Because there are so many variables on construction projects that are not within a contractors’ control, maintaining consistency for the variables that are within the contractors’ control can play a critical role in a project’s success. Two elements within a contractors’ control are bidding, estimating, and budgeting costs, as well as accumulating, allocating, and recording costs. Consistency with estimating and cost accounting can allow for easy adaptation to varying contract requirements. This article discusses the two most relevant cost accounting standards (CAS) for consistency in estimating, accumulating, reporting, and allocating costs, and provides two theoretical examples to demonstrate the implications of incorporating the standards as a general business practice versus not.
Background — CASB And CAS 401 And 402
The Cost Accounting Standards Board (CASB) was established in 1970. The board developed “standards for use in the pricing, administration, and settlement of all negotiated defense contracts and subcontracts of the United States in excess of $100,000 …The objectives of the CASB were six-fold: uniformity, consistency, allocability and allowability, fairness, materiality, and verifiability … The board issued 19 cost accounting standards: CAS 401-418 and CAS 420. The board’s primary objectives of increasing uniformity of accounting practices among government contractors and consistency in the use of accounting practices over time by individual contractors were substantially achieved.”[1] Although the original CASB was dissolved in 1980, the standards, rules, and regulations remain in effect today, with updates most recently effective in December 2011.
The 19 Cost Accounting Standards were initially established for large government contractors to assist with concerns relating to cost estimating, cost accumulating and cost reporting. However, the principals, similar to the guidance the Federal Acquisition Regulations (FARs) may provide, have some general application to all contractors and can assist with mitigating issues related to claims or requests for additional compensation. The two specific Cost Accounting Standards discussed in this article are below.
CAS 401 – Consistency in Estimating, Accumulating and Reporting Costs
The purpose of this Cost Accounting Standard is to ensure that each contractor’s practices used in estimating costs for a proposal are consistent with cost accounting practices used by him in accumulating and reporting costs. Consistency in the application of cost accounting practices is necessary to enhance the likelihood that comparable transactions are treated alike. With respect to individual contracts, the consistent application of cost accounting practices will facilitate the preparation of reliable cost estimates used in pricing a proposal and their comparison with the costs of performance of the resulting contract. Such comparisons provide one important basis for financial control over costs during contract performance and aid in establishing accountability for cost in the manner agreed to by both parties at the time of contracting. The comparisons also provide an improved basis for evaluating estimating capabilities.[2]
In a nutshell, the purpose of CAS 401 is to ensure that the contractors’ methodology for estimating costs used in his/her proposals is consistent with the contractors’ methodology for recording and accumulating costs.
Labor rates provide a good point of discussion, as there are multiple methodologies for bidding, estimating, budgeting, and recording labor costs. There can be forward-priced labor rates, actual “cost” labor rates, standard billing labor rates, recording base wages at actual cost, plus payroll taxes and fringe benefits at a flat burden percentage, and a variety of other methods for pricing labor costs. There are a number of valid reasons why one methodology may be better than another in any given set of circumstances. The key is to ensure consistency between the method in which the labor costs are estimated versus how they’re recorded. It should be noted, however, that even if a contractor uses a standard set of labor rates for estimating all projects but then records labor costs based on “actual” costs, the methodology can still be a consistent one.
Consistency is achieved by ensuring that the same types of cost components are included in both sets of labor rates and to understand the differences at the onset of the project (i.e., actual costs are not known at the time of the estimate, and therefore standard rates are a “proxy” for actual costs). So, for example, if the bid or estimated labor rates do not include general liability insurance, and the fee percentage is intended to recover general liability insurance, then the actual labor rates recorded to the project should likewise not include general liability insurance, and all other labor rate components should be consistent. This is where the “apples to apples” comparison becomes relevant, meaning that like labor costs in the budget can be compared to like labor costs that are recorded.
Going one step further, maintaining consistency is not only beneficial for an “apples to apples” comparison from the bid/estimate/budget to the cost side, but maintaining consistency across projects can also be internally beneficial. If project personnel, project accounting, and other stakeholders are all using the same methodology for bidding/estimating/budgeting and recording costs, when a new type of project opportunity arises that may call for an alternate pricing methodology, all the key players can quickly and easily adapt to the new requirements without first having to figure out the current methodology.
CAS 402 – Consistency in Allocating Costs Incurred for the Same Purpose
The purpose of this standard is to require that each type of cost is allocated only once and on only one basis to any contract or other cost objective. The criteria for determining the allocation of costs to a product, contract, or other cost objective should be the same for all similar objectives. Adherence to these cost accounting concepts is necessary to guard against the overcharging of some cost objectives and to prevent double counting. Double counting occurs most commonly when cost items are allocated directly to a cost objective without eliminating like cost items from indirect cost pools which are allocated to that cost objective.[3]
In summary, the purpose of CAS 402 is to ensure costs are allocated on only one basis and allocated only once to a contract.
As an example, contractors may choose whether to recover certain types of costs as direct costs or components of the fee or overhead markup. Some of these types of costs include: project management, equipment on site, various types of insurance, project accounting personnel, and miscellaneous indirect costs, such as job site parking, etc. This cost accounting standard attempts to remove potential double counting. For example, computer equipment and software could be part of an overhead markup pool of costs or could also be charged to a project directly. Consider the example where a particular contractor does not have a standard, consistent methodology for cost recording or allocation of these types of costs. On the first of two projects, there is a contractual requirement to exclude these types of costs from direct project costs. As such, the project management and accounting personnel record laptop purchases and purchases of project-specific software to an overhead account. However, on the second project, since the useful life for laptops is expected to expire over the life of the project, and since the software purchased for the second project cannot be used on any other projects, the project management and accounting personnel on the second project record laptop purchases and software as direct project costs. After each accounting period, overhead costs for the company are accumulated and allocated back to projects; thus, the second project has both directly recorded costs for the project’s laptop and software purchases but also incurs an allocated cost amount for the first project’s laptops and software. This can obviously make for challenging comparisons across projects and incorrectly overstates the costs of the second project.
Although not specifically addressed in this article, CAS 418 (Allocation of Direct and Indirect Costs) and CAS 402 as discussed above may also be helpful references.
Benefits Of Consistency
Following CAS 401 and 402 has benefits to contractors and subcontractors regardless of the type of contractor, type of contract, type of project or size of the project. The following lists some of these benefits:
- More reliable cost estimating and bidding, leading to better proposals and more reliability in estimating projects
- Reliable comparisons of costs incurred to estimated costs
- Consistent indirect cost allocations and profitability measures
- Higher degree of reliance on accounting and estimating systems
- Consistency between contracts and incurred costs, resulting in more efficient and better project audits
- Easier change order negotiations
- More streamlined process for conformity with contract requirements for pricing claims and requests for equitable adjustment[4]
- Minimizing double-counting between direct and indirect costs
- Consistency with the contract terms from the project outset
- Better coordination within the accounting staff and project team; projects will be set up so that they are estimated and recorded consistently
- Increased transparency for attaining internal incentives based on project profitability
- More accurate comparisons between projects in order to understand what projects are most profitable for the company
Examples
Example No. 1:
In this example, the contractor chose to estimate, budget, and record categories of project management as a direct project cost. The contractor estimated, budgeted and recorded several categories of project management in the general conditions phase codes, such as project manager, assistant project manager, project engineer, and superintendent. As the project progressed, because the recorded cost system was in place to track and compare the costs to the budgets on a consistent basis, it became clear that project management costs would exceed the budget at project completion. The contractor summarized and identified these issues contemporaneously and held discussions with the owner that resulted in contemporaneous agreement of the assignment of responsibility for certain of the identified factors. The owner reviewed the recorded costs in contrast to the original estimate and determined where costs ran over (another person was added, more time was expended, etc.).
Conversely, the contractor could have chosen to recover certain project management personnel costs, such as the project manager and assistant project manager, in the markup, and could have chosen not to estimate or budget project manager and assistant project manager costs. If the contractor did not have a consistent standard business practice for how costs should be estimated and recorded, perhaps the project management and accounting personnel could have chosen to record project management costs directly. In this scenario, the contractor may not contemporaneously be aware that the project management costs had overrun the planned amount. If there were issues that the owner and contractor identified, such as a compensable owner time delay, the contractor may not readily have the budgeted, recorded and/or associated cost overrun data available for review. In this scenario, the contractor may be required to reallocate a portion of the fee related to project management, to create a budget against which the recorded costs could be compared. This results in an estimated project management cost “overrun,” at best.
Example No. 2
This example focuses on a contractor’s methodology for estimating, budgeting, and recording company owned equipment. In this scenario, the contractor had a set of standard blended owned equipment estimating rates that had been established in the past and used for estimating all the contractor’s projects for several years. The contract was a general contractor/construction manager (GC/CM) contract that specified the contractor would be reimbursed on an actual cost basis, though the contract did not specify how costs for owned equipment would be determined. For the purpose of recording owned equipment costs to the project, the contractor relied on a separate set of owned equipment rates by piece of equipment that had been obtained from a third-party rental equipment supplier. The third-party rental equipment rates, by default, included components for profit and overhead.
At the end of the project, the contractor had a claim for increased costs due to what the contractor considered to be unforeseen increased scope. A large piece of the claimed cost amounts related to company owned equipment. The bid documents were escrowed, and the owner had access to the originally estimated equipment costs and rates. The owner compared the claimed owned equipment rates, which matched the recorded cost owned equipment rates, to the originally estimated owned equipment rates. The claimed owned equipment rates were higher than the estimated rates. Per the contract, a disputes review board was convened to review the claim. The owner put forth a summary of the analysis performed that resulted in a significant deduction to the claimed owned equipment amount. However, in addition, the owner pointed out that the contractor knowingly claimed owned equipment rates that were not based on actual costs, and also used the inconsistency as a stronghold to call into question the veracity of the remaining claim cost amounts. Ultimately the contractor settled for a reduced claim amount. Had the contractor recorded and claimed owned equipment consistent with the contract, basing their equipment on actual costs, they may have not had to accept a lower settlement offer and not had the veracity of their overall claim and costs called into question.
Conclusion
© Copyright 2019. The views expressed herein are those of the author(s) and not necessarily the views of Ankura Consulting Group, LLC., its management, its subsidiaries, its affiliates, or its other professionals. Ankura is not a law firm and cannot provide legal advice.
[1] History of Accounting: An International Encyclopedia, edited by Michael Chatfield and Richard Vangermeersch. New York: Garland Publishing, 1996, pp. 178-180.
[2] US Government Publishing Office Electronic Code of Federal Regulations (e-CFR): Title 48, Chapter 99, Subchapter B, Part 9904.401-20.
[3] US Government Publishing Office Electronic Code of Federal Regulations (e-CFR): Title 48, Chapter 99, Subchapter B, Part 9904.402-20.
[4] Of note, contractual requirements for pricing change orders, claims, and requests for equitable adjustment may not always be consistent with a contractor’s chosen methodology for estimating and recording project costs. However, if a contractor is consistent internally, it will be easier for the contractor to use contemporaneous project data for accurately adapting pricing to the contract requirements. As an example, if the contract allows for a defined labor rate for certain personnel, this may or may not be consistent with how the costs are recorded, but the contract takes precedence. This does not detract from the benefits of being internally consistent between estimating and accumulating costs.
