Let’s explore CAS 420—Accounting for Independent Research and Development Costs and Bid and Proposal Costs. Select Start to begin!
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 assignment of cost and the reassignment of a share from an indirect cost pool.
Bid and Proposal (B&P) Cost
The cost incurred in preparing, submitting, or supporting any bid or proposal which effort is neither sponsored by a grant, nor required in the performance of a contract.
Business Unit
Any segment of an organization, or an entire business organization which is not divided into segments.
General and Administrative (G&A) Expenses
Any management, financial, and other expense which is incurred by or allocated to a business unit and which is for the general management and administration of the business unit as a whole. G&A expense does not include those management expenses whose beneficial or causal relationship to cost objectives can be more directly measured by a base other than a cost input base representing the total activity of a business unit during a cost accounting period.
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.
Independent Research and Development (IR&D) Cost
The cost of effort which is neither sponsored by a grant, nor required in the performance of a contract, and which falls within any of the following three areas: (i) basic and applied research, (ii) development, and (iii) systems and other concept formulation studies.
Indirect Cost
Any cost not directly identified with a single final cost objective, but identified with two or more final cost objectives or with at least one intermediate cost objective.
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.
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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 420, 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 420.
After you have finished reading, we’ll review key points throughout the rest of the topic.
CAS 420
Independent Research and development Costs
Bid and Proposal Costs
As Oliver continues: "Since they are the focus of CAS 420, let's begin by defining IR&D and B&P costs. IR&D stands for Independent Research and Development, and B&P stands for Bid and Proposal," the two acronyms are added behind each key term: (IR&D) and (B&P) on the whiteboard.
Oliver says: "IR&D cost refers to the cost of the contractor's research efforts: basic and applied research, development, or systems and other concept formulation studies, that is not sponsored by a grant nor required under a contract." To reinforce this key point, the classic nonsmoking symbol (red circle with diagonal slash running through it) appears over the words Grant or Contract, which is added to the whiteboard, next to Independent Research and development Costs (IR&D).
At this point, everything that had been on the whiteboard disappears and is replaced with an image of a gasoline powered motor as Oliver goes on to say: "For example, a defense contractor has provided gasoline powered vehicles to the Government for decades." As Oliver continues: "This contractor decides to dedicate several millions of dollars to researching electric powered motors," the image of the gasoline powered motor is replaced on-screen with an image of an electric motor. Oliver goes on to say: "If this research is successful, it will benefit each of the company's five segments." At this point, a diagram showing the company's five segments appears beneath the electric motor with the connecting lines and borders around each segment changing to yellow for emphasis. Segments 1, 2, and 3 are on the top row. Segment 3 is labeled Intermediate Home Office, and it branches down to two segments beneath it: Segments 4 and 5.
As Oliver goes on to say: "In this case, CAS 420 requires the contractor to allocate the IR&D costs to all five segments in the company," an image of currency and coins appears to be flowing from the electric motor to each of the five segments.
At this point, the whiteboard text reverts back to CAS 420 at the top, above Independent Research and Development Costs (IR&D), which is above Bid and Proposal Costs (B&P) on the whiteboard along with the nonsmoking circle and slash over Grant or Contract that is beside Independent Research and Development Costs (IR&D), initially. As Oliver explains: "B&P costs are the costs the contractor incurs when preparing, submitting, or supporting any bid or proposal that is not sponsored by a grant nor required under a contract," the nonsmoking circle and slash over Grant or Contract slides down so it is next to Bid and Proposal Costs on the whiteboard.
Next, everything is deleted from the whiteboard, and then multiple images of currency and coins appear on the whiteboard as Oliver says: "For example, let's say a defense contractor spends hundreds of thousands of dollars preparing a proposal to respond to the Government's request for proposal to develop an underwater remote robot." At this point, the currency and coins are replaced with an image that represents the contractor's proposal and an underwater remote robot, named ABYSS.
As Oliver goes on to explain: "If the contractor wins this proposal, it should benefit three of the company's five segments," the diagram showing the five segments reappears beneath the proposal and ABYSS underwater remote robot, but only Segments 1, 2 and 3 (Intermediate Home Office) are emphasized with connecting lines and segment borders that turn yellow (for emphasis). Oliver concludes with: "In this case, CAS 420 requires the contractor to allocate the B&P costs to the three segments that will benefit from those costs."
Now that we’ve defined and provided examples of IR&D and B&P costs, let’s get into some of the most important requirements of CAS 420.
CAS 420 requires contractors to track and accumulate IR&D and B&P costs as separate, individual cost pools with an independent, internal project code assigned to each IR&D and B&P project. Contractors are required to charge direct costs; overhead costs, such as material overhead and labor overhead; and other indirect costs to their IR&D and B&P projects—with one big exception.
CAS 420 specifically prohibits charging general and administrative expenses to IR&D and B&P projects.
Consistency
Now that you know the purpose of CAS 420, let’s explore the CAS 420 rules for allocating IR&D and B&P costs. Please pay close attention as you progress through this topic because some of these CAS 420 rules may seem, at first, to contradict earlier CAS 420 rules.
In the introduction, you learned that contractors allocate direct costs and indirect costs to their independent research and development (IR&D) and bid and proposal (B&P) projects, with the important exception of general and administrative (G&A) expenses.
CAS 420 requires consistent accounting practices. This applies to the contractor’s handling of direct costs and indirect costs.
Consistency
Now that you know the purpose of CAS 420, let’s explore the CAS 420 rules for allocating IR&D and B&P costs. Please pay close attention as you progress through this topic because some of these CAS 420 rules may seem, at first, to contradict earlier CAS 420 rules.
In the introduction, you learned that contractors allocate direct costs and indirect costs to their independent research and development (IR&D) and bid and proposal (B&P) projects, with the important exception of general and administrative (G&A) expenses.
CAS 420 requires consistent accounting practices. This applies to the contractor’s handling of direct costs and indirect costs.
Direct Costs
If a contractor’s practice is to charge a cost as a direct cost when it is being allocated to a final cost objective, then that same cost must be charged as a direct cost when it is being allocated to an IR&D or B&P project.
The specific CAS wording is: “The project costs shall include costs, which if incurred in like circumstances for a final cost objective, would be treated as direct costs of that final cost objective.” [48 CFR 9904.420-50(a)(1)]
Example
For example, Business Unit A’s engineering department has an established accounting practice of charging clerical typing efforts directly to the final cost objectives they support.
When submitting a proposal, the engineering department assigned several typists to the project and charged their time to the overhead cost pool.
Because the engineering department did not adhere to their established accounting practice, this practice does not comply with CAS 420. They need to charge the typists’ time directly to the proposal project, to be consistent with their accounting practices when charging to final cost objectives.
Indirect Costs
Along with direct costs, IR&D and B&P project costs must include an allocation of overhead costs of productive activities and other indirect costs related to the project, based on the contractor’s cost accounting practice or applicable Cost Accounting Standard for allocation of indirect costs. [48 CFR 9904.420-50(a)(2)]
In other words, when charging indirect costs to their final cost objectives, e.g., Government contracts and their IR&D and B&P projects, the contractor must follow the same practices.
For example, if a contractor allocates labor overhead charges to its contracts over a base of labor hours, then labor overhead charges being allocated to their IR&D and B&P projects must also be allocated over the same base—labor hours.
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Check your knowledge by answering the following multiple choice question.
Select the best answer and then select Submit.
A contractor has a policy that any travel that can be identified specifically to a contract is charged as a direct cost to that contract. However, for bid and proposal (B&P) and independent research and development (IR&D) costs, all travel is charged as an indirect cost.
Check your knowledge by answering the following multiple choice question.
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A contractor maintains a labor overhead pool with a base of direct labor dollars. During the fiscal year, the contractor incurs the following direct labor dollars.
| Cost Objective | Direct Labor Dollars |
|---|---|
| Contract A | $100,000 |
| Contract B | $200,000 |
| Contract C | $200,000 |
| Bid and Proposal (B&P) Projects | $50,000 |
| Independent Research and Development (IR&D) Projects | $25,000 |
What happens when a contractor incurs IR&D or B&P costs that are negligible? Does the contractor have to go to the trouble of setting up an individual, internal project to track the costs of each of these negligible efforts individually in order to get reimbursed from the Government?
The answer is no. When the cost of individual IR&D or B&P efforts are not material in amount, these costs may be accumulated in one or more project(s) within each of these two types of effort.
[48 CFR 9904.420-50(c)]
View Professor Oliver's tips below for an important warning.
Now, be careful here. The contractor cannot combine these into a single project. There must be one or more projects to capture all the immaterial IR&D efforts and one or more projects to capture all the immaterial B&P efforts.
Check your knowledge by answering the following multiple choice question.
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The contractor has an established policy of accumulating bid and proposal (B&P) costs by project if the project is anticipated to cost more than $2,000. The costs of all B&P projects that are anticipated to cost less than $2,000 are accumulated in a single B&P project account.
Check your knowledge by answering the following multiple choice question.
Select the best answer and then select Submit.
The contractor has an established policy of accumulating bid and proposal (B&P) and independent research and development (IR&D) costs by project if the project is anticipated to cost more than $2,000. The costs of all B&P and IR&D projects that are anticipated to cost less than $2,000 are accumulated in a single project account. The single project account includes both the B&P and IR&D projects that are anticipated to be less than $2,000.
Requirement
At the beginning of this topic, you learned that general and administrative expenses cannot be allocated to IR&D and B&P projects.
CAS 420 includes one exception. When one segment performs work for another segment, if the work performed is not part of an IR&D or B&P project, that is to say, if the work is part of the performing segment’s normal production, then the performing segment should charge all allocable direct and indirect costs, including G&A costs to the receiving segment for the work they performed.
Requirement
At the beginning of this topic, you learned that general and administrative expenses cannot be allocated to IR&D and B&P projects.
CAS 420 includes one exception. When one segment performs work for another segment, if the work performed is not part of an IR&D or B&P project, that is to say, if the work is part of the performing segment’s normal production, then the performing segment should charge all allocable direct and indirect costs, including G&A costs to the receiving segment for the work they performed.
Example
For example, Segment 1 has an IR&D project to develop a prototype for an unmanned aerial vehicle (UAV). Segment 2 provides the navigation system for the prototype and charges Segment 1 all associated direct and indirect costs, including G&A expenses.
Producing navigation systems is part of Segment 2’s normal production. Segment 2 did not have to conduct any research. They provided an existing navigation system that they have been producing for other contracts.
Therefore, in this case, in order to comply with CAS 420, the costs charged by Segment 2 to Segment 1 for the navigation system must include G&A costs. Segment 2’s costs should not be treated as an IR&D or B&P project.
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The crucial question to ask is: “Is the work performed by the performing segment part of their normal production?” If it is, then the performing segment must charge all allocable costs, including G&A expenses to the receiving segment.
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Segment T has an independent research and development (IR&D) project to develop a prototype for a new vehicle. As part of the project, Segment S provides Segment T with wheels and axles that are used on an existing production vehicle for developing the prototype vehicle. Segment S charges Segment T $15,000, which includes the direct labor, overhead, and material costs of the wheels and axles. Segment S classifies the wheels and axles as an IR&D project and, therefore, does not add general and administrative (G&A) expenses to the cost.
No G&A Expense
You just learned the one exception—when G&A expenses must be charged—is when one segment performs work for another segment and that work is part of the performing segment’s normal production; it is not part of the performing segment’s IR&D or B&P projects.
Now let’s talk about what happens when the work done by the performing segment is part of an IR&D or B&P project of the performing segment. In this case, in accordance with CAS 420, the performing segment transfers the cost of the work to the home office to be allocated in accordance with CAS 420, and G&A expenses are not charged.
Note. G&A costs are not included, in this case.
No G&A Expense
You just learned the one exception—when G&A expenses must be charged—is when one segment performs work for another segment and that work is part of the performing segment’s normal production; it is not part of the performing segment’s IR&D or B&P projects.
Now let’s talk about what happens when the work done by the performing segment is part of an IR&D or B&P project of the performing segment. In this case, in accordance with CAS 420, the performing segment transfers the cost of the work to the home office to be allocated in accordance with CAS 420, and G&A expenses are not charged.
Note. G&A costs are not included, in this case.
Requirements
When work performed by one segment for another segment is part of an IR&D or B&P project of the performing segment, the costs of that work must be transferred to the home office and allocated in accordance with the requirements of this standard for allocation of home office costs.
[48 CFR 9904.420-50(d)]
However, the costs may be directly allocated to the receiving segments if such an allocation does not provide a substantially different result than would be made if the costs were first passed through the home office accounts.
[48 CFR 9904.420-50(g)]
Example
For example, Segment A has an IR&D project to develop a prototype for an unmanned aerial vehicle (UAV). Segment C designs and develops the ground control station for the UAV. The work in Segment C meets the definition of IR&D. Segment C incurs $75,000 in costs, not including G&A expenses.
Now, at this point, the contractor has two options:
The final result will be the same, so, in accordance with CAS 420, both of these options are acceptable. Both are compliant.
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Segment Z has an independent research and development (IR&D) project to develop a prototype for a new weapon. The firing mechanism is being developed by Segment Y. The work in Segment Y meets the definition of IR&D. Segment Y incurs $50,000 of IR&D costs for the firing mechanism. Segment Y directly allocates the $50,000 to Segment Z. The costs are not transferred to the home office.
Based on the contractor’s established practices for allocating home office IR&D costs to segments, if the costs had been transferred to the home office, Segment Z would have received a $50,000 direct allocation from the home office for Segment Y’s participation in the project.
Direct Costs
Now let’s turn our attention to IR&D and B&P cost pools at the home office. CAS 420 requires IR&D and B&P cost pools at the home office to be allocated to the segments based on the beneficial or causal relationship between the IR&D and B&P costs and the segments reporting to that home office.
IR&D and B&P cost pools for a segment consist of the project costs plus allocable home office IR&D and B&P costs. And, to be clear, G&A expenses are not allocable to IR&D and B&P projects.
Remember the allocation hierarchy, direct allocations come first. When a project can be identified with a specific segment or segments, then CAS 420 requires the contractor to allocate those home office IR&D or B&P costs directly to those segments.
Direct Costs
Now let’s turn our attention to IR&D and B&P cost pools at the home office. CAS 420 requires IR&D and B&P cost pools at the home office to be allocated to the segments based on the beneficial or causal relationship between the IR&D and B&P costs and the segments reporting to that home office.
IR&D and B&P cost pools for a segment consist of the project costs plus allocable home office IR&D and B&P costs. And, to be clear, G&A expenses are not allocable to IR&D and B&P projects.
Remember the allocation hierarchy, direct allocations come first. When a project can be identified with a specific segment or segments, then CAS 420 requires the contractor to allocate those home office IR&D or B&P costs directly to those segments.
Requirements
The specific CAS wording is: “When the costs of IR&D and B&P projects are accumulated at a home office, any projects that can be identified to specific segments must have their costs allocated to such segments.”
[48 CFR 9904.420-50(e)(1)]
Example
For example, the contractor accumulated $20,000 B&P costs for Contract Proposal A at the home office. All the significant work in this proposal will be performed in Segment 3; therefore, in accordance with CAS 420, the contractor allocates the $20,000 B&P costs for Contract Proposal A directly to Segment 3.
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Indirect Costs
Once all the direct allocations have been made, CAS 420 specifies that the remaining home office IR&D and B&P costs must be allocated among the segments using the same base that is used to allocate home office residual expenses to the segments.
Recall that earlier you learned that CAS 403 specifies that if the CAS 403 threshold is met, then the contractor must use the three-factor formula to allocate residual home office expenses among all the segments. If the CAS 403 threshold is not met, then the contractor must use a representative base to allocate the residual home office expenses among all the segments.
Indirect Costs
Once all the direct allocations have been made, CAS 420 specifies that the remaining home office IR&D and B&P costs must be allocated among the segments using the same base that is used to allocate home office residual expenses to the segments.
Recall that earlier you learned that CAS 403 specifies that if the CAS 403 threshold is met, then the contractor must use the three-factor formula to allocate residual home office expenses among all the segments. If the CAS 403 threshold is not met, then the contractor must use a representative base to allocate the residual home office expenses among all the segments.
Requirements
The specific CAS wording is: “When the costs are accumulated at the home office, the cost of B&P and IR&D projects that cannot be identified to a specific segment must be allocated among all segments by means of the same base used by the company to allocate residual expenses under CAS 403, unless a special allocation is warranted.”
[48 CFR 9904.420-50(e)(2)]
Example
This is a continuation of the example on the preceding page. Recall that the contractor accumulated $20,000 B&P costs for Contract Proposal A at the home office. All the significant work in this proposal will be performed in Segment 3; therefore, in accordance with CAS 420, the contractor allocates the $20,000 B&P costs for Contract Proposal A directly to Segment 3.
What about the remaining IR&D and B&P costs that cannot be identified with one or more segments directly?
In that case, CAS 420 requires the contractor to allocate those remaining costs to all the segments using the same base that is used to allocate residual home office expenses, in accordance with CAS 403.
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Check your knowledge by answering the following multiple choice question.
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Segment A incurs the following independent research and development (IR&D) and bid and proposal (B&P) costs during the fiscal year.
Segment A:
| Element | IR&D Projects | B&P Projects |
|---|---|---|
| Direct Labor | $50,000 | $30,000 |
| Labor Overhead | $25,000 | $15,000 |
| Direct Material | $15,000 | $10,000 |
| Allocation from Corporate Home Office | $15,000 | $5,000 |
Check your knowledge by answering the following multiple select question.
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The contractor accumulated the following bid and proposal (B&P) costs at the home office.
| Element | B&P Projects |
|---|---|
| Contract Proposal 1: All significant work to be performed in Segment T. | $50,000 |
| Contract Proposal 2: All significant work to be performed in Segment Q. | $40,000 |
| Contract Proposal 3: Work not identified to any particular segment. | $100,000 |
| Contract Proposal 4: Work not identified to any particular segment. | $90,000 |
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Select the icon for the Knowledge Check details, and then rely on those details as you answer the following questions.
Requirement
The next CAS 420 requirement we’re going to examine is related to allocating the costs of IR&D and B&P projects that have been accumulated at the business unit and benefit the cost objectives of that business unit.
In this case, CAS 420 says these costs must be allocated to the business unit’s cost objectives using the same base that is used to allocate general and administrative expenses under CAS 410.
[48 CFR 9904.420-50(f)(2)]
Requirement
The next CAS 420 requirement we’re going to examine is related to allocating the costs of IR&D and B&P projects that have been accumulated at the business unit and benefit the cost objectives of that business unit.
In this case, CAS 420 says these costs must be allocated to the business unit’s cost objectives using the same base that is used to allocate general and administrative expenses under CAS 410.
[48 CFR 9904.420-50(f)(2)]
Three Bases
Recall that CAS 410 requires either the TCI base, value-added base, or single-element base to allocate G&A expenses. The base that is used is the one that best represents the total activity of a typical cost accounting period.
The contractor must be consistent. If they use the value-added base to allocate G&A expenses, then that contractor must use the value-added base to allocate IR&D and B&P costs to the business unit’s final cost objectives.
Example
The business unit in this example allocates their G&A expenses using a value-added base. Therefore, in accordance with CAS 420, the contractor will use the value-added base to allocate business unit IR&D and B&P costs to the contracts.
In this example, we’ll focus on Contract P. The first step is to divide Contract P’s value-added costs by the total value-added costs of the business unit, to get the percentage for Contract P.
$2,000,000 Contract P’s Value-Added Costs / $20,000,000 Total Valued Added Costs for the Business Unit = 10% Contract P’s % of Total Value-Added Costs
Question
In the preceding tab, the contractor determined that Contract P’s percentage of the total value-added costs of the business unit was 10%.
10% x $900,000 total IR&D and B&P costs = $90,000 allocation to Contract P for IR&D and B&P costs.
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 select question.
Select all that apply and then select Submit.
Select the icon for the Knowledge Check details, and then rely on those details as you answer the following questions.
Check your knowledge by answering the following multiple select question.
Select all that apply and then select Submit.
Select the icon for the Knowledge Check details, and then rely on those details as you answer the following questions.
The final requirement we’re going to examine is one you’ve encountered in other topics—special allocations.
When are special allocations of IR&D and B&P costs warranted?
CAS 420 says a special allocation is warranted when a particular segment receives significantly more or less benefit from the IR&D or B&P costs than would be reflected by the allocation of such costs to the segment using the base required by CAS 403.
When a special allocation is warranted, the contractor must do two things:
The amount of the special allocation must be excluded from the IR&D or B&P home office cost allocation pool before allocating that pool to the other segments.
The base data of the segment receiving the special allocation must be excluded from the base used to allocate the home office IR&D or B&P costs to the other segments.
[48 CFR 9904.420-50(e)(2)]
Check your knowledge by answering the following multiple choice question.
Select the best answer and then select Submit.
A contractor accumulates the costs of independent research and development (IR&D) projects that benefit more than one segment of the company at the home office. The contractor has five segments. Four of these segments are involved in communications related businesses. The fifth segment, Segment M, performs mostly janitorial services with a small amount of communication related services. The contractor and the Government agree that the fifth segment does not benefit from any of the IR&D projects performed by the home office.
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A contractor business unit has $2 billion in sales and 200 contracts. The contractor uses a total cost input (TCI) base that complies with the requirements of CAS 410. On January 1, the contractor is awarded a $900 million contract. The contract requires the contractor to use a large amount of equipment, which will constitute $650 million of the total contract cost. The contractor does not normally use this type of equipment when they perform contract work, and they plan to lease the equipment. The Government and the contractor enter into an advance agreement that provides for a special allocation of bid and proposal (B&P) and independent research and development (IR&D) costs to the $900 million contract.
The following questions have been designed to reinforce key requirements of Cost Accounting Standard (CAS) 420 on allocating independent research and development (IR&D) and bid and proposal (B&P) project costs.
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Contractor H has 2,000 employees. The contractor has one overhead pool and one general and administrative (G&A) pool. The allocation base for the overhead pool is direct labor costs. The allocation base for the G&A pool is total cost input (TCI). A summary of costs for the fiscal year are as follows.
Contractor H:
| Cost Element | Amount |
|---|---|
| Direct Labor Contracts (excludes direct labor for IR&D and B&P projects) | $11,700,000 |
| Overhead | $4,000,000 |
| G&A (excludes B&P and IR&D costs) | $1,000,000 |
| Direct Labor for IR&D and B&P projects | $800,000 |
Check your knowledge by answering the following multiple choice question.
Select the best answer and then select Submit.
Let’s continue with the preceding challenge. Contractor H has 2,000 employees. The contractor has one overhead pool and one general and administrative (G&A) pool. The allocation base for the overhead pool is direct labor costs. The allocation base for the G&A pool is total cost input (TCI). A summary of costs for the fiscal year are as follows.
Contractor H:
| Cost Element | Amount |
|---|---|
| Direct Labor Contracts (excludes direct labor for IR&D and B&P projects) | $11,700,000 |
| Overhead | $4,000,000 |
| G&A (excludes B&P and IR&D costs) | $1,000,000 |
| Direct Labor for IR&D and B&P projects | $800,000 |
| Labor Overhead Rate | 32% |
That’s a lot of information! Let’s recap the main points before you proceed:
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