Total Cost Input (TCI) vs. Value Added (VA)

Background

A contractor should conduct a thorough review of their accounting practices and provide a position paper when a contractor wants to revise its G&A rate calculation using the value-added method rather than the total cost input (TCI) method.

When to Use a Value Added Base

A value-added cost base is appropriate when inclusion of material and subcontractor costs would significantly distort the allocation of the G&A expense pool in relation to benefits received.

For example if 72% of the G&A type expense, based on the combined value of direct material/subcontractors and direct labor would be allocated to material and subcontractor costs, total cost input base, would not produce an equitable allocations. G&A expenses are associated with providing resources which benefit the corporation as a whole, managing personnel and manufacturing operations as well as research and development rather than materials and subcontractors.

A Contractor’s G&A expenses should be allocated on a base representing its total activity but considering its operations, total activity is best reflected by direct labor and manufacturing overhead.

The inclusion of raw materials and subcontract costs in the base may produce a gross distortion, if included in the allocation base.

The guidance included in CAS 410, Allocating G&A expenses, and associated cases are helpful for illuminating the meaning of total activity. The justification of the use of a value added method in lieu of a TCI method is best illustrated in a classic case, Ford Aerospace and Communications (Aerospace and Communications Corporation Inc. Aeronautic Division, ASBCA 23883).

In that case, it was noted the CAS Board in its prefactory comments to CAS 410 stated that “total activity” refers to the production of goods and services during the cost accounting period. It includes material, subcontracts, labor and overhead.

In the Ford case, the government maintained that by omitting materials and subcontracts (i.e. using the value-added base) this would result in an inaccurate measure of total activity. The Board rejected this position. Though it noted material and subcontract costs can be “includible in total activity” it is fallacious to conclude “each dollar expended for materials and subcontracts necessarily bears the same relationship to incurrence of G&A expenses as each dollar of labor and overhead.” To the contrary, the total cost of each element comprising total activity “may or may not best represent total activity depending on the circumstances of each business unit. The crucial question is not what activity elements may comprise total activity, but what best represents total activity.”

CAS 410 does not establish a preference for the TCI method. Rather, CAS 410 expressly authorizes three cost input allocation methods:

1. TCI,

2. Value Added,

3. A single element representing total activity)

and leaves the selection to be based on individual circumstances of the company.

In deciding that a contractor was entitled to use the value-added method, a Board would cite two primary reasons:

1.The material and subcontract content of the contractors contract is disproportionate and G&A expenses pertain more to the contractors in-house activity than to the contractors material and subcontract activity.

2.The G&A expenses provided substantially more benefits to the contractors labor-intensive development contracts than the material intensive production contracts.