An examination of the economic consequences associated with government contractors' choice of cost allocation bases

Abstract

We demonstrate both analytically and through numerical examples that, if a firm's contract mix includes both fixed-price and cost-reimbursement (cost-plus) contracts, the choice of an indirect cost allocation method can affect profit and cash flows. The ability to shift G&A costs to cost-plus contracts is not dependent on shifting the factor inputs worked on each contract type; nor is it dependent on having a commercial component within the firm. The distortion is caused by the inherent differences in the two basic types of contract vehicles: fixed-price and cost-plus. Although incentives for firms to increase their cash flow and profit exist, our survey results, from a sample of the top 100 federal contractors, do not support the contention that firms behave in a manner that allows them to take advantage of these incentives. Our results suggests that firms are more likely to use total cost input as an allocation base even in situations in which their cost structure indicates that a single element base might be appropriate.

Document Type

Restricted Article: Campus only access

Publication Date

1999

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