Network Systems $($NS$)$ offers telecommunications design and consulting services to organizations.

The firm offers two types of contracts to its clients: a cost$-$plus $25$ percent contract

and a fixed$-$fee contract where NS offers a fixed price for the job. For cost$-$plus contracts,

total cost includes both direct costs and indirect overheads. NS completes $10$ cost$-$plus contracts

at a total direct cost of $$450,000$ and $15$ fixed$-$fee contracts. Revenues collected from

the fixed$-$fee contracts totaled $$2,400,000.$ The total direct cost of the fixed$-$fee contracts

amounted to $75$ percent of the collected revenues. NS has indirect overheads of $$350,000.$

continued

Cost Allocation: Theory $287$

Cost$-$based reimbursement is another reason for cost allocations. Government cost$-$based

contracts and medical reimbursements for cost give rise to cost allocations. The U$.$S$.$

Department of Defense purchases billions of dollars of goods a year under cost$-$plus contracts.

Most new weapons systems are procured under negotiated contracts in which the

producer$$s revenues are in part a function of reported costs. To help regulate the cost allocations

contractors use in government contracts, the federal government established the

Cost Accounting Standards Board $($CASB$).$ The CASB has issued standards covering the

cost accounting period, capitalization of tangible assets, accounting for insurance and

pension

costs, and the allocation of direct and indirect costs.

The revenues of public utilities such as electric and gas companies are also tied to reported

costs. States often grant public utilities exclusive monopolies over service territories. In return,

the state regulates the rates the utility can charge customers. In many cases, the regulated

$2.$ Cost$-$Based

Reimbursement

Required:

a$.$ Allocate the indirect overhead of $$350,000$ to the fixed$-$fee and cost$-$plus

$25$ percent

contracts using direct cost as the overhead allocation base.

b$.$ Allocate the indirect overhead of $$350,000$ to the fixed$-$fee and cost$-$plus

$25$ percent

contracts using number of contracts as the overhead allocation base.

c$.$ Should NS allocate overhead using direct cost or number of contracts?

Explain why.