A Fortune 500 defense contractor recently paid $8.7 million in penalties after DCAA auditors discovered systematic violations of tangible asset capitalization requirements under CAS 404. The contractor’s $1,000 capitalization threshold—considered “industry standard” by their CFO—directly violated federal cost accounting standards, resulting in questioned costs, contract suspensions, and a two-year remediation process that cost an additional $3.2 million in consulting fees and lost opportunities.
This violation pattern repeats across federal contracting. Contractors consistently underestimate CAS 404 requirements, implementing capitalization policies that fail basic federal compliance standards and expose organizations to significant financial penalties under multiple jurisdictions.
Legal Foundation: Federal Cost Accounting Standards Authority
Cost Accounting Standards 404, codified at 48 CFR 9904.404, establishes mandatory requirements for capitalizing tangible assets under federal contracts exceeding $2 million. The regulation operates under the authority of 41 USC 1502, which grants CASB authority to promulgate cost accounting standards binding on federal contractors.
CAS 404 specifically requires contractors to establish written policies for distinguishing costs to be capitalized from costs to be expensed. These policies must be consistently applied and cannot be changed without advance approval from the cognizant federal agency official. The regulation explicitly states that capitalization policies must be “reasonable and consistently applied,” creating a dual compliance requirement that trips up most contractors.
Federal Acquisition Regulation 31.205-11, implementing CAS 404 requirements, reinforces that depreciation costs are allowable only when based on acquisition costs capitalized in accordance with CAS 404. This creates a direct link between capitalization compliance and contract cost allowability—making violations immediately financially consequential.
Systematic Violation Patterns in Federal Contracting
DCAA audit records demonstrate three recurring violation patterns that consistently trigger questioned costs and compliance actions:
Arbitrary Dollar Thresholds Without Justification: Contractors implement $1,000, $2,500, or $5,000 capitalization thresholds based on “industry practice” rather than CAS 404’s requirement for reasonable, consistently applied policies. DCAA auditors consider any threshold established without documented justification as arbitrary and potentially discriminatory against government contracts.
Inconsistent Application Across Contract Types: Companies frequently apply different capitalization policies to commercial work versus government contracts, or vary thresholds based on contract size. CAS 404 requirements demand consistent application across all business units subject to the standard, making selective application a direct violation punishable under FAR 31.201-4.
Failure to Maintain Written Policies: Contractors rely on informal practices or undocumented “company tradition” rather than the written policies explicitly required by CAS 404-40(a). This violation alone can trigger full contract cost disallowance under 48 CFR 9904.404-60.
Each pattern creates cascading compliance failures across multiple federal regulations, multiplying potential penalties and enforcement actions.
Mandatory Compliance Requirements Under CAS 404
Federal contractors must implement five specific compliance measures to satisfy CAS 404 requirements:
Establish Written Capitalization Policies: Document specific criteria for distinguishing between capitalizable assets and period costs. Policies must address useful life thresholds, dollar amount considerations, and asset classification procedures. Documentation must be formal, approved, and accessible to DCAA auditors upon request.
Implement Reasonable Dollar Thresholds: Establish capitalization thresholds based on materiality to your organization’s financial position, not arbitrary industry benchmarks. Document the business justification for your threshold, including consideration of administrative costs versus materiality benefits. Many compliant contractors use $500-$2,500 thresholds with proper justification.
Ensure Consistent Cross-Contract Application: Apply identical capitalization policies across all business segments subject to CAS coverage. Create written procedures preventing selective application based on contract type, customer, or profitability considerations. Document compliance monitoring procedures.
Maintain Detailed Asset Records: Establish systems tracking capitalized assets from acquisition through disposal. Records must support depreciation calculations, useful life determinations, and cost allocation procedures required under CAS 414. Integration with your cost accounting system is mandatory.
Create Regular Review Procedures: Implement quarterly reviews of capitalization decisions to ensure policy compliance. Document review findings and corrective actions. Establish procedures for identifying and correcting misclassifications before DCAA discovery.
Financial Consequences: Non-Compliance Costs Versus Implementation
Non-compliance penalties under CAS 404 create immediate financial exposure across multiple enforcement mechanisms. Questioned costs average $2.3 million per major violation based on DCAA audit data from 2022-2024. Contract suspensions pending corrective action cost contractors an average of $847,000 in lost revenue per month of delay.
Administrative costs compound financial exposure. Remediation typically requires 12-18 months and costs $150,000-$500,000 in consulting fees, system modifications, and staff time. Companies face additional costs from delayed contract awards, increased DCAA audit frequency, and enhanced scrutiny on future submissions.
Contrast this with implementation costs. Proper CAS 404 compliance systems cost $25,000-$75,000 to implement for mid-sized contractors. Annual maintenance costs range from $15,000-$30,000. Most contractors recover implementation costs within six months through reduced audit adjustments and faster contract closeout procedures.
The mathematics are definitive: compliance costs represent 2-3% of typical non-compliance penalties, making implementation a financial imperative rather than discretionary investment.
Multi-State and Federal Jurisdiction Enforcement
CAS 404 violations trigger enforcement across multiple jurisdictions simultaneously. Federal enforcement occurs through DCAA audits, DCMA contract administration, and direct agency action. State enforcement applies when contractors perform state-funded work subject to federal cost principles through grant programs or cooperative agreements.
The Federal False Claims Act, 31 USC 3729, creates additional exposure for knowing violations. Contractors submitting cost proposals or invoices based on non-compliant capitalization policies face potential treble damages plus penalties of $13,508-$27,018 per violation under current adjustment rates.
State False Claims Acts in California, New York, Texas, Florida, and Illinois extend similar penalties to state contracts incorporating federal cost principles. Multi-state contractors face parallel enforcement actions that can exceed federal penalties by 200-300%.
International subsidiaries performing federal contract work create additional compliance complexity. CAS 404 applies to all business segments of covered contractors regardless of geographic location, making foreign operations subject to U.S. federal cost accounting standards.
Implementation Authority and Professional Standards
CAS 404 compliance requires executive-level commitment and professional expertise. The Comptroller General’s authority under 41 USC 1502 makes CAS violations matters of federal law, not mere contractual disagreements. Companies must approach compliance with the same rigor applied to Securities and Exchange Commission reporting requirements.
Professional implementation demands certified public accounting expertise in federal cost accounting. Internal audit functions must include CAS compliance testing. Board-level oversight ensures appropriate governance around federal contract compliance risks.
The regulation provides no safe harbor for good faith efforts or industry practice reliance. Compliance is binary: policies either meet CAS 404 requirements or create violation exposure. Contractors cannot negotiate compliance standards or seek regulatory relief through alternative approaches.
Federal contractors operating without compliant CAS 404 policies face inevitable enforcement action. The question is not whether violations will be discovered, but when discovery will occur and what penalties will be imposed. Professional compliance implementation eliminates this risk while creating competitive advantages through superior cost accounting capabilities.
