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FINAL STRATEGIC COST MANAGEMENT EXAM SPRING 2017 Wily Company works on U.S. Air Force and commercial aircraft components and is paid for government work based on cost plus fixed fees contracts. Based on a prior agreement with government auditors, general indirect costs of Wily are allocated to each contract on the basis of direct labor costs. In 2016, Wily's direct labor was used one-third on government contract work and two-thirds on commercial work. Accordingly, one-third of all general indirect costs were reimbursed by the government. In that year, general indirect costs amounted to $180 million. The contract between Wily and the government specified, in one of its many provisions, that double assignment of any indirect cost is disallowed. This provision explains that double counting occurs when the same cost element is included both as a direct cost of a contract and as an item in a group of indirect costs. The contract provision is in conformity with the Cost Accounting Standards Board Standard #402, \"Consistency in Allocating Costs Incurred for the Same Purpose." 1 Wily has a centralized security department that performs security for the entire company. This department's costs were $12 million in 2016. This cost is considered a general indirect cost and is allocated to contracts based on direct labor costs. In 2016, Wily received a contract for producing a new top-secret projectAx4000. Because of its top-secret status work on the Ax4000 could only be performed under heightened security. Wily hired a special security force (SSF) approved by the defense department. This force provided security services solely for the Ax4000, and cost Wily $3 million in 2016. This $3 million was charged directly to the Ax4000 contract and was included in its $120 million direct labor cost in 2016. It was not included in the $180 million of indirect costs allocated to contracts. Government auditors, conducting routine, periodic audits of cost data and accounting systems of defense contractors, objected to Wily's practices. The auditors concluded that there was double counting on this contract, and the Air Force should claim a refund from Wily. Specifically, the auditors charged that Wily should not have allocated indirect security costs to this contract. The responsible accounting staff member on your team was rushed to the hospital after receiving the government auditors' report and didn't have time to complete her work. She left the following notes: There are two different issues in this dispute. First, was the $3 million included in the $12 million general security cost? Second, if not, is it part of general security and should be included as an indirect cost. The Air Force is entitled to a different refund depending upon which of the scenarios is correct. The first issue is simple. Apparently, the Air Force auditors believe that the SSF is simply an assignment of personnel who are part of the general security. Indeed if this were the case, then they would be correct in asserting that there is double counting and they would be entitled to a refund as they have paid for it as part of the security costs included in the indirect costs of $180 million. The second issue stems from failing to define and agree on the cost object. Is the cost object all the work Wily does for the Air Force or just for the Ax4000 project? We assert that the cost of the special security is directly traceable to Ax4000 and therefore a direct labor component of that contract. We are not reassigning people already on the general security payroll to special security. General security provides initial access to the grounds where Ax4000 is made. SSF is a second layer that keeps employees working on commercial operations from entering the designated special area. If general security was not available, the cost to provide special security would be much higher than the charge to the Air Force because we would need to have a separate facility for Ax4000. If the Air Force prevails on double counting, then the refund is simply $3 million. If they win on the second argument that $3 million in SSF should be included as an indirect cost, then the refund they are entitled to can be calculated as follows: Air Force's Current Payment Direct Labor Cost Military (1/3 of total labor cost) $120 million Direct Labor Cost-Commercial (2/3 of labor cost) ? million* Total Direct Labor Cost General Indirect Costs: General Security Cost $12 million Other Indirect Costsa _____?______ Subtotal $180 million (*Military =120 million and this is 1/3 of total, then full labor cost = 120 1/3 = 360 million). The Air Force has currently paid $180 million ($120 million direct labor + $60 million indirect costs)**. (** The indirect costs are computed as follows: [(120/360) x 180] = $60 million. This includes the allocation for general security costs which needs to be calculated for *** below). Air Force's Revised Payment If the Air Force wins the argument about SSF, then this cost will be reclassified as general security and removed as a direct labor component chargeable to Ax4000. Direct Labor Cost-Military $ 117 million (Removal of the SSF cost) Direct Labor Cost-Commercial (2/3 of labor cost) Total Direct Labor Cost General Indirect Costs: General Security Cost (Reclassification of SSF) 240 million $ 357 million $ 15 million Other Indirect Costsa Subtotal Air Force Refund: Direct Labor $ $ 117,000,000 Indirect Costs (117/357) x Subtotal General Indirect Costs Total Due - Payment 180,000,000 Total Refund Due *** $ ***Currently the Air Force has paid direct and indirect cost for security. ($3 million direct and $X million indirect cost). Check the amount due is: SSF Total Security $ 3 million 15 million Air Force portion ($15 million *$117 DL/$357 Total DL) - Air Force payments *** ($3 million direct and $X million indirect cost). Refund due (prior to additional refund on the original amount from the reduction in the percentage) Percent reduction: (120/360 minus 117/357) x Other indirect costs Total Refund Due Case Requirements: 1. Complete the supporting schedules started by the team member. 2. Suppose that Wily can negotiate with Air Force representatives for reimbursement of security costs. Prepare a reasoned one to two page memo to the Air Force supporting the maximum amount to which Wily is entitled without violating the double counting provision. Be sure to include computations in your memo. For more information refer to: https://govcontractassoc.com/cost-accountingstandards-402/ 1