Contractors often assume that government auditors have special authority to interpret the Cost Accounting Standards. That assumption is easy to understand — auditors frequently take the position that there is just one “right” way for a company to do its contract cost accounting, based on how other companies do things. But contractors should know that CAS is flexible and generally gives them options about how to comply, based on the circumstances of their business. In short, a contractor’s business judgment matters, and contractors can use it to push back on auditors who take an overly rigid view of CAS.
Government procurement officials and auditors have no special authority to say what CAS means, i.e., their interpretations of CAS receive no deference in a dispute. See Perry v. Martin Marietta Corp., 47 F.3d 1134, 1137 (Fed. Cir. 1995); Raytheon Co., Space & Airborne Sys., ASBCA No. 57801, 15-1 BCA ¶ 36024. Among other reasons, CAS was promulgated by the Cost Accounting Standards Board, a unique federal entity created by statute, and not by federal procurement officials or auditors.
By design, the plain language of CAS generally gives the contractor discretion to choose from a range of options for structuring its cost accounting practices. There are 19 standards under CAS, and each has built-in flexibility to allow contractors to choose cost accounting practices that align with the practical realities of their business. No two businesses are exactly alike, and the standards recognize that different companies will choose different approaches. Auditors often forget this aspect of CAS, and they may take a narrow view of what it means to comply. But contractors should always ask: Does the relevant CAS give me any choices, and if so, is the auditor thinking too rigidly about the standards?
Consider CAS 410, which provides rules for allocating the general & administrative expenses of running a business (“G&A”). CAS 410 requires a contractor to allocate G&A to a base that “best represents the total activity” of the business, and it sets out three options for achieving that goal: (1) a total cost input base, using all the costs of the business unit; (2) a value-added base, which excludes material and subcontract costs; and (3) a single element base, by which the contractor selects an equitable element for allocation, such as direct labor hours or dollars. See CAS 410-50(d).
CAS 410 makes clear that there is no “right” method, and that the answer depends on the facts of the business. It states that “[t]he determination of which cost input base best represents the total activity of a business unit must be judged on the basis of the circumstances of each business unit.” Id. The Armed Services Board of Contract Appeals (“ASBCA”) has confirmed that the “judgment” at issue is the contractor’s, not the government’s.
In a foundational decision on CAS 410, the ASBCA held that “[i]n our view, an analysis of which allocation base most accurately distributes G&A expense in relation to benefits received may, consistent with CAS 410, involve the application by the contractor of reasonable judgment.” Ford Aerospace and Commc’ns Corp., ASBCA No. 23833, 83-2 BCA ¶ 16813 (emphasis added).
Similarly, consider CAS 402, which provides that “[n]o final cost objective shall have allocated to it as an indirect cost any cost, if other costs incurred for the same purpose, in like circumstances, have been included as a direct cost of that or any other final cost objective.” CAS 402-40. While that standard may seem prescriptive, CAS 402-50(b) makes clear that the contractor has a wide measure of discretion to determine what costs are properly treated as “indirect,” so long as the contractor’s Disclosure Statement explains its practices and the contractor consistently applies the standard. See CAS 402-50(b). The U.S. Court of Appeals for the Federal Circuit has commented that “CAS 402 gives the contractor considerable freedom in the classification of particular costs[.]” ATK Thiokol, Inc. v. United States, 598 F.3d 1329, 1332 (Fed. Cir. 2010).
Virtually all of the CAS standards include similar flexibility. E.g., CAS 403-60 (providing a list of “illustrative allocation bases” for home office costs, “which could be used in appropriate circumstances”); CAS 406-20 (providing criteria for “selection” of a cost accounting period); CAS 418-20 (providing “guidance relating to the selection of allocation measures based on the beneficial or causal relationship between an indirect cost pool and cost objectives”).
So how can the flexibility of CAS help a contractor to navigate an audit or dispute? When faced with an auditor who views CAS as a matter of “right/wrong” or “yes/no,” a contractor should carefully review the CAS principle at issue to see if it provides the company any discretion. The contractor should also consider the CAS Board’s regulatory history for the standard, and may also want to review case law from the Boards of Contract Appeals and Federal Courts. The contractor should then look for ways to explain its choices to the auditor, including by sharing the reasons it selected a specific approach and how other approaches could be overly burdensome or could negatively impact the interests of the business or the government.
For example, is it impractical to treat certain parts/materials as a direct cost, considering how they are stored and used on the shop floor? Would a total cost input base fail to reflect the true relationship of G&A activity with the company’s business, considering how management spends its time and resources? Would the auditor’s G&A approach lead to volatile swings in cost allocation from year to year? Depending on the answers, these practical points can back up a contractor’s choices and help justify them under CAS. A contractor may also want to demonstrate that its accounting practices are described in its internal policies and (if applicable) in its CAS Disclosure Statement. Advance written descriptions of accounting policies can also go a long way toward helping support a company’s practice.