Material Costs - Part 2

Yesterday we began a discussion on the FAR (Federal Acquisition Regulations) cost principle on Material Costs; FAR 31.205-26 by defining the types of material costs covered by the standard. Suffice it to say, that if the cost does not meet the definition as set forth in the standard, you need to find another cost principle to consider the allowability of costs. Too often, contractors and the Government try to force fit a particular cost item into a particular standard to proclaim allowability or non-allowability, whatever the case may be. Don't do it. Such arguments waste everyone's time.

So far, we have learned that material costs (as defined in the standard) are allowable under Government contracts along with the costs of getting them to the plant (or construction site) and that contractors can purchase more than the contract requirements to allow for spoilage, waste, etc, if reasonable and supportable, of course. Today we will focus on some of the prescribed accounting treatment.

Contractors must adjust the costs of material for income and other credits, including available trade discounts, refunds, rebates, allowances, and cash discounts, and credits for scrap, salvage, and material returned to vendors. Essentially, if the contractor derives any income, however represented, from purchasing materials, the cost of those materials must be reduced.

Secondly, the adjustments can be handled in one of two ways. The contractor can credit the contract(s) directly, or charge the credits to an indirect expense pool for allocating over a broad range of contracts.

Thirdly, if the contractor can demonstrate that its failure to take available cash discounts was reasonable, it does not have to credit the contract for lost cash discounts. Auditors, of course, cannot conceive of any situation where lost cash discounts are reasonable and indeed, modern Accounting software helps to ensure that available discounts are readily and easily identified. However, there could be situations where not taking discounts is reasonable.

Fourth, reasonable adjustments arising from differences between periodic physical inventories and book inventories may be included in arriving at costs. Those adjustments must be made to the proper period. This most often involves write-downs of inventory. Its rare when physical inventory exceeds book.

Tomorrow, we will discuss materials issued from inventory and materials transferred between divisions.