CAS Working Group Guidance - Accounting Changes - Income Recognition Method

Today we finish up our series on the CAS Working Group Guidance Papers. These Guidance Papers were issued between 1975 and 1981 by a group of CAS experts with the Department of Defense whose job it was to come up with practical solutions to issues that contracting officers were facing in trying to interpret and apply new CAS rules and regulations being promulgated by the CAS Board. This was a very active period for the CAS Board. By 1981, most, perhaps all, of the 19 CAS Standards had been issued and the newness and often times complexities of those standards raised a lot of questions. Although these were issued as "interim" guidance and labeled as such, 20 of the 25 Guidance Papers remain current more than 30 years later. The final Working Group Guidance Paper covers a topic that has no applicability to most Government contractors; what to do when you change your reporting of income from a percent of completion method (PCM) to a completed contract method (CCM).

WG 81-25 - Change in Cost Accounting Practice for State Income and Franchise Taxes as a Result of Change in Method of Reporting Income From Long-Term Contracts

State tax regulations usually permit taxpayers to select one of several acceptable methods of stating the elements that determine taxable income and later, under specified conditions, to change from the initial selection to another acceptable method.

According to CAS Regulation 331.20(h), a "cost accounting practice" is any accounting method or technique which is used for measurement of costs, assignment of costs to cost accounting periods, or allocation of cost to cost objectives. According to CAS 331.20(i), a change to either a disclosed cost accounting practice or an established cost accounting practice is any alteration in a cost accounting practice as defined in (h).

If a contractor changes its method of reporting income for long-term contracts from PCM to CCM, it will impact the years that state income taxes are imposed. Changing from a PCM to a CCM method will result in lower income taxes in the year of the change and the years shortly thereafter. When this occurs, the amount of state tax cost allocated to contracts will generally be lower than the amount projected to be allocated to the contracts at the time they were negotiated.

According to this guidance, a change from PCM to CCM (or, for that matter, vice versa), is a change in cost accounting practice because it alters the mearsurement and assignment of State tax costs. Consequently, if the cost impact is material, the Government will adjust contract prices as required by CAS.

By the way, this would be a legitimate reason for auditors to request copies of state income tax returns - to determine whether a change in the method for recognizing income, has been made.