Cost Accounting Standard (CAS) 403 - Allocation of Home Office Expenses to Segments

So, you have a contract with the clause FAR 52.230-2 Cost Accounting Standards, subject to full CAS coverage. If you receive allocations from a home office, the home office must comply with CAS 403, Allocation of home office expenses to segments. A home office has the responsibility for directing or managing two or more segments of an organization and includes intermediate home offices or a corporate office.

What is the Purpose of CAS 403?

CAS 403 provides the criteria for allocating home office expenses to a segment based on the benefit the segment received or the amount of expense the segment caused. Contractors are responsible for organizing their business and determine where expenses are accumulated. For instance, one company may accumulate Human Resource expenses at the home office while others accumulate the expense at the segment. There is no right or wrong way. However, contractors need to comply with CAS 403 when expenses accumulated at the home office are allocated to segments. All it takes is one full CAS covered contract at one segment to require the home office to comply with CAS 403, even if your other 4 segments are commercial. The only option is to forgo the allocation of home office expenses to the segments with full CAS covered contracts, which can be costly.

What are the Requirements of CAS 403?

CAS 403 provides the allocation criteria and uses the following hierarchy:

• Direct Allocation – These are expenses that can be identified and directly allocated to a specific segment (CAS 403-20(a)(1)).
• Homogenous Groupings – These expenses cannot be directly allocated but are allocated on the basis of the beneficial or causal relationship between supporting and receiving activities (CAS 403-20(a)(2)).
• Residual Expenses – These are expenses of managing the organization as a whole and cannot be specifically identified to a segment (CAS 403-20(a)(3)).

The intent of CAS 403 is to allocate expenses direct to the maximum extent, create homogeneous expense groupings for allocation to segments and limit the amount of “residual” expenses. Segments should not be allocated an expense through a homogenous or residual pool, if other expenses incurred for the same purpose have been allocated directly to a segment.

Let’s discuss the techniques in the hierarchy.

Direct Allocation

The first allocation in the hierarchy is to identify and allocate expenses directly to segments to the maximum extent practical. For example, the allocation of legal costs associated with an issue at a segment would be directly allocated to the segment.

Homogeneous Groupings

Expenses not directly allocated should be grouped into homogenous pools and an appropriate allocation base selected based on the support provided or expense caused by the segments. CAS 403.40(b) provides the following criteria for homogeneous groupings:

• Centralized Service Functions – (e.g., Human Resources, Information technology, Warehousing, Security, Communications, etc.)
• Staff Management of Specific Activities of Segments (e.g., Engineering management, Manufacturing management, Accounting management, etc.)
• Line Management of Particular Segments/Groups of Segments (Management of Domestic, International, Government, or Commercial Activities, etc.)
• Central Payments (e.g., pension expense, group insurance expense, state and local taxes, etc.)

It is important for contractors to determine which functions support segments and determine an appropriate pool and allocation base. For example, a segment that does not maintain inventory would not benefit from Warehousing and therefore would not receive an allocation of that expense. The allocation of facilities expense using headcount may not be an acceptable allocation base when there are manufacturing segments, which utilize more facility space, and service-based segments. The contractor should at least annually analyze the type of allocation base and adjust for changes, accordingly.

The intent is not to create an unnecessary number of pools. In fact, when different functions use a common allocation base, the functions can be combined into a single pool. For example, if the allocation base for human resources, information technology, and security is headcount, then the expenses in these three departments can be combined into one pool.

Residual Expenses

Once expenses have been allocated directly to the maximum extent and grouped in homogeneous pools based on functions, the remaining expenses are residual expenses. These expenses are for the management of the organization, as a whole (e.g., President, Chief Executive Office, Chief Financial Officer, etc.), and are not identifiable to specific activities of segments. Residual expenses can be allocated by one of two methods:

• Allocation base representative of the total activity of the segments or
• Three-factor formula

It is important that companies minimize the amount of residual expenses by properly classifying the expenses into the homogenous pools. If your residual expenses meet a threshold in CAS 403 the three factor formula must be used as the allocation base. The three-factor formula is based on the segments – payroll dollars, operating revenue, and average Net Book Value (NBV) of Assets. There can be a distortion in the allocation when some segments have significant assets and others have significantly less. DCAA will review the calculation and cite a noncompliance if they find the three-factor formula should have been used even if the amount is insignificant.

Special Allocation of Residual Expense

If a segment receives significantly more or less from residual expenses, CAS 403.403(c)(3) does allow for the Government and contractor to agree to a special allocation. If there is a need for a special allocation, we recommend you consider entering into an Advance Agreement (FAR 31.109) with the Administrative Contracting Officer to fully document the agreed to method.

Disclosure Statement

If you have even one segment required to submit a disclosure statement, your home office will be required to submit a disclosure statement with part 8 completed.

How Redstone GCI can help

Redstone Government Consulting offers many services to support your company in achieving compliance with the Cost Accounting Standards (CAS). Our team specializes in reviewing homogeneous groupings and allocation bases to ensure they meet CAS requirements. We also provide assistance in drafting written policies and procedures, creating a home office disclosure statement, and responding to DCAA noncompliance reports or ACO determinations of CAS 403 noncompliance. Moreover, Redstone offers training on Cost Accounting Standards, which can be delivered through either webinars or onsite training sessions, to equip your team with the necessary knowledge and skills for CAS compliance.