Posted on Thursday, July 10, 2003 - 11:22 am

Here's an interesting issue I can't find addressed in the FAR, CAS, or DCAA CAM. Assume a salaried manager working for a contractor routinely works in excess of 40 hours per week. The manager's salary is charged to G&A and allocated to final cost objectives as required.

Now assume the manager spends 4 hours per day one week -- a total of 20 hours -- working on a project whose costs are unallowable. How is this unallowable labor "removed" from the G&A pool for purposes of determining indirect cost rates? The manager, like other G&A employees at the contractor, does not keep track of his total hours worked per week or month (there is no requirement that "indirect" employees do so to the best of my knowledge). Removing one-half of the manager's weekly salary (20 out of 40 hours) from the G&A pool is unfair to the contractor because the manager worked well over 40 hours during the particular week.

Is there a way to remove the unallowable cost from the G&A pool with precision without knowing how many total hours (including uncompensated overtime) the manager actually worked during the particular week? I can't think of any way.

What do contractors usually do in this situation? Try to reach some type of compromise solution with their ACO or DCAA, perhaps by having the manager estimate, after the fact, how many hours he worked during the pay period at issue and then removing an appropriate percentage of the salary?

The FAR and CAM rules on uncompensated overtime address direct-charge employees but I'm not aware of any guidance on uncompensated overtime for indirect-charge employees who do not keep track of the total hours they actually work each week/month.

AnonYmus  Posted on Thursday, July 10, 2003 - 04:44 pm:

First of all, both 31.201-6 and CAS 405 recognize that unallowable costs, particularly "directly associated" unallowable costs, only need to be excluded from indirect cost pools (e.g., G&A) if material in amount. You first need to determine if you are talking about a material amount of unallowable labor costs.

Secondly, an exact precision is not required with respect to indirect costs. Many contractors would conduct a survey of their executives and determine an overall percentage of such unallowable time and decrement their otherwise allowable salary and fringe expenses by that overall percentage.

Example calculation: 20 hours out of 60 is 30% times annual salary and fringe costs times the number of executives as a percentage of the total G&A cost pool.

In my experience (20+ years) nobody from DCAA or DCMA or IG would question the above methodology, especially given that the executives in question don't fill out timesheets. It's a very good faith attempt to comply and I would confidently expect it to pass.

Also, you need to be aware that in the late 1970's, DOD developed the "30 percent rule" with respect to such costs--after extensive correspondence between the DOD CAS Working Group and the CAS Board. I wasn't involved in that correspondence (I was in high school) and, honestly, I've never seen anything in writing on such a rule -- but all the "old timers" know about it and agree that otherwise unallowable salary costs less than 30% of the executives' time can qualify as "immaterial" and, hence, there is no need to track those salary costs as being unallowable.

Finally, Dick Johnson wrote a piece on this topic in one of last years' quarterly ABA Section of Public Contract Law Journals. If you have access to a library, you should definitely check it out. If anyone has the title/volume of publication, perhaps they could post it for you ...

Hope this helps.

joel hoffman  Posted on Thursday, July 10, 2003 - 04:55 pm:  

That's an interesting question. One must be careful when categorizing labor as "direct" or "indirect." Can you please clarify what you mean when you say the manager's salary is allocated to final cost objectives as required"?

You are confusing me when you say that the manager is spending 4 hours a day on ONE [unallowable] project. Should the manager's costs be considered as G&A if they are putting that much effort into one specific job? Is it a long term effort? It would seem that allocating his/her costs to generally to all projects is inappropriate in the first place. happy sails! joel hoffman

Anonymous  Posted on Thursday, July 10, 2003 - 05:42 pm:   

AnonYmus - thanks. I've never heard of the 30% rule and will try to get a copy of that PCLJ.

Joel - I'm using the terms "direct" and "indirect" to refer to whether the person's time is direct-charged or indirect-charged. Assume the manager in the hypo is the contractor's Manager of Contracts. His salary is collected in an indirect cost pool (which pool will depend on the contractor's accounting practices) and allocated, perhaps through intermediate indirect cost pools, to final cost objectives, i.e., to individual contracts, using an equitable methodology (e.g., based on direct labor hours). It would not be unheard of for the Manager of Contracts to be given a special project, for example, working on the company's response to a government investigation. Per FAR 31.205-47, such costs might turn out to be unallowable. The fact that he will spend a certain number of hours per week on this particular task doesn't mean that the rest of his time needs to be charged as a direct cost. At least that's my understanding.

joel hoffman  Posted on Thursday, July 10, 2003 - 06:50 pm:

Okay, but allocating "overhead" or "general and administrative" costs to individual contracts "based on direct labor hours" is inconsistent with the concept of indirect costing or with the concept of "G&A". In my experience, for most smaller firms, G&A is usually allocated to each contract as a percentage of the total contract cost. The percentage is usually derived by dividing the allowable and allocable G&A pool by some base, which is normally all company contract direct costs.

In that case, the easiest way to adjust for the unallowable hours is to estimate the percentage of his/her time spent on the unallowable effort, prorate his/her costs in the G&A pool, then re-calculate the allowable G&A rate. Unless this is a pretty small firm, the disallowed costs probably won't affect the G&A rate much.

If you are into CAS, this isn't a small contract action, the firm will have a method to adjust the overhead pool, and it probably won't make a dent in the G&A rate. happy sails! joel

Anonymous  Posted on Thursday, July 10, 2003 - 08:29 pm:

Joel -

Thanks for your input. In my experience, certain types of overhead are frequently allocated based on direct labor hours (or dollars). G&A is more commonly allocated based on a broader base, such as total cost input or value-added cost input. But frankly I don't think it matters for the purpose of the real issue here. Regardless of the allocation base, you're faced with the question of whether to calculate the adjustment based on a 40-hour work week (which hurts the contractor because the person works more than 40 hours per week) or on some other basis (which could be difficult to support because these types of employees don't keep track of all hours worked).

AnonYmus indicated the contractor may not have to remove ANY unallowable hours if the total unallowables don't exceed 30% of the person's total time. This sounds more generous (to the contractor) than most govt accounting rules, but I will definitely check it out. In your view (if I'm following you), DCAA may accept good faith estimates of the percentage of the employee's total time that was spent on the unallowable activity. This isn't quite as favorable as the 30% rule, but it's still better than having to make the adjustment based on a 40-hour work week.

AnonYmus  Posted on Friday, July 11, 2003 - 08:43 am:

Joel --

Anonymous is using terms correctly and, based on that, I reckon s/he knows what's s/he is talking about. Contractors are permitted to allocate overhead pools on almost any appropriate base, and many choose Direct Labor Hours or Direct Labor Dollars as their allocation base. Perfectly in compliance with all FAR and CAS regulations.

A fully CAS-covered contractor generally has to allocate G&A expenses on one of three allocation bases, of which Total Cost Input (TCI) is one acceptable choice. A contractor not subject to CAS 410 has much broader latitude to chose an appropriate G&A allocation base ... could even use Cost of Sales or Revenue in theory. Nothing in FAR Part 31 would prohibit it.

Anonymous has correctly framed the question -- if an employee who is classified as "indirect" charges a more-than-insignificant amount of labor to an expressly unallowable activity (e.g., due diligence for a merger or acquisition)-- AND the company is using "total time accounting" -- AND the indirect employees don't fill out timesheets because they only get paid salary regardless of how many hours are worked -- then how is the value of the unallowable salary (and associated fringe benefits) calculated for purposes of complying with 31.201-6 and CAS 405?

Hopefully, I've shown Anonymous some options for dealing with the situation. The determination of materiality will definitely drive the correct answer. I'm told there is a "30 percent rule" by "oldtimers" who spent years in Pentagon policy-making positions (OUSD, AT&L). I've never seen it but I believe them.

Finally, I'm back in the office today and will get down to the library to find the Dick Johnson article I mentioned. I'll post the pertinent publication info and, if there's anything interesting, I'll post that too.

joel hoffman  Posted on Friday, July 11, 2003 - 09:35 am:  

Your right and I understand that overhead can be based on direct labor in lieu of total direct costs.

But it isn't generally "allocated" to each contract based on direct hours expended on each contract. That would then be a direct cost. It's a matter of semantics. I use the term "allocate" to indicate how overhead is "charged" to a contract, not how the rate is "calculated". I was looking for a clarification on how it is "allocated" or "charged" to each contract. happy sails! joel

AnonYmus  Posted on Friday, July 11, 2003 - 01:02 pm:

Joel,

Perhaps it is semantics, but let's take another run at it. (I apologize in advance if I'm patronizing you...)

The contractor's overhead rate (percentage) is calculated as the ratio of the cost pool to the allocation base. The sum of allowable costs in the overhead pool is the numerator and the sum of allowable + unallowable "things" in the base is the denominator. (I say "things" because an allocation base doesn't have to be dollars ... could be computer usage hours or labor hours or pages of reproduction, etc.)

As a contract incurs the "things" in the allocation base, it "absorbs" overhead in proportion to the ratio. We say overhead is allocated to the contract but the contract is absorbing the overhead based on the allocation ratio.

A contract can absorb overhead at a pre-planned (i.e., fixed) rate that then is trued-up at year-end, or a contract can absorb overhead at the current Year-to-Date actual overhead ratio as calculated from actual costs. Contractor's choice. (See CAS 418 for more on this if necessary. Note that CAS 406 prohibits contract overhead absorption at an individual actual overhead rate for each month unless there are exceptional circumstances.)

Technically speaking, ALL costs are allocated to contracts. Direct costs are directly allocated and indirect costs are indirectly allocated. We use the term "charged" but it's not really the correct term of art.

So how's that for semantics? Are we on the same page?

Regards

joel hoffman  Posted on Friday, July 11, 2003 - 04:53 pm:  

AnonYmus, Yep, I agree with you. happy sails! joel

AnonYmus  Posted on Monday, July 14, 2003 - 04:57 pm:

More on the "30 percent letter" --

On 30 November 1976 the Assistant SECDEF (Installation & Logistics), Dale Babione issued guidance to DOD regarding interpreting the CAS 405 provisions regarding "directly associated" costs.

Following are selection quotes taken from the letter ...

"This policy establishes the basis for determining whether cost is significant and should be identified to the unallowable activity or cost objective as a directly associated cost and subsequently disallowed. For these purposes, the amount, if any, to be identified to the unallowable activity or cost objective shall be determined on the basis of an official's or employee's time (actual or estimated workhours) directly attributable to the unallowable cost activity or cost objective."

"There shall be a conclusive presumption that a portion of an official's or employee's salary is a directly associated cost and significant and thus unallowable if such official or employee devotes 30% or more of his time to the unallowable cost activity or objective. That amount shall then be identified to the unallowable cost activity or cost objective and disallowed therewith."

"With respect to time of officials or employees attributable to unallowable cost activities or cost objectives, which time constitutes less than 30% of the total time associated with that official's or employee's total work time, the following criteria will be normally utilized for the purpose of determining whether such time devoted to the unallowable cost activity or cost objective is significant:
a. The absolute dollar amount involved. The larger the amount, the more likely it is to be significant. If the amount of individual salary associated with the unallowable cost activity or cost objective is less than $5,000, then such amount will not be considered to have met this criterion. However, if the aggregate amount of salary associated with the unallowable cost activity or objective for two or more employees in the same expense or cost pool, is $20,000 or more, then such aggregate amount shall be considered to have met this criterion. If the questioned salary costs fall below the applicable criterion above, such costs should not be questioned and b. and c. below do not apply.
b. The relationship of total costs to questioned costs. As applicable, compare the total salary cost pool with the questioned aggregate amount, or the total individual salary cost with the questioned amount of individual salary. The smaller the amount of questioned salary in relation to the total salary cost, the less likely it is to be significant.

c. The relationship between the activity represented by the questioned salary cost and the expressly or mutually agreed to be unallowable cost activity or cost objective. The further removed from the unallowable cost activity or cost objective, the less likely it is to be significant.
NOTE: The above criteria will be normally utilized for the purpose of determining whether associated costs other than salary are significant."


So materiality is not only driven by percentage, but also by dollar amount.

Hope this helps.

PWG  Posted on Wednesday, July 16, 2003 - 07:14 am:

AnonYmous:

I was impressed with your ability to explain the Cost Accounting concepts. Later this week or early next week I plan to post a question about the appropriate cost treatment of contractor training costs. I hope you will look for it and respond. I want to give some thought to the situation first rather than hastily posting the question. I have found that if I take the time to clearly and concisely draft my question, the forum responses are more on target and responsive to my issues.

thanks in advance

AnonYmus  Posted on Wednesday, July 16, 2003 - 03:30 pm: