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Retreadfed

Direct Overhead Costs

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For those of you who have at least a passing interest in government contract cost accounting issues, I think you will find the Court of Federal Claims' bid protest decision in IT Shows, Inc., issued Jan. 17, 2017 interesting reading.  There the court discusses the concepts of direct overhead costs and indirect overhead costs.

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What an ... unusual approach.

1. The solicitation was an SB set-aside even though the IGE indicated that the expected contract value was in the neighborhood of one-third of  a BILLION dollars. How many SB's have the capability to successfully manage that size of a contract?

2. The winning offeror decided to take some of its traditional indirect costs (overhead & G&A expense) and make them direct costs. Specifically identified for a change in accounting treatment was the contractor's PMO and program-dedicated finance staff. Further, the offeror then stated that none of the remaining indirect costs would be allocated to the contract. Now, I have no real problem with step 1 because sure, that can be done. It's easier to do at an SB where the contractor is exempt from CAS. With respect to step 2 (saying that no other indirect costs would be allocated to the contract) there is some support for a special allocation where the contract would bear a disproportionate amount of indirect costs through normal allocations, but I would have a hard time accepting that none of the traditional G&A functions benefited the contract. HR? Legal? CFO? CEO? Accounting? I would have a hard time accepting that statement at face value. On the other hand, if there was a program-dedicated HR function then maybe.

I wonder if a different attorney, one more familiar with cost accounting, might have been able to persuade the Judge that the notion that zero indirect costs would be allocated to the contract violated the FAR definition of allocability and was, in fact, a "fragmentation" of the appropriate allocation base? As a matter of fact, I recall a major defense contractor getting in trouble several years ago for treating indirect costs as direct costs in order to avoid rate ceilings. One difference between then and now was the big contractor was subject to CAS whereas this little SB would not be.

Weird solicitation. Weird approach. What can I say? I hope we don't see a repeat of this.

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Help, it appears, from my reading of the case, (decision?) , that SSI only moved the "overhead" costs from indirect to direct costs, not G&A costs in its revised proposal. During the cost realism analysis, the government used SSI's ceiling rate for G&A to adjust the probable cost, just as it did for IT Shows (the Plaintive).  

 The Court stated that SSI had moved all "overhead" costs and that SSI would not charge any other "overhead" costs to the contract . It didn't say that SSI wouldn't charge any G&A costs.   

The government also adjusted SSI's direct probable costs that had been moved from "overhead" upward to reflect its scepticism of some of those proposed costs  

The discussion was a little unclear where it included "G&A" with "overhead " when the Court stated that a it would be acceptable for a proposer to move  G&A costs from indirect to direct e.g.:

Quote

We also hold that USAID did not have to use discussions to inform IT Shows that it could bill its overhead and G&A expenses directly. 

That was a little confusing perhaps. I don't know how true G&A expenses could be billed or charged as direct costs or split and charged both ways or whatever...

 

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Joel,

We don't disagree. I was going by the words in the decision re: G&A. The GAO "decider" decided it would be okay. That could be dicta or it could be cited as precedent in a future decision. I don't know.

My concerns are not really different than yours. The question of allocability turns on a nexus between cost and benefit. (It used to be "cause" as well, but not really anymore.) If the company performs an analysis that shows that there is no nexus then it has a good argument that the cost should not be allocated, or that a special allocation should be used. With respect to G&A functions, that's a pretty difficult thing to show, absent clear duplication of function (e.g., duplicate HR functions).

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2 hours ago, here_2_help said:

Joel,

We don't disagree. I was going by the words in the decision re: G&A. The GAO "decider" decided it would be okay. That could be dicta or it could be cited as precedent in a future decision. I don't know.

My concerns are not really different than yours. The question of allocability turns on a nexus between cost and benefit. (It used to be "cause" as well, but not really anymore.) If the company performs an analysis that shows that there is no nexus then it has a good argument that the cost should not be allocated, or that a special allocation should be used. With respect to G&A functions, that's a pretty difficult thing to show, absent clear duplication of function (e.g., duplicate HR functions).

Here,

I think that the holding concerned whether USAID had to inform IT Shows that, if such costs were actually direct costs, not indirect costs, as defined by FAR, then it was not required to propose them as G&A or "overhead".

Apparently, in Amendment 6,  USAID suggested that it had assumed that there would be "overhead" costs, so had included language on how such costs would be evaluated in the realism analysis. USAID didn't specifically require the offerors to propose "overhead costs", if the costs were direct, not indirect. Offerors could propose costs as applicable to their circumstances.  

After re-reading the Decision, it looks clearer.  I don't think that the Court said that it's ok to charge G&A or overhead as a direct cost, if it is truly an indirect cost. 

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I got the impression that proposers were misled by the cost template, which included blanks for provisional and ceiling rates for overhead and for G&A. So they may have initially thought that was how the RFP required them to price their proposals. They either fit some cost categories there to "comply" or may actually have been organized consistent with the RFP pricing scheme.

Apparently, after they realized how USAID used the ceiling rates in the cost realism analysis, and after USAID took corrective action in response to an initial protest,  both firms reclassified some Overhead costs as direct costs in their final revised offers and/or organized all or part of their project management organizations. 

The direct costs were not subject to the overhead rate ceiling. In addition,  perhaps  (I'm speculating here) the direct costs wouldn't be subject to other upward adjustments made during the final cost realism analysis. 

SSI ended up reclassifying  all of its proposed overhead, while IT Shows only reclassified some overhead costs to direct.  

The result was apparently a larger spread between the firms' final adjusted pricing.

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To me, the salient point is that these were both Small Businesses, and thus exempt from the CAS requirements that would have impeded such movements. Had these been large businesses, or otherwise subject to CAS, the results may well have been different.

 

https://www.nsf.gov/oig/_pdf/07-1-006_RPSC.pdf

 

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"Here", thanks for the info.  It brings back some unhappy memories, which affected my health over a nearly four year  period during part of that same timeframe.

I had the misfortune to have to deal with a "large" Defense firm that regularly used strong arm, bully-like tactics to try to get its way, while financially floundering through two large fixed price construction contracts for us and several other large projects/contracts for others. The company had a deeply rooted, cost plus business culture. These were two of several very complex FFP construction projects that weren't in its traditional business line. As it turned out, the company was losing hundreds of million dollars or more on a variety of large, FFP construction projects.

We were able to use their CAS Disclosure Statements to help successfully challenge hundreds of thousands of dollars of proposed costs that were inconsistent with their accounting practices or were otherwise inappropriately "requested" or were inapplicable to changes to the FFP phase of an overall Cost Reimbursement, multi-phased Major Defense Systems contract .

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The decision states that the contract was to be a cost reimbursement contract.  As such, the cost principles from FAR Subpart 31.2 would apply to the contract and presumably would have been used in the evaluation of the contract.  Interestingly, it seems that no one raised the issue of compliance with FAR 31.202 which states that "No final cost objective shall have allocated to it as a direct cost any cost, if other costs incurred for the same purpose in like circumstances have been included in any indirect cost pool to be allocated to that or any other final cost objective."

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It looks to me that the costs that the contractor proposed to treat as direct were project management costs. It appears that the contractor was proposing to set up an independent project management office for the contract so it could charge those costs as direct. See page 7:

Quote

SSI proposed to dedicate a project management office (“PMO”), the PMO’s staff, and other overhead costs exclusively to this contract. Whether a cost is direct or indirect is an objective factual question. FAR 2.101 provides that “[c]osts identified specifically with a contract are direct costs of that contract.” 48 C.F.R § 2.101 (2016). Here, each cost that SSI categorized as overhead identified specifically with this contract.

That's not uncommon. By setting up the contract with its own PMO those costs were properly direct, even though sometimes referred to as "project overhead." If the PMO had been part of a larger company PM organization, its cost would arguably have been indirect.

What am I missing? Why is this troubling or confusing? What's the big deal?

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2 hours ago, Vern Edwards said:

It looks to me that the costs that the contractor proposed to treat as direct were project management costs. It appears that the contractor was proposing to set up an independent project management office for the contract so it could charge those costs as direct. See page 7:

That's not uncommon. By setting up the contract with its own PMO those costs were properly direct, even though sometimes referred to as "project overhead." If the PMO had been part of a larger company PM organization, its cost would arguably have been indirect.

What am I missing? Why is this troubling or confusing? What's the big deal?

I agree with you concerning the subject of the OP. Sorry for my rant above. I have edited it  

H2H's concerns with reference to CAS, reminded me of painful association with a CAS covered company that also didn't consistently comply with it's CAS Disclosure Statement but tried to bully its way past that. 

 

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34 minutes ago, Vern Edwards said:

What am I missing? Why is this troubling or confusing? What's the big deal?

See my point #2 in my first post.

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When a service contractor performs at a government site or a government designated location, and when the performance must or can be managed and administered at that site, then most if not all local management and administrative costs will be direct costs as defined by FAR. People sometimes loosely refer to contractor management and administrative functions, as opposed to the hands on "real" work, as "overhead," but it's not, in the official sense.

The successful contractor in the protested acquisitions was smart enough to see that and avoid the "direct overhead" ceiling rate.

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1 hour ago, Vern Edwards said:

H2H:

I saw that. So why the comment at the end of that post:"Weird solicitation. Weird approach."? What was weird?

The solicitation was weird because it was an SB set-aside for a contract that many large businesses would have trouble managing. Among many other challenges I can envision, how do you forecast indirect rates for a contract that may be x100 what your last year's revenue was? The awarding agency understood that risk and established ceiling rates but doing so only addressed the obvious risk (cost to government) and not even the real, fundamental, risk: If a contractor exceeded those rates the excess would be unallowable. At the size of the contract in question, that much unallowable costs could financially cripple a small business. Thus jeopardizing ability to perform the contract. The solicitation was weird because, by limiting the award to SBs, it created a lot of performance risk. But I'm sure the market research performed showed that two or more SBs could successfully perform a contract of this size, right?

To your other post, Retreadfed correctly pointed out the key issue, which is that the winning offeror proposed to treat as direct costs for this contract, and this contract only, what had previously been proposed, costed, and billed to its other customers as indirect costs. (Admiral Rickover would be livid.) That means that there is an allocability issue. I can see ways to get around that, and perhaps the winning offeror did them (we don't know), but it would require some contortions. I think my first post acknowledged that.

The issue here is not really about functions; it's about consistency in cost treatment. SBs have far more latitude in that regard than large businesses do. Further, while you can do the functional analysis and identify duplicative functions/costs, I have a hard time accepting that every single indirect function was duplicated. Again, see my post. What about the CEO? Was there a duplicate CEO? Was there a duplicate CFO? Was there a duplicate General Counsel? If not, then the cost of the CEO/CFO/GC (etc.) needs to be allocated as an indirect cost subject to the rate ceilings to the contract. Games were being played, successfully as it turns out. But the approach used by the winner had to involve accounting contortions, and likely skated past the FAR allocability requirements while waving at them. There is no way it could have been done in a CAS-covered environment. Thus: my shorthand "weird approach."

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4 minutes ago, here_2_help said:

To your other post, Retreadfed correctly pointed out the key issue, which is that the winning offeror proposed to treat as direct costs for this contract, and this contract only, what had previously been proposed, costed, and billed to its other customers as indirect costs. (Admiral Rickover would be livid.) That means that there is an allocability issue. I can see ways to get around that, and perhaps the winning offeror did them (we don't know), but it would require some contortions. I think my first post acknowledged that.

The issue here is not really about functions; it's about consistency in cost treatment.

Let's say that a company subject to CAS has 10 contracts with performance at different sites around the country. The company is set up so that those projects are managed out of a single project management office at company headquarters. The costs are thus allocated as indirect costs and the CAS disclosure statement reports them as such.

Now the company is looking to bid on an 11th contract. Given the terms set by the customer in its solicitation the company decides that it would be better to manage that project on site instead of through the central project management office. The company thus considers the project management costs to be direct and allocated as direct costs.

Are you saying that the company would be in violation of CAS?

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2 hours ago, Vern Edwards said:

Let's say that a company subject to CAS has 10 contracts with performance at different sites around the country. The company is set up so that those projects are managed out of a single project management office at company headquarters. The costs are thus allocated as indirect costs and the CAS disclosure statement reports them as such.

Now the company is looking to bid on an 11th contract. Given the terms set by the customer in its solicitation the company decides that it would be better to manage that project on site instead of through the central project management office. The company thus considers the project management costs to be direct and allocated as direct costs.

Are you saying that the company would be in violation of CAS?

Yes, unless the contractor successfully argues that the circumstances of the 11th contract are different than the others. (And they may be.)

CAS 402: The purpose of this standard is to ensure that each type of cost is allocated only once and on only one basis to any contract or other cost objective. The fundamental requirement is that all costs incurred for the same purpose, in like circumstances, are either direct costs only or indirect costs only with respect to final cost objectives.

DCAA Audit Guidance:

Problem. A contractor has a Government contract that requires extra effort for planning and cost management. It hired extra people to accomplish this effort and accounted for all their labor cost as a direct charge to the contract. The contractor has other people performing the same functions for more than one contract and their labor is charged to indirect costs.

Solution. Since the work being performed is the same and the only difference is in the amount of effort required to accomplish the function, this practice would not comply with the standard.

 

 

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On ‎1‎/‎18‎/‎2017 at 5:33 PM, here_2_help said:

1. The solicitation was an SB set-aside even though the IGE indicated that the expected contract value was in the neighborhood of one-third of  a BILLION dollars. How many SB's have the capability to successfully manage that size of a contract?

here-2-help -  This comment has no intent to change the great discussion regarding this thread and its primary topic direct/indirect costs.  I just wanted to pass along that in reading the thread and doing my own research related to all the thoughts expressed in reviewing FPDS-NG both the firms mentioned in the case it would seem that each has handled many contracts either individually or in total that amounted to millions of dollars.  From this view it would seem that the answer to this question was adequately addressed by the agency during market research leading to the SB set-aside.  As you note the SB set-aside also helped in making administration less arduous (with regard to CAS)?

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Carl,

I don't know the firms and I don't know the level of quality in the market research performed. All may be well and I'm not insinuating otherwise.

 

That being said, I have helped more than one SB who was handed a very large cost-type contract, and it never failed that much administrative work needed to be done in the compliance arena. One contractor I can recall (from more than 10 years ago) was performing @ $50 million in GSA sales and woke up one day with a $500M CPAF contract. Fortunately the company knew enough not to submit an invoice until some SMEs could get their house in order. I remember one discussion regarding the G&A rate. "You proposed 15% G&A, where did that come from?" I remember asking. The answer: "We asked the CO what he considered to be a reasonable G&A rate and he told us 15%. So that's what we proposed." I asked: "What is your actual G&A rate?" They answered: "What's a G&A rate?"

 

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