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You will need to understand the following terms/definitions. Take a few moments to familiarize yourself with them and commit them to memory; you will encounter them in this lesson. You will have a chance to test your memory during the Terminology Game and the Crossword Puzzle.
Allocate
To assign an item of cost, or a group of items of cost, to one or more cost objectives. This term includes both direct assignments of cost and the reassignment of a share from an indirect cost pool.
Home Office
An office responsible for directing or managing two or more, but not necessarily all, segments of an organization. It typically establishes policy for, and provides guidance to the segments in their operations. It usually performs management, supervisory, or administrative functions, and may also perform service functions in support of the operations of the various segments. An organization which has intermediate levels, such as groups, may have several home offices which report to a common home office. An intermediate organization may be both a segment and a home office.
Operating Revenue
Amounts accrued or charged to customers, clients, and tenants, for the sale of products manufactured or purchased for resale, for services, and for rentals of property held primarily for leasing to others. It includes both reimbursable costs and fees under cost-type contracts and percentage-of-completion sales accruals except that it includes only the fee for management contracts under which the contractor acts essentially as an agent of the Government in the erection or operation of Government-owned facilities. It excludes incidental interest, dividends, royalties, rental income, and proceeds from the sale of assets used in the business.
Segment
One of two or more divisions, product departments, plants, or other subdivisions of an organization reporting directly to a home office, usually identified with responsibility for profit and/or producing a product or service. The term includes Government-owned contractor-operated (GOCO) facilities, and joint ventures and subsidiaries (domestic and foreign) in which the organization has a majority ownership. The term also includes those joint ventures and subsidiaries (domestic and foreign) in which the organization has less than a majority of ownership, but over which it exercises control.
Tangible Capital Asset
An asset that has physical substance, more than minimal value, and is expected to be held by an enterprise for continued use or possession beyond the current accounting period for the services it yields.
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Previously you learned how to navigate to the e-CFR website, the source to refer to for the current Cost Accounting Standards. You can go to it anytime you wish. Refer to the job aid under Lesson Resources if you need a refresher on how to access it.
For the purposes of this course however, we have provided an annotated version of CAS 403, to assist you in navigating the CAS and to help you focus on the key take away points in each standard. After reading the highlighted portions of the CAS, the lesson will walk you through several exercises to reinforce your learning.
Select the icon to read the annotated version of CAS 403.
After you have finished reading, we’ll review key points throughout the rest of the topic.
CAS 403
Oliver continues: "CAS 403 provides criteria for allocating expenses from a home office to the segments of the organization." As he is saying this, what's on the whiteboard changes to CAS 403, Home Office, and Segments. As Oliver says: "Before we go any further, there are two terms in that statement that we need to define: home office and segments," those two terms (home office and segments) are underlined on the whiteboard.
Everything that was on the whiteboard disappears and is replaced with a large box, labeled Home Office. As Oliver says: "Let's say there is a defense contractor that has been around for many years, always does a good job for the Government, and has grown over time so that the company now has three segments," lines are extended down from the Home Office to three additional boxes beneath the home office, labeled: Segment 1, Segment 2, and Segment 3.
Oliver goes on to say: "At the top, we have the company headquarters. We'll say that office is located near Washington, D.C. In our example, that is the Home Office." At that point, the Home Office box is emphasized with a bright yellow border.
The lines connecting the home office and the segments as well as the borders around each segment box are emphasized with a bright yellow border as Oliver says: "Beneath the home office are three segments. Segment 1 is in Maryland, Segment 2 is in Oklahoma, and Segment 3 is in California."
Lines are drawn extending down from Segment 1 to three additional boxes beneath Segment 1 labeled Business Unit 1, Business Unit 2, and Business Unit 3, as Oliver continues: "And, let's say that Segment 1 is further subdivided into Business Unit 1, Business Unit 2, and Business Unit 3." At this point, the diagram remains on-screen, but all yellow borders disappear.
As Oliver says: "So, as this drawing illustrates, a home office is any office that manages two or more segments," the bright yellow border reappears around the home office box at the top, and then the three boxes for Segments 1, 2, and 3, beneath the home office. Next, Oliver says: "A segment is one of at least two subdivisions that report to a home office, and a business unit is any segment of an organization, or an entire business organization, which is not divided into segments." As Oliver is saying this, the bright yellow border reappears around Business Units 1, 2, and 3 beneath the Segment 1 box, and Segment 3 on the diagram changes to be labeled: Segment 3 Intermediate Home Office, with branches extending down to two boxes beneath the Segment 3 box for Segments 4 and 5, and then branches beneath Segment 4 and Segment 5 extending down to box beneath Segment 4 and a box beneath Segment 5 that is labeled: Multiple Business Units. All of these lines and borders are also in the bright yellow border color used for emphasis.
As Oliver says: "An intermediate organization may be both a segment and a home office," the border around the box labeled Segment 3 Intermediate Home Office expands briefly to emphasize it.
Next, a bracket appears on-screen that is labeled CAS 403 and encompasses the two top rows on the diagram: the Home Office box and the boxes for Segments 1, 2, and 3 (with Segment 3 also labeled as an Intermediate Home Office), as Oliver continues: "CAS 403 says that expenses incurred by the home office in support of its segments must be allocated to those segments."
Oliver asks: "What expenses are we talking about?" As Oliver answers this question by saying: "The salaries of the chief executives at the home office, the salaries of the folks who process payroll each week for everyone in the company, and expenses related to personnel administration, and research and development," an image of currency and coins appears flowing from the Home Office to Segments 1, 2, and 3. Oliver goes on to say: " These are just a few examples of typical home office expenses."
A bracket appears on-screen that is labeled CAS 410 and encompasses the bottom three rows of the table, and then the image of the currency and coins appears to be flowing from the segments to the business units beneath them as Oliver concludes by explaining: "After we complete this topic on CAS 403, we'll examine CAS 410, which gets into how to allocate the home office expenses from the segments down to the cost objectives of the business units, the contracts."
This is a notional organizational chart that has been simplified to show the basic relationship between the home office, segments, and business units. It also shows how they align with the requirements of CAS 403 and CAS 410.
Major defense contractors often have complex organizational structures.
Companies have flexibility to change their organizational structure as well as their accounting practices. However, they must remain in compliance with cost accounting standards, which includes properly disclosing their accounting practices and any changes in organizational structure.
An organization chart is shown with the Home Office at the top, with Segment 1, Segment 2, and Segment 3 reporting to the Home Office. Segment 3 is also designated as an Intermediate Home Office, because there are additional segments that report to Segment 3: Segment 4 and Segment 5.
The organization chart indicates that CAS 403 encompasses allocations between the Home Office and Segments 1, 2, and 3.
The organization chart also shows that Business Unit 1, Business Unit 2, and Business Unit 3 report to Segment 1.
Segment 4 and Segment 5 report to Segment 3, and Segments 4 and 5 both have multiple business units that report to them.
The organization chart indicates that CAS 410 encompasses allocations between the segments and business units.
It is important to study and understand the structure of the companies you work with to understand how they are organized as well as understanding their accounting practices so you are better able to manage and understand contract costing.
One crucial component of CAS 403 is the allocation hierarchy. You need to understand this to successfully assess contractors’ compliance with CAS 403.
Select each step in the allocation hierarchy for more information.
Near the end of this topic, we’ll get into how to calculate the CAS 403 threshold, and also how to calculate the three-factor formula to allocate the residual home office expenses to the segments. The three-factor formula must be used when the CAS 403 threshold is exceeded. We’ll wait and get into residual expenses allocation later in this topic.
Cost Pools
You just leaned that the second step in the allocation hierarchy, after making all the direct allocations that you can, is to make any indirect allocations.
The home office expenses that cannot be allocated directly will be collected in logical, homogeneous pools. A pool is homogeneous if all the expenses in the pool have the same or similar relationship to the cost objectives or base over which they are allocated.
The indirect expenses in the pool are allocated using a base that results in those segments that benefitted from or caused them receiving their fair share of the indirect expense.
Cost Pools
You just leaned that the second step in the allocation hierarchy, after making all the direct allocations that you can, is to make any indirect allocations.
The home office expenses that cannot be allocated directly will be collected in logical, homogeneous pools. A pool is homogeneous if all the expenses in the pool have the same or similar relationship to the cost objectives or base over which they are allocated.
The indirect expenses in the pool are allocated using a base that results in those segments that benefitted from or caused them receiving their fair share of the indirect expense.
Example
For example, a home office performs the payroll function for Segments 1, 2, and 3, and the total payroll expense is $200,000.
The $200,000 payroll expense will be allocated to each segment based on the number of employees. Number of employees is a reasonable allocation base for payroll expense that should result in each segment receiving its fair share.
Therefore, we would divide the $200,000 total payroll expense by the total number of employees in all three segments—400 employees—to get the allocation rate of $500 per employee.
$200,000 total payroll expense / 400 employees = $500 per employee allocation rate
Example (cont.)
Then, to calculate each segment’s fair share of payroll expense, we multiple the $500 allocation rate times the number of employees in each segment.
So, if Segments 1 and 2 both have 100 employees, they would each be allocated $50,000 payroll expense.
$500 allocation rate x 100 employees = $50,000 allocation to Segments 1 and 2
Segment 3, with 200 employees, would receive an allocation of $100,000.
$500 allocation rate x 200 employees = $100,000 allocation to Segment 3
Help?
For indirect cost allocations, when we’re referring to the expense pool as the numerator being divided by the allocation base as the denominator to get the allocation rate, is that completely clear to you?
If it is not, please stop and take a refresher on indirect cost allocations. Otherwise, you’re going to struggle with the material in this lesson.
Some good sources on indirect rates are:
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Recall that the CAS 403 allocation hierarchy specifies that home office costs must be charged directly to the segments as much as possible—“to the maximum extent practical.”
Check your knowledge by answering the following multiple choice question.
Select the best answer and then select Submit.
A contractor performs building cleaning services for Segments A, B, and C. Segment A is in Ohio, Segment B is in Texas, and Segment C is in Georgia. Although these contracts have not been bundled into one large contract, the contractor groups the entire cost of the cleaning services into a single pool and allocates the costs on the basis of total square footage of all buildings occupied by Segments A, B, and C.
Recall that CAS 403-40(a)(1) specifies that home office costs are allocated on the basis of the beneficial or causal relationship between supporting and receiving activities.
Check your knowledge by answering the following multiple choice question.
Select the best answer and then select Submit.
A contractor’s home office performs the materials inspection function for its three segments. Segment X performs mostly service contracts with very little materials costs. Segments Y and Z are manufacturing operations that use a large quantity of materials. The contractor allocates the materials inspection costs to the three segments based on direct labor dollars.
Check your knowledge by answering the following multiple select question.
Select all that apply and then select Submit.
In the company that you read about in the previous question, the home office performs the materials inspection function for the three segments. The contractor was not compliant with Cost Accounting Standard (CAS) 403 because they were using a base of direct labor dollars to allocate materials inspection costs to the three segments. That base did not make sense for that expense pool.
Recall that a compliant base is one that reflects the causal or beneficial relationship between the materials inspection function and the receiving segments, and would, therefore, result in a “fair” allocation of the materials inspection costs to each segment.
Recall that expenses that are not directly allocated shall be grouped in logical and homogeneous expense pools. [48 CFR 9904.403-40(a)(1)]
Check your knowledge by answering the following multiple choice question.
Select the best answer and then select Submit.
A home office performs the payroll and software development functions for both of its segments, Segments A and B. Segment A is a service industry in which almost all employees have their own computer workstation and use the computer on a daily basis. Segment B is a manufacturing operation in which only about one in ten employees uses a computer, and only about one in fifteen has their own computer workstation. The contractor groups the payroll and software development functions in a single pool and allocates the pool to the segments based on number of employees.
No segment shall have allocated to it as an indirect cost any costs, if other costs incurred for the same purpose have been allocated directly to that or any other segment. This prevents double counting of home office expenses.
Example
The no double-counting requirement (presented on the preceding page) is stating that the same dollars cannot be charged to the Government twice.
For example, a home office performs a security function for Segments 1, 2, and 3. The purpose of the security function is the same for all segments. The security function totals $100,000. The contractor determined that $20,000 was for security at Segment 1, $40,000 was for Segment 2, and $40,000 was for Segment 3.
The contractor allocates $40,000 directly to Segment 3. The remaining $60,000 ($100,000 minus the $40,000) is accumulated in a home office expense pool that is allocated using a base of total personnel in Segments 1, 2, and 3.
Example
The no double-counting requirement (presented on the preceding page) is stating that the same dollars cannot be charged to the Government twice.
For example, a home office performs a security function for Segments 1, 2, and 3. The purpose of the security function is the same for all segments. The security function totals $100,000. The contractor determined that $20,000 was for security at Segment 1, $40,000 was for Segment 2, and $40,000 was for Segment 3.
The contractor allocates $40,000 directly to Segment 3. The remaining $60,000 ($100,000 minus the $40,000) is accumulated in a home office expense pool that is allocated using a base of total personnel in Segments 1, 2, and 3.
Comply?
This practice does not comply with CAS 403 since Segment 3 is incurring costs incurred for the same purpose—security—as both direct and indirect cost.
In this case, the contractor could do one of three things.
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Check your knowledge by answering the following multiple choice question.
Select the best answer and then select Submit.
The home office performs a security function for Segments A, B, and C. The purpose of the security function is the same for all Segments. During the fiscal year, the total costs of the security function were $160,000. The home office determined that $20,000 was for security at Segment A, $40,000 was for security at Segment B, and $40,000 was for security at Segment C. The contractor directly allocates $20,000 to Segment A, $40,000 to Segment B, and $40,000 to Segment C. The remaining $60,000 is accumulated in a home office expense pool that is allocated on the basis of total personnel in Segments A, B, and C.
Centralized Functions
You’re doing a good job applying the CAS 403 allocation hierarchy of making direct allocations first, and then identifying bases for indirect allocations that make sense. Now let’s take a closer look at possible allocation bases for functions that are centralized at the home office.
Why do we allow contractors to allocate these home office costs to the segments? The reasoning is that if these functions were not being performed at the home office, they would have to be performed by one or more of the segments. [48 CFR 9904.403-40(b)(1)]
On this page, you’ll have a chance to read the CAS 403 requirement related to centralized service functions and discover examples of possible bases that could be used to allocate these centralized service costs to the applicable segments.
Recall that these are expenses that cannot be allocated directly and therefore, 48 CFR 9904.403-40(a)(1) tells us we must group and allocate these costs in accordance with 48 CFR 9904.403-40(b).
Centralized Functions
You’re doing a good job applying the CAS 403 allocation hierarchy of making direct allocations first, and then identifying bases for indirect allocations that make sense. Now let’s take a closer look at possible allocation bases for functions that are centralized at the home office.
Why do we allow contractors to allocate these home office costs to the segments? The reasoning is that if these functions were not being performed at the home office, they would have to be performed by one or more of the segments. [48 CFR 9904.403-40(b)(1)]
On this page, you’ll have a chance to read the CAS 403 requirement related to centralized service functions and discover examples of possible bases that could be used to allocate these centralized service costs to the applicable segments.
Recall that these are expenses that cannot be allocated directly and therefore, 48 CFR 9904.403-40(a)(1) tells us we must group and allocate these costs in accordance with 48 CFR 9904.403-40(b).
Requirement
Centralized service functions shall be allocated on the basis of the service furnished to or received by each segment. Centralized service functions performed by a home office for its segments are considered to consist of specific functions which, but for the existence of the home office, would be performed or acquired by some or all of the segments individually. [48 CFR 9904.403-40(b)(1)]
Possible Bases
| Centralized Service Functions | Examples of Possible Allocation Bases |
|---|---|
| Personnel administration | Number of personnel; labor hours; payroll; number of hires |
| Data processing services | Machine time; number of employees |
| Centralized purchasing and subcontracting | Number of purchase orders; value of purchases; number of items |
| Centralized warehousing | Square footage; value of material; volume of material |
| Company aircraft service | Actual or standard rate per hour or per mile; passenger mile; or similar unit |
| Central telephone service | Usage costs; number of instruments |
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Requirement
This page provides the CAS 403 requirement related to centralized management functions, and it provides examples of allocation bases that could be used to legitimately allocate those indirect management costs to the appropriate segments.
Staff management shall be allocated to segments over a base representative of the total activity being managed. [48 CFR 9904.403.40(b)(2)]
Line management of particular segments or groups of segments shall be allocated only to the segment or group of segments being managed or supervised. Line management shall be allocated to segments using a base representative of the total activity of such segments. [48 CFR 9904.403-40(b)(3)]
Requirement
This page provides the CAS 403 requirement related to centralized management functions, and it provides examples of allocation bases that could be used to legitimately allocate those indirect management costs to the appropriate segments.
Staff management shall be allocated to segments over a base representative of the total activity being managed. [48 CFR 9904.403.40(b)(2)]
Line management of particular segments or groups of segments shall be allocated only to the segment or group of segments being managed or supervised. Line management shall be allocated to segments using a base representative of the total activity of such segments. [48 CFR 9904.403-40(b)(3)]
Possible Bases
| Centralized Service Functions | Examples of Possible Allocation Bases |
|---|---|
| Personnel administration | Number of personnel; labor hours; payroll; number of hires |
| Manufacturing activities | Manufacturing cost input; manufacturing direct labor |
| Engineering activities | Total engineering costs; engineering direct labor; number of drawings |
| Material/Purchasing activities | Number of purchase orders; value of purchases |
| Marketing activities | Sales; segment marketing costs |
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Requirement
This page provides the CAS 403 requirement related to central payments and accruals, and it provides examples of allocation bases that could be used to legitimately allocate those indirect payments and accruals to the receiving segments. These are payments or accruals that are made by a home office on behalf of their segments.
Central payments or accruals that cannot be identified specifically with individual segments shall be allocated using an allocation base representative of the factors on which the total payment is based. [48 CFR 9904.403-40(b)(4)]
Requirement
This page provides the CAS 403 requirement related to central payments and accruals, and it provides examples of allocation bases that could be used to legitimately allocate those indirect payments and accruals to the receiving segments. These are payments or accruals that are made by a home office on behalf of their segments.
Central payments or accruals that cannot be identified specifically with individual segments shall be allocated using an allocation base representative of the factors on which the total payment is based. [48 CFR 9904.403-40(b)(4)]
Possible Bases
| Central Payments or Accruals | Examples of Possible Allocation Bases |
|---|---|
| Pension expenses | Payroll or other factor on which total payment is based. |
| Group insurance expenses | Payroll or other factor on which total payment is based. |
| State and local income taxes and franchise taxes | Any base or method which results in an allocation base that equals or approximates a segment’s proportionate share of the tax imposed by the jurisdiction in which the segment does business, as measured by the same factors used to determine taxable income for that jurisdiction. |
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Check your knowledge by answering the following multiple choice question.
Select the best answer and then select Submit.
In accordance with CAS 403, when the contractor is determining which segments to include in the allocation base being used to allocate the indirect expense of a given function, the contractor must:
Exclude any segments that did not receive significant benefits from, or contribute significantly to the cause of the expense to be allocated, and
Include all the segments that did receive significant benefits from, or contribute significantly to the cause of the expense.
[48 CFR 9904.403-50(a)(2) (i) (ii)]
Check your knowledge by answering the following multiple choice question.
Select the best answer and then select Submit.
Contractor Q does the payroll function for Segments 1, 2, and 3. Segment 4 does its own payroll function. Contractor Q includes Segments 1, 2, and 3 in the allocation base for allocating the costs of processing payroll but excludes Segment 4.
At the beginning of this topic, you learned that the whole purpose of CAS 403 is to specify how home office expenses are allocated from the home office to the supported segments. You learned that the allocation hierarchy dictates that direct allocations must be made to the maximum extent practical, and then indirect allocations should be made on the basis of the beneficial or causal relationship between such expenses and the receiving segments.
Now, what about any home office expenses that remain after all the direct and indirect allocations have been made? CAS 403 refers to the remaining expenses as residual expenses.
These residual expenses may include such things as the salaries of the executives at the home office, such as the Chief Executive Officer and Chief Financial Officer.
Residual Expenses Allocations
.......... CAS 403 Threshold ..........
Whew, there was a lot in that explanation. Let’s unpack it, starting with the CAS 403 threshold calculation. In the upcoming screens, you’ll see how to calculate the CAS 403 threshold and then you’ll see how to calculate and use the three-factor formula.
Calculation
One key thing to remember about the CAS 403 threshold calculation is that it is based on the contractor’s prior fiscal year’s operating revenue and home office residual expenses. To calculate the threshold:
Calculation
One key thing to remember about the CAS 403 threshold calculation is that it is based on the contractor’s prior fiscal year’s operating revenue and home office residual expenses. To calculate the threshold:
Example
This is illustrated best with an example. Last year, a contractor had $500,000,000 in operating revenue and $7,000,000 in residual expenses.
Step 1 of the CAS 403 threshold calculation is to take 3.35 percent of the contractor’s first $100,000,000:
.0335 x $100,000,000 = $3,350,000.
Recall that the contractor had $500,000,000 in operating revenue and we already used the first $100,000,000 for Step 1, so that leaves $400,000,000.
Step 2 is to take 0.95 percent of the next $200,000,000.
.0095 x 200,000,000 = $1,900,000.
Example (cont.)
Step 3 is to take 0.30 percent of the next $2.7 billion. At this point, we’ve already used $300,000,000 of the contractor’s $500,000,000 operating revenue, so we only have $200,000,000 remaining.
We’ll take .0030 x $200,000,000 to get $600,000.
Next we total the results of Steps 1, 2, and 3:
$3,350,000 (Step 1: 3.35% of $100 million) + $1,900,000 (Step 2: 0.95% x $200 million) +
$600,000 (Step 3: 0.30% x $200 million) = $5,850,000.
Therefore, $5,850,000 is the contractor’s CAS 403 threshold.
Question
Since the contractor’s residual expenses of $7,000,000 exceed their CAS 403 threshold of $5,850,000, this means this contractor needs to use the three-factor formula to allocate their residual home office expenses.
Select the Q/A question when you are ready to check your answer.
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Three Factors
This is a continuation of the preceding example. Since the contractor’s residual expenses of $7,000,000 exceed the CAS 403 threshold of $5,850,000, the contractor needs to use the three-factor formula to allocate their home office residual expenses.
The three factors in the formula are payroll dollars, operating revenue, and net book value of the segment’s tangible assets, also from the previous fiscal year. These three factors are used because they represent the three major functions of the company that are of management concern:
Three Factors
This is a continuation of the preceding example. Since the contractor’s residual expenses of $7,000,000 exceed the CAS 403 threshold of $5,850,000, the contractor needs to use the three-factor formula to allocate their home office residual expenses.
The three factors in the formula are payroll dollars, operating revenue, and net book value of the segment’s tangible assets, also from the previous fiscal year. These three factors are used because they represent the three major functions of the company that are of management concern:
Example
The contractor in our example has Segments A, B, and C. This first table shows each segment’s percentage of the three factors in the formula: payroll, operating revenue, and average net book value (NBV).
| Segment | Payroll % | Operating Revenue % | NBV % |
|---|---|---|---|
| A | 35% | 24% | 31% |
| B | 22% | 17% | 42% |
| C | 43% | 59% | 27% |
| Total | 100% | 100% | 100% |
Example (cont.)
Now, in this second table, we’ve listed the segments in the columns, with the three factors in the rows. The next-to-last row shows each segment’s total percentage. The final row shows each segment’s average percentage, calculated by dividing the segment’s total percentage by three.
| Factor | Segment A | Segment B | Segment C |
|---|---|---|---|
| Payroll | 35% | 22% | 43% |
| Operating Revenue | 24% | 17% | 59% |
| NBV | 31% | 42% | 27% |
| Total | 90% | 81% | 129% |
| Average % (Total % / 3) | 30% | 27% | 43% |
Question
To complete this example, recall the contractor’s residual expenses for the home office amounted to $7,000,000. On the preceding table, you saw that Segment A’s average 3-factor percentage amounted to 30%, Segments B’s was 27%, and Segment C’s was 43%.
Segment A will get $2,100,000, calculated as 30% x $7,000,000.
Segment B will get $1,890,000, calculated as 27% x $7,000,000.
Segment C will get $3,010,000, calculated as 43% x $7,000,000.
Select the Q/A question when you are ready to check your answer.
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Check your knowledge by answering the following multiple choice question.
Select the best answer and then select Submit.
Last year, the contractor’s operating revenue amounted to $350,000,000 and their residual home office expenses amounted to $6,000,000. So, the contractor needs to determine if the CAS 403 threshold has been exceeded. If the threshold has been exceeded, they will need to use the three-factor formula to allocate the residual home office expenses to the segments. If the threshold has not been exceeded, then the contractor will allocate the residual home office expenses using a representative base.
Here is the CAS 403 threshold calculation:
3.35 percent of first $100 million
0.95 percent of next $200 million
0.30 percent of next $2.7 billion
0.20 percent of all amounts over $3 billion
Check your knowledge by answering the following multiple choice question.
Select the best answer and then select Submit.
This is a continuation of the preceding Knowledge Check in which we determined that the CAS 403 threshold has been exceeded; therefore, the contractor must use the three-factor formula to allocate the residual home office expenses to the segments.
Recall that the contractor’s residual home office expenses amounted to $6,000,000.
| Segment | Percentage of Segment Payroll Dollars to Total Payroll Dollars for all Segments | Percentage of Segment Operating Revenue to Total Operating Revenue for all Segments | Percentage of Segment Average Net Book Value (NBV) to Total Average NBV for all Segments |
|---|---|---|---|
| D | 50% | 40% | 30% |
| E | 20% | 30% | 20% |
| F | 30% | 30% | 50% |
| Total % | 100% | 100% | 100% |
Requirement
Now that you know what residual home office expenses are and how to allocate them, let’s talk about special allocations. CAS 403 includes a requirement to allow for special allocations of residual expenses, when
they are warranted.
Where a particular segment receives significantly more or less benefit from residual expenses than would result if the requirements of the standard were applied, a special allocation may be agreed to between the Government and the contractor. [48 CFR 9904.403-40(c)(3)]
Requirement
Now that you know what residual home office expenses are and how to allocate them, let’s talk about special allocations. CAS 403 includes a requirement to allow for special allocations of residual expenses, when
they are warranted.
Where a particular segment receives significantly more or less benefit from residual expenses than would result if the requirements of the standard were applied, a special allocation may be agreed to between the Government and the contractor. [48 CFR 9904.403-40(c)(3)]
Explanation
A special allocation may be warranted to prevent a particular segment from receiving an unreasonably large or small portion of the residual expenses. If there is something in that segment’s data that would skew the results unjustly, then the contractor and Government might agree on a special allocation for that one segment.
The contractor must deduct the amount of the special allocation before they allocate the remaining residual expenses among the other segments.
Please proceed to the next page, assess the situation, and see if you believe a special allocation is warranted.
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Check your knowledge by answering the following multiple choice question.
Select the best answer and then select Submit.
A contractor who is required to allocate home office expenses using the three-factor formula has five segments. Four of these segments provide services with very little tangible capital assets. The fifth segment, Segment E, is in the construction business and owns a very large dollar amount of real and personal property. In fact, Segment E owns 98% of the contractor’s total tangible capital assets. Segment E has approximately the same number of employees as each of the other segments and generates approximately the same amount of revenue.
No Contract
We’re nearly finished examining the CAS 403 requirements. There is one more requirement that we need to discuss: 48 CFR 9904.403-50(e).
Would it surprise you to learn that, in some cases, a home office that the Government does not have a contract with is allowed to allocate a portion of its home office expenses to the defense contractor?
If the Government contracts directly with a corporation that is wholly or partly owned by another corporation, the “parent” corporation serves as the home office and the defense contractor serves as the segment.
In accordance with 48 CFR 9904.403-50(e), the contracting corporation, i.e., the defense contractor, may only accept allocations from the “parent” corporation to the extent that such allocations meet the requirements in CAS 403.
No Contract
We’re nearly finished examining the CAS 403 requirements. There is one more requirement that we need to discuss: 48 CFR 9904.403-50(e).
Would it surprise you to learn that, in some cases, a home office that the Government does not have a contract with is allowed to allocate a portion of its home office expenses to the defense contractor?
If the Government contracts directly with a corporation that is wholly or partly owned by another corporation, the “parent” corporation serves as the home office and the defense contractor serves as the segment.
In accordance with 48 CFR 9904.403-50(e), the contracting corporation, i.e., the defense contractor, may only accept allocations from the “parent” corporation to the extent that such allocations meet the requirements in CAS 403.
Requirement
In some cases, home office functions are performed by an organization that is not part of the legal entity with which the Government has contracted. The contracting corporation may only accept allocations from this organization to the extent that such allocations meet the requirements set forth in CAS 403. [48 CFR 9904.403-50(e)]
Example
For example, Contractor X has three subsidiaries, Subsidiary A, Subsidiary B, and Subsidiary C. The Government enters into contracts with Subsidiary A. The Government does not enter into any contracts with the corporate home office of Contractor X.
The question is: Can Contractor X allocate the cost of home office functions to Subsidiary A?
The answer is yes, Contractor X can allocate the cost of home office functions to Subsidiary A, provided such allocations meet the CAS 403 requirements.
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In the preceding question you learned that Wright Manufacturing Corporation has a home office and three divisions, one in California, one in Georgia, and one in Ohio. So far, they have accumulated $1,745,000 in their home office residual expense pool.
This table lists other expenses incurred by the home office.
| Other Home Office Expenses | Amount |
|---|---|
| State Income Tax for California | $200,000 |
| State Income Tax for Georgia | $50,000 |
| State Income Tax for Ohio | $100,000 |
| Payroll Processing | $700,000 |
| Home Office Occupancy Costs | $255,000 |
| Total Operating Revenue | $1,305,000 |
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Let’s continue with Wright Manufacturing Corporation’s home office residual expenses. As you learned in the preceding questions, after making all the direct and indirect allocations they can, they have accumulated $2,000,000 in their residual home office expense pool.
$1,745,000 executive office expenses + $255,000 home office occupancy cost = $2,000,000 residual home office expenses
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Recall that Wright Manufacturing Corporation’s residual home office expenses amounted to $2,000,000.
The following table reports their operating revenue from each segment, i.e., division.
| Wright Manufacturing Corporation’s Divisions | Operating Revenue |
|---|---|
| Segment A: Commercial Aircraft Division in Ohio | $20,000,000 |
| Segment B: Military Aircraft Division in Georgia | $20,000,000 |
| Segment C: Missile Division in California | $10,000,000 |
| Total Operating Revenue | $50,000,000 |
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Wright Manufacturing Corporation’s residual home office expenses exceeded the Cost Accounting Standard (CAS) 403 threshold; therefore, they need to use the three-factor formula to allocate residual expenses to each segment.
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That’s a lot of information! Let’s recap the main points before you proceed:
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