Cost Accounting Standards Board; Allocation of Selling and Marketing Costs

OFFICE OF MANAGEMENT AND BUDGET

Office of Federal Procurement Policy

Cost Accounting Standards Board; Allocation of Selling and

Marketing Costs

ACTION: Notice.

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SUMMARY: The Office of Federal Procurement Policy, Cost Accounting

Standards Board (CASB), invites public comments concerning a Staff

Discussion Paper on the allocation of selling and marketing costs to

government contracts.

DATES: Comments must be in writing and must be received by November 18,

1996.

ADDRESSES: All comments should be addressed to Dr. Rein Abel, Director

of Research, Cost Accounting Standards Board, Office of Federal

Procurement Policy, 725 17th Street, NW., Room 9001, Washington, DC

20503. Attn: CASB Docket No. 96-03.

FOR FURTHER INFORMATION CONTACT: Rein Abel, Director of Research or

Richard C. Loeb, Executive Secretary, Cost Accounting Standards Board

(telephone: 202-395-3254).

SUPPLEMENTARY INFORMATION:

A. Regulatory Process

The Cost Accounting Standards Board's rules, regulations and

Standards are codified at 48 CFR Chapter 99. Section 26(g)(1) of the

Office of Federal Procurement Policy Act, 41 U.S.C. 422(g), requires

that the Board, prior to the establishment of any new or revised Cost

Accounting Standard, complete a prescribed rulemaking process. The

process generally consists of the following four steps:

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1. Consult with interested persons concerning the advantages,

disadvantages and improvements anticipated in the pricing and

administration of Government contracts as a result of the adoption of a

proposed Standard.

2. Promulgate an Advance Notice of Proposed Rulemaking.

3. Promulgate a Notice of Proposed Rulemaking.

4. Promulgate a Final Rule.

This proposal is step one of the four-step process.

B. Background and Summary

In response to the Cost Accounting Standards Board's (CASB's)

continuing research, a number of commenters have identified selling and

marketing costs as an issue requiring consideration. The primary

concern raised is the causal/beneficial relationship of selling costs

to final cost objectives and their subsequent cost allocations. More

specifically, issues have arisen in which the allocation of selling and

marketing costs as a direct or as an indirect cost, and/or the

appropriate pooled cost composition or allocation base selection, have

caused substantial controversies.

This Staff Discussion Paper represents the results of research

performed by the staff of the Cost Accounting Standards Board, and is

issued by the Board in accordance with the requirements of 41 U.S.C.

422(g)(1)(A). The statements contained herein do not necessarily

represent the position of the Cost Accounting Standards Board.

C. Public Comments

Interested persons are invited to participate by submitting data,

views or arguments with respect to this Staff Discussion Paper. All

comments must be in writing and submitted to the address indicated in

the Addresses section.

Richard C. Loeb,

Executive Secretary, Cost Accounting Standards Board.

Allocation of Selling and Marketing Costs

Outline

Introduction

Scope of Project

Preliminary Research

Part I--Terminology and Definition

A. Discussion

B. Issues

Part II--Homogeneity of Pools

A. Discussion

B. Issues

Part III--Selection of Allocation Bases

A. Discussion

B. Issues

Part IV--Composition of Allocation Bases

A. Discussion

B. Issues

Part V--Current Expensing vs. Deferral

A. Discussion

B. Issues

Allocation of Selling and Marketing Costs

Introduction

In response to the Cost Accounting Standards Board's (CASB's)

research, a number of commenters have identified selling and marketing

costs as an issue requiring consideration. The primary concern raised

is the causal/beneficial relationship of selling costs to final cost

objectives and their subsequent cost allocations. The prior CASB also

identified selling and marketing costs as an area requiring research.

When the prior CASB promulgated Cost Accounting Standard (CAS) 9904.410

``Allocation of Business Unit General and Administrative Expenses to

Final Cost Objectives'', a separate research project dealing with

selling and marketing costs was established. In its prefatory comments

on CAS 9904.410, the CASB stated: ``* * * the Board is currently

working on projects involving IR&D, B&P and selling costs. The Board at

this time does not require changing the accounting for these costs.''

CAS 9904.420, ``Accounting for Independent Research and Development

and Bid and Proposal Costs'' was promulgated in September 1979.

However, no Standard was ever promulgated to deal with the unique

issues relating to selling and marketing costs. The CAS Board has asked

the staff to begin the necessary research to resolve these matters.

Scope of Project

In its Statement of Objectives, Policies and Concepts, July 1992,

the CASB states: ``* * * the Board believes in the desirability of

direct identification of costs with final cost objectives where the

following allocation characteristics exist:

1. The beneficial or causal relationship between the incurrence of

cost and cost objectives is clear and exclusive.

2. The amount of resource used is readily and economically

measurable.''

The aforementioned document further states:

``Where units of resources used are not directly identified with

final cost objectives, the cost of such resources should be grouped

into logical and homogeneous pools for allocation to cost objectives

in accordance with a hierarchy of preferable techniques.''

Under certain circumstances in government contracting, selling and

marketing costs may be properly susceptible to direct identification

with final cost objectives. In most cases, however, selling and

marketing costs are indirectly allocated.

Several Armed Services Board of Contract Appeals (ASBCA) cases have

concluded that selling costs identified with a final cost objective

(e.g., sales commissions) could be treated as an indirect cost,

Daedalus Enterprises, Inc., 93-1 BCA 25499 and Aydin Corp. (West), 94-2

BCA 26899, aff'd in part, rev'd in part, Aydin Corp. (West) v. Widnall,

61 F.3d 1571 (Fed. Cir. 1995). Accordingly, the scope of this project

includes selling and marketing costs identified with final cost

objectives and those not identified with final cost objectives.

Preliminary Research

The staff's preliminary research to date includes:

a. Review of literature;

b. Analysis of ASBCA decisions; and

c. Review of the prior CASB's research relating to selling and

marketing costs.

This research disclosed a number of cost accounting issues which we

believe must be considered by the Board in developing a potential CAS.

These issues, presented in more detail in the ensuing parts of this

SDP, deal with the following matters:

a. Terminology and Definition

b. Homogeneity of Pools

c. Selection of Allocation Bases

d. Composition of Allocation Bases

e. Current Expensing vs. Deferral

Part I

Terminology and Definition

A. Discussion

The problem of terminology and definition is closely related to--in

fact, it is sometimes difficult to separate it from--the question

concerning the number of cost pools, or the degree of homogeneity of

such pools (see Part II). It seems that any CAS evolving from this

project must use terms that are adequately defined so as to ensure

understanding by all parties concerned of the types of costs, functions

and activities being covered.

Kohler, defines ``selling expense (cost)'' and ``marketing cost''

as follows:

``Selling Expense (Cost)--Any expense or class of expense incurred

in selling or marketing. Examples: salesmen's salaries, commissions,

and traveling; selling department salaries and expenses; samples;

credit and

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collection costs. Shipping costs are often so classified.''

``Marketing Costs--The cost of locating customers, persuading them

to buy, delivering goods, and collecting sales proceeds; selling

cost.''

The Institute of Management Accountants (IMA) classifies

``marketing costs'' into two general categories: ``1. Costs of getting

orders--i.e. advertising, sales promotion, direct selling, sales

administration and sales research. 2. Costs of filling orders--

warehousing, shipping, clerical operations connected with filling

orders and collecting the money.'' Most authors of accounting

literature (for example, Anthony and Shillinglaw) define the term

``marketing costs'' (or ``distribution costs'') generally in the same

fashion as the IMA; that is, the term is broken down into two major

categories of costs: ``order-getting costs'' and ``order-filling

costs.''

In government contracting, however, the terms are often defined in

a narrower sense; that is, most government contractors limit the terms

to include only ``order-getting'' costs. ``Order-filling costs'' are

often classified as general and administrative expenses, e.g.,

collection, and as manufacturing overhead costs or as other indirect

costs, e.g., warehousing. For example, the Federal Acquisition

Regulation (FAR) 31.205-38 states: ``Selling is a generic term

encompassing all efforts to market the contractor's products or

services, some of which are covered specifically in other subsections

of 31.205. Selling activity includes the following broad categories:

(1) Advertising

(2) Corporate image enhancement including broadly-targeted sales

efforts, other than advertising

(3) Bid and proposal costs

(4) Market planning

(5) Direct selling''

Some contractors, however, make a distinction between selling and

marketing activities. Marketing is defined as being long-range in its

objectives and includes market research and development and

advertising. Selling is short-range in its objectives and includes

direct selling efforts, sales promotion and demonstration, and customer

liaison.

Discussions with contractor and government representatives indicate

that terminology and definition in this area are not without problems.

There is a considerable amount of diversity in the specific meaning

being attached to the term ``selling and marketing costs.''

Furthermore, problems are being encountered in distinguishing between

selling and marketing costs and certain other costs, such as IR&D and

B&P costs.

In addition to the costs of such activities as market research and

development, direct selling effort, selling administration and sales

promotion and demonstration, many government contractors consider the

costs of some or all of the following activities as part of selling and

marketing costs:

a. Business planning

b. Bid and proposal

c. Contract administration including negotiation and pricing

d. Technical marketing (or work performed by ``marketing

representatives'')

e. Program management

f. Subcontract administration

g. Spares administration or logistical support

Other contractors, however, treat the costs of these activities

differently; some contractors treat the costs of some of the activities

as part of general and administrative expenses (``G&A''); others treat

them either as part of manufacturing, engineering or comparable

overhead pools; and still others treat them as direct costs. Likewise,

some contractors treat the costs of selling efforts performed by

salaried employees differently than the costs of similar selling

efforts performed by outside sales agents.

Of the cost of those activities listed above, preliminary research

has indicated that costs of contract administration are often as

significant as selling and marketing costs and that opinions appear to

be divided as to whether or not such costs should be part of selling

and marketing costs. In this regard, one recognized expert has stated:

``Selling costs normally include bidding and proposal costs not

directly assignable to contracts obtained from such effort * * * as

well as costs of contract administration and sales and service.'' A

number of companies, however, treat contract administration costs as

part of G&A.

Those companies which treat the costs of contract administration as

part of selling and marketing costs cite several reasons in support of

such treatment. Among the reasons cited are: (i) The same people

perform both contract administration and selling and marketing

activities, (ii) the two activities are often difficult to distinguish

or they overlap; and (iii) people who are assigned contract

administration responsibility perform selling or negotiation work on

potential follow-on contracts. An additional reason cited by those

contractors with a mix of government and commercial business--although

this is more closely related to the question of allocation--is that

because selling and marketing costs tend to be higher on commercial

than on government business, whereas contract administration costs tend

to be higher on Government than on commercial business, combining the

two types of costs produces results similar to those of separate cost

allocations.

B. Issues

1. What activities should be encompassed by the term ``selling and

marketing''? In responding to this issue, please address your comments

to whether each of the activities listed above should be part of

selling and marketing. Please state your reasons for including, or

excluding, the activities and provide a brief description of the

activities.

2. Should ``selling'' and ``marketing'' be separately defined and

how should they be defined?

3. What are the distinctive characteristics of selling and

marketing activities that can be used to assure that such activities

are properly segregated from other activities?

Part II

Homogeneity of Pools

A. Discussion

As mentioned previously, the CASB has emphasized the need for and

the importance of grouping indirect costs into logical and homogeneous

pools. The literature also indicates the general weight of opinion that

homogeneity of indirect cost pools should be achieved by establishing

separate pools, rather than a single pool for a ``blanket'' allocation.

CAS 9904.410 defines G&A as ``Any management, financial and other

expense which is incurred for the general management and administration

of the business unit as a whole. G&A expense does not include those

management expenses whose beneficial or causal relationship to cost

objectives can be more directly measured by a base other than a cost

input base representing the total activity of a business unit during a

cost accounting period.''

In a recent decision, the ASBCA concluded that selling costs are

different from G&A expenses. The ASBCA stated: CAS 410.30(6) defines

``General and Administrative (G&A) expense'' as an expense incurred for

the general management and administration of the business as a whole.

Aydin acknowledges that its sales commission costs were essentially

selling costs. In this case, the Solar II commission incurred was not

incurred for the management and administration of

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Aydin as a whole * * * We conclude, therefore, that Aydin's sales

commission costs in general, and the Solar II sales commission in

particular, were not G&A expenses for purposes of CAS 410. See Aydin

Corp. (West), 94-2 BCA 26899.

The idea that selling and marketing costs are different from G&A

can be found in accounting literature. Kholer, for example, expresses

this idea by defining ``administrative expense'' as ``A classification

of expense incurred in the general direction of an enterprise as a

whole, as contrasted with expense of a more specific function, such as

manufacturing or selling * * *'' (underscoring added). In a similar

vein, the IMA distinguishes selling and marketing costs from G&A by

defining G&A as costs of ``* * * president's office, treasurer's office

[and] controller's office.''

The idea of establishing homogeneous indirect cost pools is

expressed in CAS 9904.418-40(b) and 50(b)(1). CAS 9904.418-40(b)

states:

Indirect costs shall be accumulated in indirect pools which are

homogenous.

CAS 9904.418-50(b)(1) states:

An indirect cost pool is homogenous if each significant activity

whose costs are included therein has the same or a similar

beneficial or causal relationship to cost objectives as the other

activities whose costs are included in the cost pool. It is also

homogenous if the allocation of the costs of the activities included

in the cost pool result in an allocation to cost objectives which is

not materially different from the allocation that would result if

the costs of the activities were allocated separately.

The concept of homogenous indirect cost pools is also discussed in

FAR 31.203(b) as ``Indirect costs shall be accumulated by logical cost

groupings with due consideration of the reasons for incurring such

costs * * * Commonly, manufacturing overhead, selling expenses and

general and administrative expenses are separately grouped.'' In

practice, however, only some contractors have established a separate

pool of selling and marketing costs. Discussions with some contractors

disclosed that selling and marketing costs are significant,

particularly when they are compared with G&A.

As discussed above, accounting opinion generally supports the need

for increased homogeneity. However, there is no agreement as to how to

achieve a degree of homogeneity of indirect costs that assures their

accurate allocation. Although the literature deals with the subject of

selling and marketing costs, most of the discussion is presented from

the perspectives of internal cost controls and managerial decisions.

Such accounting literature suggests a number of different ways to

accumulate selling and marketing costs which could be adopted for

purposes of allocation to contracts. Among the various methods cited

are: (i) By activities (direct selling efforts, sales administration,

market research, etc.), (ii) by product lines, (iii) by customers, and

(iv) by geographical locations.

The concept of segregating selling costs on a beneficial or causal

relationship was addressed in CAS Working Group Item 78-21,

Implementation of CAS 410, Allocation of Business Unit General and

Administrative Expenses to Final Cost Objectives. The Working Group

responded to a question raised concerning whether selling costs could

be included in the G&A pool if an inequitable distribution resulted.

The Working Group concluded that selling costs could not remain in the

G&A pool when an inequitable distribution resulted. Working Group Item

78-21 states in part:

Although the prefatory remarks are permissive in this regard, the

standard's fundamental requirement paragraph 410.40(d)(1) requires a

separate allocation of costs which can be allocated to business unit

cost objectives on a beneficial or causal relationship which is best

measured by a base other than a cost input base * * * Therefore, if

a significant disparity exists in marketing activity for elements of

the business, selling expenses should be the subject of a separate

distribution in reasonable proportion to the benefits received. For

example, it may be appropriate to separately allocate selling costs

of foreign and domestic markets.

In light of Working Group Item 78-21, questions have arisen as to

the allocability of foreign selling costs on domestic government

contracts. The government regulations addressing foreign selling costs

have changed over the past decade. DAR 15.205-37 stipulated that the

allocability of selling costs were to be determined in light of

reasonable benefit to the U.S. government. However, the current FAR

31.205-38 states:

The costs * * * to promote export sales of products normally sold to

the U.S. Government, including the costs of exhibiting and

demonstrating such products, are allowable on contracts with the

U.S. Government provided--

(i) The costs are allocable, reasonable, and otherwise allowable

under this Subpart 31.2;

(ii) That, with respect to a business segment which allocates to

U.S. Government contracts, $2,500,000 or more of such costs in a

given year of such business segment, a ceiling on the allowable

costs shall apply.

At corporate and group home offices, accumulating selling and

marketing costs in separate pools is not an uncommon practice. A number

of such offices accumulate the costs in terms of commercial versus

government business--some group home offices perform only selling and

marketing functions and some have separate group home offices for

commercial marketing and for government marketing.

A number of corporate and group home offices also accumulate

selling and marketing costs in terms of foreign versus domestic, and

some have separate marketing organizations for foreign marketing and

for domestic marketing. This kind of accumulation of selling and

marketing costs presumably reflects the need occasioned by significant

amounts of exports of U.S. products. In this regard, it is probably

important to note the various recurring changes in policy regarding the

allowability of marketing costs associated with Foreign Military Sales

(FMS) contracts.

A government representative suggests that selling costs be

segregated from marketing costs. According to this logic, marketing

costs which are long-range in objective should be segregated from

selling costs which are short-range in objective. The former should be

allocated on a broad base to all business of a contractor, whereas the

latter should be allocated only to those products or product lines

benefiting from the incurrence of selling costs.

Based on the foregoing discussion, the argument can be made that,

at one extreme, the accuracy of most contractors' allocations of

selling and marketing costs could be improved by creating several

pools. This would mean establishing pools by class of customers (such

as commercial versus government), by various activities (such as field

selling costs, sales demonstration, sales administration and marketing

research), by geographical locations (such as foreign versus domestic)

and by product lines.

At the other extreme, selling and marketing costs could be combined

with G&A, or a single pool of selling and marketing costs could be

used, on the theory that little additional accuracy will be provided by

increased homogeneity, and that any additional accuracy achieved would

be too costly or would not make much difference in the ultimate amounts

of selling and marketing costs to be allocated.

The central question, then, seems to be: How can the homogeneity of

selling and marketing costs be further improved in a way which will

have both theoretical validity and practical

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applicability? A related question is: To what extent can greater

comparability among contractors be achieved in this area?

B. Issues

1. Under what circumstances should selling and marketing costs be

accumulated in a pool separate and apart from G&A? Under what

circumstances should they be accumulated by: a. class of customers

(e.g., commercial versus government), b. geographical location (e.g.,

foreign versus domestic), c. type of activity (e.g., marketing versus

selling), d. product line, or e. some other methods?

2. Please describe the guidelines and criteria governing the

accumulation of selling and marketing costs which you believe should be

included in a potential standard. Is a new standard required or can

this issue be addressed within existing standard(s)?

3. Should a potential standard establish criteria and guidance on

when it would be inappropriate to establish a pool, i.e., when selling

or marketing expenses should be allocated directly to particular final

cost objectives?

Part III

Selection of Allocation Bases

A. Discussion

Theoretically, there are two ways to go about selecting an

allocation base; one way is to use judgmental criteria and the other is

to use a statistical analysis approach. Practical experience suggests

that the statistical analysis approach is seldom, if ever, used by

government contractors.

Government contractors use a variety of allocation bases for

selling and marketing costs. Among the bases being used are: sales,

three-factor formula, direct labor costs or hours and level of effort.

For the purpose of this Discussion Paper, the term ``level of

effort'' is used to refer to the time and effort incurred or to be

incurred by those personnel engaged in selling and marketing functions.

In practice, a variety of methods are used to express the ``level of

effort''. Some companies use ``projected time to be spent'' on selling

of certain products or product lines or selling to certain customers

during certain time intervals, such as every six months; others use the

actual time spent and recorded.

Output Bases

The Armed Services Pricing Manual (ASPM No. 1) states that ``Common

bases for distribution or estimation of selling expenses are total cost

of sales and total selling price.'' However, the document does not

describe the reasons or the circumstances for the use of such

allocation bases. On the other hand, the Defense Contract Audit

Agency's Contract Audit Manual states: ``Manufacturing expenses are

usually apportioned without regard to the specific end item being

manufactured or the customer to whom the item may ultimately be sold.

These latter factors, however, are important considerations in

apportioning selling expenses which may indicate that an overall

allocation of selling expenses on the basis of cost of sales or costs

of goods manufactured may not be equitable.''

Usry and Hammer advocate the use of ``gross sales value of products

sold'' for allocating what they term as ``functional costs of

selling.'' Horngren, on the other hand, criticizes the sales allocation

base: ``A commonly, but wrongly, used basis for allocation is dollar

sales. The costs of effort are independent of the results actually

obtained, in the sense that the costs are programmed by management, not

determined by sales.''

Level of Effort

Usry and Hammer advocate (in addition to sales) the use of ``number

of salespersons' calls on customers (based on salespersons' time

reports).'' The Defense Contract Audit Agency's Contract Audit Manual

appears to be advocating the same theory. As mentioned previously,

after cautioning auditors that the costs of sales or costs of goods

manufactured base may not be equitable for selling and marketing costs,

it goes on to state: ``The auditor should perform a careful analysis of

the time, effort and expense incurred for selling activities in

relation to the company's products, product lines, or other objectives

to determine the most suitable base * * *''

B. Issues

1. Under what circumstances should the output base(s) (sales, cost

of sales), the input base(s) (total cost input, direct labor cost,

value added, etc.) and other methods such as level of effort be used in

allocating selling and marketing costs at the business unit level?

2. Under what circumstances should these bases and methods be used

at the corporate home office level and/or the group home office level?

3. What criteria should be provided for selection among alternative

bases?

Part IV

Composition of Allocation Bases

A. Discussion

The problem of allocating selling and marketing costs is

complicated by the question concerning the composition of allocation

bases. Research of the available literature failed to disclose any

discussions of this question. Discussions with selected contractor and

government representatives revealed, however, that practices and

opinions vary as to whether certain kinds of sales or costs ought to be

reflected in an allocation base for selling and marketing costs. These

sales or costs pertain to:

1. Intracompany transfers.

2. Subcontract costs and purchased materials including

accommodation purchases and drop shipments.

3. Capitalized projects.

4. Certain kinds of contacts such as those for field services.

Those contractors which exclude some or all of these sales or costs

from an allocation base, or those which believe such sales or costs

should be excluded, advance various arguments. For example, they

contend that selling and marketing costs are incurred to sell products

and services to outside customers; accordingly, such costs should not

be allocated to intracompany transfers. Others exclude subcontract

costs and purchased materials from an allocation base on the theory

that the subcontractors' and vendors' selling and marketing costs are

already included in the prices of subcontracts and purchase orders.

Those contractors which exclude certain contracts, such as field

service contracts, express the view that selling and marketing costs

had been incurred on the ``parent contract'' under which the products

being serviced had been produced and sold and that few such costs are

incurred on the field service contracts. Capitalized projects are also

excluded from the allocation base on the theory that selling and

marketing costs are incurred to sell to outside customers. Conversely,

there are a number of contractors that include all or some of these

sales or costs or those which believe that such sales or costs should

be included.

Practices and opinions also vary as to whether the selling and

marketing costs incurred at corporate and group home offices should be

allocated to all segments under such offices or to just some segments.

Those contractors which exclude certain segments contend that the

excluded segments have their own selling and marketing organizations or

that the product lines

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of such segments are significantly different from those of the rest of

the segments.

The question of whether or not all of the above-mentioned sales or

costs, or all segments under a corporate or group home office, should

be included in an allocation base is presumably influenced by the

following factors among others:

1. How a contractor views the beneficial or causal relationship

between the selling and marketing costs and the sales, costs or

segments; that is, whether a contractor considers the relationship to

be close or remote (benefit to overall business).

2. How a contractor interprets the longstanding FAR 31.203(c)

policy regarding ``non-fragmentation of allocation bases''.

3. Whether a contractor considers the added refinement of its

allocation practices to be worthy of the efforts involved or to be

conductive to producing different allocation results.

A related question on the output bases concerns the use of

different methods of recognition of sales; that is, the completed-

contract method and the unit-of-delivery method as contrasted with the

percentage-of-completion method (or the ``cost-incurred'' method for

cost-type contracts). A number of contracts use different methods of

recognizing the sales of the same cost accounting period for the

different types of contracts performed. Obviously this practice creates

additional allocation problems.

B. Issues

1. Should an allocation base for selling and marketing costs

include the following?

a. Intracompany transfers.

b. Subcontract costs and purchased materials.

c. Capitalized projects.

d. Contracts such as for field services.

Please state the reasons for your answer.

2. Do you perceive any other output or input similar to the above

which may be included in an allocation base? Conversely, do you

perceive other similar output or input which may be excluded from an

allocation base? Please describe them.

3. Under what circumstances should a segment be excluded from the

allocation base of corporate home office or group home office selling

and marketing costs, and what criteria should be established regarding

allocation to segments?

4. Under what circumstances would it be appropriate to use

different methods of sales recognition to determine an output

allocation base for selling and marketing costs? If you believe that

the use of different methods is inappropriate, which method should be

used to determine the base?

Part V

Current Expensing vs. Deferral

A. Discussion

Previous parts of this Discussion paper discussed the problems

associated with terminology and definition and with allocation bases

for selling and marketing costs. Allocation of selling and marketing

costs is further complicated by the fact that such costs usually

include significant amounts of costs that are incurred in a current

cost accounting period but are for the benefit of future periods.

Accounting Principles Board Statement (APBS) No. 4 addresses

expense recognition and specifies three primary principles for

recognizing expenses. They are associating cause and effect, systematic

and rational allocation, and immediate recognition.

Under associating cause and effect, costs are recognized as

expenses on the basis of a presumed direct association with specific

revenue. APBS No. 4 states:

Some costs are recognized as expenses on the basis of a presumed

direct association with specific revenue. Although direct cause and

effect relationships can seldom be conclusively demonstrated, many

costs appear to be related to particular revenue and recognizing

them as expenses accompanies recognition of the revenue. Examples of

expenses that are recognized by associating cause and effect are

sales commissions and costs of products sold or services provided.

The term matching is often applied to this process.

Using the above language, sales commissions earned on a multi-year

contract would be recognized over the life of the contract rather than

expenses in the year of contract award.

Under immediate recognition, APBS No. 4 states:

Some costs are associated with the current accounting period as

expenses because (1) Cost incurred during the period provide no

discernible future benefits, (2) costs recorded as assets in prior

periods no longer provide discernible benefits or (3) allocating

costs either on the basis of association with revenue or among

several accounting periods is considered to serve no useful purpose.

APBS No. 4 states that examples of costs recognized in the current

period include such costs as most selling costs and general and

administrative type expenses.

Making the determination of whether selling and marketing costs can

be associated with revenue on the basis of cause and effect may be

difficult. Accounting literature has recognized these difficulties.

Usry and Hammer state: ``Cause and effect, generally obvious in the

factory, are not so readily discernible in the marketing processes. For

example, many promotional costs are incurred for future results,

creating a time lag between cause and effect. Conversely, the effects

of manufacturing changes are usually felt quickly; and matching between

effort and result usually can be determined. Furthermore, manufacturing

results are more readily quantified than are marketing costs. For

marketing costs, it is often not so easy to identify quantities or

units of activity with the cost incurred and results achieved.''

Lawrence (Cost Accounting, revised by Ruswinckel) states: ``A very

large number of manufacturing companies make their products to order,

and a great amount of expense is undertaken in order to sell products

that are not in existence at the time of sale. It is not considered

improper to defer an expense that will result in future benefit.''

In government contacting, the time lag between cause and effect,

referred to by Usry and Hammer, could be as much as 3 to 5 years.

However, government contractors rarely defer selling and marketing

costs. Presumably, this is because of the difficulties involved in

distinguishing between those costs that should be currently expensed

and those that should be deferred, and because of the high degree of

uncertainty as to future benefits. In a few instances, however,

contractors are known to have deferred those selling and marketing

costs incurred to secure substantial new programs.

B. Issues

1. Should selling and marketing costs incurred for the benefit of

future periods be deferred? If they should: a. under what circumstances

should selling and marketing costs be deferred; b. what criteria should

be established to distinguish between those costs that should be

currently expensed and those that should be deferred, and c. how should

the deferred costs be amortized?

2. If you do not believe that selling and marketing cost should be

deferred, which allocation base(s) should be used in order to minimize

the possible distorted allocations of costs incurred for future

periods?

[FR Doc. 96-24072 Filed 9-18-96; 8:45 am]

BILLING CODE 3110-01-P