The CBCA decision in Brinks/Hermes JV, CBCA 1188, 2009 WL 2351798 (July 28, 2009) was just brought to my attention. (Saw it in the latest edition of the Government Contract Costs, Pricing & Accounting Report, from which I'm paraphrasing below.)

The Court held that the T&M contract's Variation in Quantity clause provided for an adjustment of the hourly billing rates based on actual amounts of labor hours ordered. The State Department ordered 3 percent of the estimated hours. The contractor claimed an increase in overhead and other indirect costs stemming from the shortfall in hours ordered. The Court reasoned that the contract's clause was "clear and unambiguous and must be given its plain and ordinary meaning. The type of costs contemplated to be adjusted ... include the indirect and overhead costs ... the unrecovered costs are directly tied to the non-performance of the labor hours ...."

Perhaps I'm the only one, but I found it to be very interesting. It would not have occurred to me to claim unabsorbed overhead in that situation. I guess I never thought it through ... I always considered unabsorbed overhead in the context of a government-caused delay/stop-work order, and not in the context of a shortfall in hours ordered.

The CBCA decision in Brinks/Hermes JV, CBCA 1188, 2009 WL 2351798 (July 28, 2009) was just brought to my attention. (Saw it in the latest edition of the Government Contract Costs, Pricing & Accounting Report, from which I'm paraphrasing below.)

The Court held that the T&M contract's Variation in Quantity clause provided for an adjustment of the hourly billing rates based on actual amounts of labor hours ordered. The State Department ordered 3 percent of the estimated hours. The contractor claimed an increase in overhead and other indirect costs stemming from the shortfall in hours ordered. The Court reasoned that the contract's clause was "clear and unambiguous and must be given its plain and ordinary meaning. The type of costs contemplated to be adjusted ... include the indirect and overhead costs ... the unrecovered costs are directly tied to the non-performance of the labor hours ...."

Perhaps I'm the only one, but I found it to be very interesting. It would not have occurred to me to claim unabsorbed overhead in that situation. I guess I never thought it through ... I always considered unabsorbed overhead in the context of a government-caused delay/stop-work order, and not in the context of a shortfall in hours ordered.

I agree that the contractor is probably due an adjustment of some sort, but the decision appears to be based on obsolete law, refers to unabsorbed overhead, and refers to an incorrect interpretation of the standard Variation in Estimated Quantities Clause. In the instant case, the State Department used a custom Variation in Quantity clause. The CBCA referred to the FAR Variation in Estimated Quantities Clause (52.212-11) in its analysis.

The Court mentioned the purpose of the VEQ Clause was to prevent windfalls or losses due to excess quantities or underruns. It cited the language in Burnett v. US ("26 Cl. Ct. at 303") and the Corps of Engineers Board of Contract Appeals' Bean Dredging Corp. Decision, "ENGBCA 5507, 89-3 BCA, 22,034, at 110,824". Those cases essentially involved the principle of re-pricing overruns, based upon actual costs.

Those cases were rejected by the US Court of Appeals back in 1993.

US Court of Appeals rejected the holding in Burnett in the Nov 4, 1993 Decision of Foley Company v. US, "11 F. 3d 1032". Instead, it reaffirmed what I term the "Victory Principle" (Victory Const. v. US, 510 F. 2d 1379, 206 Ct. Cl. 274 (1975)). The Victory Principle doesn't allow re-pricing. Instead, the party seeking an adjustment has to show that the cost to the contractor per unit outside of the estimated band (85-115%) was increased or decreased solely as a result of the variation in estimated quantities. It doesn't seem to matter whether or not there was a windfall or loss on the work, so the excess or underrun isn't priced at actual costs plus markup.

We have traditionally looked at recovery of 85% (75% in the instant State Department case) of certain fixed and one-time costs for underruns, as well as anything else that the contractor can justify as an increased cost due to the underrun. Examples include higher unit costs due to the "learning curve", waste materials, mob and demob costs, fixed field office costs, etc. We haven't looked at paying "underabsorbed" or "unabsorbed" home office overhead on the un-earned quantities, instead added HOOH onto the additional unabsorbed direct and other indirect costs. This Court seemed to extend the application of unabsorbed or unearned home office overhead to underruns.

There may be some discussion of this new case in Nash and Cibinic Reports or elsewhere - I don't have access to those type reports anymore. However, I thought it was strange that the CBCA would refer to case law that has been since rejected. With the Foley Decision, we got away from the Bean Dredging and Burnett logic way back in 1993.

The pendulum may be swinging back, but I don't think that a Board of Contract Appeals can overrule Appeals Courts. Of course - I'm not a lawyer or a paralegal. My last Business Law course was in night school in 1983.

This was a guard contract with a regular hours CLIN and an Emergency hours CLIN for the same paygrade of guard. We wrote hundreds of contracts configured like this for posts worldwide and this was the first time the subject came up. We assumed we could add the regular hours and emergency hours together when comparing to the 25% variation. What Brinks charged was that the CLINs had to be treated separately and they were entitled to an adjustment of the Emergency hours CLIN. We thought we had it covered with our custom clause but the court has disagreed. We have since rewrote the clause and hope it holds up next time.

Good luck, Boof.ill have to reread the case and the wording of the clause, but I think the idea of unabsorbed home office overhead on underruns is a stretch of the original and current application of the concept. Then, the Civilian Agency BCA has, in my opinion, also gone down the wrong road as to the intent of VEQ clauses. The Court of Appeals rejected the Bean Dredging/Burnett approach in 1993.

Good luck, Boof.ill have to reread the case and the wording of the clause, but I think the idea of unabsorbed home office overhead on underruns is a stretch of the original and current application of the concept. Then, the Civilian Agency BCA has, in my opinion, also gone down the wrong road as to the intent of VEQ clauses. The Court of Appeals rejected the Bean Dredging/Burnett approach in 1993.

Joel:

Are you saying that the Victory decision precludes the recovery of unabsorbed overhead under the variation in estimated quantity (VEQ) clause, when the under absorption is due to a variation in quantity?

Nope.

But application of the Eichleay method of determining "unabsorbed overhead" (home office overhead) has been pretty much limited to govt caused delays of undeterminable duration, primarily under the Suspension of Work clause. The delay causes the contractor to standby ready to work, thus preventing it from taking on replacement work.

Underruns don't normally fit those circumstances.

G&A rates are often developed based upon using the overhead pool in the numerator and cost of sales in the denominator, based upon the past full accounting period, and perhaps adjusted for predicted changes in volume for the year that the rates will be applicable to.thus, overhead rates may reflect actual delays that occurred during the past year, anyway. Plus, the G&A rate is really an approximation anyway, adjusted when necessary to reflect business conditions.

At any rate, if the contractor can claim "unabsorbed overhead" on underrun CLINs, shouldn't the government be similarly entitled to claim a reduction for "overabsorbed overhead" on overrun CLINS?

Nope. But application of the Eichleay method of determining "unabsorbed overhead" has been pretty much limited to govt caused delays of undeterminable duration, primarily undr the Suspension of Work clause. The delay causes the contractor to standby ready to work, thus preventing it from taking on replacement work.

Underruns don't normally fit those circumstances.

Joel:

The Brinks/Hermes decision has nothing to do with Eichleay. The decision is sound.

Joel:

The Brinks/Hermes decision has nothing to do with Eichleay. The decision is sound.

Vern, sorry - I edited my post above to be more specific. I am referring to unabsorbed home office overhead, not other types, such as job or field "overheads", which are often recoverable to a certain extent on underruns. By the way, such costs are not always classified as "indirect" or "overhead", either. Many companies charge all on-site costs as well as some home office costs as direct costs to a contract, not as indirect costs.

Regarding "unabsorbed home office overhead", I believe that the Courts have said that the exclusive method for recovering such costs is to use Eichleay formula. Thus, there are certain circumstances that must be applicable in order to recover "unabsorbed home office overhead using the prescribed Eichleay method.

At any rate, the CBCA was explaining the purpose of variation in estimated quantity clauses, referring to obsolete cases.

The "Victory" principle didn't maintain that either party was entitled to get out of a bad deal (reprice the CLIN for original work outside the range) just because the limits were exceeded. That is the premise of Bean Dredging and the Burnett case. Victory was based upon the premise that both parties agreed to the unit price and were to abide by it, absent a change to the work, unless the over or underrun of estimated quantities of the originally contemplated work caused a change in the unit cost to the contractor.the adjustment is only for the difference in cost (plus applicable markups), not re-priced for actual costs.

I haven't seen the term "unabsorbed overhead" applied to other than home office, G&A and other similar costs. Job specific "indirects", such as job supervision and other fixed costs have been referred to as "unrecovered costs" in my experience. Of course, I haven't read lots of cases where somebody may have applied the term "unabsorbed overhead" to such costs. For the last ten years of my regular duties, our Chem-Demil contractors accounted for all job specific expenses as "direct costs" in their accounting systems.

I haven't seen the term "unabsorbed overhead" applied to other than home office, G&A and other similar costs. Job specific "indirects", such as job supervision and other fixed costs have been referred to as "unrecovered costs" in my experience. Of course, I haven't read lots of cases where somebody may have applied the term "unabsorbed overhead" to such costs. For the last ten years of my regular duties, our Chem-Demil contractors accounted for all job specific expenses as "direct costs" in their accounting systems.

Having reread the CBCA Decision, I'm confused as to what the Board considers to be "overhead costs". That is a broad term. My organization has long recognized unrecovered fixed and job type indirect costs as allowable to the extent that they would have been recovered had the "minimum" quantity been encountered (here 75%). However, "home office overhead" and "G&A" has been generally charged to the job as a percentage applied to the job costs. Thus, we would have allowed G&A to be marked up on the other costs.

The Board seems to be saying here that the contractor is entitled to charge G&A/HOOH to the unearned quantities, which I disagree with - of course they are the Board, not me. "Brink’s is entitled to be reimbursed for the indirect costs associated with the number of hours below the range that were not ordered."

Using that logic, it should follow then that every time there is an overrun beyond the range of the estimated quantities, the contractor has "over-recovered" its G&A/Home office type overhead and the government is entitled to a credit for the excess. The logic is correct for certain one-time or fixed job type costs, which don't involve additional time. But recovery of G&A/HOOH has traditionally been proportional to the amount of work done, not some guaranteed range of income.

And - I maintain that the CBCA is citing rejected case law and the incorrect premise for adjustments for variations in estimated quantity. "Adjustment to the unit prices or the total contract price is intended “to prevent either windfalls or losses, potentially even immense windfalls or ruinous losses, to the contract. The object is to retain a fair price for the contract as a whole in the face of unexpectedly large variations from the estimated quantities on which bids are based.” Burnett, 26 Cl. Ct. at 303 (quoting from the concurring opinion in Bean Dredging Corp., ENG BCA 5507, 89-3 BCA ? 22,034, at 110,824.). The Court of Appeals rejected that reasoning and those cases over 16 years ago in Foley Company v. US, "11 F. 3d 1032.

Joel:

When a contract stipulates estimated quantities and fixed unit prices, the contractor must decide at what quantity it wants to break even, which is the quantity at which it will have fully recovered its fixed costs. (The fixed costs are usually part of overhead.) If the contractor sells less than its break-even quantity, it will not have fully recovered its fixed costs. Some of that cost will be "unabsorbed" or "under-absorbed." The result is that the unit cost of the units actually sold will be increased, because the unabsorbed fixed costs must be allocated to those units. See the discussion of cost-volume-profit analysis in the DOD Contract Pricing Reference Guides, Vol. II. Ch. 2, http://www.acq.osd.mil/dpap/cpf/contract_p...nce_guides.html.

One of the purposes of a VEQ clause is to provide for a unit price adjustment when actual quantities fall short of estimated quantities by more than a certain percentage, so that the contractor can fully recover its unabsorbed overhead, assuming that the contractor can prove that the under-absorption was caused by the quantity shortfall. On the other hand, when actual quantities exceed the estimate by more than a certain amount, the government can seek to reduce the unit price of the excess quantity in order to eliminate the fixed cost component of that unit price.

The Brinks decision seems to me to be in line with the purpose of the clause, and it does not strike me as particularly controversial. The Federal Circuit's Victory decision, if I understand it properly, stands for the proposition that when actual quantities exceed estimated quantities the VEQ clause does not permit complete repricing, but only price adjustment. It thus reconciled two conflicting board decisions: Bean and Foley. Bean had permitted complete repricing and Foley had permitted only adjustment. None of the those decisions -- Victory, Bean, or Foley -- prohibited price adjustment to permit recovery of unabsorbed overhead when actual quantities fall short of estimated quantities. See: "Postscript II: 'Variation in Estimated Quantity' Clause," The Nash & Cibinic Report (Dec. 1993).

The Civilian Board of Contract Appeals addressed this in Brinks:

Although the Government recognizes that Brink?s would have recovered more overhead had the estimated hours been ordered, it contends that appellant is not entitled to such costs under the Changes clause, which provides the mechanism for adjusting the rates under the Variation in Quantity clause set forth in H.12. Citing Nicon, Inc. v. United States, 331 F.3d 878, 887 (Fed. Cir. 2003), the Government urges that appellant is not entitled to adjust the hourly rate because appellant did not prove a government-caused delay. Respondent?s Motion for Summary Relief at 9. Nicon, a construction case, is inapposite here. That case involved the entirely different principle of the application of the Eichleay formula for recovery of unabsorbed overhead resulting from government-caused delay, not application of a VEQ clause. As stated in Natco Limited Partnership, which did include a VEQ clause:

[t]here is no reason why the costs recoverable should not include overhead which would have been absorbed had the estimated quantities been ordered, but were left unabsorbed by the order shortfall. These costs are real, whether they result from delay or some other cause, and the absence of delay allegations does not prevent their recovery.

ENG BCA 6183, 96-1 BCA ? 28,062, at 140,132 (1995) (citing Henry Angelo & Co., ASBCA 43,669, 94-1 BCA ? 26,484, at 131,824 (1993)). The principle that costs are real and recoverable even in the absence of government-caused delay applies here.

To summarize, the Variation in Quantity clause in the contract is clear and unambiguous and must be given its plain and ordinary meaning. The type of costs contemplated to be adjusted in accordance with the clause include the indirect and overhead costs sought by Brink?s. See Gulf Construction Group, Inc., ENG BCA 5945, et al., 94-1 BCA ? 26,525, at 132,034 (1993) (?In general, where a contractor seeks a cost increase

pursuant to the VEQ provision for a quantity underrun, the equitable adjustment usually reflects unrecovered fixed costs attributable to non-performance of the adjustable or underrun quantities.?).

I don't see any problem with Brinks, except that the CO didn't understand pricing and the government's lawyers didn't understand the case law. The case law relied upon by the Board is still good for the purposes for which the Board relied on them, which was to state the purpose of the VEQ clause. The Board mentioned Burnett twice and Bean only once, as follows:

In construction contracts, items of work are often priced on a per unit basis, rather than on a lump sum basis. Burnett Construction Co. v. United States, 26 Cl. Ct. 296, 302 (1992)...

Adjustment to the unit prices or the total contract price is intended ?to prevent either windfalls or losses, potentially even immense windfalls or ruinous losses, to the contract The object is to retain a fair price for the contract as a whole in the face of unexpectedly large variations from the estimated quantities on which bids are based.? Burnett, 26 Cl. Ct. at 303 (quoting from the concurring opinion in Bean Dredging Corp., ENG BCA 5507, 89-3 BCA ? 22,034, at 110,824.)

The Board did not rely on those cases for their overturned holdings.

Joel:

When a contract stipulates estimated quantities and fixed unit prices, the contractor must decide at what quantity it wants to break even, which is the quantity at which it will have fully recovered its fixed costs. (The fixed costs are usually part of overhead.) If the contractor sells less than its break-even quantity, it will not have fully recovered its fixed costs. Some of that cost will be "unabsorbed" or "under-absorbed." The result is that the unit cost of the units actually sold will be increased, because the unabsorbed fixed costs must be allocated to those units. See the discussion of cost-volume-profit analysis in the DOD Contract Pricing Reference Guides, Vol. II. Ch. 2, http://www.acq.osd.mil/dpap/cpf/contract_p...nce_guides.html.

One of the purposes of a VEQ clause is to provide for a unit price adjustment when actual quantities fall short of estimated quantities by more than a certain percentage, so that the contractor can fully recover its unabsorbed overhead, assuming that the contractor can prove that the under-absorption was caused by the quantity shortfall. On the other hand, when actual quantities exceed the estimate by more than a certain amount, the government can seek to reduce the unit price of the excess quantity in order to eliminate the fixed cost component of that unit price.

The Brinks decision seems to me to be in line with the purpose of the clause, and it does not strike me as particularly controversial. The Federal Circuit's Victory decision, if I understand it properly, stands for the proposition that when actual quantities exceed estimated quantities the VEQ clause does not permit complete repricing, but only price adjustment. It thus reconciled two conflicting board decisions: Bean and Foley. Bean had permitted complete repricing and Foley had permitted only adjustment. None of the those decisions -- Victory, Bean, or Foley -- prohibited price adjustment to permit recovery of unabsorbed overhead when actual quantities fall short of estimated quantities. See: "Postscript II: 'Variation in Estimated Quantity' Clause," The Nash & Cibinic Report (Dec. 1993).

The Civilian Board of Contract Appeals addressed this in Brinks:

I don't see any problem with Brinks, except that the CO didn't understand pricing and the government's lawyers didn't understand the case law. The case law relied upon by the Board is still good for the purposes for which the Board relied on them.

Vern, my problem is with HOOH and/or G&A, which have traditionally been "absorbed", "earned" or whatever, based on some formula such as a percentage of sales or cost of sales, etc. I explained earlier how these costs are charged to all the firm's jobs over the year, then periodically adjusted, as necessary to reflect past performance or projected future performance. These have been treated as "variable costs". This decision seems to say that G&A/HOOH is guaranteed as a lump sum or fixed amount, similar to job overhead expenses, whether or not the estimated amount of work is actually there. G&A has been traditionally charged as a variable cost to a project (percentage), not as a lump sum cost allocated to a project (fixed $).

Traditional job costs, such as mobilization, management, supervision, etc. are the type costs that get "underabsorbed" when there are overall underruns in the estimated unit priced work. I have no problem with an adjustment for them, when it can be shown that they weren't recovered to the extent that they would have been had (75%) (85%) of the units priced work have been realized.

I do have a huge problem with treating a cost that is generally "absorbed" by a project based upon the cost or amount of sales and overall calculated to be "absorbed" over the accounting year from all projects, is traditionally charged to jobs as a percentage (variable cost).

This Board just seems to not understand how such business costs have traditionally been charged and simplistically treats such costs as fixed or lump sum costs. The Contractor will eventually "absorb" G&A costs, because they will often adjust future rates on past period cost of sales and/or adjust for future sales projections. Bigger firms are more sophisticated and make more adjustments. Small firms may or may not make interim adjustments of their rates. At any rate, that is how G&A/HOOH has traditionally been "absorbed" in the lines that I've been familiar with over the years (A-E and Construction). Maybe the service contract industry treats general business expense differently than construction and A-E world. I doubt it though.

For gosh sakes, though - estimated quantities of work are just that - estimated or variable quantities, based upon actual needs or circumstances. The VEQ clauses have been there to help alleiviate the problem under recovery of certain costs that have traditionally been spread over some or all of the estimated quantity, not for costs that are charged as a percentage of costs, like G&A/HOOH. Even if a contractor only has one contract and it is unit-priced, it may probably establish the next G&A/HOOH rate based upon the previous accounting period's sales or cost of sales, etc.

Am I making any sense in my distinction between how various indirects have been charged and/or treated over the years, some being fixed or one-time, while others are recovered as a percentage of all sales or cost of sales?

Vern, my problem is with HOOH and/or G&A, which have traditionally been "absorbed", "earned" or whatever, based on some formula such as a percentage of sales or cost of sales, etc. I explained earlier how these costs are charged to all the firm's jobs over the year, then periodically adjusted, as necessary to reflect past performance or projected future performance. These have been treated as "variable costs". This decision seems to say that G&A/HOOH is guaranteed as a lump sum or fixed amount, similar to job overhead expenses, whether or not the estimated amount of work is actually there. G&A has been traditionally charged as a variable cost to a project (percentage), not as a lump sum cost allocated to a project (fixed $).

Traditional job costs, such as mobilization, management, supervision, etc. are the type costs that get "underabsorbed" when there are overall underruns in the estimated unit priced work. I have no problem with an adjustment for them, when it can be shown that they weren't recovered to the extent that they would have been had (75%) (85%) of the units priced work have been realized.

I do have a huge problem with treating a cost that is generally "absorbed" by a project based upon the cost or amount of sales and overall calculated to be "absorbed" over the accounting year from all projects, is traditionally charged to jobs as a percentage (variable cost).

This Board just seems to not understand how such business costs have traditionally been charged and simplistically treats such costs as fixed or lump sum costs. The Contractor will eventually "absorb" G&A costs, because they will often adjust future rates on past period cost of sales and/or adjust for future sales projections. Bigger firms are more sophisticated and make more adjustments. Small firms may or may not make interim adjustments of their rates. At any rate, that is how G&A/HOOH has traditionally been "absorbed" in the lines that I've been familiar with over the years (A-E and Construction). Maybe the service contract industry treats general business expense differently than construction and A-E world. I doubt it though.

For gosh sakes, though - estimated quantities of work are just that - estimated or variable quantities, based upon actual needs or circumstances. The VEQ clauses have been there to help alleiviate the problem under recovery of certain costs that have traditionally been spread over some or all of the estimated quantity, not for costs that are charged as a percentage of costs, like G&A/HOOH. Even if a contractor only has one contract and it is unit-priced, it may probably establish the next G&A/HOOH rate based upon the previous accounting period's sales or cost of sales, etc.

Am I making any sense in my distinction between how various indirects have been charged and/or treated over the years, some being fixed or one-time, while others are recovered as a percentage of all sales or cost of sales?

To look at it another way - if there is a deductive change, the owner or government would be entitled to a credit for HOOH/G&A, if it is similarly been charged as a variable type (%) cost on increase changes. The Contractor isn't guaranteed a fixed amount of HOOH/G&A. Same with Termination for convenience. The settlement should include HOOH/G&A on its costs as part of the termination settlement. The Contractor isn't entitled to those overheads on the unearned amount of the terminated contract. Why should unperformed unit priced work be treated differently? That is inconsistent! Yes - of course, the Courts have created an exception where government delays keep the contractor's forces tied up and unable to obtain replacement work, thus the concept of unabsorbed overhead is applicable. A mere underrun by itself doesn't create that type of situation, so should be treated similarly to deducted or terminated work.

If there are unrecovered direct type home office costs, those should be reimbursable on unit priced underruns.

Vern, my problem is with HOOH and/or G&A, which have traditionally been "absorbed", "earned" or whatever, based on some formula such as a percentage of sales or cost of sales, etc. I explained earlier how these costs are charged to all the firm's jobs over the year, then periodically adjusted, as necessary to reflect past performance or projected future performance. These have been treated as "variable costs". This decision seems to say that G&A/HOOH is guaranteed as a lump sum or fixed amount, similar to job overhead expenses, whether or not the estimated amount of work is actually there. G&A has been traditionally charged as a variable cost to a project (percentage), not as a lump sum cost allocated to a project (fixed $).

Traditional job costs, such as mobilization, management, supervision, etc. are the type costs that get "underabsorbed" when there are overall underruns in the estimated unit priced work. I have no problem with an adjustment for them, when it can be shown that they weren't recovered to the extent that they would have been had (75%) (85%) of the units priced work have been realized.

I do have a huge problem with treating a cost that is generally "absorbed" by a project based upon the cost or amount of sales and overall calculated to be "absorbed" over the accounting year from all projects, is traditionally charged to jobs as a percentage (variable cost).

This Board just seems to not understand how such business costs have traditionally been charged and simplistically treats such costs as fixed or lump sum costs. The Contractor will eventually "absorb" G&A costs, because they will often adjust future rates on past period cost of sales and/or adjust for future sales projections. Bigger firms are more sophisticated and make more adjustments. Small firms may or may not make interim adjustments of their rates. At any rate, that is how G&A/HOOH has traditionally been "absorbed" in the lines that I've been familiar with over the years (A-E and Construction). Maybe the service contract industry treats general business expense differently than construction and A-E world. I doubt it though.

For gosh sakes, though - estimated quantities of work are just that - estimated or variable quantities, based upon actual needs or circumstances. The VEQ clauses have been there to help alleiviate the problem under recovery of certain costs that have traditionally been spread over some or all of the estimated quantity, not for costs that are charged as a percentage of costs, like G&A/HOOH. Even if a contractor only has one contract and it is unit-priced, it may probably establish the next G&A/HOOH rate based upon the previous accounting period's sales or cost of sales, etc.

Am I making any sense in my distinction between how various indirects have been charged and/or treated over the years, some being fixed or one-time, while others are recovered as a percentage of all sales or cost of sales?

I'm enjoying the discussion and learning new things, which is always good. I'm glad I posted the case here. But I need to jump in here because Joel is making several misstatements that need to be cleared up. Joel, I'm not necessarily disagreeing with your fundamental point, but you are confused in several respects.

1. For CAS-covered contractors (including construction and A/E contractors), G&A is allocated pursuant to CAS 410. That Standard mandates use of one of three allocation bases, none of which are cost of sales or percentage of sales (revenue). Use of those bases would be a CAS noncompliance.

2. Home office costs, whether called home office overhead or G&A or whathaveyou, are allocated pursuant to several CAS (e.g., 403, 410, 418) via what is usually a set of relatively complex allocations. Joel is wrong, wrong, wrong when he says that recovery of such costs is "adjusted to reflect ... past performance or projected future performance." Joel seems to be conflating forward pricing or bid rates with actual cost rates. Actual G&A is allocated based on (a) actual G&A expenses as incurred, and ( actual G&A allocation base expenses as incurred. Joel has it completely wrong when he states "The Contractor will eventually 'absorb' G&A costs, because they will often adjust future rates on past period cost of sales and/or adjust for future sales projections." Vern has it right: failure to order hours means less G&A allocation base to absorb the G&A/HOOH expenses, increasing the actual cost rate. In a cost-plus world, the contractor will seek to pass the additional G&A onto the customer, but in a fixed unit or FFP world, there is no mechanism to do so unless the VEQ clause is used.

3. G&A contains as much "fixed costs" as any indirect cost pool -- see CAS 403's definition of "residual expenses" as well as FAR 31.201-4©.

4. Again, Joel seems to create distinctions between cost pools that don't necessarily exist (e.g., G&A versus management, supervision, etc.). G&A expense benefits the business (or business segment) as a whole. Overhead benefits a portion of the business, but not its entirety. (Again, see 31.201-4 as well as the definition of G&A in CAS 410.) Basically, some costs are direct contract costs and some costs are indirect contract costs. Management and supervision can be direct or indirect, depending on the contractor's disclosed or established practices. Management and supervision can be in G&A pool(s) or in overhead pool(s) or even direct charged in certain circumstances.

So Joel, though I'm not sure you were directing your question to me, I'll answer it anyway. No, you were not making (good) sense in your distinctions.

I hope this helps.

Here, I don't disagree with you about how G&A rates are established. I have dealing with them for years. My explanation was probably not very clear and was generalized.

By "future rates" rates I meant the next time they are updated, they will reflect what occurred during the latest accounting period. I didn't mean to infer that the contractor arbitrarily increases them to make up for past losses.

However, I do know that DCAA and our auditors also looked at the proposed G&A rates to see if they track how the company is doing during the period of performance. For instance if the rate was based on last year's base and nUmerator, but this year the company's business doubles with little increas in the G&A pool, the auditors would question the proposed G&A rate. The Contractor could also ask for an adjustment if the calculated rate is not representative of conditions in the next accounting period. I don't know whether CAS allows these practices or not.

At any rate, actual events during the last accounting period that provide the numbers for the cost pool and for the base in the G&A calculation will reflect, for example, the underrun. The next calculated rate will, in effect, reflect the underruns. That's what I was trying to say.

Of course, the costs within the G&A pool will be a mix of fix and variable costs, duh. Depending upon the company's accounting system, some home office costs may be direct charged to contracts and with other companies, they are charged to the G& a pool.

However, when the method of allocating or recovering, absorbing or whatever term used to charge G&A costs to contracts is to charge X percent to the contract costs or revenues, etc., you are recovering G&A on a variable basis, not on a fixed or lump sum basis.

My choice of terms might not match yours but I generally know how G& A is applied to contracts - it isn't applied as a lump sum.

Companies treat various costs in different ways. Some don't distinguish between G&A and "home office overhead". Some have several layers of indirects for branch offices, etc. Many companIes have field overhead or job overhead while others don't. One large contractor I work with, for instance, considers all costs charged at the project or contract level to be "direct costs", including site supervision and admin, safety, job trailers, inspectors, admin staff, as well as many home office personnel who direct charge to the contract rather than charge as G&A.

Here, I don't disagree with you about how G&A rates are established. I have dealing with them for years. My explanation was probably not very clear and was generalized.

By "future rates" rates I meant the next time they are updated, they will reflect what occurred during the latest accounting period. I didn't mean to infer that the contractor arbitrarily increases them to make up for past losses.

However, I do know that DCAA and our auditors also looked at the proposed G&A rates to see if they track how the company is doing during the period of performance. For instance if the rate was based on last year's base and nUmerator, but this year the company's business doubles with little increas in the G&A pool, the auditors would question the proposed G&A rate. The Contractor could also ask for an adjustment if the calculated rate is not representative of conditions in the next accounting period. I don't know whether CAS allows these practices or not.

At any rate, actual events during the last accounting period that provide the numbers for the cost pool and for the base in the G&A calculation will reflect, for example, the underrun. The next calculated rate will, in effect, reflect the underruns. That's what I was trying to say.

Of course, the costs within the G&A pool will be a mix of fix and variable costs, duh. Depending upon the company's accounting system, some home office costs may be direct charged to contracts and with other companies, they are charged to the G& a pool.

However, when the method of allocating or recovering, absorbing or whatever term used to charge G&A costs to contracts is to charge X percent to the contract costs or revenues, etc., you are recovering G&A on a variable basis, not on a fixed or lump sum basis.

My choice of terms might not match yours but I generally know how G& A is applied to contracts - it isn't applied as a lump sum.

Companies treat various costs in different ways. Some don't distinguish between G&A and "home office overhead". Some have several layers of indirects for branch offices, etc. Many companIes have field overhead or job overhead while others don't. One large contractor I work with, for instance, considers all costs charged at the project or contract level to be "direct costs", including site supervision and admin, safety, job trailers, inspectors, admin staff, as well as many home office personnel who direct charge to the contract rather than charge as G&A.

Joel, perhaps I'm a bit oversensitive since it's a rare day when I get to discuss cost accounting in this Forum. Anyway, the issue is simply that when the contractor does update its G&A rates -- which will be used to bid future work or to bill current work -- it cannot always recover the increased G&A that is or will be applied to its other contracts stemming from the instant contract not absorbing its expected share as the parties intended. Some of those other contracts will be FP, others will be T&M, still others will have funding ceilings. So the contractor needs to be made whole for its "losses" from too much G&A going to other contracts.

That's the whole concept of unabsorbed overhead in a nutshell: you can adjust the pricing of all other affected contracts to make the contractor whole for the unplanned increased indirect costs they all absorb, or you can adjust the price of the instant contract that failed (for whatever reason) to absorb its planned share. The Courts and the contracting parties have agreed to adjust only the price of the instant contract.

Sorry if I jumped on my soapbox too quickly. As I said, I tend to get excited when these concepts are discussed. (I know, I know....)

H2H

Let me simplify my point.

I need a large area to be excavated. I know the overall quantities but don't know how much rock will be encountered.

I negotiate a contract with a contractor. We agree to use unit prices for common and for rock excavation.

I establish estimated quantities based upon local experience. In negotiating the unit rates, we agree on productivity rates and all the associated costs,such as rock drill rental, bringing in a dynamiter, site supervision, a job trailer, etc.

To all these direct costs the contractor adds 10% for home office overhead or G&A and adds a profit percentage. The contractor charges every job 10% for G&A, based upon last year's accounting period. In the end, the unit price for rock excavation is ten times the unit price for common excavation.

Then, the contractor performs the work but only 10% of the estimated rock excavation was encountered. We have the FAR VEQ clause in the contract. I agree to allow an adjustment to recover 85% of the contractor's one time and fixed costs associated with the rock excavation effort that weren't recovered during performance. No problem so far.

Now, the contractor requests to be paid 85% the G&A that was included in the estimated quantity of the rock excavation bid item. I say, wait a minute - we priced G&A at 10% of the other costs based on your practice of charging all jobs 10%. Now you say - "no, I want the "unearned" overhead that I thought I was going to get, even though we both knew that rock excavation was a best guess.

Now, don't pay any attention to the fact either that since there was less rock there was more common excavation than expected, so I recovered additional G&A for that overrun". But if it really bothers you, I will give you a credit for the extra G&A on common if you pay me the G&a I "lost" on the unperformed rock excavation."

"Oh- also don't pay any attention to the fact that we finished the job sooner beca_se of the lower rock quantity and went on to another job - where I also charged 10% for G&A."

My reaction would be BULL. I have paid you the agreed 10% rate on all quantities performed, including the overrun of common excavation. Plus, I will pay you 10% on every dollar included in our VEQ adjustment.I never guaranteed you 10% of the original contract price."

The contractor replies - "Nope. There is a new Board decision that says you owe me 10% on every yard of rock excavation that wasn't necessary up to 85% of the estimated quantity. I'm guaranteed to be paid G&A on 85% of the original estimated quantity..."

Sorry - that is a ridiculous conclusion to me.

Joel, you're making an argument based at least one dubious assumption.

To all these direct costs the contractor adds 10% for home office overhead or G&A and adds a profit percentage. The contractor charges every job 10% for G&A, based upon last year's accounting period. In the end, the unit price for rock excavation is ten times the unit price for common excavation.

The contractor's 10% G&A is just as likely (in fact more likely) to be based on a forecasted volume of work for the current year. When the contractor put together its forecasted G&A rate last year, it assumed that this year it would have to excavate all that rock you and it estimated would be encountered. But the work never happened. Had the contractor known that fact, it would have bid a 15% G&A rate because it would have roughly the same G&A expense pool allocated over a smaller base -- since the numerator was essentially unchanged while the denominator shrank, that means (mathematically) that the rate goes up. You need to make the contractor whole, especially because you have a contract clause that envisions this circumstance and it directs the parties to reprice the work.

The reality, though is that your hypothetical is not really a good analogy. In this case, the State Department ordered dramatically less (97% less) of the estimated quantities. That amount of descope is a heckuva lot closer to a T4C than it is to a variation in quantity. It's so much less that (in my mind) it calls into question the good faith of the Government's initial estimate on which the contractor based its pricing. Had the Government issued a T4C -- or a partial T4C -- there would be no question in your mind that the contractor would be made whole, right? The contractor would be reimbursed for all actual allowable costs allocated to the contract, plus TSP prep costs. If the contractor's actual G&A rate was higher than initially forecasted, it would be permitted to recover that higher G&A rate against the instant contract. Assuming a partial T4C, if the remaining non-terminated work cost more because of lost economies of scale or disruption or whatever, you would allow that higher cost, right? Even if the higher cost was partially comprised of higher indirect costs such as G&A.

So what's the difference here?

Regards.

H2H

Joel:

You're not making much sense to me, but, in fairness, I'm not reading you carefully. Here_2_help seems to be doing just fine in telling you why you're wrong and doesn't need my help.

One point: You are talking about construction and the Brinks case was about unit-priced security guard services and a particular clause. My point to you is that your reading and criticism of the CBCA are off base. The Brinks decision is right-on.

Have been away at the hunting camp since last week.

Here to Help, unless things have changed over the past couple of years, contractors weren't guaranteed every dollar of G&A originally allocated to a contract when the contract was terminated for convenience (or for delete changes). Nash and Cibinic, at least through the 3rd edition of "Administration of Government Contracts" explain that, for deductive changes, the government is due a credit for overhead and profit on delete changes. Thus, they weren't "guaranteed" all the costs that they originally contemplated or allocated to a job when they priced it.

Beyond the case law, my logic argument, at least for construction TFC's, has been that many or most contractors have backlogs that they can redirect their resources to when there is a TFC. They don't automatically "underabsorb" G&A when there is a TFC or partial TFC. If that were true, then when we add work by change order to a contract, why should we allow any additional G&A? Using your logic, the contractor has supposedly already allocated its expected overhead to the contract.

I agree that there may well be differences between service contracts and construction.

Its interesting how Here to Help jumped on me when I said that contractors might adjust G&A rates to reflect differences between the past accounting period and the current business expectations. I also said that the DCAA may look to see that the rates are reflective of current business load. In his/her last post above, Here has said the same thing.

Hmmm, it seems that the concept of "unabsorbed overhead" that was created to handle government caused suspension of work delays of indeterminate periods which prevented a contractor from seeking or obtaining replacement work has somehow morphed into an entitlement for any situation where the expected amount of work doesn't materialize.

Termination for Convenience was not set up to "make the contractor whole" had it performed the contract. I'm not at home to read about it in N&C, but I believe TFC was developed to avoid breach of contract claims when the government had to terminate contracts due to changes in requirements. The TFC is intended to allow the contractor to recoup its costs invested in the performed and unperformed work, (unless it was in a loss position to begin with). If G&A is typically charged to a contract in the accounting system as a percentage of costs, then we should be consistent in a TFC settlement, an increase or deductive change.

The US Court of Claims didn't state in Victory or in Foley, that the VEQ clause was set up to "make the contractor whole", either.