5.1 INTRODUCTION

5.1.1 General. The contractor's accounting system must provide for adequately recording all direct and indirect costs applicable to the contract. Such costs must be directly summarised from the level at which they are applied to the contract through both the CWBS and functional organisation structures according to procedures acceptable to Defence.

5.1.2 Cost Accounts. Ordinarily, cost accounts are established by the contractor at the lowest level in the CWBS at which actual costs are recorded and compared with budgeted costs. As the natural control point for Cost Schedule planning and control, the cost account provides a logical point for cost collection and evaluation.

5.1.3 Direct Cost Accounting. The Criteria require the contractor to record direct costs on an applied or other acceptable basis for performance measurement and unit costing purposes. Direct labour costs are normally applied to work-in-progress on an as-used (applied) basis. Direct material costs should also be recorded in the same manner; however, there may be cases where it is not logical to make this a uniform requirement. In these cases, if existing contractor systems provide the fundamental elements for cost and schedule performance measurement and for determining unit or lot cost as appropriate, they may be accepted even though they do not record material as a direct cost at the point of usage.

5.1.4 Level Of Effort. LOE costs are normally segregated from costs of discrete effort at the cost account level to permit an evaluation of the measurable effort before it is combined with the support effort. This segregation is intended to prevent distortion of measurable activity until at least one comparison of BCWP versus ACWP has been made.

5.1.5 Apportioned Effort. Cost of apportioned effort should be directly related to the discrete work packages or cost accounts to which the cost pertains. Factors and methods used to apply apportioned effort should be formally defined in established procedures with such costs accumulated on the same basis as budgets are allocated.

5.2 MATERIAL ACCOUNTING SYSTEM

5.2.1 Characteristics. Contractor material accounting systems should have the following characteristics:

a. Accurate cost accumulation assigning material cost to appropriate cost accounts in a manner consistent with the budget.

b. Recognised costing techniques acceptable to Defence.

c. Capability to establish material price variances and usage variances attributed to material usage where appropriate.

5.2.2 With regard to material accounting, the contractor should be able to account for all material sub-contracted items and purchased parts which, by their value and significance, warrant such attention. It is not necessary to require individual identification of such things as small hardware, miscellaneous wiring materials, and other items of a similar nature. Accurate recording of transfers between contracts is required in the material accounting system.

5.2.3 Price Variance. Material price variance is an essential element of material cost control. This can be determined early in the cycle of ordering materials, at which point the price of the materials can be compared with the amount budgeted for that material. Accumulation of these differences represents the total material price variance. Various routines can be used to calculate this variance, but the system should readily provide such data. When it becomes known that material costs will vary from the amounts planned, the contractor's management system should show these differences in the estimates of final costs.

5.2.4 Usage Variance. Material usage variance is an important cost factor on repetitive large volume, production-type jobs, but may be of marginal significance on single copy research and development equipment. Final material usage variances are not available until the work is completed. However, acceptable cost accounting techniques for analysing and determining current and projected usage variances should be expected to provide continuing internal measurement when the value and nature of the material warrant. The Criteria contain a requirement that contractors' systems be capable of formally planning and tracking the cost of material usage. For most contractors, purchases of material in excess of bill of material requirements are standard practice for many categories of material. Planning for material usage allowance to cover scrap, test rejections, unanticipated test quantities, and the like, is a practical necessity and the contractor should have records of such provisions. The more uncertain the expected usage, the more important it is to have a good plan and to keep track of performance against it particularly for contract peculiar materials or materials which require long procurement lead-times.

5.2.5 Excessive Scrap. There are two preferred methods for budgeting for unanticipated excessive scrap (although other methods may be acceptable):

a. Management reserve may be used to increase the budget for the replacement lot (or increased subsequent lot size) which was required due to unusually large percentage scrap; or

b. Negative BCWP can be assigned in the current period to recognise BCWP which had previously been overstated due to higher than anticipated percentage scrap. (Negative BCWP which appears on the Cost Performance Report should be explained in Format 5 of the CPR).

5.2.6 Actual Direct Costs. In those instances where the contractor maintains separate stores inventory areas, actual or applied direct cost of "store" material or components will be removed from the inventory account as they are issued and charged as actual direct cost against the contract when issued. Normally, all unused material should be returned to stores for disposition. Actual direct material cost includes the materials in the final product, scrap, damaged materials, and so forth, plus any material purchased for the contract but not used, for which an alternate use cannot be found. However, unit cost projections for follow-on procurements would be expected to include material consumed plus material requirements for schedule assurance based on waste and spoilage trends determined from a relevant phase (development or production) of the contract performance.

5.2.7 Work Progress. Work progress is determined on the basis of completion of individual segments of work or the attainment of specific milestones. Each such segment of work or milestone is assigned a budget for the resources estimated as necessary to perform that work. Actual resources expended must be recorded on the same basis as resource budgets were assigned if meaningful comparisons are to be made:

a. The definition of applied direct costs takes into consideration the different types of material involved in a contract. Not all material items are processed through inventory accounts. High-dollar value items such as major components or assemblies are frequently scheduled for delivery in accordance with the assembly line schedule. Items of this type are not usually scrapped if found defective, but are returned to the supplier for rework or repair. Under the applied direct cost approach, the costs of such items may be considered as applied direct material costs at the time they are received provided they are either scheduled for use within 60 days or are specifically identified to a unique, serially-numbered end item.

b. If a contractor's system is qualified on other than an applied cost basis, actual direct costs may be recorded upon receipt of material, or upon payment, as appropriate under the system.

5.2.8 Neither the applied direct cost approach nor any acceptable alternate should be interpreted to relieve the contractor of the need to maintain records of contract commitments for material.

5.2.9 Material BCWS and BCWP. Material BCWS and BCWP are intended to permit measurement of events which reflect progress in contract performance, not for measurement of administrative or financial events (eg. booking of actual costs or invoice payment). Therefore, BCWS should normally be scheduled in accordance with a contract event and BCWP should be earned when the event occurs.

a. To avoid distortion, actuals should be recorded when BCWP is earned. In situations where BCWP is earned and the invoice has not been paid, estimated actual cost may be incorporated into ACWP from purchase order information.

b. Administrative or financial events may be used as indicators for contract events when such indicators occur in the same reporting period as the contract events. However, it is not generally acceptable to use administrative or financial events as indicators when they would depict performance past the actual material use or need dates.

5.3 CRITERIA

5.3.1 General. The remainder of this CHAPTER is devoted to discussion of the Accounting Criteria. The objective is to clarify the requirements of the Criteria as an aid to interpretation for both Review Teams and contractors. Criterion Accounting 4 deals with Indirect Costs and is discussed in CHAPTER 6. Further amplification is found in the Evaluation/Documentation Review Checklist in ANNEX D which contains check-list questions used by Review Teams to evaluate performance measurement systems.

RECORD DIRECT COSTS ON AN APPLIED OR OTHER ACCEPTABLE BASIS CONSISTENT WITH THE BUDGETS IN A FORMAL SYSTEM THAT IS CONTROLLED BY THE GENERAL BOOKS OF ACCOUNT.

It was an original intention of the Criteria to maximise the ability to measure performance of Defence contractors. As part of this intention it was logical and prudent for contractor's accounting systems to be able to account for all resource expenditures on an "applied" basis (ie. on an "as-used" or "as-consumed" basis). This requirement caused little or no difficulty in the categories of labour (where time cards or other time-measurement devices are used) or other direct charges (where services are rendered on some type of dollar value per-unit basis). In the area of material accountability, considerable variation existed between contractors and their respective methods of accounting for material usage. To ease this differential in material accounting methodology the criteria are interpreted as follows to give some leeway to the interpretation of what constitutes an "applied" basis of material accounting:

Direct material costs shall be those amounts recognised in the time period associated with the consumption of materials without regard to the date of commitment or the date of payment. These amounts may be charged to work that is in-process when any of the following takes place:

a. Materials are actually consumed;

b. Material resources are withdrawn from inventory for use;

c. Material resources are received that are uniquely identified to the contract and scheduled for use within 60 days; or

d. Major components or assemblies are received on a line-flow basis that are specifically and uniquely identified to a single, serially-numbered end-item.

Some contractor's accounting systems simply may not be capable of accounting for materials as they are "used." Contractors may seek to validate the ability of their performance measurement systems to account for materials on an "other-than-applied" basis (ie. at a point other than at consumption). Of the other points at which material can be accounted for (at commitment, at receipt, at payment, at inventory acceptance, or at inventory release) the only point which Defence will not accept is the point of "commitment."

For those contractors who seek to account for materials on an "other-than-applied" basis, the main requirement is to account for materials in a manner consistent with the way in which materials are budgeted. If materials are going to be accounted for at the point of receipt, then material budgets should be established based on the point of expected receipt. It is not acceptable to budget for materials at one accounting point and then to actually account for them at another point. To do so would cause distortions in the performance measurement data and reflect incorrect contractor progress status. The seventh accounting criterion will also reference some parameters/restrictions for material accountability.

SUMMARISE DIRECT COSTS FROM COST ACCOUNTS INTO THE CWBS WITHOUT ALLOCATION OF A SINGLE COST ACCOUNT TO TWO OR MORE CWBS ELEMENTS.

Cost accounts are formed at the juncture where the lowest level of functional responsibility exists for individual CWBS elements. Allowable costs collected within the cost account by element of expense must "roll-up" from the cost account level through the CWBS to the top level without being simultaneously applied to two or more higher level elements. If the CWBS was carefully developed and reviewed for adequacy in accordance with MIL-STD-881 (latest revision), the CWBS structure itself, should prevent any one single element's data from being rolled-up to two or more higher level elements. The reasons for this prohibition should be obvious. First if a roll-up of data to multiple elements were allowed to occur the values of that data would be multiplied by the number of higher-level elements receiving that data. Secondly. if multiple roll-up occurs, one must question the validity of the CWBS to adequately reflect the way work is actually to be done. And thirdly, multiple roll-up of data questions who is really in charge of the lower-level element whose data is being rolled-up. Careful development of the CWBS breakdown and the use of "integration/assembly-type" CWBS elements will usually preclude the need for common-item cost accounts being subsequently allocated to the "using" cost account.

SUMMARISE DIRECT COSTS FROM THE COST ACCOUNT INTO THE CONTRACTOR'S FUNCTIONAL ORGANISATIONAL ELEMENTS WITHOUT ALLOCATION OF A SINGLE COST ACCOUNT TO TWO OR MORE ORGANISATIONAL ELEMENTS.

The intent of this criteria is similar to Accounting 2: the data representing the ACWP collected at the cost account may not be rolled up (ie., summarised) to multiple higher-level organisational elements. If the CWBS and OBS are properly constructed, and if the responsibility assignment matrix adequately assigns OBS responsibility to all CWBS elements of work, it will be extremely difficult to violate the intent of these two criteria.

IDENTIFY THE BASES FOR ALLOCATING THE COST OF APPORTIONED EFFORT.

Apportioned effort may be included (and budgeted) as part of the work package to which it relates, or it may be established as a separate work package with its own budget (which is based on a percentage of the related work package). Apportioned effort may also be included (and budgeted) as part of the cost account to which it relates or it may be established as a separate cost account with its own budget (which is based on a percentage of the related cost account or work packages). It is important that the contractor have apportioned effort and procedures for use of apportioned effort, well defined in his System Description.

The intent of this Criterion is that the contractor adequately identifies, justifies, and quantifies the relationship between the apportioned effort and the base effort to which it is related. If this relationship is not sufficient, that apportioned account may not be a valid collection point for the accumulation of actual costs. When establishing a time-phased budget and when measuring performance of apportioned effort, the percentage factors of the base effort by which the apportioned effort is multiplied is directly dependent upon the quantified relationship between the base and apportioned accounts. For this reason, the factors established for the application of apportioned effort must be documented and applied in a formal, consistent manner.

Apportioned effort should be restricted to only that which is genuinely related to discrete effort. The collection of the ACWP in an apportioned account, however, is not dependent upon the same factored relationship established for the "time-phased budget" data and "earned value" data; ACWP for the apportioned effort will be whatever is actually expended to accomplish the apportioned effort.

IDENTIFY UNIT COSTS, EQUIVALENT UNIT COSTS, OR LOT COSTS, AS APPLICABLE.

Just as a contractor acquires materials, vended items, and subcontracted components by unit of cost, so also is he expected to produce his contracted items in a manner that facilitates derivation of unit cost. Future pricing efforts are intimately concerned with the cost per unit of previous contract acquisitions. Such data helps provide the important justification for what is termed a "fair and reasonable" acquisition cost of items being procured by Defence.

Where production situations exist such that items are being produced on an accelerated assembly-line basis, it may not be practical to determine individualised unit costs. In these instances, it is sufficient to accumulate "lot" costs (wherein a "lot" is an aggregate of a specified and consistent number of units).

There are yet other situations wherein units are being produced on a single production line for more than a single customer. In these situations units are taken off the line in more or less random order according to the delivery agreements of the different customer's contracts. It is difficult, therefore, to establish exactly what the cost was of the specific units that went into each customer's order. In such instances, it is sufficient to establish "equivalent unit costs." (ie. all things being equal, on a "mature" production run each unit's cost is approximately equivalent to every other unit's cost). Where learning curves are indicated, equivalent unit costing must incorporate the value of the learning curve into each equivalent unit.

THE CONTRACTOR'S MATERIAL ACCOUNTING SYSTEM WILL PROVIDE FOR: ACCURATE COST ACCUMULATION AND ASSIGNMENT OF COSTS TO COST ACCOUNTS IN A MANNER CONSISTENT WITH THE BUDGETS USING RECOGNISED, ACCEPTABLE COSTING TECHNIQUES, DETERMINATION OF PRICE VARIANCES BY COMPARING PLANNED VERSUS ACTUAL COMMITMENTS; COST PERFORMANCE MEASUREMENT AT THE POINT IN TIME MOST SUITABLE FOR THE CATEGORY OF MATERIAL INVOLVED,
BUT NO EARLIER THAN THE TIME OF ACTUAL RECEIPT OF MATERIAL; DETERMINATION OF COST VARIANCES ATTRIBUTABLE OF THE EXCESS USAGE OF MATERIAL; DETERMINATION OF UNIT OR LOT COSTS WHEN APPLICABLE; AND FULL ACCOUNTABILITY FOR ALL MATERIAL PURCHASED FOR THE CONTRACT, INCLUDING THE RESIDUAL INVENTORY.

Recognising the differences that can exist between contractors' material accounting systems (especially the point at which materials are accounted for), this Criterion's intent is to establish those characteristics that, as a minimum, all material accounting systems should be capable of providing. Regardless of whether contractors account for materials at the point of consumption (on an "applied" basis), or at some other material control point (on an "other-than-applied" basis), these accounting parameters/restrictions must be met.