounting Changes? 

There are four basic types of changes: required, unilateral, desirable and noncompliance.  Each type is treated differently in a cost impact calculation.

Required Changes

Required changes occur when a company is required to make a change to comply with a new or modified cost accounting standard or when the prospective change is necessary for the company to remain in compliance with CAS.  In this case, the change must be from one compliant practice to another compliant practice.  Remember our company above that changes from a TCI G&A base to a value-added base?  This is an example of a compliant change because prior to award of the material intensive contract, the company was compliant using a TCI base, but after award of the contract, the company must use value-added to remain in compliance with CAS.  In this type of change the result may be either price/cost increases or decreases.

Unilateral Changes

Unilateral changes also change from one compliant practice to another compliant practice, but is a company’s election, without any requirement to do so.  This is a change that the CFAO has not determined to be desirable.  In this case, no increased costs may be paid by the Government.

Desirable Changes

Desirable changes also change from one compliant practice to another compliant practice, but in this case, the CFAO has determined the change to be desirable.  If it is determined to be desirable, it may result in either price/cost increases or decreases.  For many years, the only time a CFAO would deem a change desirable was if it resulted in a cost decrease to the government.  However, there has now been guidance disseminated that said that the change resulting in a cost increase could not be the sole reason to deem a change “not desirable.”

Noncompliance

A change because of a noncompliance can be because the company is in noncompliance with the applicable CAS or the company’s own disclosed cost accounting practices.  You could have a practice that is compliant with CAS but is not in compliance with your disclosure statement and still end up having a cost accounting practice change due to the noncompliance.  This type of change is the worst.  Not only will the government not pay any increased costs due to the change but will require interest be paid from the time the payment of those increased costs was made until the repayment of those costs are accomplished. 

Cost Accounting Change Example

In 2018, a company changed from capitalizing assets with a useful life over two years to capitalizing assets with a useful life over one year.  Either of these practices is compliant with CAS, but the company did not change their disclosed practice to reflect this change.  In December 2017, the company had been awarded a large cost-type contract that had a 12-month period of performance.  As a result, $1M of assets with a useful life of 18 months were expensed on this government cost type contract.  In September of 2019, the auditor finds out about this change while auditing the 2018 incurred cost submission.  At that point, the company owes the government $1M, plus interest beginning the date of the first invoice in 2018 that had costs for assets that were expensed, rather than capitalized and ending when they repay that $1M plus interest sometime in 2019 or 2020.

In addition to the amount the company had to repay, it also had to go through the calculations to arrive at that amount and submit a cost impact statement to the CFAO to reach the repayment stage.  In a future blog, I will discuss the process types of cost impact statements and the process for calculating the cost impact.

I hope this helped illustrate why it is so important that when you submit a disclosure statement that you “get it right.”  RGCI can not only help you prepare that initial disclosure statement but point out potential noncompliances and make recommendations changes you might want to consider prior to submission.  Then, if you do decide to make a change to your cost accounting practices, we can help you navigate preparing that cost impact.

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Written by Cheryl Anderson

Cheryl Anderson Cheryl Anderson is a Director with Redstone Government Consulting, Inc. She provides Government Contract Consulting services to our government contractors primarily related to equitable adjustment claims, terminations, and DCAA audit expectations. Prior to joining Redstone Government Consulting, Cheryl served in a number of capacities with DCAA for over thirty-five years. Upon her retirement, Cheryl was a regional audit manager with DCAA. Cheryl began her DCAA career in 1977 as an auditor-trainee with the Ingalls Resident Office in Pascagoula, Mississippi. After instructing at the Defense Contract Audit Institute for four years, she returned to the Eastern Region in 1990, holding various audit positions before ultimately becoming a Regional Audit Manager in August 2005. She had overall management responsibility for audits performed by approximately 200 employees. During Cheryl’s tenure with DCAA, she was involved in conducting or managing a variety of compliance audits, to include cost proposals incurred cost submissions, systems, Cost Accounting Standards, claims, defective pricing, financial capability and agreed-upon procedures. She directly supported the government litigation team on a contract dispute and has prepared and presented various lectures and seminars to DCAA staff. In addition, she has served as an instructor for the Government Audit Training Institute for over 20 years. She currently specializes in preparing clients for more complex DCAA audits, providing advice on FAR cost principles and contracts regulatory provisions, and assisting clients in anticipating and addressing audit. Education Cheryl has a BS Degree in Accounting from Auburn University at Montgomery and a Masters of Business Administration from Wichita State University. Cheryl also completed courses at OPM’s management and executive development centers and at the Federal Executive Institute and is a Georgia Certified Public Accountant.

About Redstone GCI

Redstone Government Consultants are a team of the most senior industry veterans and the brightest new talent in the industry. Many have held senior government positions including leadership roles in the DCAA. Our new talents bring significant accounting and software experience along with fresh perspectives, inspiration and energy to our team. Through our leadership and combined experience, we provide a unique perspective, bringing both government and contractor proficiencies to bear and ensuring rock-solid government compliance for our clients.

Topics: Compliant Accounting Infrastructure, Cost Accounting Standards (CAS)