Subcommittee Staff Study on the Accounting Establishment

Published by the Government Accountability Office on 1977-05-26.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                                        Statement        of
. Elmer        B.     Staats,  Chairman,       Cost      Accounting        Standards                                                Board
                                         Before      the
              Subcommittee      on Reports,         Accounting       & Management
                                             of the
                        Committee      on Governmental          Affairs
                                  United    States       Senate
                                                on               *
                          ithe Subcommittee          Staff    Study on
                          : The Accounting          Establishment'
                                        May 26, 1977


          I am appearing                     before             you        today         in     my capacity                  as

Chairman            of     the    Cost         Accounting                    Standards               Board         to       discuss

various            aspects        of     the        Subcommittee                       Staff         Study         on the           AC-

counting            Establishment                   as     it         relates            to     the       CASB.

          Before           discussing               the         staff           study,          I would            like        first

to    review          briefly          for      you        our            activities                to    date.

          We have            promulgated                  14 cost               accounting                standards,                2

interpretations                   of     standards,                       and     implementing                    regulations.

All      of    these         promulgations                      are        required             to       be included                in

major         negotiated           defense                contracts.

          In       addition,           we have             developed                   a cost            accounting                con-

ceptual            framework.                The      essence                of    that         framework               was pub-
lished         in     March       1973,         in        our      Statement                   of    Operating               Policies,

Procedures,                and Objectives.                         The          framework                has    recently                been

updated            and     expanded            and        a restatement                        has       just      been       published.

We believe                that    establishing                        concepts            for        cost       accounting,                 as

early         in    our      history           as     1973,               was very          important                  to    our
                                                                                         --   ,,1
                                                                                                  I                5

  success.               The              framework                  establishes                 as one             of        our     principal

  purposes              the         setting                of        standards              to      measure               the        cost          of

I supplies              and          services               acquired                 by the             Government                   in      a

  way      that         is         fair         to     both            buyer        and       seller.                Beyond                provid-

  ing      for      a reasonable                           profit,             the        Government                  wants           to         pay

  the      cost         of         the      resources                   used         to     fulfill .              a Government

  contract--             no more                 and            no less.                 Therefore,                 our         principal

  guideline                  for         measuring                   and     allocating                  cost            is     to    match

  costs          with         resources                    used.             The         details          of        our         objec-

  tives,          policies,                     and concepts                       are      outlined                in        the     published

  restatement.                            I would               like        that         document              made a part                       of     the

  hearing           record.

            Our         major              promulgations                       are        listed              in    appendix                 A to

  this       statement.                         We expect                   13 additional                      subjects,                   now in

  various           stages                 of        research               and development,                             to     culminate                in

  cost       accounting                      standards                  or     regulations;                        these            are      briefly

  described                  in      appendix                   B.

             At     this             point            it        may be useful                      to    summarize                   the         process

  by which              we identify                        subjects                for      research                leading                to      poten-

  tial       new standards.

            We began                      operations                   in    1971         with          the        benefit            of         major

  research              work              recently               completed                as part              of        GAO’s            feasi-

  bility          study              which            supported                the        desirability                        of     a Cost

  Accounting                  Standards                    Board.              That         research                included                 im-

  pressive              work              by groups                  outside             GAO.           We used               the
  feasibility                    study       report            as one             of     the        major       guides           in

  selecting               the       first        subjects                  for      standards;                 in     effect,           we

’ started             working            on the          major             problems             which          had     already

  been       pinpointed.

             Our         staff       provides               us with               time-phased                  technical              work

  plans,           including                proposals                for         additional              topics.                We peri-

  odically               review          these        work           plans.              We also             keep       informed

  about         the       entire            process            of     staff             research             and      the       develop-

  ment       of       potential              standards.

             We have              from       time        to      time            sought         and      obtained               advice

  about         the        importance               of      various               subjects.                  We have            asked

  Government                agencies,               contractors,                        industry             associations,

  academicians,                     professional                     accounting                 associations                    and

  others           for      their           suggestions                    for         research             topics.             We

  have       especially                  asked        for           instances              where         contracting                  parties

  found         problems              or     difficulties.                          Decisions                on whether               and when

  to     research                a subject            are        based            primarily              on three               factors:

             (1)          The       subject’s               relationship                       to     the      objectives               of

                          Public            Law 91-379,

             (2)          The       importance                 of     contract                 cost         accounting

                           problems            in     the        area,            and

             (3)          The       subject’s                 relationship                     to     other         work        of    the


             The         Board        also       has        designed                   a cost         accounting                practices

  disclosure                statement               which            must         be submitted                  by companies
 who       receive             negotiated                   defense              contracts                   and    subcontracts

  exceeding              $10 million                      in    1 year.                 Contractors                     are       required

i to      follow         their            stated            practices                  in     pricing              contract                pro-

  posals           and        in    accumulating                      and        reporting                   contract             perform-

  ance       cost        data.

             As of        December                  31,        1976,         we have                received               copies           of

  1,447       disclosure                   statements                  from            203         companies.                    Information
  from       these        statements                      is    fed         into          a computer                which            can      pro-

  vide       aggregate                  data        on any            question                 or       combination                  of

  questions              covered               by      the      disclosure                     statement.                   This           data

  bank       helps        us        in     our         research.                   Much            of     this      information

  is      published                in     aggregate                  form         in     our        progress               report           to

  the      Congress                and     is       available                to        the         public.

             The       task         of     issuing              sound,             fair            cost       accounting

  standards              is        exceedingly                  complex.                    To help              us achieve                 our
  objectives,                  we continually                         seek         the         cooperation                  of       all      those

  who have           an interest                       in      our     work.                We have              established                  ac-
  tive,       open        consultations                         with         representatives                          of       all         groups,

  including              Government                    agencies,                 professional                      and        industry

  associations,                     the        academic               community,                    and       representatives

  of      individual                companies.                   There             are         now        more      than          1,300

  Organizations                     and         individuals                  from            all        of    these         groups            to

  whom our           proposals                   are         regularly                 mailed             during         our         research.

 These        organizations                         and        individuals                    have           provided             construc-

  tive       comments.

            Recognizing                    that            training            on Board               regulations              and            newly

 issued            standards               would               serve      both         industry            and Government,
* we are           participating                      in        established                 training            programs                of     the

 Government                 and      of        professional                    accounting                 and    legal         associa-

 tions.             In      addition,                 Board            members             and    staff         speak         to        in-

 terested             groups             and participate                         in        panel’s,        conferences,                       and

 the       like,           sponsored                 by        accounting              or     legal        professional                       as-

 sociations                 or     by      industry                  associations.                      These       occasions

 have        afforded              us opportunities                            to      inform           interested             parties

 about         the        Board          and         to        answer       questions                 and discuss              concerns

 about         the         Board’s              standards               and      regulations.                    In      conjunction

 with        the      Department                     of        Defense,          we have              undertaken              special

 efforts             to     explain                 our        standards             and      regulations                to    European

 contractors                     involved                 in    negotiated                 defense         contracts                and


            We have               also          cooperated                with         Federal            agencies            in        develop-

  ing      regulations                    to        implement             Board            promulgations.                     We spon-

 sored         establishment                         of        an Interagency                    Advisory           Committee,

 to     which            procurement                      and     finance
                                                                      *               representatives                    of    DOD,

 ERDA,         NASA,             GSA,      HEW, and DOT are                            appointed.                This         Committee

 meets         from         time          to        time        to     discuss             problems         of      common              in-

 terest            concerning                   the        Board’s          regulations                   and    cost         account-

  ing      standards                and         to        discuss         ways         that       all      executive                branch

  agencies                can     act      uniformly                   on such             matters.             The      Administrator

  of    the        Office           of     Federal                Procurement                 Policy,           Office             of        Manage-

 ment         and        Budget,               is    Chairman             of        this      Committee.

         We receive               annual          reports              from     Federal            agencies             who

use    our     standards.                The       agencies               comment         on their               experience

in    using         standards           and Board                regulations.                  They       have

reported            several          improvements                 in      contract            negotiation                and

administration                  because          of    Board         promulgations:
         1.     More          meaningful              cost        data   is being                  submitted             in

                    contractors’              proposals.

         2.     Questions               and       time-consuming                     controversies                 on cost

                    accounting           practices                have         been     reduced             in    the

                    negotiating             phase,           thereby            leaving            the    negotiating

                    parties        better          able          to     concentrate                on anticipated

                    overall        cost.

         3.         Many      long-term            accounting                  and    estimating                 problems

                    have      been      resolved             by narrowing                 the       range         of     ac-

                    counting           options           and          issues      among         auditors,               con-

                    tractors,           and procurement                        personnel.

         4.         Contractors             have         been          encouraged             to    discuss             pro-

                    posals        to    change           their          cost      accounting              practices

                    with      Government              personnel,                thereby            reducing             the

                    number        of    such       changes.

         At    our         request,         the       Department                of    Defense            has      reviewed
218    of     the      largest          defense           contractors                 (whose         contracts

represent            75 percent             of     the       Defense            Contract            Audit         Agency’s

annual        workload            in    dollars)             to        estimate         the        impact         of     cost

accounting             standards            on Government                      contracts.                We requested
the     DOD review                   because             a recent               report            released                  by the

Aerospace                Industries                 Association                     of     America,              Inc.,            stated

that        industry                surveys            they         had    participated                         in        "show      clearly

that        extensive                efforts             in    furtherance                       of      [P.L.            91-3791          have

produced            little,                 if    any,        benefits."                        The-Association                      con-

cluded         that           "the          expenditures                  of        effort             required              to     develop,

promulgate                and        administer                CAS far               exceed              any     quantifiable


            The     DOD review                    concluded               that            for      the         218 defense                 con-

tractors            it        is     estimated                that        there            has         been          a nonrecurring

net     decrease               of         contract            costs         of        approximately                         $121     million

since        1972         that            can     be     related               to        cost         accounting               standards.

Also,        there            is     estimated                to        be an additional                         annual             recurring

decrease            in        contract               costs          of    $106            million.

            We do not                write           standards                 to     affect             the         flow      of    cost
to     or    from         Government                   contracts.                    We are              pleased             to     note,

however,            that            required             compliance                  with             standards              which         were

developed                to        increase            uniformity                   and         consistency                  has     had

the     additional                       effect        of     helping               to      achieve             decreases              in

contract            costs.                  These        monetary               benefits                 are         in     addition           to

the      reported                  improvements                    in    contract                negotiation                   and

administration                           enumerated            previously.

-                  between
     ----l-----____el__P                          FASB and               CASB

            The     staff                study       mentions             CASB at                several              points,          but

chapter           X of             the      study        focuses               on its            operations                  and my

comments              will          relate          to        that        chapter.                 Several                  comparisons

are      made         between              CASB and              the           Financial              Accounting                       Standards

Board.           The          following                 statement                    is     made      in        the         study:

          “The          CASB establishes                             cost            accounting                 standards                   in

          a manner                  which          is    essentially                        similar             to     the           FASB’s
          for         establishing                      financial                    accounting                 standards                   used

          in      reporting                  the        results                of     business             activities                       to

          the         public.                Both        have          technical                 staffs               and        proce-

          dures              to     ensure          that         proposed                   standards                 are        well-

          researched                      and      subjected                   to     public          comment.                       Members

          of     the          CASB and              the        FASB exercise                       the          same type                   of

          analysis                  in     reaching              decisions                    on accounting                          stand-

          ards          in        their          respective                    areas.”

          As Chairman                      of     CASB and                 a member              of      the          Financial                  Ac-

counting              Standards                  Advisory             Committee,                   I believe                     I    am in            a

fairly          good          position              to        compare                the      similarities                       and dif-

ferences              in      the         operations                 of        the         two   Boards.

          --FASB              is     a full-time                     Board            that       has       been             in       operation

                for          more         than      4 years;                 CASB is             a part-time                         Board         that
                has          been         operational                  for           a little          over            6 years.

          --The              scope         of     CASB’s             mission                in   developing                      cost        ac-

                counting                  standards              is       more             specialized,                     in       that        the

                standards                  must         be     used          by       companies              with            negotiated

                contracts                  with         the      Federal                  Government.                  FASB develops

                accounting                   standards                to        be applied                 in        presenting

   financial                statements                  for          all      publicly                  and        privately

   owned        companies.                       In     essence,                  financial                   accounting

   standards                must      be followed                          by all          of         the      companies

   who must             comply             with         cost             accounting                   standards,

   plus        the      rest         of     American                     business               that         has        to         pre-

   pare        financial              statements.                                    ,'

--CASB         relies          heavily                 on         the      work      of         its         staff.                 Be-

   cause        of      the        reliance                  placed           upon         the          staff,               its         out-

   put      includes               numerous                  issue          papers              and preliminary

   draft        standards                  that,             after           review             by      the        Board,                are

   distributed                 for         comment                 by the          staff              as part            of         their

   research             effort.                  FASB has                  no comparable                        staff              ac-


--In       empirical               research,                      the      CASB staff                   takes           a dif-

   ferent            approach              from             the         FASB staff's                    in      that          our

   staff        can         find          out         the         how and           the         why of             companies'

   cost        accounting                  practices                     because           it         has       access               to

   company            records.                   They             can      also       request                 assistance

   on a reimbursable                             basis             from       the         Defense              Contract

   Audit        Agency             and          other             Government               agencies                  which

   have        such         accgss.

--Fourteen              Standards                     have         been       promulgated                      by       each             of

   the      two       Boards.                   CASB,             however,            as required                       by         law,

   has      also            developed                  and promulgated                            two         separate

   forms        of      disclosure                     statement--                   one          for         companies

   and      one       for      colleges                     and         universities.                         In     addition,

           CASB has                  developed              and            issued           regulations,                         including                a

           contract                  clause,             dealing                with        the     manner                 in     which           standard

           and          disclosure                  statement                   requirements                     are        to      be applied.

           The          staff             study      states            that            since            CASB is             successfully

setting                accounting                 standards                 with        half            of     the         resources                 used

by      FASB,           Federal              agencies            have             demonstraied                       the         ability             to

perform                that         task      more         efficiently                      than         private                 organiza-

tions.             The            study       recommends                    either           the         Government                   should

directly                establish                 financial                 accounting                       standards              for

publicly                owned             corporations--                    through               the         Securities                   and

Exchange                Commission                  or     through                a Federal                   board         similar               in

operation                    to     CASB-- or            accounting                    standards                 should             be estab-

lished            by         the     General             Accounting                    Office.

           I do not                  agree          that        the         job        of    setting                 financial                ac-

counting                standards                  should        be legislated                           away          from         the       pri-

vate       sector.                   FASB has              been            in     operation                   only      a short               time,

part       of          which         was devoted                 to         recruiting                   board          members               and

staff           and          setting          up operations.                            Under            the         circumstances,
I believe                    FASB’s          progress            has            been        good.              They         have           a num-
ber      of       problems                 which         have         been            reported                by the             structure

committee                    of     the      Financial             Accounting                      Foundation.                        I believe

that       prompt                  implementation                     of        the     committee’s                        recommenda-

tions           will          go a long              way        toward                overcoming                 some of              the         prob-

lems       it          reported;              these         also            are        discussed                 in        the      staff            study.
           In          summary,              although            CASB has                   been         effectively                       per-

forming                the         scope      of     its      mission,                  this        mission                 is      quite

 different                 from         that         of        FASB.           Any         comparison                   between           the

 operations                  of    the         two        Boards           must            be looked               at       in     a proper

: perspective.                     The         current                approach               to        setting             accounting

 standards                 in     the      private                sector              is     appropriate,                    particularly

 if   it        is    coupled              with           close          SEC oversight                          and        review         of

 FASB operations                         and         output.

 ---------- Study -----------------
                    Comments                          on CASB

           We are               pleased              that         the         staff          study            acknowledges                 that

 CASB is             performing                 it        task          successfully.                          We are             concerned,

 however,             with         some of                the         stated           or        implied           criticisms                   of


           1.        The        composition                     of      the      Board            is      criticized                as being

                     dominated                 by representatives                                 of         industry             and     the

                     accounting                 profession.                           The        Board’s           enabling               legis-

                     lation,             P.L.         91-379,              very            clearly             prescribes                 the

                     criteria              to        be followed                      by the            Comptroller                 General

                     in      appointing                   the         other           four        members             of     the        Board.

                                  Two members                     are         required              to        be appointed                 from

                     the        accounting                  profession,                      one        of     whom must                be particu-
                     larly         knowlqdgeable                         about             the     cost          accounting                prob-

                     lems         of     small            business.                    The        two         appointed             from         the
                     accounting                 profession                     have          continued                as members                 of

                     the        Board          since            its      inception                 in         1971.          Mr.        Berman         W.

                     Bevis         retired                as the           senior             partner              of      Price         Water-

                     house         and Co.                in     1969.                Be was a member                        of     the

President’s                       Task         Force              on Improving                       the     Prospects

of       Small           Business.                      Mr.        Robert             K.    Mautz            was a profes-

sor       of        accountancy                     at        the        University                   of     Illinois            when

he accepted                       his         appointment,                      and        he has            been        a partner

in       the         firm         of      Ernst              & Ernst            since           1972.             Both

Mr.       Mautz             and Mr.                Bevis           assisted                me in           studying             the

feasibility                       of      developing                     cost         accounting                   standards

and       both           joined            with           me in           recommending                       legislation

to      provide                for        their           development.

           One member                         is    required                 by law             to     be appointed

as       representative                            of        industry.                   That         member           pre-

sently              is      Mr.         John        M. Walker,                     Senior             Vice        President

and       Corporate                     Treasurer                  of     Texas            Instruments,                   Inc.

               In     my opinion,                       these            Board           Members             have        acted
fully           in       the         spirit             of        the     law.             They        have         in    no
sense           “represented”                           industry,                  the      accounting                   profes-
sion,           or       the         Government.                        At      all        times,            they        have
acted           in       their            capacity                 as Board                members            in     an

effort              to      carry          out          the        statute.

           As might                     be expected,                      they           sometimes              disagree

on key              issues              and        they           have       on occasion                     written

reservations                         or    dissented                    from          Board          decisions

when       a standard                      was promulgated.                                 They           have      been
performing                   a valuable                       public            service              and      they

have       contributed                         greatly              to       the       Board’s               success.

2.   The      staff          study             recommends                   that        appointment                     of       a

     member           from       the           Federal               Government                 should                be rotated

     among         the       many         Federal                   departments                 and         agencies

     affected             by     standards                      and        should         not         always            rep-

     resent               the         Department                     of     Defense.

               NO reasoning                         or         facts        are        offered              in        support          of

     this       recommendation.                                 DOD contracts                        represent               about

     75 percent                 of      the         total            national             defense                 contracts

     that       are       required                  to         include            the     cost             accounting

     standards               contract                 clause.                   DOD has              the      leading                and

     dominant             role          in      the            implementation                        and      administra-

     tion       of       cost         accounting                       standards.                    In     many         instances,

     DOD negotiates                       and            audits            contracts                 on behalf               of

     other         Government                   agencies.                       The     Cost          Accounting

     Standards               Board             is        aided            by receiving                     DOD’s         input

     before           deciding                 whether                 proposed           standards                    can       be

     successfully                     implemented                         and     administered.                          For

     these          strong            reasons,                  I have            to    date          selected               a

     DOD representative                                  as the            other        Government                     member.

3.   CASB is             criticized                      for        not     having             its         meetings              open

     to      the      publi’c           and         for         not        being         subject                 to    the

     “sunshine”                 legislation                         (P.L.         94-409).

                   I am convinced                         that            subjecting                 CASB to             the

     “sunshine”                 legislation                         would         seriously                 jeopardize

     the      Board’s                ability              to        maintain             the         privacy             and

     confidentiality                           of        the        commercial                 and         financial

information                     which          it      obtains                 from         Government

          Much            of        such       information                      is      volunteered                     by

Government                 contractors,                       during              the        Board’s               exten-

sive      research                    into          possible         cost , accounting     stand-
ards,         under             pledges               of     confidentiality.          The Board

relies         heavily                 on that               information                      in     its         own


          We could                    endeavor               to     close             Board         meetings                 at       the

time      when            we knew              that          this          confidential                      information

was      to     be discussed,                          but         this         information                      is     closely

linked          to        other             research               data         which          our         staff          devel-

ops.          All         of         the      staff          research,                     including               both        pri-

vate      information                         and      information                      which          may         be     dis-

closed          to        the         public,              must       be discussed                          in     detail

as the         Board                 considers               the      formulation                      of        a cost

accounting                     standard.                   We do not                  know         how we could

isolate             the         private               information                     to     avoid           any        discus-

sion      of         it        in     public.

          In         these            circumstances,                           I think             Board           meetings

open                to         the     public              would           involve             a great                risk

of      inadvertent                        disclosure               of         private             information.

          We enclose                          as appendix                      C a paper               which            sug-

gests         other             arguments                  against              including                  the        Cost

Accounting                 Standards                   Board              in    the         “sunshine”

     legislation.                     We strongly                  urge          that         the       Board           not         be


4.   The      staff         study            criticizes             the        membership                    of     CASB per-

     sonnel           in    AICPA            and other             professional                      accounting

     associations                    which         are      among          the          sponsors             of     FASB.

     The      staff         study            recommends             that:           Federal             employees

     not      serve         on committees                     of    these               associations,                    be-

     cause       such           organizations                    directly                or      indirectly                   in-

     fluence           accounting                  policies             and         regulations                    of    the

     Federal           Government.

                The        members            and        professional                    staff          of    CASB

     all      were         members            of    these          accounting                    associations

     for      years         before            becoming             affiliated                    with        the        Board.

     Generally,                 accountants                 join        such            associations                    to

     keep       current              with       new       developments                     in       the      profession.

     Membership                 in     the      associations                       is    entirely             voluntary

     and      the      dues          assessed              members            by the               associations                     are

     paid       for        by    the         individual,                not         by     the       Federal             Gov-


                Host        Federal             Government                 employees                 who are

     chosen           to    serve            on committees                    of        these        professional

     accounting                 organizations                    must         devote             much        of     their

     own time              to    those          committees.                    They           look        upon          such
     committee              service             as an opportunity                             to

           --obtain             recognition                 of     their            professional                    compe-


          --exchange                  ideas          with            fellow             professionals                     and

               further              their           education.

          --influence                    the        direction                    and      policies             of        these

               organizations                        so that                the         interests              of     Federal

               agencies              and         the          professional                      needs         of     associa-

               tion          members             might              be better              ‘served.

5,   The       staff           study           states               that         in     two      cases         the        Board

     has       shown           a disturbing                         tendency              to     benefit             private

     contractors                    by      issuing                 standards                 that       depart           from

     accepted                concepts               of        “costs.”                  The      first         case        cited

     was       a proposal                   dealing                 with         the      effects             of     inflation.

     The       second            case          cited           was Cost                 Accounting                 Standard

     No.       414:            “Cost           of      Money              as an Element                   of       the     Cost

     of    Facilities                    Capital              .‘I

                The          proposal               to        deal         with         the      effects             of     in-

     flation             was developed,                             not     to         benefit           contractors,

     but       to      provide              a rational                     basis          for        measuring             the

     impact            of      inflation.                      As early                 as March              1973,        the

     Board’s                 Statement                 of      Operating                  Policies,                Procedures,

     and Objectives                           mentioned                    that         a in     periods             of    con-

     tinuing                inflation               or        deflation                 the      reliance                on his-

     torical             cost         * * * can                     be     misleading.”                       The     Board

     reported                then        that            it    was         “interested                   in    all        aspects

     of    measurement                      of      cost            of     contractual                   performance

     including                 concepts                of      measurement                      on the         basis         of

     current             value           or      price-level                      accounting.*                       The     impact

of     inflation                was greater                    in     1973,         1974,         and        1975        than

it     had       been         before          the        Board’s             Statement              was prepared.

Even       so,      we did             not        take         hasty         action.              Inflation                  has

an impact               on all           business,                   not     just      on those               who

sell       to      the        Government.                      In  October             1975,           the        Board
published               a proposed                  cost         accounting                standard               on this


          The       staff            study          mentions                an estimate                of     the

increases                in     contract               costs          which         could         have        been

attributed                to      the        proposed                standard.              The        Board,            of

course,            was         aware         that        the         proposal          would           have         raised

measured            contract                 costs.              The        Board’s         withdrawal                   of

the     proposal                in      March,            1976,            was not         based         primarily

on any           such          estimate.                 Rather,             it     was     based            on the

determination                     that        the        major             impact      of        inflation

could        be dealt                with         much more                 effectively                in     connec-

tion       with          the      other           proposed                 standard         mentioned                   in

the      staff           study.

           This          Standard,                No.      414:             “Cost      of        Money        as an

Element            of     the        Cost         of      Facilities                Capital,”                is     an

excellent                example             of     the        Board’s             willingness                to

recognize                that        providing                   funds        to    acguire             facilities
to     carry        out         a contract                  is       a real         cost         and        should

be uniformly                    measured               and          allocated,             not      paid          for

in     profit            allowances                 or     buried             in    some other                cost

allocation                    such      as depreciation,

           In       developing                 Standard               No.      414 we worked                            closely

with       the       Department                     of    Defense.                 It      was,         as you                 may

know,         engaged             during             1975        and        1976         in      a major                study

called           “Profit           ‘76”,              resulting              in         a new profit                      policy

which            recognizes                   the        cost     of     money             determined                        in

accordance                 with         the         new standard.                        Prices             will          thus           be

negotiated                 with      more             uniform          understanding                          by the                con-

tracting             parties             of         how cost           of      money             relates                to        facili-

ties       capital            and        to         profit        policies.

           Standard               No.         414        has     enabled                the      procurement

agencies             to     discriminate                        more        effectively                     between

capital-intensive                             contractors,                   whose              cost        of     money

is     significant,                     and         others        who may have                         been        receiv-                    E

ing      a disproportionate                               share        of      the         potential                    profits

under         old       pricing               policies.                Also,             to      the        extent

that       the       standard                 results            in    investment                      in     cost-

reducing             equipment,                     the      Government                  will          be able                 to

procure             goods         and         services            at        lower         prices.

           At       the     time         that            Standard            No.         414 was              issued                by

the      Board,            Senator             Proxmire               recognized                   these           bene-

fits       and       commended                 the        Board        for         its          action.                 He stated:

“The       Board           has     come             up with           a proposal                   that          will

help       to       stimulate                 defense            contractor                     investment

in     badly         needed          new cost-saving                           equipment                    and

facilities.                   I    feel             certain           that         the        Congress                  will
accept           this       proposal.

     “Up       to      now,       federal            agencies                  have           not        permitted

     reimbursement                      of     a company’s                     cost           for        financing

     facilities                for       performance                     of         government                  con-

     tracts.               This        encourages                   defense                 contractors                   to

     continue              using         old        and outmoded                           plant         and       equip-

     ment,          since         the        government                  does, reimburse
                                                                         --I                                       them

     for       their          entire           labor           costs.                This           adds        to      defense


     “The       new standard                    changes                 facilities                      investment

     expenses              from         an open-ended                         profit
                                                                                --e-m              factor          to     a

     documentable                    cost
                                     ----       factor.                  It         will       permit              pro-

     curement              agencies             to        discriminate                        more          effectively

     between              contracts             in        which          a contractor                         has       made

     a significant                      investment                  of        his      own funds                   and

     contracts                where          this         is      not         true.”

6.   The       staff          study          also         cites          as disturbing                          the       Cost

     Accounting                Standards                  Board’s              recent               proposal              to

     increase              exempt ions               from                      cost           accounting                  stand-

     ards.             The     study           states             that         adoption                  of     the       pro-

     posal          would         impair            the        application                         of    cost         account-

     ing       standards                to     major           contractors--the                               reason           for

     which          the       Congress              created              the          Cost          Accounting                 Stand-

     ards       Board.

                Section              719(h)(2)                 of       the         Defense              Production
     Acts       of        1950       as amended                   authorizes                   the          Cost        Accounting


“*     * * to          prescribe                rules            and        regulations

exempting              from         the        requirements                      of       this        sec-
tion      such         classes            or        categories                   of     defense

contractors               or        subcontractors                          under            contracts

negotiated              in     connection                      with         defense                procure-

ments       as    it      determines,                       on the              basis         of      size      of

the      contracts               involved                 or     otherwise                   are      appro-

priate         and      consistent                    with           the        purpose             sought

to     be achieved                  by this               section.”

          Since         its         creation,                  the         Board        has         viewed           its

exemption              authority                as a responsibility                                  which           must

be exercised                  with         great            care           to     insure            that       the

purpose          of     the         law        is     not        frustrated.                        With       this

in     mind,      the         Board         has           made a series                       of      studies              of

numerous          classes                 and       categories                   of     defense              contrac-

tors      and     subcontractors,                              to     determine                    which      could

properly          be exempted.                            No class               or     category              has

been      exempted             by the               Board            unless            the         information

available              clearly             established                      that        the         exemption

was appropriate                      and        consistent                      with         the     act’s     pur-


          The     purpose              of       the        act        is        clearly             stated           in

its      requirement                 that           the        Board            promulgate                  standards

designed          to      increase                  uniformity                   and         consistency.

However,          the         act      states               that       the         Board            shall       take

into      account             the      probable                  costs           of     implementing                       a

standard                with          the        probable               benefits.                        This            require-

ment         was        amplified                  in        an amendment                         to     the        act          in

1975         which           specifically                         included                  in     the            probable

benefits                improvements                         in    pricing,                  administering,

and      settling                  contracts.                      Consequently,                             if         the     Board

finds           categories                   of         contractorsi-small                                   business,

for      example --where                           such           improvements                          would            be con-

sistently                   small           in     relation                to         the         probable                    costs

of      implementation,                            it        considers                 that             exempting                     such

a class               of     contractor                      would         be         appropriate                        and          con-

sistent               with         the       purposes                of         the         act.

             The        Board            has       been           studying                  for         some time

the       subject                of      exemptions                  for         small                 business                con-

cerns           and         predominantly                         commercial                      companies.                          We

have         gathered                 substantial                    data             as who would                            and who

would           not         be exempt                   under        the         proposed                    modifica-

tions           to         the     Board’s                regulations,                       and         we have                 re-

ceived            numerous                  comments               in      response                     to        our         proposal.

It      is      difficult                   to     achieve                the         proper              balance                between

exempting                   concerns               whose           alleged                  problems                    in     imple-

menting               standards                   outweigh                the         benefits                    and         assur-

ing       that             those         companies                 whose              cumulative                        activities

affect            defense                procurement                      are         covered.                     This          matter

is      still              under         consideration.                               We are             grateful                     for

the       views             of     your           staff           on this              matter;                    they         will          be

taken           fully            into            account           in      our         action.

7.       As a final              point,             the            staff          study        questions                    CASB’s

         need      for        presenting                  public                service           awards              to     orqani-

         zations             such      as AICPA,                    which           it     so honored                  in        1976.

                   The        award          was made                 in        recognition                  of       the        assist-

         ance      received                 from     the            CASB Committee                      of        AICPA            in

         providing             the      Board             and         its         staff        with          information

         and     advice             during          the            many phases                 of      the        Board’s

         research             into          potential                 cost          accounting                   standards.

         The     AICPA         Committee                  has         participated                     extensively                         in

         the     Board’s             research                 and          has      met      frequently                     with

         its     staff          to     discuss                proposals                   under        consideration,

         The Board             has          seen     no            indication                that       Committee

         members             have      attempted                     to     influence                 the        Board           to

         serve         the      interests                 of         the         accounting                 firms           rep-

         resented             on the           Committee                    or      of      clients              of    those

         accounting                 firms.               In        fact,          the       contrary              has        been

     ,   true      on some occasions.                                      For      example,                in    comment-

         ing     on Standard                   No.        409:              “Depreciation                        of    Tangible

         Capital             Assets,”              the        AICPA             Committee              agreed               in     gen-

         eral      with         the         accounting                     principles                provided                in

         that      standard.                   Since               the      fundamental                     requirements

         of     that         standard              were            generally                opposed              by most              of

         industry,              one         can     conclude                     that       the      AICPA’s                views

         represented                  the      objective                    and          technical               judgment                of

         professional                  accountants.                             The       Board        believes                  that

         the     comments              it      receives                    on     its       proposals                 from         all

                 professional                      accounting             associations                     are   essential

                 inputs            to    its        research.                 Those          inputs         generally          deal

                 with        the        cost        accounting                 concepts            involved           and are

                 not      viewed           as an attempt                       to     subjectively               or     improperly
                 influence               standards                set     by CASB.

          In     conclusion,                   I    welcome             these         hearings,             which       have

brought          to     public           attention                issues             which       need       to   be aired.

While          I disagree               with         some of            the         criticisms             and   recommenda-
tions      made         in    the        staff           study,          the         subject          is    a most       important

one      and debate                about           the    issues          raised             can      be constructive.

          This         completes               my prepared                statement.                   I will         be glad

to      answer         any    questions.

                                                                                                                                         APPENDIX            A

                                  MAJOR                             PROMULGATIONS BY THE COST ACCOUNTING STANDARDS BOARD

                                                                                AS OF JANUARY 31,                   19'77


                           Description                             I                                                                  Effective             Date

            1.                                Contract                 Clause                                                          July       1,         1972

             2.                               Disclosure                  Statement                                                    July       1,         1972

             3.                              Standard     401                 - Consistency            in Estimating,
                                             Accumulating                     and Reporting            Costs                           July       1,         1972

             4.                                 Interpretation                  No.    1 to      Standard           401                July       1,         1972

             5.                              Standard      402                - Consistency in Allocating
                                             Costs    Incurred                  for the Same Purpose                                   July       1,         1972

            6.                                  Interpretation                  No.    1 to      Standard           402                July       1,         1972

             7.                                 Standard                403 - Allocation           of      Home Office
                                                Expenses                to Segments                                                    July       1,         1973

             8.                               Standard                  404   - Capitalization                 of   Tangible
                                              Assets                                                                                   July       1,         1973

             9.                                Standard                 405   - Accounting          for        Unallowable
                                               costs                                                                                  April       1,         1974
  10.                                          Standard                 406   - Cost    Accounting              Period                July      1,           1974

  11.                                          Standard   407 -                  Use of Standard     Costs                  for
                                               Direct   Material                  -and Direct  Labor                                  October          1,    1974

  12.                                         Standard    408 - Accounting      for                            Costs      of
                                              Compensated    Personal    Absence                                                      July      1,           1975

 13.                                          Standard                 409 -     Depreciation             of    Tangible
                                              Capital                 Assets                                                          July      1,           1975

  14.                                         Standard     410 - Allocation                        of Business                 Unit
                                              General     and Adminstrative                        Expenses    to
                                              Final    Cost Objectives                                                                October          1,    1976

                                                                                          APPENDIX            A


                                         Description                                     Effective            Date

15.      Standard               411 - Accounting                     for   Acquisition
         Costs    of            Material                                                 January         1,       1976

16.      Standard    412 - Composition      and
         Measurement    of Pension     Cost                                              January         1,       1976

17.      Standard              414 - Cost                  of     Money as an
         Element             of the Cost                   of     Facilities  Capital    October         1,       1976

18.      Standard             415 - Accounting     for                     the
         Cost of             Deferred  Compensation                                      July      10,            1977

                                                                                                                                APPENDIX               B

                                                            CURRENT STUDIES
          Specific                    areas            are      selected              for         research              and         possible

development                     of     cost            accounting               standards                  primarily                 on the

basis          of        (1)     their             relationship                      to     the         objectives                  of     Public

Law 91-379,                     (2)         the        importance               of        obse’rved              costing             problems,

and      (3)         their            relationship                    to       other         work          of     the         Board.             The

Board          has         sought            advice             about          the        importance                   of     various

problems                 involved                 in    contract               cost         accounting.                       The         research

projects                 may     result                in     one     or       more         promulgations                       on each

subject.                   Preliminary                       proposals               and     research                  papers             have

been       widely               circulated                     for    some           subjects.

           1.            Cost       Accounting
                         --------------                           Practice
                                                                ---------             --This             project               is    expected

to     result              in        amending                the     Board’s              regulations                    to     define            the

terms           “cost           accounting                     practice”              and         “materiality”                          as used           in

the      Board’s                promulgations.                            The        project             also          will         provide

guidance                 to     determining                        when    a change                in      a cost              accounting

practice                 occurs.

              2.         Adjustment          and Allocation      of
                         a- ------------------_-_________y________                                 Pension               Cost--This

project              deals            with         the         criteria              used         for      measuring                     and    assign-

ing      to         cost        accounting                     periods          the         value          of     actuarial                    gains

and      losses.                 Criteria                    will     be       developed                 for      both          recurring

and      abnormal                    gains         and         losses.               The     standard                  will         also        pro-

vide          criteria                for         allocating               pension                cost          from          a home

off     ice         to     segments.

                                                                                                                  APPENDIX            B

           3.        Allocation              of
                     --------------------------         Manufacturing                ‘--- Enqineerinq
                                                                                              -------             L----and
--- ---------------Overhead                    --This           project         covers        the       allocation               of

pools         of     manufacturing,                      engineer           ing,      and     comparable                 over-

head       costs.

           4.      Distinguishing
                   ------     ------                  Between          Direct     and Indirect
                                                    ----------------------e---m--ma-me                               Costs--

This       study           covers          the         accounting            concepts            and      principles

and     the        bases          governing              consistent                classification                  of     costs

as direct             or     indirect.

           5.        Accounting
                     ---------                   for Costs           of Service
                                               --------------------_______I                   Centers--Research                           on

this       subject               involves           developing               concepts            for      use       in    account-

ing     for        the      cost         of      service           centers.

           6.        Allocation            of Material-related
                     ------------------I-________I_                                         Expenses--This
                                                                                                -----                         subject

deals         with         the      criteria              for      creating           expense           pools        and      select-

ing     allocation                 bases          for      material-related                      expenses.                The      scope
of     research             includes              the      functions               traditionally                  associated

with       the       flow         of     materials,                such      as material                planning             and
control,             purchasing,                  receiving               and      storage,            internal           and
external             transportation,                       distribution,                  etc.

           7.        Accountinq
                     ---------                   for Insurance
                                               --------------------             Costs--This               research            deals

with       criteria               for      measuring               costs        of     insurance,              including

self-insurance,                         and      the     appropriate                 treatment            of      retrospec-

tive       premium               adjustments.

           8.        Independent
                     I--                   Research
                            --------------------__I-----                 and Development         and Bid
                                                                                      ----------------                       and

--Przosal---------- Costs--             This      subject            covers          accounting            for       costs         of

                                                                                                                                     APPENDIX             I3

. performing                independent                    research                and development                          and       costs          of

  preparing               bids         and        certain          proposals.

             9.       Indirect          Costs
                      ---------_-----_------                 of    Colleqes --_-______---_-_-__--This
                                                                                 and Universities

  study         concerns               the        nature          and        composition I                    of      indirect             cost

  rates         of    colleges                and       universities                      which           have         Government

  contracts               and     grants.

          10.         Cost
                      -_---------of         Money --------------------------w---w
                                                    as an Element                of                     the        Cost         of    Operat-
 ina -a-Capital
            -w-             --This            project             was part                of      the         broader             topic

 dealing             with        the         cost       of     capital.                   That          topic          was        split

  into       two      distinct                subjects             before                the      cost         accounting

  standard            on Cost                of     Money         as an Element                         of      the        Cost       of

  Facilities                Capital               was      issued.                 The         coverage               of    that          stand-
  ard     is      limited              to     the       cost       of        money             as related                  to     facilities

  capital.                Research                is    continuing                  on the              cost         of     money          as

  related            to     operating                  capital.

          11.         Joint       Product
                      ------------a------                 Costinq--            This             study           involves              special

  cost       accounting                 problems               related              to     manufacturing                          processes

  in     which        mulitple                products             are        produced                  in     a joint               operation.

 Such        processes               are          usually          used            in,      although                 not        limited            to,

 the      chemical               and        petroleum              refining                    industries.

          12.         Accountinq
                      -m--m-                        for Contract
                                                  --------------1-------1-          Terminations                       and-----Excess

 -   ----                 This         study           concerns              the         inquiry              into         cost       account-

  ing     principles                 and          practices             applicable                   to        contracts                  which

                                                                                                     APPENDIX      B

are    terminated               for      the      Government’s          convenience             and    the

..costing          of    excess        and      idle   plant       capacity.

       13.          Accounting            for      Intracompany          Transfers--This                 project

 is   in     the        preliminary             research       stage.          It      covers    inquiry       into

the    accounting              problems            involved        in   the-pricing             of    intra-

company            sales      or      transfers        of     goods     and         services.

                                                                                                                               APPENDIX                     C

                      ARGUMENTS AGAINST                             MAKING THE COST-ACCOUNTING
                      STANDARDS BOARD SUBZJECT TO PUBLIC                                                    LAW-94-409

          The    Cost          Accounting                    Standards                  Board         is    among                 those             agen-

cies      not    subject                 to     Public           Law 94-409..Reasons                                        why         it      should

not     be subject                  to    the         requirements                      of    that         law         are         as follows:

          1.    5 U.S.C.                 552b(c)             states          an exception                        to         the         require-

ment      of    5 U.S.C.                 552b(b)             that          every         portion            of         every                 meeting

of     an agency          covered                   by    the       bill          shall            be open             to      public

observation.                   Paragraph                  4 of           subsection                 (c)     provides                         that       the

requirement              for         public              meetings            does            not     apply             if         the         meet-

ings      are    likely              to        disclose             trade           secrets               and     commercial                           or

financial             information                    considered                   privileged                or         confidential.

At     almost         every          Board           meeting,               staff            papers         are             made             avail-
able      to    the     Board             which           describe                the        accounting                     practices

of     many     contractors                     doing         business               with           the     Government.                               The
accounting             practices                    described               are      discussed                   in         detail              dur-

ing     the     Board          meeting.                   Most        contractors                    consider                  such             ac-
counting         practices                     to    be privileged                       and        confidential                             finan-

cial      information.                         The       information                 on those               accounting
practices             almost             invariably                 is      only         made available                           during

research         performed                     by the         Board's               staff          with          the         understand-

ing     that     it     will             not        be made public.                           Having            Board             meetings
that      are    open          to        the        public          would           preclude               the        Board’s                   dis-

cussing         such      information                        and would               render            those            meetings

                                                                                                                                                APPENDIX               C

    almost           wholly              useless               for         issuing                 cost      accounting                        standards

    that      accommodate                      industry's                        best         accounting                  practices.
               2.     None         of       the          five            Board          members              is     employed                    full         time

    on Board              work.             The          Board            meets          typically                  for         one            or      two

    days      each          month.                To prepare                      for         Board   meetings,     members per-
    form      much          work          in          their          offices,                 reading    and drafting     mate-

    rials       which             will         be discussed,                            meeting              with         staff            members

    to      discuss           those            materials,                        and     telephoning                      other                Board

    members           and         staff.

              The         business                    transacted                  in     the          Board         meetings                    themselves

    is      based         on all            of         the       work            done         in      advance             of        the         meetings.

    The meetings                    provide                   the        only       monthly                opportunity                         for      members

    to      meet       to     discuss                  proposed                  cost         accounting                  standards                     and

    related            issues.                 Having                those          meetings                 open         to        the         public

    would           severely               inhibit                  the     discussion                     of      accounting                        practices

    that       are        currently                     followed                 by contractors                      and            of         the      rami-

    fications               of         requiring                    changes             in         certain          of      those               practices.

    Because            of        the      Board's                   part-time                 nature,              having            its             meetings

    open       to      the        public               would              impede             its      progress                 in    issuing                 cost

    accounting                standards.

               3.     The         Board               has,          at     all      times,                attempted                 to         operate            in       1

    an open           manner.                    It      has         an open-door                         policy          for        any             organi-

    zation           or      individual                       who wishes                 to          appear         before                it         and goes

    through            as        thorough                a consultation                              and     exposure                process                 as

    any      organization                        in       the        Federal             Government.                       Proposals                     for

                                                                                                                                        APPENDIX                C

standards                or     rules               and            regulations                    are       published                  in     the

Federal            Register                   to        give             the      public             an opportunity                          to        com-
ment.             The      Board              has            received                 up to          150 comments                      from            in-

terested                members               of         the        public              on a proposal.                           All         of        these

comments                are      available                         at     the         Board's              office          for         inspection

by any            interested                       person.                     Additionally',                    in       researching                        each

proposed                cost       accounting                            standard,                  the     Board          has         developed

extensive                techniques                          for         consulting                  with          the     public             and

interested                    groups               in        Government,                      industry,                public               account-

ing,         and        academia.                        These             techniques                     assure          consideration

of     the        views           of         all         those            who will                  be affected                   by cost

accounting                    standards                      and         provide              essential                  openness                 in     the

Board’s              entire             research                        and deliberative                           process.

             4.      The       Board's                   authorizing                        legislation,                   P-L.             91-379,

requires                the       Board                 to      submit             to       the      Congress              any         cost            ac-

counting                standard,                       rule,            or      regulation                  which          it     promulgates.

The      standard,                     rule,             or        regulation                  does          not         take      effect                if

the      two         Houses             pass             a concurrent                         resolution,                  within                 60

calendar                days           of      continuous                        session             of      the         Congress,                 stating

in      substance                 that             the          Congress                does         not       favor             the        proposed

standard,                 rule,              or         regulation.                         This          provides               an opportunity

for      the         fullest                 possible                    public             participation                        and        scrutiny

of      the       Board’s               activity                        through             the      procedures                   of        the        two

Houses.                 Thus,               the         Congress                 is        afforded            an opportunity                            to

review            all         proposed                    standards,                       rules,          and        regulations                      be-

fore          they        take              effect.