corporation entered into another such contract, the total contract price of which was $40,000. Both contracts were completed within the calendar year 1936, the first at a cost of $155,000 and the second at a cost of $45,000. The net income of the B Corporation for the year 1936 amounted to $96,000, which included the total net profit of $40,000 upon the two contracts. For the year 1936 the B Corporation paid a Federal income tax of $13,240, no part of which was surtax imposed by section 14 of the Revenue Act of 1936. The excess profit liability is $13,600, computed as follows:

Less: 10 per cent of total contract prices (10 per cent of $240,000)

24, 000

Excess profit---.

16,000

Less: Credit for Federal income taxes (normal tax on $16,000 at 15 per cent)-

2,400

Net profit on contracts_

5.7 Total contract price. The total contract price of a particular contract or subcontract (see § 5.1) may be received in money or its equivalent. If something other than money is received, only the fair market value of the thing received, at the date of receipt, is to be included in determining the amount received. Bonuses earned for bettering performance and penalties incurred for failure to meet the contract guarantees are to be regarded as adjustments of the original contract price. Trade or other discounts are also to be deducted in determining the true total contract price.*+

5.8 Cost of performing a contract or subcontract-(a) General rule. The cost of performing a particular contract or subcontract shall be the sum of (1) the direct costs, including therein expenditures for materials, direct labor and direct expenses, incurred by the contracting party in performing the contract or subcontract; and (2) the proper proportion of any indirect costs (including therein a reasonable proportion of management expenses) incident to and necessary for the performance of the contract or subcontract.

(b) Elements of cost. No definitions of the elements of cost may be stated which are of invariable application to all contractors and subcontractors. In general, the elements of cost may be defined for purposes of the Act as follows:

(1) Manufacturing cost, which is the sum of factory cost (see paragraph (c) of this section) and other manufacturing cost (see paragraph (d) of this section);

(2) Cost of installation and construction (see paragraph (e) of this section); and

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*For statutory citation, see note to § 5.0.

(3) General expenses, which are the sum of indirect engineering expenses, usually termed "engineering overhead" (see paragraph (f) of this section) and expenses of administration, usually termed "administrative overhead" (see paragraph (g) of this section).

(c) Factory cost. Factory cost is the sum of the following:

(1) Direct materials. Materials, such as those purchased for stock and subsequently issued for contract operations and those acquired under subcontracts, which become a component part of the finished product or which are used directly in fabricating, converting or processing such materials or parts.

(2) Direct productive labor. Productive labor, usually termed "shop labor," which is performed on and is properly chargeable directly to the article manufactured or constructed pursuant to the contract or subcontract, but which ordinarily does not include direct engineering labor (see subparagraph (3) of this paragraph).

(3) Direct engineering labor. The compensation of professional engineers and other technicists, and of draftsmen, properly chargeable directly to the cost of the contract or subcontract.

(4) Miscellaneous direct charges. Items which are properly chargeable directly to the factory cost of performing the contract or subcontract but which do not come within the classifications in subparagraphs (1), (2), and (3) of this paragraph, as for example royalties which the contracting party pays to another party and which are properly chargeable to the cost of performing the contract or subcontract (but see paragraph (d) of this section).

(5) Indirect factory expenses. Items, usually termed "factory overhead," which are not directly chargeable to the factory cost of performing the contract or subcontract but which are clearly incident to and necessary for the performance of the contract or subcontract and consist of the following:

(i) Labor. Amounts expended for factory labor, such as supervision and inspection, clerical labor, timekeeping, packing and shipping, stores supply, and services in the factory employment bureau, which are not chargeable directly to productive labor of the contract or subcontract.

(ii) Material and supplies. The cost of materials and supplies for general use in the factory, such as shop fuel, lubricants, plating, cleaning and anodizing supplies, stationery, such as time tickets and other forms, and boxing and wrapping materials.

(iii) Service expenses. Factory expenses of a general nature, such as those for power, heat and light (whether purchased or produced), ventilation and air-conditioning and operation and maintenance of general plant assets and facilities used in the performance of the contract or subcontract.

(iv) Fixed charges. Recurring charges with respect to property used for manufacturing purposes of the contract or subcontract, such as premiums for fire and elevator insurance, property taxes, rentals and allowances for depreciation of such property.

(v) Miscellaneous indirect factory expenses. Miscellaneous factory expenses not directly chargeable to the factory cost of performing the contract or subcontract, such as employees' welfare

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expenses; premiums or dues on compensation insurance; employers' payments to unemployment, old age and social security Federal and State funds not including payments deducted from or chargeable to employees or officers; pensions and retirement payments to factory employees; factory accident compensation (as to self-insurance, see paragraph (g) of this section); but not including any amounts which are not incident to services, operations, plant, equipment or facilities used or employed in the performance of the contract or subcontract. (d) Other manufacturing cost. Other manufacturing cost as used in paragraph (b) of this section includes items of manufacturing cost which are not properly chargeable to factory cost (see paragraph (c) of this section), as for instance, "deferred" or "unliquidated" experimental and development charges if upon a complete showing of all pertinent facts they are properly to be included as a cost of manufacturing under the contract or subcontract; and payments of royalties and amortization of the cost of patent rights, the nature of which payments or amortization precludes a satisfactory charge to the classifications of factory cost (see paragraph (c) (4) of this section).

(e) Cost of installation and construction. Cost of installation and construction which is an element of cost (see paragraph (b) (2) of this section) includes the cost of materials, labor and expenses necessary for the erection and installation after delivery of the product or material manufactured or constructed pursuant to the contract or subcontract.

(f) Indirect engineering expenses. Indirect engineering expenses, usually termed "engineering overhead," which are treated in this section as a part of general expenses in determining the cost of performing a contract or subcontract (see paragraph (b) (3) of this section), comprise the general engineering expenses which are incident to and necessary for the performance of the contract or subcontract, such as the following:

(1) Labor. Compensation of employees for personal services to the engineering department, such as supervision, which is properly chargeable to the contract or subcontract, but which is not chargeable as direct engineering labor (see paragraph (c) (3) of this section).

(2) Material. Supplies for the engineering department, such as paper and ink for drafting and similar supplies.

(3) Miscellaneous expenses. Expenses of the engineering department, such as services purchased outside of the engineering department for blue printing, drawing, computing, and like purposes. (g) Expenses of administration. Expenses of administration, usually termed "administrative overhead," which are treated in this section as a part of general expenses in determining the cost of performing a contract or subcontract (see paragraph (b) of this section) comprehend the expenses incident to and necessary for the performance of the contract or subcontract, which are incurred in the general administration of the business, such as

(1) Compensation for personal services of employees. The salaries of the corporate and general executive officers and the salaries and wages of administrative clerical employees and of the office services

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employees (telephone operators, janitors, cleaners, watchmen and office equipment repairmen).

(2) Selling (including bidding) and servicing expenses. In lieu of direct charges for selling expenses (including bidding expenses) or for servicing expenses incident to delivered or installed articles, there may be allocated to the cost of performing a contract or subcontract the proportions of such expenses which by reference to all the pertinent facts and circumstances reasonably constitute a part of such cost. For the purposes of this method of treating selling and bidding expenses, the total of such allowable expenses which may be the basis of an allocation to the cost of performing a contract or subcontract shall include all expenditures in connection with preparing and submitting bids or other work incident to a prospective contract or subcontract.

(3) Other expenses. Miscellaneous office and administrative expenses, such as stationery and office supplies, postage, repair and depreciation of office equipment, employees' welfare expenses, premiums and dues on compensation insurance; employers' payments to unemployment, old age and social security Federal and State funds not including payments deducted from or chargeable to employees_or officers; pensions and retirement payments to administrative office employees and accident compensation to office employees (as to selfinsurance, see the following subparagraph); but including no items which are not incidental to activities necessary for the performance of the contract or subcontract.

Subject to the exception stated in this subparagraph, in cases where a contracting party assumes its own insurable risks (usually termed "self-insurance"), losses and payments will be allowed in the cost of performing a contract or subcontract only to the extent of the actual losses suffered or payments incurred during, and in the course of, the performance of the contract or subcontract and properly chargeable to such contract or subcontract. If a contracting party assumes its own insurable risks (i) for compensation paid to employees for injuries received in the performance of their duties, or (ii) for unemployment risks in States where insurance is required, there may be allowed as a part of the cost of performing a contract or subcontract a reasonable portion of the charges set up for purposes of selfinsurance under a system of accounting regularly employed by the contracting party, as determined by the Commissioner of Internal Revenue, at rates not exceeding the lawful or approved rates of insurance companies for such insurance, reduced by amounts representing the acquisition cost in such companies, providing the contracting party adopts and consistently follows this method with respect to selfinsurance in connection with all contracts and subcontracts subsequently performed by him.

Allowances for interest on invested capital are not allowable as costs of performing a contract or subcontract.

Among the items which shall not be included as a part of the cost of performing a contract or subcontract or considered in determining such cost, are the following: Selling expenses, including compensation of employees engaged in selling, operation and maintenance of sales

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offices, commissions, advertising and demonstrations, depreciation of sales equipment, and gratis service, which do not constitute proper charges as direct costs or as provided in paragraph (g) (2) of this section; entertainment expenses; dues and memberships other than of regular trade associations; donations; losses on other contracts; profits or losses from sales or exchanges of capital assets; extraordinary expenes due to strikes or lockouts; fines and penalties; amortization of unrealized appreciation of values of assets; expenses and depreciation of idle plant; increases in reserve accounts for contingencies, repairs, compensation insurance (except as above provided with respect to selfinsurance) and guarantee work; Federal and State income and excess profits taxes and surtaxes; cash discount earned up to 1 per cent of the amount of the purchase, except that all discounts on subcontracts subject to the Act will be considered; interest incurred or earned; bond discount or finance charges; income from royalties; premiums for life insurance on the lives of officers; legal and accounting fees in connection with reorganizations, security issues, capital stock issues and the prosecution of claims against the United States (including income tax matters); taxes and expenses on issues and transfers of capital stock; losses on investments; bad debts; and expenses of collection and exchange.

In order that the cost of performing a contract or subcontract may be accounted for clearly, the amount of any excess profits repayable to the United States pursuant to the Act should not be charged to or included in such cost.

Excessive or unreasonable payments whether in cash, stock or other property ostensibly for salaries, bonuses or other compensation for personal services, may not be included in the cost of performing a contract or subcontract.

(h) Allocation of indirect costs. No general rule applicable to all cases may be stated for ascertaining the proper proportion of the indirect costs to be allocated to the cost of performing a particular contract or subcontract. Such proper proportion depends upon all the facts and circumstances relating to the performance of the particular contract or subcontract. Subject to a requirement that all items which have no relation to the performance of the contract or subcontract shall be eliminated from the amount to be allocated, the following methods of allocation are outlined as acceptable in a majority of cases:

(1) Factory indirect expenses. The allowable indirect factory expenses (see paragraph (c) (5) of this section) shall ordinarily be allocated or "distributed" to the cost of the contract or subcontract on the basis of the proportion which the direct productive labor (see paragraph (c) (2) of this section) attributable to the contract or subcontract bears to the total direct productive labor of the production department or particular section thereof during the period within which the contract or subcontract is performed.

(2) Engineering indirect expenses. The allowable indirect engineering expenses (see paragraph (f) of this section) shall ordinarily be allocated or "distributed" to the cost of the contract or subcontract on the basis of the proportion which the direct engi

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