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Cost Accounting Standard (CAS) 420 outlines accounting standards for Independent Research and Development (IR&D) and Bid & Proposal (B&P) costs incurred by government contractors, ensuring consistent and transparent reporting.
What is the Purpose of CAS 420?
CAS 420 was put in place for two basic reasons:
- How to allocate the period expenses of independent research and development (IR&D) and selling costs required by Financial Accounting Standards and
- The process for collecting the direct costs invested in independent research and development and selling activities.
Under CAS 420 selling costs are referred to as bid and proposal (B&P) costs. This blog is going to address independent research and development. Bid and proposal costs are addressed in our article, “Why Bid and Proposal Cost is so Confusing to Government Contractors”.
What is R&D?
While CAS 420 addresses Independent Research and Development (IR&D) costs, there are two types of R&D costs:
- Independent research and development costs which is the research and development effort undertaken by a contractor to improve its current products and services or develop new products or services it can sell.
- Research and development effort for which the contractor has been awarded a contract by a customer to perform.
Financial Accounting allows for the same treatment of research and development and so does the Federal Acquisition Regulations (FAR) part 31; expensed in the period incurred. FAR part 31 has two cost principles:
- FAR 31.205-18, Independent research and development and bid and proposal costs, research and development effort the contractor “independently” engages in to support it future sales and
- FAR 31.205-48, Research and development costs, research and development effort required under a contract.
Our focus is on the treatment of the research and development effort the contractor independently engages in referred to as independent research and development.
What are the Requirements of CAS 420?
When it comes to independent research and development things are a little more straight forward. For the most part the contractor’s independent research and development effort is going to be performed by its direct employees that would normally be performing on contract effort. We know what you are thinking, why don’t contractors just have the direct employees charge an indirect charge number assigning their labor costs to an overhead pool. The CAS board did not feel that truly captured all the costs of the contractor’s investment in independent research and development. CAS 420 requires:
- All independent research and development effort be set up as projects – the same way you would set up a project to collect the cost of a contract and
- All direct and indirect costs, other than General and Administrative (G&A) costs, are assigned to the IR&D project.
The IR&D Costs are Collected Like a Contract – Now What?
Now that you have all the direct and indirect costs (e.g., labor, material, other direct costs, etc.) of the IR&D projects collected in your accounting records, you add up the total cost of all the different projects and move that amount from your G&A base to your G&A pools. Remember your IR&D projects are assigned all cost except for general and administrative. The CAS board believed that the contractor’s investment in independent research and development benefits the business as a whole and is therefore best allocated to contracts as a G&A cost.
When is CAS 420 Applicable?
While you may think CAS 420 is only applicable when you have contracts subject to full CAS coverage, this is incorrect. CAS 420 is incorporated in its entirety in FAR part 31.205-18, Independent research and development and bid and proposal costs. Even if you don’t have any CAS covered contracts, if you have contracts subject to FAR Part 31 Cost Principles then CAS 420 is applicable. This would include cost reimbursable contracts and fixed price contracts whenever a cost analysis is performed or negotiation of costs (FAR 31.102).
Cost Accounting vs. Financial Accounting
Under US Financial Accounting all R&D is a period expense, so GAAP and CAS 420 align well. When it comes to International Financial Reporting Standards (IFRS) the treatment of research is consistent with CAS 420, however, development costs under IFRS are placed on the balance sheet as an asset and amortized in the period in which the developed products are sold – not the way CAS 420 has you do it. We would like to see the CAS board address this IFRS and CAS inconsistency – one can hope.
Redstone Government Consulting offers a range of services tailored to support your company's needs, including reviewing the accounting of IR&D project costs and drafting customized written policies and procedures. Additionally, we provide valuable assistance in crafting responses to DCAA noncompliance reports and ACO determinations of CAS 420 noncompliance. Our expertise extends to conducting comprehensive training sessions on Cost Accounting Standards, which can be delivered conveniently via webinar or through onsite training sessions. With our assistance, you can ensure compliance and efficiency in managing your accounting processes.
