CAS 418 requires that cost pools not containing a significant amount of costs of management or supervision where a direct labor or direct material would not be an appropriate base to allocate the indirect pooled costs, one of the following, in descending order of preference be used: (i) a resource consumption measure (ii) an output measure or (iii) a surrogate that is representative of resources consumed. According to CAS 418-50(e)(3) when the third method is used, which was the case here, a permissible surrogate is the use of "preestablished rates, based on either forecasted actual or standard costs" which if used "shall be reviewed at least annually and revised as necessary to reflect the anticipated conditions." In addition, if preestablished rates are revised during a cost accounting period and the variances of the two rates are substantial then the costs allocated up to the time of the adjustment should be adjusted to reflect the revised preestablished rates.

The government did not assert the use of preestablished rates was impermissible but rather asserts Lockheed failed to review the rates "at least annually" and revise them "as necessary." Lockheed asserted it was compliant with CAS 418 but did not put forth any evidence to contradict the government’s assertions. The Court ruled Lockheed cost allocation method did violate the CAS.

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