ABC Corporation was a large multi product company with numerous U.S. Government
ID: 2765668 • Letter: A
Question
ABC Corporation was a large multi product company with numerous U.S. Government contracts. Their contracts were a mix of Cost type contracts and Fixed Price contracts. All of their contracts were subject to Cost Accounting Standards (CAS). Their Disclosure Statement had been approved as adequate and on file for several years. At the time in question, ABC Corp. was in midway complete on three large contracts – two Fixed Price, and one Cost Plus Incentive Fee. ABC was in the process of bidding on a large weapon system program which management believed was critical to its long term plans. The Government’s Request for Proposal specified that the resulting contract would be Fixed Price. Past history, and current Marketing G-2 told ABC that two of their competitors would have a price very close to that of ABC. They were seeking an edge in the competition. Mr. John Sharp, Deputy Assistant, Controller of AMC had information he felt was critical. He had been at a conference where the Government Procurement official who was in charge of this project spoke, and emphasized how important a low overhead rate was in keeping costs in control. Mr. Sharp convinced management to change ABC’s accounting system to lower its overhead. His suggestion was to take a large department that had previously been indirect, and make it a direct charge to contracts. This he argued would dramatically reduce the overhead rates for the firm. He did point out that overall costs would remain the same, but the overhead rate would be lowered.
Items the Company had to consider. Was the change possible in the face of a currently approved Disclosure Statement? Was it wise from a business standpoint? Would it have impacted other contracts in ABC’s portfolio? Would have it been legal?
Explanation / Answer
Ans;
To calculate the overhead rate, the overhead costs are divided by the direct costs. Tracking overhead rates will help establish trends and normalize exceptions that result from extra ordinary items or timing of monthly expenses. In this case the items to consider include: expenses like rent, utilities, office supplies and advertising among other indirect costs. Changing the above items from indirect to direct will cause a decline in the overhead rate.
The changes are not possible with an approved disclosure statement. When changes are made to the cost accounting practices with or without the knowledge of the government amendments to the disclosure statements are necessary. The statements are then resubmitted for approval.
It was wise from a business point of view as the overhead rate would reduce making it possible for ABC to get the contract. On the contrary, it would affect other contracts in ABC’s portfolio since this would have tampered with disclosure statement making it invalid and requiring re-approval.
Changing the cost accounting practice will require that the disclosure statement be amended and resubmitted for approval, failure to which the changes will be illegal.