Accounting Systems - Problematic Standards - Part 3

This is the third in our installment of DoD standards for contractor accounting systems that are often problematic for contractors. There are 18 standards in total - most are easily understood and can be implemented without too much pain. There are a few however that are difficult to comprehend or where applicability is not intuitive. In Part 1, we discussed the limitation of cost/limitation of funds clauses where these are compliance with contract terms issues, not accounting system issues. In Part 2, we looked at the control environment and determined what that means in the context of an accounting system. Today we will discuss Criterion No. 4 which requires adequate accounting systems to have a logical and consistent method for the accumulation and allocation of indirect costs to intermediate and final cost objectives.

You have probably already noticed the words "logical and consistent". Logical and consistent according to who? The Government? The contractor. Who's to decide? A method for allocating indirect costs may be logical to you, the contractor, but may seem not so logical to an auditor. We can't begin to count the number of times an auditor has decided based on two minutes of deep analytical thought and computation, that a contractor's rate structure is no good. And often, the pronouncement is made because your way is not what they've seen at other contractors. Or, they get some wild notion that if you use a value-added base for allocating G&A expenses, then you must also have a material handling indirect rate.

Here's what contractors need to know concerning indirect rate pools and allocation bases. It comes from FAR 31.203:

The contractor shall accumulate indirect costs by logical cost groupings with due consideration of the reasons for incurring such costs. The Contractor shall determine each grouping so as to permit use of an allocation base that is common to all cost objectives to which the grouping is to be allocated. The base selected shall allocate the grouping on the basis of the benefits accruing to intermediate and final cost objectives. When substantially the same results can be achieved through less precise methods, the number and composition of cost groupings should be governed by practical considerations and should not unduly complicate the allocation.

There's no hard and fast rules in the foregoing requirement. There is nothing that says you must use a total cost input (TCI) method when such and such is the case. Of course, if you have methods of allocating costs that result in egregious misallocations of indirect costs to final cost objectives (e.g. contracts), you deserve the audit attention.  That's not usually the case however. Disputes generally arise because an auditor usually thinks he/she has a better way.