for personnel services reasonable surrogates would be number of personnel, labor hours, or labor dollars of the segments receiving the service. Any surrogate used should be a reasonable measure of the services received and, logically, should vary in proportion to the services received.

(c)(1) Where residual expenses are required to be allocated pursuant to

§ 403.40(c)(2), the three factor formula described below must be used. This formula is considered to result in appropriate allocations of the residual expenses of home offices. It takes into account three broad areas of management concern: The employees of the organization, the business volume, and the capital invested in the organization. The percentage of the residual expenses to be allocated to any segment pursuant to the three factor formula is the arithmetical average of the following three percentages for the same period:

(i) The percentage of the segment's payroll dollars to the total payroll dollars of all segments.

(ii) The percentage of the segment's operating revenue to the total operating revenue of all segments. For this purpose, the operating revenue of any segment shall include amounts charged to other segments and shall be reduced by amounts charged by other segments for purchases.

(iii) The percentage of the average net book value of the sum of the segment's tangible capital assets plus inventories to the total average net book value of such assets of all segments. Property held primarily for leasing to other shall be excluded from the computation. The average net book value shall be the average of the net book value at the beginning of the organization's fiscal year and the net book value at the end of the year.

such

(2) The first time a change is made from a technique previously followed to the techniques specified in § 403.50(c)(1), change shall be deemed to be within the scope of paragraph (a)(3) of the clause appearing at § 351.50 of the Board's regulation entitling a contractor to an equitable adjustment under paragraph (a)(4)(A) of the contract clause.

(d) The following subparagraphs provide guidance for implementing the requirements of § 403.40(c)(3).

§ 403.60 Illustrations.

(1) An indication that a segment received significantly less benefit in relation to other segments can arise if a segment, unlike all or most other segments performs on its own many of the functions included in the residual expense. Another indication may be that, in relation to its size, comparatively little or no costs are allocable to a segment pursuant to § 403.40(b)(1) through (5). Evidence of comparatively little communication or interpersonal relations between a home office and a segment, in relation to its size, may also indicate that the segment receives significantly less benefit from residual expenses. Conversely, if the opposite conditions prevail at any segment, a greater allocation than would result from the application of § 403.40(c)(1) or (2) may be indicated. This may be the case, for example, if a segment relies heavily on the home office for certain residual functions normally performed by other segments on their own.

(2) Segments which may require special allocations of residual expenses pursuant to § 403.40(c)(3) include, but are not limited to foreign subsidiaries, GOCO's, domestic subsidiaries with less than a majority ownership, and joint ventures.

(3) The portion of residual expenses to be allocated to a segment pursuant to § 403.40(c)(3) shall be the cost of estimated or recorded efforts devoted to the segments.

(e) Home office functions may be performed by an organization which for some purposes may not be a part of the legal entity with which the Government has contracted. This situation may arise, for example, in instances where the Government contracts directly with a corporation which is wholly or partly owned by another corporation. In this case, the latter corporation serves as a "home office," and the corporation with which the contract is made is a "segment" as those terms are defined and used in this standard. For purposes of contracts subject to this standard, the contracting corporation may only accept allocations from the other corporation to the extent that such allocations meet the requirements set forth in this standard for allocation of home office expenses to segments.

Staff management of specific activites:

1. Personnel management..

2. Manufacturing policies (quality control, industrial engineering, production, scheduling, tooling, inspection and testing, etc.).

3. Engineering policies.

4. Material/purchasing policies.

5. Marketing policies..

Central payments or accruals:

1. Pension expenses

2. Group insurance expenses

3. State and local income taxes and franchise taxes

(c) The listed allocation bases in this section are illustrative. Other bases for allocation of home office expenses to segments may be used if they are substantially in accordance with the beneficial or causal relationships outlined in § 403.40.

§ 403.70 Exemptions.

(a) Any contractor or subcontractor which together with its subsidiaries did not receive net awards of negotiated national defense prime contracts during Federal fiscal year 1971 (July 1, 1970, through June 30, 1971) totaling more than $30 million is exempt from this Standard (40 FR 32747, Aug. 4, 1975).

(b) This standard shall not apply to contractors who are subject to the provisons of Office of Management and Budget Circular No. A-21 (Principles for Determining Costs Applicable to Research and Development Under Grants and Contracts with Educational Institutions and Principles for Determining Costs Applicable to Training and Other Educational Services Under Grants and Contracts with Educational Institutions (FPR Note: Federal Management Circular (FMC) 73-8, 12/19/73, replaced OMB Circular No. A-21); or Circular No. A-87 (Principles for Determining Costs Applicable to Grants and Contracts with State and Local Governments) (FPR Note: Federal Management Circular (FMC) 74-4, 7/18/74, replaced OMB Circular No. A-87).

[37 FR 26680, Dec. 14, 1972, as amended at 40 FR 32747, Aug. 4, 1975]

§ 403.80 Effective date.

This standard shall be followed by each contractor as of the beginning of his next

items sold in substantial quantities to the general public, or (b) prices set by law or regulation.

$404.20 Purpose.

This standard requires that, for purposes of cost measurement, contractors establish and adhere to policies with respect to capitalization of tangible assets which satisfy criteria set forth herein. Normally, cost measurements are based on the concept of enterprise continuity; this concept implies that major asset acquisitions will be capitalized, so that the cost applicable to current and future accounting periods can be allocated to cost objectives of those periods. A capitalization policy in accordance with this standard will facilitate measurement of costs consistently over time.

§ 404.30 Definitions.

(a) The following definitions of terms which are prominent in this standard are reprinted from Part 400 of this chapter for convenience. Other terms which are used in this standard and are defined in Part 400 of this chapter have the meanings ascribed to them in that part unless the text demands a different definition or the definition is modified in paragraph (b) of this section:

(1) Asset accountability unit. A tangible capital asset which is a component of plant and equipment that is capitalized when acquired or whose replacement is capitalized when the unit is removed, transferred, sold, abandoned, demolished, or otherwise disposed of.

(2) Original complement of low cost equipment. A group of items acquired for the initial outfitting of a tangible capital asset or an operational unit, or a new addition to either. The items in the group individually cost less than the minimum amount established by the contractor for capitalization for the classes of assets acquired but in the aggregate they represent a material investment. The group, as a complement, is expected to be held for continued service beyond the current period. Initial outfitting of the unit is completed when the unit is ready and available for normal operations.

(3) Repairs and maintenance. Maintenance is the regularly recurring activity of keeping assets in normal or expected operating condition. Repair is the activity of putting them back into normal or expected operating condition. The total endeavor to obtain the expected service during the life of tangible capital assets is generally called repairs and maintenance.

(4) Tangible capital asset. An asset that has physical substance, more than minimal value, and is expected to be held by an enterprise for continued use or possession beyond the current accounting period for the services it yields.

(b) The following modifications of definitions set forth in Part 400 of this chapter are applicable to this standard:

None.

§ 404.40 Fundamental requirement.

(a) The acquisition cost of tangible capital assets shall be capitalized. Capitalization shall be based upon a written policy that is reasonable and consistently applied.

(b) The contractor's policy shall designate economic and physical characteristics for capitalization of tangible assets.

(1) The contractor's policy shall designate a minimum service life criterion, which shall not exceed 2 years, but which may be a shorter period. The policy shall also designate a minimum acquisition cost criterion which shall not exceed $500, but which may be a smaller amount.

(2) The contractor's policy may designate other specific characteristics which are pertinent to his capitalization policy decisions (e.g., class of asset, physical size, identifiability and controllability, the extent of integration or independence of constituent

units).

(3) The contractor's policy shall provide for identification of asset accountability units to the maximum extent practical.

(4) The contractor's policy may designate higher minimum dollar limitations for original complement of low cost equipment and for betterments and improvements than the limitation established in accordance with paragraph (b)(1) of this section, provided such higher limitations are reasonable in the contractor's circumstances.

(c) Tangible assets shall be capitalized when both of the criteria in the contractor's policy as required in paragaph (b)(1) of this section are met, except that assets described in paragraph (b)(4) of this section shall be capitalized in accordance with the criteria established in accordance with that paragraph.

(d) Costs incurred subsequent to the acquisition of a tangible capital asset which result in extending the life or increasing the productivity of that asset (e.g., betterments and improvements) and which meet the contractor's established criteria for capitalization shall be capitalized with appropriate accounting for replaced asset accountability units. However, costs incurred for repairs and maintenance to a tangible capital asset which either restore the asset to, or maintain it at, its normal or expected service life or production capacity shall be treated as costs of the current period.

§ 404.50 Techniques for application.

(a) The cost to acquire a tangible capital asset includes the purchase price of the asset and costs necessary to prepare the asset for use.

(1) The purchase price of an asset shall be adjusted to the extent practical by premiums and extra charges paid or discounts and credits received which properly reflect an adjustment in the purchase price.

(i) Purchase price is the consideration given in exchange for an asset and is determined by cash paid, or to the extent payment is not made in cash, in an amount equivalent to what would be the cash price basis. Where this amount is not available, the purchase price is determined by the current value of the consideration given in exchange for the asset. For example, current value for a credit instrument is the amount immediately required to settle the obligation or the amount of money which might have been raised directly through the use of the same instrument employed in making the credit purchase. The current value of an equity security is its market value. Market value is the current or prevailing price of the security as indicated by recent market quotations. If such values are unavailable or not appropriate (thin market, volatile price movement, etc.), an acceptable alternative is the fair value of the asset acquired.

(ii) Donated assets which, at the time of receipt, meet the contractor's criteria for capitalization shall be capitalized at their fair value at that time.

(2) Costs necessary to prepare the asset for use include the cost of placing the asset in location and bringing the asset to a condition necessary for normal or expected use. Where material in amount, such costs, including initial inspection and testing, installation and similar expenses shall be capitalized.

(b) Tangible capital assets constructed or fabricated by a contractor for its own use shall be capitalized at amounts which include all indirect costs properly allocable to such assets. This requires the capitalization of general and administrative expenses when such expenses are identifiable with the constructed asset and are material in amount (e.g., when the in-house construction effort requires planning, supervisory, or other significant effort by officers or other personnel whose salaries are regularly charged to general and administrative expenses). When the constructed assets are identical with or similar to the contractor's regular product, such assets shall be capitalized at amounts which include a full share of indirect costs.

(c) In circumstances where the acquisition by purchase or donation of previously used tangible capital assets is not an arm's length transaction, acquisition cost shall be limited to the capitalized cost of the asset to the owner who last acquired the asset through an arm's length transaction, reduced by depreciation charges from date of that acquisition to date of gift or sale.

(d) Under the "purchase method" of accounting for business combinations, acquired tangible capital assets shall be assigned a portion of the cost of the acquired company, not to exceed their fair value at date of acquisition. Where the fair value of identifiable acquired assets less liabilities assumed exceeds the purchase price of the acquired company in an acquisition under the "purchase method," the value otherwise assignable to tangible capital assets shall be reduced by a proportionate part of the

excess.

(e) Under the "pooling of interest method" of accounting for business combinations, the values established for tangible capital assets for financial accounting shall be the values used for determining the cost of such assets.

(f) Asset accountability units shall be identified and separately capitalized at the time the assets are acquired. However, whether or not the contractor identifies and separately capitalizes a unit initially, the contractor shall remove the unit from the asset accounts when it is disposed of and, if replaced, its replacement shall be capitalized.

§ 404.60 Illustrations.

(a) Illustrations of costs which must be capitalized. (1) Contractor has an established policy of capitalizing tangible assets which have a service life of more than 1 year and a cost of $1,000. The contractor's policy must be modified to conform to the $500 policy limitation on minimum acquisition cost established by the standard.

(i) Contractor acquires a tangible capital asset with a life of 18 months at a cost of $600. The standard requires that the asset be capitalized in compliance with contractor's policy as to service life.

(ii) Contractor acquires a tangible asset with a life of 18 months at a cost of $450. The asset need not be capitalized unless the contractor's revised policy establishes a minimum cost criterion below $450.

(2) Contractor has an established policy of capitalizing tangible assets which have a service life of more than 1 year and a cost of $250. Contractor acquires a tangible asset with a life of 18 months and a cost of $300. The standard requires that based upon contractor's policy the asset be capitalized.

(3) Contractor establishes a major new production facility. In the process, a number of large and small items of equipment were acquired to outfit it. The contractor has an established policy of capitalizing individual items of tangible assets which have a service life of over 1 year and a cost of $500, and all items meeting these requirements were capitalized. In addition, the contractor's policy requires capitalization of an original complement which has a service life of over 1 year and a cost of

00. Items of durable equipment acquired the production facility costing less than each aggregated $50,000. Based upon contractor's policy, the durable equipitems must be capitalized as the origicomplement of low cost equipment. concept of original complement apto such items as books in a new library, act wrenches in a new factory, work ches and racks in a new production faor furniture and fixtures in a new Fire building.)

4) Contractor has an established policy treating its heavy presses and their er supplies as separate asset accountty units. A power supply is replaced ng the service life of the related press. standard requires that, based upon the tractor's policy, the new power supply be alized with appropriate accounting for replaced unit.

Illustrations of costs which need not be alized. (1) The contractor has an estabed policy of capitalizing tangible assets

have a service life of 2 years and a of $500. The contractor acquires an with a useful life of 18 months and a of $5.000. The tangible asset should be pensed because it does not meet the 2 criterion.

The contractor establishes a new asbly line. In outfitting the line, the conactor acquires $5,000 of small tools. On milar assembly lines under similar condis, the original complement of small is was expensed because the complement replaced annually as a result of loss, pilrage, breakage, and physical wear and Because the unit of original compleent does not meet the contractor's service criterion for capitalization (1 year), the all tools may be expensed.

44.70 Exemptions.

None for this standard.

14430 Effective date.

The effective date of this standard is July 1973. The standard shall be applied to acared expenditures for acquisition of tangibe capital assets during the contractor's ext fiscal year beginning on or after October 1, 1973.

33 FR 12319, May 5, 1973]

1-31220-5 Accounting for unallowable

costs.

PART 405-ACCOUNTING FOR UNALLOWABLE

COSTS

46.10 General applicability. 45 20 Purpose.

45.30 Definitions.

45.40 Fundamental requirement.

45.50 Techniques for application.

Sec.

405.60 Illustrations. 405.70 Exemptions. 405.80 Effective date.

AUTHORITY: 84 Stat. 796, Sec. 103 (50 U.S.C. App. 2168).

SOURCE: 38 FR 24195, Sept. 6, 1973, unless otherwise noted.

§ 405.10 General applicability.

This standard shall be used by defense contractors and subcontractors under Federal contracts entered into after the effective date hereof, and by all relevant Federal agencies, in estimating, accumulating, and reporting costs in connection with the pricing, administration, and settlement of all negotiated prime contract and subcontract national defense procurements with the United States in excess of $100,000, other than contracts or subcontracts where the price negotiated is based on (a) established catalog or market prices of commercial items sold in substantial quantities to the general public, or (b) prices set by law or regulation.

§ 405.20 Purpose.

(a) The purpose of this Cost Accounting Standard is to facilitate the negotiation, audit, administration, and settlement of contracts by establishing guidelines covering: (1) Identification of costs specifically described as unallowable, at the time such costs first become defined or authoritatively designated as unallowable; and (2) the cost accounting treatment to be accorded such identified unallowable costs in order to promote the consistent application of sound cost accounting principles covering all incurred costs. The standard is predicted on the proposition that costs incurred in carrying on the activities of an enterprise (regardless of the allowability of such costs under Government contracts) are allocable to the cost objectives with which they are identified on the basis of their beneficial or casual relationships.

(b) This standard does not govern the allowability of costs. This is a function of the appropriate procurement or reviewing authority.

§ 405.30 Definitions.

(a) The following definitions of terms which are prominent in this standard are reprinted from Part 400 of this chapter for convenience. Other terms which are used in this standard and are defined in Part 400 of this chapter have the meanings ascribed to them in that part unless the text demands a different definition or the definition is modified in paragraph (b) of this section:

(1) Directly associated cost. Any cost which is generated solely as a result of the incurrence of another cost, and which would