(Editors Note. The following is an edited version of a memo prepared for our client. Though the original memo addressed details of its product lines and manufacturing processes we eliminated those sections to keep the client’s identity confidential and to highlight only selected considerations in deciding whether to change its indirect rate structure. Though the client is a manufacturing concern we should stress the same concepts apply to service firms with two or more locations.)

Our client was in the process of negotiating a $55 million contract (which it won) to manufacture several items of its major product line and asked us to prepare a disclosure statement in compliance with the cost accounting standards since the new contract would be CAS covered. Shortly after beginning work on the disclosure statement they indicated the large contract will likely require them to have an additional facility where two of their products would be manufactured and asked us several questions related to the new facility such as How do other government contractors approach this scenario? What will be the impact of moving two product lines out of their existing facility with respect to our being compliant with CAS? Will the move trigger a new set of separate overhead pools at the new facility to be spread down only to the products in the new facility or will the current overhead rate structure still be appropriate?

We said we are glad they brought this up before we proceeded with the disclosure statement and indicated the best time for making any changes would probably be now. Several factors should be considered in making their decision.

In our mind, this is the most critical issue because decisions about cost methodologies are not merely about accounting theory but should be based on the practical considerations of how the company wants to price its products. Unless you price items on a competitive or commercial item basis – catalogs, commercial market prices, GSA supply schedule – your prices negotiated with the government will likely be based on a cost buildup where allowable direct and indirect costs allocable to the items being offered will largely determine the price to be charged. Since the FAR and CAS provide considerable latitude in costing, you need to decide first on your pricing objectives. For example, are your items highly competitive with numerous other firms where low price is a significant factor in being awarded the contract. In that case, you will likely want to minimize or lessen the costs allocated to the items being sold to the government since you want to be able to offer a sufficiently low price to be competitive. On the other hand, if your items are unique and few to no other firms offer the products the government wants to buy, then you likely have greater pricing flexibility. In that case, you will probably want to maximize, or at least increase, the costs allocated to the offered items you are selling.

The analysis of pricing strategy should not be limited to a discussion between accounting personnel but should be informed by insights from the firm’s marketing and senior level executives. Pricing strategy insight should be based not only on current opportunities but future opportunities because decisions made now will affect pricing in the future.

{TAG_FORM_TITLE}