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.