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CAPITAL EDGE NEWS
JANUARY 2013
Changing a Cost Accounting Practice
 
There comes a time in every business when it becomes necessary (or desirable) to change a cost accounting practice. It may have been acceptable at one point in your cost accounting to simply allocate engineering effort as a component of the manufacturing overhead cost pool due to the direct relationship between engineering effort and production. Over time, however, customers started to purchase engineering services as a stand-alone product. Consequently, the old relationship between engineering and manufacturing no longer held true. 
 
If customer demand for stand-alone engineering services represents a fundamental shift in the company's product mix - selling both products and engineering services - it may be necessary to make a change in a cost accounting practice. For this example, the change might be to create a separate engineering overhead rate to allocate engineering indirect costs to final cost objectives using an allocation base made up of engineering direct labor.
 
Regardless of what triggers the need for modifications to a cost accounting practice, management must carefully think through how to accomplish that change. Failing to think through the transition could be a very costly mistake. The key is understanding how the change will affect cost allocations on existing contracts containing the cost accounting standards clause. The cost accounting standards clause entitles the customer to contract price adjustments for certain modifications.The objective is to ensure the change will not trigger price adjustments resulting in the company paying back money to the customer. 
It is hard enough to earn money in the contracting world without management coming up with a scheme to give some of that hard-earned money back to the customer.

The simplest way to ensure there will be no adverse cost impact due to a modification is to schedule the change(s) to occur over time. The illustration below shows one example of how to make the cost accounting transition. In this case, a company is moving from one manufacturing overhead pool to a manufacturing and engineering overhead pool. By employing this technique, there is literally no risk of having to give money back to the customer because there simply is no cost impact.


 
When considering a change to a cost accounting practice, try to take your time - do not make the change without considering the cost impact and develop and execute a strategy to avoid giving money back to customers.

Before making any changes to a cost accounting practice:
1. Make sure the cost accounting change addresses a fundamental shift in your business - and is not simply a market driven reaction to a single contract opportunity.
2. Determine the financial results of the change at a macro level to get a sense of the impact on contracts subject to cost accounting standards (make sure you understand the difference between full CAS coverage vs. modified CAS coverage and which applies to what contract - it can make a tremendous difference in the dollars involved).
3. Determine a transition strategy keeping in mind that, as a rule, if you give a customer the opportunity to ask for money back, they will want some.
4. Try to rationally "bid" in any changes to avoid or at least minimize the potential cost impact.
5. Avoid making a change in the middle of a fiscal year - it can get messy and expensive.
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