CAS 418, formally titled “Allocation of Direct and Indirect Costs,” is the federal cost accounting standard that tells government contractors how to separate direct costs from indirect costs, group indirect costs into pools, and distribute those pools across their contracts. It is codified at 48 CFR 9904.418. Its purpose is to keep contractors from shifting costs between projects in ways that overcharge the government on one contract while undercharging on another. The allocation method you choose determines how much the government pays for your shared overhead, and getting it wrong can trigger price adjustments, interest charges, and long audit disputes.
Who Has to Comply
CAS 418 applies to business units performing negotiated federal contracts that aren’t otherwise exempt. The exemption list is broad. All CAS requirements fall away for sealed bid contracts, negotiated contracts and subcontracts below the Truth in Negotiations Act threshold, any contract or subcontract with a small business, commercial item acquisitions, firm-fixed-price awards made on adequate price competition without certified cost or pricing data, contracts with foreign governments or their agents, price-regulated contracts, and contracts under $7.5 million when the business unit isn’t currently performing any CAS-covered work valued at $7.5 million or more.1eCFR. 48 CFR 9903.201-1 – CAS Applicability
Contracts that survive the exemptions fall into one of two tiers. Modified coverage requires compliance with only a handful of CAS standards. Full coverage kicks in when a business unit receives a single CAS-covered contract of $50 million or more, or when the unit’s total CAS-covered awards reach $50 million in its current cost accounting period. Full coverage means compliance with all 19 CAS standards, CAS 418 included.1eCFR. 48 CFR 9903.201-1 – CAS Applicability
One boundary worth flagging: in March 2026 the Cost Accounting Standards Board proposed raising the initial CAS applicability threshold to $35 million and the full-coverage and Disclosure Statement threshold from $50 million to $100 million. The rule is still a proposal. Continue following the current thresholds until any change is officially adopted.
Classifying Direct and Indirect Costs
Everything in CAS 418 rests on a clean split between direct and indirect. A direct cost is any expense you can tie to a single final cost objective: labor hours logged on a particular contract, raw materials purchased for one prototype. An indirect cost benefits two or more cost objectives and can’t be pinned to just one: shared facility rent, IT support used across departments.2eCFR. 48 CFR 9904.418-30 – Definitions
Every business unit must maintain a written statement of its accounting policies for classifying costs as direct or indirect, and the policy must be applied consistently.3eCFR. 48 CFR 9904.418-40 – Fundamental Requirements This is where contractors most often trip up. You can’t treat engineering labor as direct on one contract and indirect on another without a documented, defensible reason for the difference. If an auditor finds inconsistency, the entire cost allocation on every affected contract comes into question.
A related standard, CAS 401, reinforces the point by requiring that costs be classified the same way during bidding as they are during performance. If you estimated engineering hours as a direct charge in your proposal, you can’t reclassify that labor as indirect once work starts. Your accounting system and your proposal pricing have to speak the same language from day one.
Building Homogeneous Indirect Cost Pools
Indirect expenses have to be grouped into pools, and CAS 418 requires those pools to be homogeneous. That means every significant activity in a pool shares a similar beneficial or causal relationship to the cost objectives that receive the allocation.4eCFR. 48 CFR 9904.418-50 – Techniques for Application
There’s a practical test built into the standard. A pool is also treated as homogeneous if allocating its costs as a single pool produces results that aren’t materially different from what you’d get by allocating each activity separately. That gives some flexibility. You don’t need a separate pool for every minor cost category, but you do need to confirm that lumping activities together doesn’t skew the numbers in a meaningful way.4eCFR. 48 CFR 9904.418-50 – Techniques for Application
The illustrations in the standard make this concrete. Combining building ownership, maintenance, and utility costs into a single occupancy pool works because those activities all relate similarly to the cost objectives using the space. Combining machining and assembly costs into one manufacturing overhead pool fails if those activities have different relationships to the work and separate allocation would produce materially different results. In that situation you need separate pools.5eCFR. 48 CFR 9904.418-60 – Illustrations
Whether a difference is material gets evaluated under a multi-factor test that considers the absolute dollar amount, the proportion relative to contract cost, the impact on government versus non-government cost objectives, and whether individually small items accumulate in the same direction. The administrative cost of processing an adjustment also matters.6eCFR. 48 CFR 9903.305 – Materiality
Once pools are established, they need to stay stable. Restructuring pools every year to chase a more favorable allocation is exactly the manipulation CAS 418 is designed to prevent.
Choosing an Allocation Base
This is where the standard gets most prescriptive. CAS 418 establishes a hierarchy, and you’re expected to use the highest-ranked method that’s practical. Which hierarchy applies depends on whether the pool contains management or supervisory costs.
Pools With Management or Supervisory Costs
If a pool contains a material amount of management or supervisory costs for activities involving direct labor or materials, the standard accepts that you can’t trace resource consumption to specific cost objectives. Use a base that represents the activity being managed or supervised. Direct labor hours or direct labor dollars are the most common choices, because supervisory effort roughly tracks the volume of labor being overseen.3eCFR. 48 CFR 9904.418-40 – Fundamental Requirements
Pools Without Significant Management Costs
For pools that don’t contain material management or supervisory costs, the standard assumes a more direct link is possible. The hierarchy runs from most to least direct:
- A resource consumption measure comes first. This is a direct measurement of how much of the pooled resource each cost objective actually uses. Machine hours and kilowatt-hours are classic examples. It creates the tightest causal link between cost and contract.
- An output measure comes next. If measuring actual consumption isn’t practical, use a measure of what the pool activities produce, such as units completed or square feet provided. If different units require significantly different levels of resources, you have to modify the output measure or use more than one to avoid distortion.
- A surrogate measure is the fallback. When neither consumption nor output can be measured practically, use a surrogate that varies in proportion to the services each cost objective receives. Direct labor hours and total cost input are common surrogates.
The hierarchy isn’t optional. If a resource consumption measure is feasible, you can’t skip to a surrogate just because it’s easier to calculate.4eCFR. 48 CFR 9904.418-50 – Techniques for Application One illustration in the standard walks through a contractor allocating occupancy costs by square feet who then discovers that warehouse, factory, and office space cost vastly different amounts per square foot. A flat square-footage measure would overcharge programs in cheap warehouse space and undercharge those in expensive office space. The fix is weighted square footage or separate sub-pools.5eCFR. 48 CFR 9904.418-60 – Illustrations
Whatever base you choose, apply it consistently to every cost objective that benefits from the pool. Cherry-picking which contracts get included in the base is a fast way to draw an audit finding.
Special Allocations
Sometimes the standard allocation doesn’t fit. One contract might use a shared resource far more heavily than any other, or barely use it at all. CAS 418 provides a special allocation mechanism for these cases. The government and the contractor can agree to pull a particular cost objective out of the normal pool allocation and assign it a share that better reflects the actual benefit received. The specially allocated amount comes out of the pool, and that cost objective’s base data comes out of the denominator used to allocate what remains.7eCFR. 48 CFR 9904.418-50 – Techniques for Application
This isn’t unilateral. It requires agreement with the government, and the justification has to be clear. But it’s a useful safety valve when the normal allocation would produce an obviously inequitable result.
The Disclosure Statement
Contractors that hit the full-coverage threshold must file a Disclosure Statement before contract award. The document lays out the contractor’s cost accounting practices in detail: how costs are classified, how pools are structured, what allocation bases are used, and how the system handles changes. Once filed, it functions as a binding commitment. The government relies on it when negotiating contract prices, and deviating from it without proper notice is treated as noncompliance.8eCFR. 48 CFR 9903.202-1 – General Requirements
Auditors use the Disclosure Statement as their baseline when reviewing your cost submissions. If your actual accounting doesn’t match what you disclosed, the burden falls on you to explain the gap, and you may owe money regardless of your explanation.
Changing Your Accounting Practices
Business operations evolve, and cost accounting practices sometimes need to change with them. CAS 418 allows this, but the process has strict guardrails. Any change to a disclosed or established practice must be reported to the Cognizant Federal Agency Official (CFAO). Under FAR 52.230-6, the contractor must submit a description of the change and a statement on whether the cost impact is immaterial.9Acquisition.GOV. 48 CFR 52.230-6 – Administration of Cost Accounting Standards
Failing to submit the required notice can turn a legitimate practice change into a finding of noncompliance. A properly reported change triggers a cost-impact analysis and possible price adjustments, but the contractor keeps credibility. An unreported change looks like an attempt to avoid scrutiny and gives the government much broader remedial options.
What Noncompliance Costs
When an auditor flags a potential CAS violation, the CFAO has 15 days to either disagree with the finding or issue a notice of potential noncompliance to the contractor. The contractor then gets 60 days to respond, either explaining why the practice actually complies or arguing that the cost impact is too small to matter.10Acquisition.GOV. 48 CFR 30.605 – Processing Noncompliances
If the CFAO determines the cost impact is immaterial, the process ends without contract adjustments, though the contractor is still expected to correct the practice. The government reserves the right to revisit the issue if the impact becomes material later.11Acquisition.GOV. 48 CFR 30.602 – Materiality
When the impact is material, the consequences get real. The CFAO calculates the increased costs the government paid as a result of the noncompliance, and the contractor owes that amount back. On top of the overpayment itself, the government charges interest from the date of overpayment to the date of repayment, calculated using the federal underpayment rate established under 26 U.S.C. 6621(a)(2). That rate compounds, so a noncompliance that goes undetected for years can generate substantial interest on top of the principal adjustment.12eCFR. 48 CFR 30.605 – Processing Noncompliances
The price adjustment is limited to the government’s actual increased costs in the aggregate. The CFAO can’t use noncompliance as a windfall. But within that limit, every affected contract gets adjusted, and the administrative burden of unwinding years of misallocated costs across dozens of contracts can be staggering before you even account for the dollars owed.