[Federal Register Volume 61, Number 183 (Thursday, September 19, 1996)]
[Notices]
[Pages 49351-49356]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-24072]


=======================================================================
-----------------------------------------------------------------------

OFFICE OF MANAGEMENT AND BUDGET

Office of Federal Procurement Policy


Cost Accounting Standards Board; Allocation of Selling and 
Marketing Costs

ACTION: Notice.

-----------------------------------------------------------------------

SUMMARY: The Office of Federal Procurement Policy, Cost Accounting 
Standards Board (CASB), invites public comments concerning a Staff 
Discussion Paper on the allocation of selling and marketing costs to 
government contracts.

DATES: Comments must be in writing and must be received by November 18, 
1996.

ADDRESSES: All comments should be addressed to Dr. Rein Abel, Director 
of Research, Cost Accounting Standards Board, Office of Federal 
Procurement Policy, 725 17th Street, NW., Room 9001, Washington, DC 
20503. Attn: CASB Docket No. 96-03.

FOR FURTHER INFORMATION CONTACT: Rein Abel, Director of Research or 
Richard C. Loeb, Executive Secretary, Cost Accounting Standards Board 
(telephone: 202-395-3254).

SUPPLEMENTARY INFORMATION:

A. Regulatory Process

    The Cost Accounting Standards Board's rules, regulations and 
Standards are codified at 48 CFR Chapter 99. Section 26(g)(1) of the 
Office of Federal Procurement Policy Act, 41 U.S.C. 422(g), requires 
that the Board, prior to the establishment of any new or revised Cost 
Accounting Standard, complete a prescribed rulemaking process. The 
process generally consists of the following four steps:

[[Page 49352]]

    1. Consult with interested persons concerning the advantages, 
disadvantages and improvements anticipated in the pricing and 
administration of Government contracts as a result of the adoption of a 
proposed Standard.
    2. Promulgate an Advance Notice of Proposed Rulemaking.
    3. Promulgate a Notice of Proposed Rulemaking.
    4. Promulgate a Final Rule.
    This proposal is step one of the four-step process.

B. Background and Summary

    In response to the Cost Accounting Standards Board's (CASB's) 
continuing research, a number of commenters have identified selling and 
marketing costs as an issue requiring consideration. The primary 
concern raised is the causal/beneficial relationship of selling costs 
to final cost objectives and their subsequent cost allocations. More 
specifically, issues have arisen in which the allocation of selling and 
marketing costs as a direct or as an indirect cost, and/or the 
appropriate pooled cost composition or allocation base selection, have 
caused substantial controversies.
    This Staff Discussion Paper represents the results of research 
performed by the staff of the Cost Accounting Standards Board, and is 
issued by the Board in accordance with the requirements of 41 U.S.C. 
422(g)(1)(A). The statements contained herein do not necessarily 
represent the position of the Cost Accounting Standards Board.

C. Public Comments

    Interested persons are invited to participate by submitting data, 
views or arguments with respect to this Staff Discussion Paper. All 
comments must be in writing and submitted to the address indicated in 
the Addresses section.
Richard C. Loeb,
Executive Secretary, Cost Accounting Standards Board.

Allocation of Selling and Marketing Costs

Outline

Introduction

Scope of Project

Preliminary Research

Part I--Terminology and Definition
    A. Discussion
    B. Issues
Part II--Homogeneity of Pools
    A. Discussion
    B. Issues
Part III--Selection of Allocation Bases
    A. Discussion
    B. Issues
Part IV--Composition of Allocation Bases
    A. Discussion
    B. Issues
Part V--Current Expensing vs. Deferral
    A. Discussion
    B. Issues

Allocation of Selling and Marketing Costs

Introduction

    In response to the Cost Accounting Standards Board's (CASB's) 
research, a number of commenters have identified selling and marketing 
costs as an issue requiring consideration. The primary concern raised 
is the causal/beneficial relationship of selling costs to final cost 
objectives and their subsequent cost allocations. The prior CASB also 
identified selling and marketing costs as an area requiring research. 
When the prior CASB promulgated Cost Accounting Standard (CAS) 9904.410 
``Allocation of Business Unit General and Administrative Expenses to 
Final Cost Objectives'', a separate research project dealing with 
selling and marketing costs was established. In its prefatory comments 
on CAS 9904.410, the CASB stated: ``* * * the Board is currently 
working on projects involving IR&D, B&P and selling costs. The Board at 
this time does not require changing the accounting for these costs.''
    CAS 9904.420, ``Accounting for Independent Research and Development 
and Bid and Proposal Costs'' was promulgated in September 1979. 
However, no Standard was ever promulgated to deal with the unique 
issues relating to selling and marketing costs. The CAS Board has asked 
the staff to begin the necessary research to resolve these matters.
Scope of Project
    In its Statement of Objectives, Policies and Concepts, July 1992, 
the CASB states: ``* * * the Board believes in the desirability of 
direct identification of costs with final cost objectives where the 
following allocation characteristics exist:
    1. The beneficial or causal relationship between the incurrence of 
cost and cost objectives is clear and exclusive.
    2. The amount of resource used is readily and economically 
measurable.''
    The aforementioned document further states:

``Where units of resources used are not directly identified with 
final cost objectives, the cost of such resources should be grouped 
into logical and homogeneous pools for allocation to cost objectives 
in accordance with a hierarchy of preferable techniques.''

    Under certain circumstances in government contracting, selling and 
marketing costs may be properly susceptible to direct identification 
with final cost objectives. In most cases, however, selling and 
marketing costs are indirectly allocated.
    Several Armed Services Board of Contract Appeals (ASBCA) cases have 
concluded that selling costs identified with a final cost objective 
(e.g., sales commissions) could be treated as an indirect cost, 
Daedalus Enterprises, Inc., 93-1 BCA 25499 and Aydin Corp. (West), 94-2 
BCA 26899, aff'd in part, rev'd in part, Aydin Corp. (West) v. Widnall, 
61 F.3d 1571 (Fed. Cir. 1995). Accordingly, the scope of this project 
includes selling and marketing costs identified with final cost 
objectives and those not identified with final cost objectives.

Preliminary Research

    The staff's preliminary research to date includes:
    a. Review of literature;
    b. Analysis of ASBCA decisions; and
    c. Review of the prior CASB's research relating to selling and 
marketing costs.
    This research disclosed a number of cost accounting issues which we 
believe must be considered by the Board in developing a potential CAS. 
These issues, presented in more detail in the ensuing parts of this 
SDP, deal with the following matters:

a. Terminology and Definition
b. Homogeneity of Pools
c. Selection of Allocation Bases
d. Composition of Allocation Bases
e. Current Expensing vs. Deferral

Part I

Terminology and Definition

A. Discussion

    The problem of terminology and definition is closely related to--in 
fact, it is sometimes difficult to separate it from--the question 
concerning the number of cost pools, or the degree of homogeneity of 
such pools (see Part II). It seems that any CAS evolving from this 
project must use terms that are adequately defined so as to ensure 
understanding by all parties concerned of the types of costs, functions 
and activities being covered.
    Kohler, defines ``selling expense (cost)'' and ``marketing cost'' 
as follows:
    ``Selling Expense (Cost)--Any expense or class of expense incurred 
in selling or marketing. Examples: salesmen's salaries, commissions, 
and traveling; selling department salaries and expenses; samples; 
credit and

[[Page 49353]]

collection costs. Shipping costs are often so classified.''
    ``Marketing Costs--The cost of locating customers, persuading them 
to buy, delivering goods, and collecting sales proceeds; selling 
cost.''
    The Institute of Management Accountants (IMA) classifies 
``marketing costs'' into two general categories: ``1. Costs of getting 
orders--i.e. advertising, sales promotion, direct selling, sales 
administration and sales research. 2. Costs of filling orders--
warehousing, shipping, clerical operations connected with filling 
orders and collecting the money.'' Most authors of accounting 
literature (for example, Anthony and Shillinglaw) define the term 
``marketing costs'' (or ``distribution costs'') generally in the same 
fashion as the IMA; that is, the term is broken down into two major 
categories of costs: ``order-getting costs'' and ``order-filling 
costs.''
    In government contracting, however, the terms are often defined in 
a narrower sense; that is, most government contractors limit the terms 
to include only ``order-getting'' costs. ``Order-filling costs'' are 
often classified as general and administrative expenses, e.g., 
collection, and as manufacturing overhead costs or as other indirect 
costs, e.g., warehousing. For example, the Federal Acquisition 
Regulation (FAR) 31.205-38 states: ``Selling is a generic term 
encompassing all efforts to market the contractor's products or 
services, some of which are covered specifically in other subsections 
of 31.205. Selling activity includes the following broad categories:

(1) Advertising
(2) Corporate image enhancement including broadly-targeted sales 
efforts, other than advertising
(3) Bid and proposal costs
(4) Market planning
(5) Direct selling''

    Some contractors, however, make a distinction between selling and 
marketing activities. Marketing is defined as being long-range in its 
objectives and includes market research and development and 
advertising. Selling is short-range in its objectives and includes 
direct selling efforts, sales promotion and demonstration, and customer 
liaison.
    Discussions with contractor and government representatives indicate 
that terminology and definition in this area are not without problems. 
There is a considerable amount of diversity in the specific meaning 
being attached to the term ``selling and marketing costs.'' 
Furthermore, problems are being encountered in distinguishing between 
selling and marketing costs and certain other costs, such as IR&D and 
B&P costs.
    In addition to the costs of such activities as market research and 
development, direct selling effort, selling administration and sales 
promotion and demonstration, many government contractors consider the 
costs of some or all of the following activities as part of selling and 
marketing costs:

a. Business planning
b. Bid and proposal
c. Contract administration including negotiation and pricing
d. Technical marketing (or work performed by ``marketing 
representatives'')
e. Program management
f. Subcontract administration
g. Spares administration or logistical support
    Other contractors, however, treat the costs of these activities 
differently; some contractors treat the costs of some of the activities 
as part of general and administrative expenses (``G&A''); others treat 
them either as part of manufacturing, engineering or comparable 
overhead pools; and still others treat them as direct costs. Likewise, 
some contractors treat the costs of selling efforts performed by 
salaried employees differently than the costs of similar selling 
efforts performed by outside sales agents.
    Of the cost of those activities listed above, preliminary research 
has indicated that costs of contract administration are often as 
significant as selling and marketing costs and that opinions appear to 
be divided as to whether or not such costs should be part of selling 
and marketing costs. In this regard, one recognized expert has stated: 
``Selling costs normally include bidding and proposal costs not 
directly assignable to contracts obtained from such effort * * * as 
well as costs of contract administration and sales and service.'' A 
number of companies, however, treat contract administration costs as 
part of G&A.
    Those companies which treat the costs of contract administration as 
part of selling and marketing costs cite several reasons in support of 
such treatment. Among the reasons cited are: (i) The same people 
perform both contract administration and selling and marketing 
activities, (ii) the two activities are often difficult to distinguish 
or they overlap; and (iii) people who are assigned contract 
administration responsibility perform selling or negotiation work on 
potential follow-on contracts. An additional reason cited by those 
contractors with a mix of government and commercial business--although 
this is more closely related to the question of allocation--is that 
because selling and marketing costs tend to be higher on commercial 
than on government business, whereas contract administration costs tend 
to be higher on Government than on commercial business, combining the 
two types of costs produces results similar to those of separate cost 
allocations.

B. Issues

    1. What activities should be encompassed by the term ``selling and 
marketing''? In responding to this issue, please address your comments 
to whether each of the activities listed above should be part of 
selling and marketing. Please state your reasons for including, or 
excluding, the activities and provide a brief description of the 
activities.
    2. Should ``selling'' and ``marketing'' be separately defined and 
how should they be defined?
    3. What are the distinctive characteristics of selling and 
marketing activities that can be used to assure that such activities 
are properly segregated from other activities?

Part II

Homogeneity of Pools

 A. Discussion

    As mentioned previously, the CASB has emphasized the need for and 
the importance of grouping indirect costs into logical and homogeneous 
pools. The literature also indicates the general weight of opinion that 
homogeneity of indirect cost pools should be achieved by establishing 
separate pools, rather than a single pool for a ``blanket'' allocation.
    CAS 9904.410 defines G&A as ``Any management, financial and other 
expense which is incurred for the general management and administration 
of the business unit as a whole. G&A expense does not include those 
management expenses whose beneficial or causal relationship to cost 
objectives can be more directly measured by a base other than a cost 
input base representing the total activity of a business unit during a 
cost accounting period.''
    In a recent decision, the ASBCA concluded that selling costs are 
different from G&A expenses. The ASBCA stated: CAS 410.30(6) defines 
``General and Administrative (G&A) expense'' as an expense incurred for 
the general management and administration of the business as a whole. 
Aydin acknowledges that its sales commission costs were essentially 
selling costs. In this case, the Solar II commission incurred was not 
incurred for the management and administration of

[[Page 49354]]

Aydin as a whole * * * We conclude, therefore, that Aydin's sales 
commission costs in general, and the Solar II sales commission in 
particular, were not G&A expenses for purposes of CAS 410. See Aydin 
Corp. (West), 94-2 BCA 26899.
    The idea that selling and marketing costs are different from G&A 
can be found in accounting literature. Kholer, for example, expresses 
this idea by defining ``administrative expense'' as ``A classification 
of expense incurred in the general direction of an enterprise as a 
whole, as contrasted with expense of a more specific function, such as 
manufacturing or selling * * *'' (underscoring added). In a similar 
vein, the IMA distinguishes selling and marketing costs from G&A by 
defining G&A as costs of ``* * * president's office, treasurer's office 
[and] controller's office.''
    The idea of establishing homogeneous indirect cost pools is 
expressed in CAS 9904.418-40(b) and 50(b)(1). CAS 9904.418-40(b) 
states:

Indirect costs shall be accumulated in indirect pools which are 
homogenous.

    CAS 9904.418-50(b)(1) states:

    An indirect cost pool is homogenous if each significant activity 
whose costs are included therein has the same or a similar 
beneficial or causal relationship to cost objectives as the other 
activities whose costs are included in the cost pool. It is also 
homogenous if the allocation of the costs of the activities included 
in the cost pool result in an allocation to cost objectives which is 
not materially different from the allocation that would result if 
the costs of the activities were allocated separately.

    The concept of homogenous indirect cost pools is also discussed in 
FAR 31.203(b) as ``Indirect costs shall be accumulated by logical cost 
groupings with due consideration of the reasons for incurring such 
costs * * * Commonly, manufacturing overhead, selling expenses and 
general and administrative expenses are separately grouped.'' In 
practice, however, only some contractors have established a separate 
pool of selling and marketing costs. Discussions with some contractors 
disclosed that selling and marketing costs are significant, 
particularly when they are compared with G&A.
    As discussed above, accounting opinion generally supports the need 
for increased homogeneity. However, there is no agreement as to how to 
achieve a degree of homogeneity of indirect costs that assures their 
accurate allocation. Although the literature deals with the subject of 
selling and marketing costs, most of the discussion is presented from 
the perspectives of internal cost controls and managerial decisions. 
Such accounting literature suggests a number of different ways to 
accumulate selling and marketing costs which could be adopted for 
purposes of allocation to contracts. Among the various methods cited 
are: (i) By activities (direct selling efforts, sales administration, 
market research, etc.), (ii) by product lines, (iii) by customers, and 
(iv) by geographical locations.
    The concept of segregating selling costs on a beneficial or causal 
relationship was addressed in CAS Working Group Item 78-21, 
Implementation of CAS 410, Allocation of Business Unit General and 
Administrative Expenses to Final Cost Objectives. The Working Group 
responded to a question raised concerning whether selling costs could 
be included in the G&A pool if an inequitable distribution resulted. 
The Working Group concluded that selling costs could not remain in the 
G&A pool when an inequitable distribution resulted. Working Group Item 
78-21 states in part:

Although the prefatory remarks are permissive in this regard, the 
standard's fundamental requirement paragraph 410.40(d)(1) requires a 
separate allocation of costs which can be allocated to business unit 
cost objectives on a beneficial or causal relationship which is best 
measured by a base other than a cost input base * * * Therefore, if 
a significant disparity exists in marketing activity for elements of 
the business, selling expenses should be the subject of a separate 
distribution in reasonable proportion to the benefits received. For 
example, it may be appropriate to separately allocate selling costs 
of foreign and domestic markets.

    In light of Working Group Item 78-21, questions have arisen as to 
the allocability of foreign selling costs on domestic government 
contracts. The government regulations addressing foreign selling costs 
have changed over the past decade. DAR 15.205-37 stipulated that the 
allocability of selling costs were to be determined in light of 
reasonable benefit to the U.S. government. However, the current FAR 
31.205-38 states:

The costs * * * to promote export sales of products normally sold to 
the U.S. Government, including the costs of exhibiting and 
demonstrating such products, are allowable on contracts with the 
U.S. Government provided--
    (i) The costs are allocable, reasonable, and otherwise allowable 
under this Subpart 31.2;
    (ii) That, with respect to a business segment which allocates to 
U.S. Government contracts, $2,500,000 or more of such costs in a 
given year of such business segment, a ceiling on the allowable 
costs shall apply.

    At corporate and group home offices, accumulating selling and 
marketing costs in separate pools is not an uncommon practice. A number 
of such offices accumulate the costs in terms of commercial versus 
government business--some group home offices perform only selling and 
marketing functions and some have separate group home offices for 
commercial marketing and for government marketing.
    A number of corporate and group home offices also accumulate 
selling and marketing costs in terms of foreign versus domestic, and 
some have separate marketing organizations for foreign marketing and 
for domestic marketing. This kind of accumulation of selling and 
marketing costs presumably reflects the need occasioned by significant 
amounts of exports of U.S. products. In this regard, it is probably 
important to note the various recurring changes in policy regarding the 
allowability of marketing costs associated with Foreign Military Sales 
(FMS) contracts.
    A government representative suggests that selling costs be 
segregated from marketing costs. According to this logic, marketing 
costs which are long-range in objective should be segregated from 
selling costs which are short-range in objective. The former should be 
allocated on a broad base to all business of a contractor, whereas the 
latter should be allocated only to those products or product lines 
benefiting from the incurrence of selling costs.
    Based on the foregoing discussion, the argument can be made that, 
at one extreme, the accuracy of most contractors' allocations of 
selling and marketing costs could be improved by creating several 
pools. This would mean establishing pools by class of customers (such 
as commercial versus government), by various activities (such as field 
selling costs, sales demonstration, sales administration and marketing 
research), by geographical locations (such as foreign versus domestic) 
and by product lines.
    At the other extreme, selling and marketing costs could be combined 
with G&A, or a single pool of selling and marketing costs could be 
used, on the theory that little additional accuracy will be provided by 
increased homogeneity, and that any additional accuracy achieved would 
be too costly or would not make much difference in the ultimate amounts 
of selling and marketing costs to be allocated.
    The central question, then, seems to be: How can the homogeneity of 
selling and marketing costs be further improved in a way which will 
have both theoretical validity and practical

[[Page 49355]]

applicability? A related question is: To what extent can greater 
comparability among contractors be achieved in this area?

B. Issues

    1. Under what circumstances should selling and marketing costs be 
accumulated in a pool separate and apart from G&A? Under what 
circumstances should they be accumulated by: a. class of customers 
(e.g., commercial versus government), b. geographical location (e.g., 
foreign versus domestic), c. type of activity (e.g., marketing versus 
selling), d. product line, or e. some other methods?
    2. Please describe the guidelines and criteria governing the 
accumulation of selling and marketing costs which you believe should be 
included in a potential standard. Is a new standard required or can 
this issue be addressed within existing standard(s)?
    3. Should a potential standard establish criteria and guidance on 
when it would be inappropriate to establish a pool, i.e., when selling 
or marketing expenses should be allocated directly to particular final 
cost objectives?

Part III

Selection of Allocation Bases

A. Discussion

    Theoretically, there are two ways to go about selecting an 
allocation base; one way is to use judgmental criteria and the other is 
to use a statistical analysis approach. Practical experience suggests 
that the statistical analysis approach is seldom, if ever, used by 
government contractors.
    Government contractors use a variety of allocation bases for 
selling and marketing costs. Among the bases being used are: sales, 
three-factor formula, direct labor costs or hours and level of effort.
    For the purpose of this Discussion Paper, the term ``level of 
effort'' is used to refer to the time and effort incurred or to be 
incurred by those personnel engaged in selling and marketing functions. 
In practice, a variety of methods are used to express the ``level of 
effort''. Some companies use ``projected time to be spent'' on selling 
of certain products or product lines or selling to certain customers 
during certain time intervals, such as every six months; others use the 
actual time spent and recorded.
Output Bases
    The Armed Services Pricing Manual (ASPM No. 1) states that ``Common 
bases for distribution or estimation of selling expenses are total cost 
of sales and total selling price.'' However, the document does not 
describe the reasons or the circumstances for the use of such 
allocation bases. On the other hand, the Defense Contract Audit 
Agency's Contract Audit Manual states: ``Manufacturing expenses are 
usually apportioned without regard to the specific end item being 
manufactured or the customer to whom the item may ultimately be sold. 
These latter factors, however, are important considerations in 
apportioning selling expenses which may indicate that an overall 
allocation of selling expenses on the basis of cost of sales or costs 
of goods manufactured may not be equitable.''
    Usry and Hammer advocate the use of ``gross sales value of products 
sold'' for allocating what they term as ``functional costs of 
selling.'' Horngren, on the other hand, criticizes the sales allocation 
base: ``A commonly, but wrongly, used basis for allocation is dollar 
sales. The costs of effort are independent of the results actually 
obtained, in the sense that the costs are programmed by management, not 
determined by sales.''
Level of Effort
    Usry and Hammer advocate (in addition to sales) the use of ``number 
of salespersons' calls on customers (based on salespersons' time 
reports).'' The Defense Contract Audit Agency's Contract Audit Manual 
appears to be advocating the same theory. As mentioned previously, 
after cautioning auditors that the costs of sales or costs of goods 
manufactured base may not be equitable for selling and marketing costs, 
it goes on to state: ``The auditor should perform a careful analysis of 
the time, effort and expense incurred for selling activities in 
relation to the company's products, product lines, or other objectives 
to determine the most suitable base * * *''

B. Issues

    1. Under what circumstances should the output base(s) (sales, cost 
of sales), the input base(s) (total cost input, direct labor cost, 
value added, etc.) and other methods such as level of effort be used in 
allocating selling and marketing costs at the business unit level?
    2. Under what circumstances should these bases and methods be used 
at the corporate home office level and/or the group home office level?
    3. What criteria should be provided for selection among alternative 
bases?

Part IV

Composition of Allocation Bases

A. Discussion

    The problem of allocating selling and marketing costs is 
complicated by the question concerning the composition of allocation 
bases. Research of the available literature failed to disclose any 
discussions of this question. Discussions with selected contractor and 
government representatives revealed, however, that practices and 
opinions vary as to whether certain kinds of sales or costs ought to be 
reflected in an allocation base for selling and marketing costs. These 
sales or costs pertain to:
    1. Intracompany transfers.
    2. Subcontract costs and purchased materials including 
accommodation purchases and drop shipments.
    3. Capitalized projects.
    4. Certain kinds of contacts such as those for field services.
    Those contractors which exclude some or all of these sales or costs 
from an allocation base, or those which believe such sales or costs 
should be excluded, advance various arguments. For example, they 
contend that selling and marketing costs are incurred to sell products 
and services to outside customers; accordingly, such costs should not 
be allocated to intracompany transfers. Others exclude subcontract 
costs and purchased materials from an allocation base on the theory 
that the subcontractors' and vendors' selling and marketing costs are 
already included in the prices of subcontracts and purchase orders. 
Those contractors which exclude certain contracts, such as field 
service contracts, express the view that selling and marketing costs 
had been incurred on the ``parent contract'' under which the products 
being serviced had been produced and sold and that few such costs are 
incurred on the field service contracts. Capitalized projects are also 
excluded from the allocation base on the theory that selling and 
marketing costs are incurred to sell to outside customers. Conversely, 
there are a number of contractors that include all or some of these 
sales or costs or those which believe that such sales or costs should 
be included.
    Practices and opinions also vary as to whether the selling and 
marketing costs incurred at corporate and group home offices should be 
allocated to all segments under such offices or to just some segments. 
Those contractors which exclude certain segments contend that the 
excluded segments have their own selling and marketing organizations or 
that the product lines

[[Page 49356]]

of such segments are significantly different from those of the rest of 
the segments.
    The question of whether or not all of the above-mentioned sales or 
costs, or all segments under a corporate or group home office, should 
be included in an allocation base is presumably influenced by the 
following factors among others:
    1. How a contractor views the beneficial or causal relationship 
between the selling and marketing costs and the sales, costs or 
segments; that is, whether a contractor considers the relationship to 
be close or remote (benefit to overall business).
    2. How a contractor interprets the longstanding FAR 31.203(c) 
policy regarding ``non-fragmentation of allocation bases''.
    3. Whether a contractor considers the added refinement of its 
allocation practices to be worthy of the efforts involved or to be 
conductive to producing different allocation results.
    A related question on the output bases concerns the use of 
different methods of recognition of sales; that is, the completed-
contract method and the unit-of-delivery method as contrasted with the 
percentage-of-completion method (or the ``cost-incurred'' method for 
cost-type contracts). A number of contracts use different methods of 
recognizing the sales of the same cost accounting period for the 
different types of contracts performed. Obviously this practice creates 
additional allocation problems.

B. Issues

    1. Should an allocation base for selling and marketing costs 
include the following?
    a. Intracompany transfers.
    b. Subcontract costs and purchased materials.
    c. Capitalized projects.
    d. Contracts such as for field services.
    Please state the reasons for your answer.
    2. Do you perceive any other output or input similar to the above 
which may be included in an allocation base? Conversely, do you 
perceive other similar output or input which may be excluded from an 
allocation base? Please describe them.
    3. Under what circumstances should a segment be excluded from the 
allocation base of corporate home office or group home office selling 
and marketing costs, and what criteria should be established regarding 
allocation to segments?
    4. Under what circumstances would it be appropriate to use 
different methods of sales recognition to determine an output 
allocation base for selling and marketing costs? If you believe that 
the use of different methods is inappropriate, which method should be 
used to determine the base?

Part V

Current Expensing vs. Deferral

A. Discussion

    Previous parts of this Discussion paper discussed the problems 
associated with terminology and definition and with allocation bases 
for selling and marketing costs. Allocation of selling and marketing 
costs is further complicated by the fact that such costs usually 
include significant amounts of costs that are incurred in a current 
cost accounting period but are for the benefit of future periods.
    Accounting Principles Board Statement (APBS) No. 4 addresses 
expense recognition and specifies three primary principles for 
recognizing expenses. They are associating cause and effect, systematic 
and rational allocation, and immediate recognition.
    Under associating cause and effect, costs are recognized as 
expenses on the basis of a presumed direct association with specific 
revenue. APBS No. 4 states:

    Some costs are recognized as expenses on the basis of a presumed 
direct association with specific revenue. Although direct cause and 
effect relationships can seldom be conclusively demonstrated, many 
costs appear to be related to particular revenue and recognizing 
them as expenses accompanies recognition of the revenue. Examples of 
expenses that are recognized by associating cause and effect are 
sales commissions and costs of products sold or services provided. 
The term matching is often applied to this process.

    Using the above language, sales commissions earned on a multi-year 
contract would be recognized over the life of the contract rather than 
expenses in the year of contract award.
    Under immediate recognition, APBS No. 4 states:

    Some costs are associated with the current accounting period as 
expenses because (1) Cost incurred during the period provide no 
discernible future benefits, (2) costs recorded as assets in prior 
periods no longer provide discernible benefits or (3) allocating 
costs either on the basis of association with revenue or among 
several accounting periods is considered to serve no useful purpose.

    APBS No. 4 states that examples of costs recognized in the current 
period include such costs as most selling costs and general and 
administrative type expenses.
    Making the determination of whether selling and marketing costs can 
be associated with revenue on the basis of cause and effect may be 
difficult. Accounting literature has recognized these difficulties. 
Usry and Hammer state: ``Cause and effect, generally obvious in the 
factory, are not so readily discernible in the marketing processes. For 
example, many promotional costs are incurred for future results, 
creating a time lag between cause and effect. Conversely, the effects 
of manufacturing changes are usually felt quickly; and matching between 
effort and result usually can be determined. Furthermore, manufacturing 
results are more readily quantified than are marketing costs. For 
marketing costs, it is often not so easy to identify quantities or 
units of activity with the cost incurred and results achieved.''
     Lawrence (Cost Accounting, revised by Ruswinckel) states: ``A very 
large number of manufacturing companies make their products to order, 
and a great amount of expense is undertaken in order to sell products 
that are not in existence at the time of sale. It is not considered 
improper to defer an expense that will result in future benefit.''
    In government contacting, the time lag between cause and effect, 
referred to by Usry and Hammer, could be as much as 3 to 5 years. 
However, government contractors rarely defer selling and marketing 
costs. Presumably, this is because of the difficulties involved in 
distinguishing between those costs that should be currently expensed 
and those that should be deferred, and because of the high degree of 
uncertainty as to future benefits. In a few instances, however, 
contractors are known to have deferred those selling and marketing 
costs incurred to secure substantial new programs.

B. Issues

    1. Should selling and marketing costs incurred for the benefit of 
future periods be deferred? If they should: a. under what circumstances 
should selling and marketing costs be deferred; b. what criteria should 
be established to distinguish between those costs that should be 
currently expensed and those that should be deferred, and c. how should 
the deferred costs be amortized?
    2. If you do not believe that selling and marketing cost should be 
deferred, which allocation base(s) should be used in order to minimize 
the possible distorted allocations of costs incurred for future 
periods?

[FR Doc. 96-24072 Filed 9-18-96; 8:45 am]
BILLING CODE 3110-01-P