Depreciation costs are often significant and government regulations provide considerable latitude on how and when to recognize the expenses for pricing and costing government contracts. Whether firms want to maximize or minimize cost recovery, several ways of flexibly treating depreciation expenses come to mind:

1. Asset cost – various initial costs may be capitalized or expensed

2. Asset life – e.g. IRS guidelines, "economic life", contract period

3. Method of depreciation – straight line, various accelerated methods

4. Direct versus indirect charging

5. Where to assign the expense - cost center, plant, company, which indirect cost pool

6. Differentiating assets – dedicated assets for different types of contracts versus pooled assets for all work

7. Method of ownership - capital versus operating lease, related party versus non-related parties

8. Treatment of fully depreciated assets – e.g. charge out rates

9. Estimates for salvage value

10. Improvements – capitalized as betterments or expensed as patchwork repairs

Some of the rules and guidance auditors follow are intended to somewhat limit so-called "inequitable" cost and pricing actions but still considerable latitude exists. We will discuss the basic rules for depreciation and allude to those significant areas auditors can be expected to look at. We have drawn on numerous texts, the Defense Contract Audit Manual and our experience as consultants to government contractors.

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