Cost Accounting Standard 406 - Consistency for Accrual, Deferral and Adjustment Practices
CAS 406 provides that a contractor must follow consistent practices in selecting the cost accounting periods for accumulation and allocating any expense and type of adjustment to expenses (including prior period adjustments). It is quite common for some expenses (e.g. taxes, insurance, employee leave) to be identified with fixed, recurring annual periods different from the contractor’s accounting period. The standard permits use of such separate annual periods other than the contractor’s accounting period provided the expenses are assigned to cost accounting periods in accordance with the contractor’s established practices. The standard provides an illustration where it is acceptable to adjust employees’ vacation expenses in October 2XX2 for its "vacation year" ending September 2XX1 in spite of the fact that the fiscal year ends November 2XX1 since this is its established policy. Or, for example, the contractor pays all salaried employees on the 25th of each month for the entire month even though there is really a receivable from the employee for the remaining period of each month.
Accruals and Deferrals. An accrual is an adjustment where revenue or expense is recognized in a period prior to the period a related cash receipt or payment occurs while a deferral refers to a situation where revenue or expense is recognized in a period subsequent to the period of cash receipt or determination an obligation exists. Adjusting entries are often required to make certain a cost accounting period reflects proper amounts of costs for that period where accountants normally believe there is a need for adjustments to keep the accounting system on an accrual basis. Adjustments may be needed when many accounts are maintained on a cash basis and need to be adjusted to keep the accounting system on the accrual basis or may be necessary to update certain accounts such as inventories.
Prior-Period Adjustments. A prior period adjustment is usually needed to correct an error such as a mathematical mistake, mistake in applying an accounting practice or oversight or misuse of facts. Neither the CAS nor FAR provide requirements for handling prior-period adjustments but under Generally Accepted Accounting Practices there are three approaches available: (a) restatement method – retroactive adjustments to a prior period (b) cumulative effect method – assigns an adjustment to the current period and (c) current and prospective method – spreading the cumulative effects over the current and future periods. Only adjustments that are material should be made. Under government contracts where the restatement method may not be practical for completed or closed out contracts, the cumulative method is commonly used to adjust previous depreciation costs when an asset is disposed of and errors in depreciation expenses are often best covered under the current and prospective method.
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