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 Recovery of Indirect Costs in the Pricing of Equitable

Adjustments and Terminations for Convenience

By

David George Anderson

B.S. June 1973, University of Akron

M.A. May 1977, Central Michigan University

J.D. June 1982, University of Tennessee

Certified Public Accountant

Certified Internal Auditor

A thesis submitted to

The Faculty of

The National Law Center

of The George Washington University

in partial satisfaction of the requirements

for the degree of Master of Laws

May 1988

Thesis directed by
K---
'
John Cibinic, Jr.

Professor of Law

* 1f

I,-/

" I
 PREFACE

The author is a United States Air Force judge advocate,

currently assigned to the Air Force Contract Law Center, at

Wright-Patterson Air Force Base, Ohio.

The views expressed herein are solely those of the author and

dc not purport to reflect the position of the Department of

Defense, or any other agency of the United States Government.

 TABLE OF CONTENTS

PREFACE

INTRODUCTION 1

CHAPTER 1 UNDERSTANDING THE FUNDAMENTAL PRINCIPLES

I. Equitable Adjustments 7

A. Purposes Served by Equitable Adjustments 7

B. Defining an Equitable Adjustment 8
II. Terminations for the Convenience of the Government 10

III. Cost--Its Relationship To Price 11

IV. Defining, Measuring, and Allocating Costs 12

A. Defining Cost 12
B. Cost Accounting Standards (CAS) 13
C. The Cost Principles 14
D. Measurement of Cost 15
E. Accounting Systems 16
F. Allocation of Costs 17
1. Direct Costs 17
2. Indirect Costs 18
3. Classification of Costs as Direct or Indirect 18
4. Process of Allocating Indirect Costs To Cost
Objectives 20
a. Indirect Cost Groupings 20
(i) Cost Principles 20
(ii) Common Indirect Cost Groupings 22
b. Distribution Base 23
c. Base Period 24
d. Indirect Cost Rates 26
V. How Volume Affects Costs 26

A. Classification of Costs as Fixed or Variable 27

B. Contribution Margin and Breakeven Point 29

VI. Methods of Product Costing 29

A. Absorption Costing 30
1. In General -30
2. Absorption Costing for Financial Reporting Purposes 31
B. Full Costing 32
C. Direct Costing 32

ii
VII. Allowability Under the Cost Principles 33

A. Reasonableness 34
1. Burden of Proof 34
2. Determining Reasonableness of Indirect Costs 35
B. Generally Accepted Accounting Principles 35
C. Terms of the Contract 36
1. Advance Agreements 36
2. Limiting Clauses 37
D. Limitations Set Forth in FAR Subpart 31.2 38
E Accounting for Unallowable Costs 38
1. Unallowable Costs Included in Indirect Cost
Groupings 39 U.

2. Unallowable Costs in the Distribution Base 39

CHAPTER 2 DETERMINING INDIRECT CHARGES FOR EQUITABLE

ADJUSTMENTS
I. Indirect Cost Rates 40

A. Projected Indirect Cost Rates 41

B. Actual Indirect Cost Rates 42
C. Negotiated Indirect Cost Rates 43
D. Application of Indirect Cost Rates 44
1. Changes Adding Work 44
2. Changes Deleting Work 45
3. Changes Both Adding and Deleting Work 45
4. Delay Related Indirect Indirect Costs 46
E. Using a Standard Markup for Overhead 46
F. Clauses Limiting Recovery of Indirect Costs 47
II. How Volume Affects Indirect Cost Rates 48

III. Do Equitable Adjustments Do More Than Make a Contractor

Whole? 51

A. Effect of Using Full Costing Rather Than Direct

Costing 51
B. Why Full Costing Is Used 53
C. The Real Objective of an Equitable Adjustment 55

CHAPTER 3 UNABSORBED OVERHEAD

I. How Delay Affects Contractors 57

II. Unabsorbed/Extended Overhead 58

A. Defining Unabsorbed and Extended Overhead 58

1. Unabsorbed Overhead 58
2. Extended Overhead 59

iii
 B. Entitlement to Unabsorbed and Extended Overhead 60
1. Unabsorbed Overhead 61
2. Entitlement Where Delay Does Not Ultimately Reduce
the Contractors Distribution Base 62
3. Extended Overhead 63
4. The Rationale Supporting Extended Overhead as a
Separate Basis of Recovery 67
5. Entitlement Under Various FAR Clauses 69
C. Measuring Unabsorbed Overhead 71
1. A Parade of Formulas 71
2. The Eichleay Formula 72
a. Background -- ----- 72
b. The Eichleay Formula 76
c. Criticisms of Eichleay 76
d. Alternative to Formulas Such as Eichleay 83
(i) Unabsorbed Overhead 83
(ii) Extended Overhead 84
3. Getting the Boards and Courts to Accept Alternatives
to Eichleay 85
a. Overcoming Capital Electric and Savoy
Construction 85
b. Contractually Establishing the Method of Recovering
Unabsorbed Overhead 88
4. Preventing Double Recovery of Unabsorbed Overhead 90
a. Percentage Markup on Direct Cost 90
b. Direct Recovery of Normally Fixed Indirect Costs 92
D. Unabsorbed Overhead in the Context of a Termination for
Convenience 92

CHAPTER 4 TERMINATIONS FOR CONVENIENCE

I.Termination Settlements 93

A. Objective 93
B. Complex Nature of Termination Settlements 94

II. Indirect Costs of Performing and Preparing to Perform the

Terminated Contract 96

A. Indirect Cost Rates 96

B. Direct Charging of Costs Normally Treated as Indirect
Costs 97
1. Indirect Costs Specifically Permitted as Direct
Costs 97
2. Indirect Costs Not Specifically Permitted as Direct
Costs 99

iv
 -- T ._

B. 3. Consistency Issues Raised by Direct Charging of

Normally Indirect Costs 100
a. Is Direct Charging of Indirect Pre-termination
Costs Permissible Under the Cost Principles and the
CAS? 100
b. Preventing Double Recovery 103
c. Whether Costs Normally Charged Indirectly Should Be
Burdened with Indirect Costs? 105
C. Subcontractor Claims 106
D. Unabsorbed Overhead 108
E. Accounting Records 110
F. Cost Principles III
G. General Limits on Recovery of Indirect Costs 113

III. Continuing Costs 113

IV. Settlement Costs 114

A. Direct Recovery of Normally Indirect Costs 115

B. Burden of Proof 117
C. Types of Settlement Costs 119
1. Costs of Preparing and Presenting a Termination
Settlement 119
a. Reasonableness 120
b. Proving that Costs Claimed Were Not Costs of Making
a Claim Against the Government 120
2. Costs of Safeguarding, Inventorying, and Disposing of
Terminated Inventory 121

V. Unabsorbed Overhead After Termination for Convenience 122

VI. Partial Terminations for Convenience 127

A. Indirect Costs of the Terminated Portion of the

Contract 128
B. Indirect Costs of the Unterminated Portion of the
Contract 128
1. Volume Discounts, Learning Curve Benefits, and
Nonrecurring Direct Costs 129
2. Unabsorbed Indirect Costs 130

CHAPTER 5 CONSISTENCY

I. Requirement for Consistency 136

A. Purpose of Consistency Requirement 136

B. Source of the Consistency Requirement 137
1. Generally Accepted Accounting Principles 137
2. The Cost Principles 138
3. The Cost Accounting Standards I_9
a. Cost Accounting Standard 401 140
b. Cost Accounting Standard 402 142

V
II. Application of the Consistency Requirement 143
A. Classifying Costs as Direct or Indirect 144
1. Overcharging Results from Inconsistent Classification
of Costs as Direct or Indirect 145
2. "Costs Incurred for the Same Purpose in Like
Circumstances" 147
a. CAS 402 Guidance 147
(i) Costs Incurred for the Same Purpose 148
(ii) Costs Incurred in Like Circumstances -150
b. Decisions of the Boards and Courts 151
(i) One of Several Cost Objectives Requires More of
an Indirect Costs than Other Cost Objectives 152
(ii) Direct Cost Functions Performed by an Employee
or officer Whose Salary Is Normally Charged
Indirectly 153
B. Assignment of Costs to Indirect Cost Groupings 155
C. Distribution of Costs to the Several Cost Objectives 156
D. Base Period Selection 157

III. Change in Cost Accounting Practice 158

A. Change Under the CAS 160
B. Change When the CAS Are Not Appicable 161
C. Prospective Versus Retroactive Appliacation of
Changes 162
1. CAS-Covered Contracts 162
2. Non-CAS-Covered Contracts 163

IV. Consistency in the Pricing of Equitable Adjustments 166

A. Direct Charging of Normally Indirect Costs 166

B. Methods of Recovering Indirect Costs 168
1. Standard Markup for Indirect Costs 168
2. Recovery of Indirect Costs During Delay 169
C. Bid and Proposal Costs - 169
V. Consistency in the Pricing of Terminations for
Convenience 171

CONCLUSION 173
FOOTNOTES 176

APPENDIX ONE 286

APPENDIX TWO 288

Vi
I|

INTRODUCTION
/A

Equitable adjustments and terminations foe convenience are

noncompetitive pricing actions--cost rather than market

forces determines whether price is fair and reasonable.

'Determining indirect costs for purposes of pricing an

equitable adjustment or termination for convenience presents

a number of problems for the contracting community' First,

lawyers, judges, and contracting officers often do not

understand how contractors accumulate and assign indirect

costs to the work performed during an accounting period.

They do not understand what an indirect cost rate is or how

f- unction!3 and for this reason are ill equipped to deal

with the more complex issues of consistency and unabsorbed

overhead.

S-e d all costs do not respond to changes in production "

volume in the same way. - For example, fixed costs do not

increase or decrease with production volume within a relevant

range of production. Therefore, the effect that a change

order or termination for convenience has on the amount of

indirect cost depends upon the types of indirect costs

involved and their response to change. While the amount of

fixed indirect cost does not increase or decrease in response

to changing volume, the proportionate share of fixed indirect

cost borne by each unit of production increases as volume

falls and decreases as volume rises.

VWPdt, most contractors have unsophisticated cost accounting

systems that cannot measure performance costs accurately at

various stages of contract completion or the increase in

costs caused by an event necessitating an equitable

adjustment. This is because contractors do not need
sophisticated cost accounting systems for financial reporting

or normal decision making purposes.

F-au*tbh- consistent classification of costs as direct or

indirect is necessary to prevent over recovery.7 Contractors

have considerable incentive to classify the costs of an

equitable adjustment or termination settlement as direct

costs. Not only are direct costs recovered in their entirety

but a percentage markup for indirect costs is added thereto.

In contrast, indirect costs go into an indirect cost

grouping, where at best they serve to increase the percentage

markup on direct costs. Serious overcharging results when

indirect costs are improperly classified as direct.

-Fifth, when contracts are terminated for convenience direct

recovery of certain normally indirect costs is permitted. )

Although direct charging may be necessary to equitably

compensate the contractor for its efforts, direct charging

creates opportunities for over recovery of costs--

2I

.. 'WOW,
or1U
 particularly when a markup for indirect costs is also

permitted.

-- ° Unfortunately, the procurement regulations and accounting and

legal literature give little guidance on how to determine

indirect costs for purposes of equitable adjustments and

terminations for convenience. The purpose of this thesis is,

in part, to fill that gap. Chapter one presents fundamental

principles; it examines (1) the purpose of equitable

adjustments and termination settlements, (2) the relationship

between cost and price, (3) classification of costs as direct

or indirect, (4) the basic elements of an indirect cost rate,

(5) the effect of fluctuations in volume on cost, (6) the

difference between full costing and direct and absorption

costing, and (7) allowability of costs under the Cost

Principles. -4 / -

Chapter 2 explains how indirect cost rates are used to price

equitable adjustments. Projected, actual, negotiated, and

standard indirect cost rates are discussed. Of particular

importance is the discussion of how changes in production

volume affect projected indirect cost rates. Finally,

Chapter 2 suggests that equitable adjustments infrequently

return contractors to the position they would have been in

"but for" the event necessitating the equitable adjustment.

This is because equitable adjustments include recovery of

1
fixed indirect costs although the event necessitating the

ft
3
equitable adjustment does not cause the contractor to incur

more or less fixed indirect cost.

Chapter 3 analyzes unabsorbed and extended overhead.

Extended overhead is shown to be distinct from unabsorbed

overhead and probably unrecoverable. Generally, the boards

of contract appeals and the courts have used the Eichleay

formula to measure unabsorbed overhead. The author finds the

Eichleay formula to be an accurate measure of unabsorbed

overhead in very limited circumstances and identifies six

presumptions upon which the formula's validity rests.

Unabsorbed overhead need not be measured by a formula; the

amount of unabsorbed overhead can be estimated accurately.

Furthermore, the boards of contract appeals are not bound by

precedent to use the Eichleay formula where it does not apply

or a more useful method of measuring unabsorbed overhead is

available.

Chapter 4 studies recovery of indirect costs upon termination

for convenience. Termination settlements involve three broad

categories of costs: pre-termination, continuing, and

settlement costs. Additionally, when a contract is partially

terminated for convenience, contractors are allowed an

equitable adjustment for any resulting increase in the costs

of performing the unterminated portion of the contract. For

purposes of a termination settlement many normally indirect

costs are recovered directly. Chapter 4 explores whether

4
direct recovery is a consistent accounting practice and

determines what adjustments, if any, are necessary to prevent

over recovery of cost. Frequently unabsorbed overhead is

recoverable when a contract is terminated for convenience.

Chapter 4 analyzes recovery of pre-termination and post-

termination unabsorbed overhead as well as unabsorbed

overhead for partially terminated contracts.

Chapter 5 discusses consistency as it applies to recovery of

indirect costs. This chapter examines the purpose and source

of the consistency requirement and how it relates to

classification of costs as direct or indirect, assignment of,'.

costs to indirect cost groupings, distribution of indirect

cost groupings, and base period selection. Particularly L

noteworthy is the illustration of over recovery resulting

from inconsistent classification of costs as direct or

indirect. Despite the consistency requirement, contractors

are permitted if not required to change their cost accounting

practices when such practices become inequitable as a result

of changing circumstances. Chapter 5 explains when cost

accounting practices can be changed without running afoul of

the consistency requirement and whether the change can be

applied retroactively. Chapter 5 closes by examining the

consistency requirement as it specifically applies to

equitable adjustments and termination settlements.

5
 .5

It is hoped that this thesis will help the contracting

community better understand recovery of indirect costs in the

pricing of equitable adjustments and terminations for

convenience.

.5

6
 CHAPTER 1

UNDERSTANDING THE FUNDAMENTAL PRINCIPLES

I. EQUITABLE ADJUSTMENTS

A. Purposes Served by Equitable Adiustments

One significant difference between contracting with the

Government and contracting with most commercial organizations

is the Government's insistence on the contractual right

unilaterally to order "changes" in rork during contract

performance. 1 In return for this right, the Government
promises to make an "equitable adjustment" to the contract

price whenever a change is ordered that either increases or

decreases the contractor's costs of performance. The Changes

clause 2 allows the Government flexibility in return for the

promise of an equitable adjustment should the Government

exercise that flexibility. It permits the Government to

respond to changing circumstances and take advantage of

technological advances.

In addition, an equitable adjustment is used, by contractual

agreement, as the remedy in situations where the Government

otherwise would be in breach of contract. For example, an

equitable adjustment is the contractually required remedy

when government furnished property is late or defective. 3

Similarly, where the Government unreasonably delays

7
 performance of a construction contract, the contractor is

entitled to an adjustment for any increased costs of

performance rather than damages for breach of contract.4

An equitable adjustment is also a vehicle to allow the

Government to assume certain risks which at common law

were assumed by the selling party. For example, construction

contracts include a Differing Site Conditions clause that

permits an equitable adjustment if the contractor encounters

subsurface or latent defects of an unknown and unusual

nature. 5 Thus, a contractor can bid on a contract without

making an extensive site examination or including a

contingency in its bid to protect itself against potential

6
unfavorable conditions.

Equitable adjustments have other uses as well. The above

discussion merely discloses the more important uses and

provides an indication of the role adjustments play in

Government contracting.

B. Definina an Eauitable Adiustment

Although provisions for "equitable adjustments" are contained

in numerous contract clauses, the procurement regulations

neither define equitable adjustments nor explain how they

should be computed. This has been left to courts and the

boards of contract appeals. 7 In general, "[t]he term

.- . . .. .. .. .. .~ .
'equitable adjustment' refers to a legal concept of returning

the parties in a contract to the same relative positions they

occupied before implementing the change, preserving to each

as nearly as possible the advantages and disadvantages of

8
their bargain."

The Court of Claims defines equitable adjustments as "simply

corrective measures utilized to keep a contractor whole when

the Government modifies a contract." 9 "[Tihe purpose of an

equitable adjustment under the Changes clause is 'to

compensate the contractor for the unanticipated and extra

out-of-pocket expense it incurred in performing the contract

as a result of the changes.'"1 0 For this reason, damages are

measured by the contractor's increased costs of performance

rather than by the increase in value, if any, received by the

Government. 1 1

Another important concept is the idea that an equitable

adjustment should not change the contractor's "profit or

loss" on the unchanged portion of the contract. 1 2 Repricing

should be limited to the effect of the change alone and

should not alter the basic profit or loss position of the

contractor on the unchanged work. 1 3

The formula for pricing an equitable adjustment is based upon

"the difference between what it reasonably would have cost to

perform the work as originally required and what it

9
 - - a~a .YW . .. .

reasonably cost to perform the work as changed." 1 4 Restated,

the amount of an equitable adjustment is determined by the

amount of "increase or decrease" in a contractor's costs of

performance. 1 5 Once this cost difference is ascertained, a

fair and reasonable amount of profit is calculated for the

change. The cost difference plus profit equals the amount of

an equitable adjustment.

Under certain contract clauses, a contractor is entitled to

an "adjustment" rather than an "equitable adjustment." 1 6 The

difference between the terms is simply that an equitable

adjustment includes profit on the increased costs of

performance, while an adjustment does not include any amount

for profit. Because this is the only difference between the

two terms, for convenience, I will use the terms

interchangeably during the course of this paper.

II. TERMINATIONS FOR THE CONVENIENCE OF THE

GOVERNMENT

Another important right the Government usually obtains by

contractual provision is the right to terminate the contract

(in whole or in part) for its convenience. The Termination

for Convenience clause 1 7 "gives the Government the broad

right to terminate without cause and limits the contractor's

recovery to costs incurred, profit on work done and the costs

10
of preparing the termination settlement proposal." 18 What a

contractor does not get is anticipatory profit.

"A [termination] settlement should compensate the contractor

fairly for the work done and the preparations made for the

terminated portions of the contract, including a reasonable

allowance for profit." 1 9 The goal is to compensate the

contractor for its reasonable costs in performance of the

contract including those costs that cannot be discontinued

immediately upon termination, 2 0 and for costs caused by the

termination--such as settlement costs. 2 1 The contractor's

costs determine the amount of a termination settlement.

Computation of "cost" for a termination settlement is more

complex than for an equitable adjustment, in that more costs

are involved (costs of work performed before termination,

continuing costs, and settlement expenses). In addition, if

the termination is only partial, the costs of the

unterminated portion of the contract may need to be

reassessed 22

III. COST--ITS RELATIONSHIP TO PRICE

Cost of performance is the dominant factor in pricing both

adjustments and termination settlements. Performance costs

are not nearly so important in other pricing situations. For

example, in a "competitive" market, performance cost does not

determine price. 2 3 Price is determined by competition and

opportunity cost.

Pricing of adjustments and termination settlements takes

place in a noncompetitive environment. Any "[r]eal or

potential competition existing before . . . award [of a

contract] disappears when the contract is signed. The

competing offeror becomes a sole source contractor. ' 2 4 With
competition no longer present as a restrpint on price, the

contractor's reasonable costs of performance are used as the

measure of an adjustment or termination settlement.

IV. DEFINING. MEASURING, AND ALLOCATING COSTS

Because cost is the focus of an equitable adjustment or

termination settlement, it is important to ascertain just

what cost is and how the cost of an item is determined.

A. Defining Cost 2 5

Surprisingly, the procurement regulations do not attempt to

define the word "cost' although the FAR devotes an entire

part to cost. 2 6 Similarly the four major texts 2 7 on

Government accounting do not define the word "cost." The
probable reason for this omission is the difficulty in
devising one definition to fit the many ways in which the

word "cost" is used. In lieu of defining "cost," the

12

WmI~~ ~ ,'C~A ~ ~ r - *, * ~ .
procurement regulations and the Government accounting texts

define various types of cost.

B. Cost Accountina Standards (CAS)2 8

The cost data upon which cost reimbursement and price

negotiation are based depend upon informati,,n developed from

a contractor's cost accounting system. For this reason, the

Government takes great interest in the quality of a

contractor's cost accounting system and cost accounting

practices. The purpose of the CASB and the standards it

promulgated was to improve the quality of cost data available

for negotiation and cost reimbursement purposes.

The CAS are included in the FAR at Subpart 30.3. They apply

only to certain high dollar value contracts. 29 When

applicable, the CAS impose accounting controls upon

Government contractors. The CAS prescribe methods to (1)

measure (2) assign, and (3) allocate cost. In addition, for

certain large-volume Government contractors, the CAS require

extensive cost accounting disclosure. 3 0 The CAS are

mandatory only when the subject contract is CAS-covered 31 or

when a CAS is incorporated by the Cost Principles. 3 2

For recovery of indirect costs, the most important of the CAS

are:

13
 a. CAS 401, Consistency in Estimating, Accumulating, and
Reporting Costs;
b. CAS 402, Consistency in Allocating Costs Incurred for
the Same Purpose;
c. CAS 403, Allocation of Home Office Expenses to
Segments;
d. CAS 406, Cost Accounting Period;
e. CAS 410, Allocation of Business Unit General and
Administrative Expenses to Final Cost Objectives;
f. CAS 418, Allocation of Direct and Indirect Costs.

The CAS listed above are general standards. The CAS also

prescribe detailed accounting rules for specific indirect

costs, such as personal absence compensation, 3 3

depreciation, 3 4 material acquisition costs, 3 5 pension

costs, 3 6 37
cost of facilities capital, deferred

compensation, 3 8 insurance costs, 3 9 independent research and

development costs (IR&D),40 and bid and proposal costs

(B&P).41

C. The Cost Principles

The Cost Principles 4 2 prescribe rules for determining cost.

They govern many aspects of cost including measurement,

allocability, and reasonableness. Unlike the CAS, the Cost

Principles apply to all Government contracts. The FAR

requires the contracting officer to incorporate the Cost

Principles, by reference, in all commercial contracts as the

b
basis for, among other things, proposing, negotiating, or

14
'I
 determining costs under terminated contracts; 4 3 and for
4
pricing changes and other contract modifications. 4

D. Measurement of Cost

"In ascertaining what constitutes a cost, any generally

accepted method of determining or estimating costs that is

equitable and is consistently applied may be used, including

standard costs properly adjusted for applicable variances." 4 5

Surprising as it might seem, there is no one correct way of

determining or measuring cost. Inventory can be valued by a

number of methods including the last in first out (LIFO),

first in first out (FIFO), or moving average method.

Purchases of raw materials, labor, and overhead can be

charged to a project using either standard or actual costing.

Alternative methods exist for calculating depreciation and a

variety of methods can be properly used to allocate costs to

cost objectives.

As indicated above, the method chosen to determine and

measure costs must be generally accepted, equitable, and

consistently applied. 4 6 Reasonable minds can differ in each

of these areas--there are few clear lines. Judgment plays an

important role. It is therefore not surprising that what

constitutes cost and how cost is measured has been the

subject of frequent litigation.

".0 'Al
 1.i

E. Accounting Systems

Accounting systems designed for financial reporting purposes

usually do not provide the information necessary to make

individual pricing decisions. 4 7 Accounting for financial

reporting purposes is concerned with the information needs of

investors, creditors, and government agencies and focuses on

presenting the overall financial condition of the firm--it

does not measure the additional costs of performance caused

by a change.

To determine the cost of a change, a contractor's accounting

system must identify, measure, accumulate, and distribute

costs to the change. A cost accounting system is needed to

provide management with this information.

Ordinarily, cost accounting systems are designed to record

the costing of "normal recurring activities.",4 8 "Changes

tend to involve 'abnormal' situations. Thus, most cost

accounting systems do not readily identify and measure the

cost of changes." 4 9 For this reason, professors Bedingfield

and Rosen recommend that contractors be prepared to perform

special analyses to identify and measure the cost impact of V

changes and other events necessitating equitable

adjustments. 50 Finally, cost accounting systems "produce[)

approximations, not precise statements of the true cost.

16
L
Because many estimates and allocations are involved in every
51
cost system, 'true' costs exist only in theory."

F. Allocation of Costs

A significant number and variety of costs must be incurred in

order to perform a contract successfully. The process of

52 is called
assigning costs to cost objectives
"allocation."'5 3 Under the FAR, a cost is allocable to a

Government contract if it "(a) is incurred specifically for

the contract; (b) benefits both the contract and other work,

and can be distributed to them in reasonable proportion to

the benefits received; or (c) is necessary to the overall

operation of the business, although a direct relationship to

54
any particular cost objective cannot be shown."

1. Direct Costs

"Total cost" for purposes of an equitable adjustment or

termination settlement is the sum of the allowable direct

and indirect costs allocable to the adjustment or

termination settlement. 5 5 A "direct cost" is commonly

defined as a cost incurred for the exclusive benefit of a

single cost objective. 5 6 Under the FAR, "[a] direct cost is

any cost that can be identified specifically with a

particular final cost objective. '5 7 Direct costs are charged

benefited. 58 In a
directly to the cost objective

17
 Ai. - K... t . A- . - h - . 8 4:,V . :

manufacturing company direct costs usually refer to costs

easily identified with the product. 59 "Generally, this

includes direct materials (raw materials) and direct

labor."60

2. indirect Costs

"Indirect costs" are those costs incurred for the benefit of

two or more cost objectives. 61 "After direct costs have

been determined and charged directly to the contract or other

work, indirect costs are those remaining to be allocated to

the several cost objectives. '62 Indirect costs are not

charged directly to cost objectives, but are accumulated in

logical cost groupings and then allocated to benefited cost

objectives in proportion to the benefits received. 63 In a

manufacturing company, indirect costs include "factory

utilities, salary of the plant manager, depreciation on the

factory building, and factory telephone costs." 6 4

3. Classification of Costs as Direct or Indirect

"The Cost Principles express a preference for direct

charging- -requiring that all costs which can be identified

specifically with a particular cost objective be charged

directly to that cost objective." 6 5 Costs which can be

specifically identified with other final cost objectives are

direct costs of those cost objectives and are not includable

18

5 4
- ' m. p'J 5 x ' --' |;c~ .... .. -. S '% .'% ' * . . .. - .
in indirect cost groupings. 6 6 This preference for direct

costing has, as a general rule, been followed by the boards

of contract appeals in pricing equitable adjustments and

7
contract termination settlements.6

However, before a cost can be charged directly, "[it] must

not only meet the criteria established for direct costs, but

must also be segregated from other costs and recorded in

accounts identifying the costs with the contract or other

cost objective." 6 8 An accounting system capable of

accurately segregating costs for direct charging is expensive

to develop and maintain, and is often impractical. 6 9 For

this reason, both the Cost Principles and CAS 402 permit

direct costs of a minor dollar amount to be treated as

indirect costs, if the accounting treatment is applied

consistently and produces substantially the same results as

70
direct treatment.

The "nature" of a cost (material, labor, supplies, etc.) does

not determine whether it will be classified as direct or

indirect. 7 1 "The critical factor is the essential

relationship between the cost and the benefit conferred,

regardless of the nature of the goods or service used. Where

only one cost objective benefits from the goods or services

consumed, it alone should bear the expense." 7 2 Thus, a cost

may be direct in one set of circumstances and indirect in

another. For example, telephone costs are usually treated as

19
an indirect cost. However, when telephone costs are material

in amount, a contractor may monitor and charge telephone

calls directly to specific cost objectives while treating the

equipment, advertisement, and tax portion of the expense as

73
an indirect expense.

4. PZocess of Allocating Indirect Costs to Cost

Objectives

Allocation of indirect costs requires selection of (1)

logical cost groupings or pools for accumulating indirect

costs, (2) a distribution base for allocating indirect costs

to the several cost objectives, and (3) a base period over

which indirect costs can be accumulated.

a. Indirect Cost Groupings

(1) Cost Principles. The FAR provides the following

guidelines for grouping indirect costs:

Indirect costs shall be accumulated by logical cost

groupings with due consideration of the reasons for
incurring such costs. Each grouping should be
determined so as to permit distribution of the
grouping on the basis of the benefits accruing to the
several cost objectives. Commonly, manufacturing
overhead, selling expenses, and general and
administrative (G&A) expenses are separately grouped.
Similarly, the particular case may require
subdivisions of these groupings, e.g., building
occupancy costs might be separable from those of
personnel administration within the manufacturing
overhead group. This necessitates selecting a
distribution base common to all cost objectives to

20
 which the grouping is to be allocated. The base
should be selected so as to permit allocation of the
grouping on the basis of the benefits accruing to the
several cost objectives. 7 4 When substantially the
same results can be achieved through less precise
methods, the number and composition of cost groupings
should be governed by practical considerations and
should not unduly complicate the allocation. 7 5

Since costs are incurred for different reasons, the larger

the number of cost groupings, the more precisely indirect

costs can be assigned to cost objectives. 7 6 "Notwithstanding

the accuracy obtained from multiple pools, the expense and

inconvenience involved in maintaining an accounting system

sufficient to handle the establishment of many pools is a

critical factor in determining how many indirect pools will

be maintained." 7 7 "[T]he general practice is to use few

78
pools and few bases."

In contrast to general practice in the private sector, the

FAR requires a cost accounting system capable of allocating

indirect costs with considerable precision. 7 9 Such a system

is appropriate for a contractor performing work on a cost

reimbursement basis, where precision is required and where

the Government routinely reimburses the contractor, at least

in part, for the costs of maintaining such a system. But a

contractor with a fixed priced contract cannot realistically

be expected to maintain a complex cost accounting system,

solely for the purpose of supporting a "possible" equitable

adjustment or termination settlement. 8 0

21

YA-
 |WA

(ii) Common Indirect Cost Groupinos. The FAR lists

"manufacturing overhead, selling expenses, and general and

administrative (G&A) expenses" as examples of costs that are

often grouped separately. 8 1 Other categories of cost that

are often grouped separately include material overhead,

engineering overhead, field service, job site, use and

occupancy, quality control, fringe benefits, and home

82
office.

The term "overhead" has several meanings. It is used as (1)

a synonym for indirect cost, 8 3 and (2) the name of a specific

type of indirect cost grouping--support costs associated with

general product lines, organizational groups, and groups of

contracts. 8 4 The indirect cost grouping "overhead" should be

distinguished from G&A costs (a separate indirect cost

grouping), which represents accumulation of indirect costs on

a much broader level. G&A costs provide support to the

business unit as a whole and do not relate to any particular

product or service. 8 5 The CAS distinguish between overhead

and G&A and require that contractors use different allocation

procedures. 8 6 The CAS recognize a third indirect cost

grouping--home office expense. 8 7 Again, separate allocation

procedures are prescribed. 8 8

22(
22

. _ '. . ".-' ' • '. -. . #-. -. % . . % . % °*

b. Distribution Base

The allocation process requires that indirect costs be

accumulated in logical cost groupings and then distributed

to the several cost objectives. An element that closely

relates to the benefits received from an indirect cost

grouping and is common to the several cost objectives is

selected as the "distribution base." The indirect cost

grouping is divided (allocated) among the several cost

objectives in proportion to the amount of the distribution

base that each cost objective has generated. Horngren

defines a distribution base as a systematic means of linking

a given cost pool with cost objectives. 8 9

Selection of a proper distribution base is important, because

it determines how an indirect cost grouping will be

distributed among the several cost objectives. Under the

FAR, the base selected should "permit allocation of the

grouping on the basis of the benefits accruing to the

several cost objectives." 9 0 Not everyone agrees. Rishe, for

example, states that "[t]he most proper base is that which

will allocate accumulated costs to contracts in approximately

the same proportion as each contract generated the costs." 9 1

A cost may be "generated" or "caused" by a cost objective and

yet not be consumed by that cost objective. Thus, the cost

may benefit other cost objectives as well. The FAR's

approach is that each cost objective benefiting from the cost

23
should be allocated a share of the cost in proportion to the

benefits received, whether or not the cost was generated or

caused by the benefiting cost objective. 9 2

When relative benefit is not ascertainable, the FAR will

permit allocation on another "equitable basis." 9 3 However,

allocation based on relative benefit is the preferred
4
approach. 9

Bases commonly used to distribute indirect costs include:

direct labor hours, machine hours, direct labor cost, direct

material cost, number of employees, square footage, and

kilowatt hours. 9 5 The CAS, when applicable, .provide specific

guidelines for selecting a distribution base. 9 6 A "cost of

sales" base although commonly used by commercial enterprises

generally is unacceptable for Government contracting

purposes.97

c. Base Period

The period during which indirect costs are incurred and

accumulated for distribution to work performed in that period

is called the "base period." 9 8 The "length" of the base

period is important because of its ability to affect the

indirect cost rate and ultimately the amount of indirect cost

allocated to a cost objective.

24
 A short cost period might be subject to seasonal
variations, and thus yield cost allocation rates which
do not accurately reflect the normal operations of the
contractor's business. Cost recovery would then vary
greatly, although the contractor's operations might
have remained at a constant level. On the other hand,
long cost periods could attenuate the relationship
between.the indirect costs and the direct costs which
generated them, especially when a significant change
in the contractor's operations occurs. 9 9

CAS 406 provides the criteria and guidance for base periods

of contracts subject to "full CAS coverage." 1 00 CAS 406

requires use of a year long base period. 1 01 For non-CAS-

covered and modified CAS-covered 1 0 2 contracts, a base period

shorter than one year may be permitted when performance

involves only a minor portion of the fiscal year or when it

is general practice in the industry to use a shorter

period. 1 03 Adjustments may be necessary when a period

shorter than one year is used in order to match indirect

costs incurred during that period with the benefits they

generated. 1 04 While the FAR is silent on whether periods

longer than one year may be used, their use may distort the

relationship between costs and the operations which generated

such costs. 1 0 5 Further, the base period cannot include years

in which no contract costs were incurred--even if production

volume varies significantly by year and inclusion would

better approximate the contractor's average indirect cost

06
rate. 1

25

_w . .. . .. Ar Ur S
d. Indirect Cost Rates

Indirect costs are usually allocated to cost objectives by

use of an indirect cost rate. An indirect cost rate is "the

percentage or dollar factor that expresses the ratio of

indirect expense incurred in a given period to direct labor

cost, manufacturing cost, or another appropriate base for the

same period." 1 0 7 To illustrate how an indirect cost rate

would determine indirect costs for purposes of a change

order, assume a contractor in FY 1988 (base period) had

material overhead of $1 million (indirect cost grouping) and

direct material of $25 million (distribution base). The

material overhead rate is calculated by dividing the $1

million material overhead cost grouping by the $25 million of

direct material to obtain a 4% material overhead rate. This

material overhead rate, when multiplied by the increased

I
direct material costs caused by a change, will equal the

material handling costs allocable to the change. Assume the

change increased direct material costs by $15,000. The

material handling costs of the change would be 4% of $15,000,

or $600.
J.

V. HOW VOLUME AFFECTS COSTS_

Change orders and terminations for convenience normally

either increase or decrease the amount of work to be

performed by a contractor. In order to determine their "cost

26

Ak.-
impact" on a contractor, the relationship between volume and

cost must be understood.

A. Classification of Costs as Fixed or Variable

Costs vary in their response to changes in volume--some costs

will not increase at all and others will increase

significantly in the face of even minor volume changes.

Understanding which costs respond to fluctuations in volume

and measuring that response is critical to accurately

assessing the increase or decrease in costs caused by a

change.

The Accountant's Cost Handbook categorizes costs as variable,

fixed, semifixed, or semivariable depending upon their

response to changes in volume.1 0 8 Each category is discussed

below.
(1) Variable Costs. "Variable costs change proportionately

with changes in volume and would be zero at zero volume. . .

In a manufacturing operation, variable costs normally

include materials, direct labor, and some overhead costs." 1 0 9

(2) Fixed Costs. "Fixed costs do not vary with volume." 1 1 0

Costs are fixed only in the short run; over time all costs

are variable. In practice, costs are considered fixed if

they do not vary over the "relevant range" of production. 1 1 1

"The relevant range is that level of activity for which the

firm budgets and expects to operate."'1 12 Examples of fixed

27
,~ ~A J(177"-7'~
.A'. . V .5 #.,VV, Ir.' TV * c -'0, -- -

costs include rent, depreciation, property insurance, and

11 3
property taxes.

(3) Semifixed Costs. Semifixed costs are also known as step

fixed costs. "[They] are fixed over some range of output and

then increase (or decrease) by a given amount at certain

critical points.",1 1 4 An example of a semifixed cost is the

salaries of foremen, each of whom can supervise the

manufacture of 5 units of production, but no more.

(4) Semivariable Costs. 1 1 5 Semivariable costs have elements

of both fixed and variable costs. The fixed component

usually reflects a minimum charge necessary to make service

available. 1 1 6
Examples include electricity and telephone

costs.

The concept of fixed and variable costs is critical not only

for pricing, but also for planning, decision making, and

evaluating and controlling management performance.1 17 In

practice, it is not always easy to determine which costs, or

portions of costs, are fixed and which are variable.

Techniques used to separate fixed from variable costs include

subjective estimates by managers, graphic correlation, the

accounting method, the standby cost method, the high-low

method, simple linear regression, and multiple linear

regression. 1 1 8 4

28
B. Contribution Marqin and Breakeven Point

Contribution margin is an important concept in pricing a

product. A contractor cannot remain in business long unless

its prices allow recovery of both its fixed and variable

costs. Contribution margin and breakeven point are used in

determining the price and sales volume necessary to allow

recovery of fixed costs. "Contribution margin" is the amount

by which sales price exceeds all variable expenses--the

amount of the selling price available for recovery of fixed

costs. 1 1 9 The "breakeven point" is the number of units that

must be sold at a given price to permit recovery of fixed

costs. 1 2 0 To illustrate, assume fixed costs of $10,000,

variable costs of $1500, and a unit selling price of $2500.

The contribution margin would be $1000 ($2500 selling pric-

less $1500 variable costs) and the breakeven point 10 units

($10,000 fixed costs/$1000 contribution margin).

VI. Methods of Product Costinq

The cost of a product is generally determined by using one of

three accounting methods: absorption costing, full costing,

or direct costing. What distinguishes the three costing

'

methods is their treatment of "fixed" costs as either a cost

of the product or a "period expense."'1 2 1 Fixed costs are

often substantial and the "cost" of a product can vary

significantly depending upon the costing method selected.

29

-. . . . . . . .Ja.
A. AbsorDtion Costina

1. In General

The term "absorption costing" refers to the process of

allocating costs to products as opposed to charging costs

off as period expenses in the year incurred. Two forms of

absorption costing should be distinguished: (1) absorption

costing required for financial reporting purposes and (2)

absorption costing used for pricing equitable adjustments and

termination settlements. The two differ markedly.

Failure of the accounting profession to give different names

to the two forms of absorption costing is a source of

confusion. The term "absorption costing" is most commonly

associated with the product costing method required for

financial reporting purposes. 1 2 2 For this reason, I will use

the term "absorption costing" to mean the product costing

method required for financial reporting purposes. I will use

the term "full costing" will mean the product costing method

used to determine cost for pricing equitable adjustments and

12 3
termination settlements.

30

Re r.
2. Absorption Costing For Financial RePortina Purposes

Generally Accepted Accounting Principles (GAAP) require that

"absorption costing" be used for financial reporting

purposes. 1 2 4

Absorption costing requires the allocation of all

manufacturing costs, direct or indirect, fixed or
variable, to products. . . Specifically no
distinction is made in allocating indirect costs
between the amount which is fixed and the amount which
is variable. Both are fully allocated to or
'absorbed' by the final cost objectives--the
12 5
products.

Non-manufacturing expenses such as selling and G&A are

not allocated to products, but are expensed as "period

costs."

Absorption costing is not a particularly useful tool for

either decision making or pricing. 1 2 6 For decision making,

the relevant costs are variable costs; for pricing, the

relevant costs are opportunity costs. 1 2 7 Absorption costing

is a better indicator of cost for retroactive pricing i

(pricing which takes place after the work is complete) than

for prospective pricing, but even here it is not particularly

useful because it treats costs other than manufacturing costs

as period costs unrelated to the product.

31
B. Full costina,

"Full costing" is the product costing method used to

determine cost for pricing Government change orders and

termination settlements. Under full costing every cost is

identified with a particular contract. 1 2 8 All of a

contractor's costs, whether direct or indirect, fixed or

variable, including costs normally treated as period costs

are allocated to final cost objectives; that is, they are

fully absorbed. 1 2 9 Full costing differs from the costing

required for financial reporting purposes in that all costs-

13 0
-not just manufacturing costs--are allocated to products.

Because of the need to allocate all of the contractor's

costs, "full costing requires . . . a more sophisticated

accounting system than the average contractor would need for

'1 3 1
purely commercial operations."

C. Direct Costina

"Direct costing differs from absorption costing in that under

direct costing only variable manufacturing costs are

allocated to a product. Fixed manufacturing expenses are

charged as period--not product--costs." 1 3 2

The primary objective of direct costing is control.

By eliminating . . . expenses over which local
management has little or no control, direct costing
focuses attention on the items that local management
is responsible for controlling. Variable expenses are
controllable; fixed expenses--at least in the short

32

",, -. .. - °- , ... -...-....-.-.-

.-.--.. ,.- . - . . - .. .- -.. . .. .-. v ..-- - - .- %v .- - 'S.
 run--are not. Direct costing is built on this
distinction.133 ,.
I

If direct costing were used to price adjustments, recovery

would be limited to the incremental manufacturing expenses

caused by the change. The contractor would recover only

variable manufacturing costs and would not recover any fixed

costs.

VII. ALLOWABILITY UNDER THE COST PRINCIPLES

'S

Under the Cost Principles, a contractor can include only -V

134
"allowable" costs in any billing, claim or proposal.

Thus, the "total cost" of a change order or a terminated

contract, for pricing purposes, is the sum of its allowable

direct and indirect costs. 1 3 5 If a cost is "unallowable," a

contractor will not recover that cost even if it is otherwise

properly allocable to the modification or termination

settlement. Several factors determine whether a cost is 5'

allowable:136

(1) Reasonableness;

(2) Allocability; .

(3) Standards promulgated by the CASB, if applicable;

otherwise, generally accepted accounting principles and

practices appropriate to the particular circumstances; .'

(4) Terms of the contract;

(5) Any limitations set forth in FAR Subpart 31.

33 .
,%
The CAS and allocability have already been discussed. 1 3 7 The

remaining factors are discussed below.

A. Reasonableness

A cost is generally not recoverable if its incurrence is

deemed unreasonable. Under the Cost Principles, "[a] cost is

reasonable if, in its nature and amount, it does not exceed

that which would be incurred by a prudent person in the

conduct of competitive business." 138 "What is reasonable

depends upon a variety of considerations and circumstances

involving both the nature and amount of the cost in

question. "139

1. Burden of Proof,

Recent changes to the Cost Principles, eliminate the

presumption that costs actually incurred by a contractor are

reasonable and place the burden of proving reasonableness on

the contractor. 1 4 0 The previous rule, established in 1963 by

the Court of Claims, created a presumption that costs

actually incurred were reasonable and placed the burden of

proving unreasonableness upon the Government. 14 1 The

previous rule still applies to contracts executed before the

effective date of the change, unless the parties mutually

agree otherwise.142

34

hi-
2. Determinina Reasonableness of Indirect Costs

"The proper way to apply the standard of reasonableness to

. overhead costs is to examine them on an item by item

basis and exclude from the allowable overhead pools the

specific overhead cost items or parts of items found to be

unreasonable under the prevailing circumstances. , 1 4 3 The

focus is on the reasonableness of the individual elements

making up the overhead cost pool, not on how high the

overhead rate is. An overhead rate of 90% can be

unreasonably high while an overhead rate of 400% can be

unreasonably low, "depending on what costs are classified as

direct, what costs are included in overhead, and the actual

situation depicted by the nature of the costs in both

categories. "144

B. Generally Accepted Accounting Principles 1 4 5

When the CAS do not apply and the procurement regulations do

not prescribe a particular practice, GAAP and practices

appropriate to the particular circumstances provide the rules

for measuring, accumulating, and allocating costs. 1 4 6 GAAP'

usefulness in this role is questionable. "[GAAP] were

developed only to provide guides to acceptable financial

accounting practices, not to cost accounting

practices." 1 4 7 Thus, GAAP do not adequately address issues

14 8
such as allocability of cost to specific cost objectives.

35
I).
 An additional problem is the large number of sources of

authority for GAAP including: (1) substantial practice within I

an industry, (2) accounting textbooks and references books of

individuals whose views are generally respected, (3)

publications of recognized industry associations, and (4)

published articles and speeches of distinguished

individuals. 14 9 Trueger states that "[w]ithin this

framework, contractors (have] experienced few difficulties in

describing a wide variety of allocation methods as being in

'1 5 0
consonance with GAAP.1

C. Terms of the Contract

The reasonableness and allowability of certain indirect costs

may be difficult to determine--the cost regulations do not

cover every situation and are often difficult to apply. Such

uncertainty poses significant risk for both the Government

and the contractor.

1. Advance Aareements

This risk can be lessened substantially by resolving

questions concerning reasonableness and allowability before

expenditure through an advance agreement. 1 5 1 The Cost

Principles expressly recognize the importance of an advance

agreement for costs such as: use charges for fully

depreciated assets, deferred maintenance, precontract costs,

36

A A-' AP MM
independent research and development (IR&D) and bid and

proposal (B&P), selling and distribution, data processing

equipment, professional services, and G&A. 1 5 2 "Advance

agreements may be negotiated either before or during a

contract but should be negotiated before incurrence of the

costs involved. The agreement must be in writing, executed

by both contracting parties, and incorporated into

[the] contract[]. '"153 Advance agreements are limited in that

a contracting officer cannot agree to a treatment of costs

inconsistent with the Cost Principles. 1 5 4

2. Limitina Clauses

Often a Government agency will limit a contractor's recovery

of indirect costs on changes by including in its Changes

clause a maximum overhead rate. 1 5 5 In addition to setting

a maximum overhead rate, these clauses may limit who may

recover overhead costs. Such clauses are particularly

effective in limiting allowable overhead costs on changed

work performed by subcontractors. 156 Without this

limitation, the Government could pay, on a single change

order, the indirect cost markups of the prime contractor, the

first tier subcontractor, the second tier subcontractor, and

so on. 1 5 7 Clauses limiting recovery of indirect costs are

discussed in Chapter 2.158

37
 p

D. Limitations Set Forth in FAR Subpart 31.2

The basic rules for allowability of costs are set forth at

FAR Subpart 31.201 through 31.204. In addition to these

basic provisions, FAR Subpart 31.2, includes provisions which

govern allowability of "selected costs." 1 5 9 The selected

cost provisions govern the allowability of 50 selected costs-

-from public relations and advertising to relocation costs

and alcoholic beverages. These provisions designate certain

selected costs as allowable or unallowable, prescribe rules

for cost measurement, and, in some instances, allocation.

.A

Selected costs are often indirect in nature and significant

in amount.

E. Accounting for Unallowable Costs

Costs that are unallowable under the Cost Principles must be

"identified and excluded from any billing, claim, or

proposal."11 6 0 Contractors must establish and maintain

records adequate for this purpose. 1 6 1 A cost directly

associated with an unallowable cost is also unallowable and

likewise must be excluded from any billing, claim, or

proposal.162

_n

38
 1. Unallowable Costs Included in Indirect Cost
Groupinas

Unallowable costs must be removed from any indirect cost

grouping prior to its distribution. 1 6 3 Failure to remove

unallowable costs will result in Government contracts being

allocated a portion of the unallowable costs. Normally,

directly associated costs included in the indirect cost

1 64
grouping must be removed also.

2. Unallowable Costs in the Distribution Base

The FAR prohibits removal of unallowable costs from a

contractor's distribution base. 16 5 In effect, the

unallowable costs in a distribution base are allocated a

166 If
proportionate share of the indirect cost grouping.

unallowable costs are left unburdened by the indirect costs

from which they benefit (if they are given a free ride),

other cost objectives including Government contracts bear a

share of the indirect cost grouping disproportionate to the

benefits received.167

39 A

a -PA(v
 CHAPTER 2

DETERMINING INDIRECT CHARGES FOR EQUITABLE ADJUSTMENTS

Chapter 1 discussed basic concepts such as the important role

cost plays in pricing equitable adjustments, the behavior of

cost in response to changes in volume, the allocation of

indirect costs, and allowability. Chapter 2 examines how

indirect cost rates are used to allocate indirect costs to

change orders, how volume changes affect indirect cost rates,

and whether the purpose of an equitable adjustment really is

to reimburse a contractor for its out-of-pocket expenses

caused by a change.

I. INDIRECT COST RATES

Indirect cost rates are used almost exclusively as the means

of allocating indirect costs to changes. For this reason, a

major portion of this chapter is devoted to their use.

Please note, however, that some contractors do not use

indirect cost rates, but charge what traditionally are

considered overhead and G&A type costs directly to the

change. 16 8 While acknowledging that such treatment is

unusual, the boards have generally allowed the contractor to

charge these expenses directly when such treatment is

consistent with the contractor's normal accounting

1 69
practices.

40

- ~ ~ . A-%. %
The following process normally is used to determine the

amount of an equitable adjustment: (1) direct costs of the

change are determined; 17 0 (2) direct costs are multiplied by

an agreed upon indirect cost rate to obtain the indirect

costs of the change, (3) direct and indirect costs are added

together to obtain total cost of the change, (4) profit is

determined by multiplying total cost by an agreed upon

percentage of profit (usually 10%), (5) profit is added to

total cost. Indirect costs and profit are often referred to

as "markups" because of their relationship to direct costs.

For purposes of convenience, boards will sometimes award a

single combined markup for indirect costs and profit. 1 7 1

This usually occurs when a contractor fails to prove its

indirect cost rate adequately.

A. Projected Indirect Cost Rates

When an equitable adjustment is priced before completion of

the contract or before the end of the contractor's base

period, indirect costs are often assigned to the change

through use of a "projected" indirect cost rate. A projected

rate is necessary because the costs required to compute the

actual indirect cost rate have not yet been incurred.

The accuracy with which a projected indirect cost rate will

predict the indirect costs of a change depends upon the

validity of a series of estimates. 17 2 These estimates are of

41
two groups: (1) estimates concerning how the change will

increase or decrease direct costs of performance, and (2)

estimates for development of the projected indirect cost

rate. 1 7 3 When these estimates are of questionable validity

it may be advantageous, particularly if large dollar amounts

are involved, to delay pricing the change order until the

cost data necessary to compute the actual indirect cost rate

are available.

A contractor normally develops a projected annual indirect

cost rate for purposes unrelated to changes. The contractor

may have used this rate to price the original contract.

Typically, use of this rate results in a fair approximation

of the indirect costs of a change. 1 7 4 However, when a change

is significant, application of a projected annual rate may

cause "over" or "under" recovery of the contractor's indirect

costs. 1 7 5 A projected indirect cost rate allocates indirect

costs accurately only at the originally estimated volume of

production. The effect of volume on indirect cost rates is

discussed more fully below. 17 6

B. Actual Indirect Cost Rates

Actual indirect cost rates can be computed only after the

changed work is completed and the contractor's base period

has ended. When actual indirect cost rates are available,

the boards usually will require their use. 1 7 7 A surprising

42

...... ......
amount of litigation has been generated by contractors who

argue, without success, that the projected indirect cost rate

used in bid preparation should be used to price a change

rather than the actual indirect cost rate. Litigation

usually has occurred when the contractor's bid was calculated

based on lower than actual overhead costs and the change is a

deletion.178

C. Neaotiated Indirect Cost Rates

Sometimes a contractor and the Government will negotiate a

written agreement to make certain indirect cost rates

available during a specified period for L,-e in pricing

contracts or modifications. Such forward pricing rate

agreements (FPRA's) are projections of indirect costs and

normally are negotiated only with contractors having a

17 9
significant volume of Government contract proposals.

Procedures governing use and development of an FPRA are set

out at FAR 15.809. In brief, a contractor submits a proposed

FPRA along with supporting cost or pricing data to the

administrative contracting officer (ACO). The ACO contacts

audit personnel and contracting personnel who have a

significant interest in the establishment of an indirect cost

rate and invites them to participate in development of a

Government position and in negotiations. 1 8 0 Negotiations

take place and a formal FPRA is established. This negotiated

43
rate is not applied automatically to change orders. The FAR

requires systematic monitoring to assure the continued

validity of the negotiated rate and permits cancellation at

the option of either party.181

D. Aiplication of Indirect Cost Rates

An adjustment to contract price can result from work being

added, deleted, substituted, or delayed. Indirect cost rates

are applied differently depending upon the nature of the

event necessitating the adjustment.

1. Chanqes Adding Work

-A'

The indirect cost rate multiplied by the increase in direct

costs (caused by the change) equals recoverable indirect

costs. 1 8 2 The computation is very simple once the indirect

cost rate and the amount of direct costs are agreed upon. A

complicating factor for contracts involving more than one

fiscal year is determining in which fiscal year the changed

work was or will be performed. Overhead rates often vary

significantly from year to year and a contractor's failure to

adequately prove the period in which the change will be or

was performed can be costly. 1 8 3

44
 - . -' < , $; - , C . aJ. S -. - - - -;

2. Changes Deleting Work

The Government is entitled to a downward equitable adjustment

in contract price when changes deleting work decrease a
contractor's costs of performance. 1 8 4 The indirect cost
portion of the downward equitable adjustment is usually
determined by multiplying the contractor's indirect cost rate
by the estimated decrease in direct costs 1 8 5 caused by the
change. 1 8 6 Contractor's have occasionally argued that a
deletion reducing direct costs did not result in a
corresponding reduction in indirect costs and therefore, use
of the established indirect cost rate to determine the
reduction in contract price due the Government would be
inequitable. The boards have rejected these arguments. 1 8 7
When a relatively minor item of work is deleted, it is
customary to use the price bid for the item as the amount of
the equitable adjustment rather than going through the
process of determining the decrease in costs and negotiating
an adjustment. 18 8

3. Changes Both Adding and Deleting Work

The indirect cost portion of the equitable adjustment is

determined through a four step process: (1) the increase in
direct costs resulting from added work is determined; (2) the
decrease in direct costs resulting from the deleted work is
determined; (3) the two amounts are totalled to obtain "net"

45
direct costs; and (4) the indirect cost rate is multiplied by

the net direct cost to obtain indirect costs of the

change. 1 8 9 Indirect costs should be allocated to the net

increase or decrease via the contractor's actual rate when

available rather than its "bid" indirect cost rate. 1 9 0

4. Delay Related Indirect Costs

During periods of delay, direct costs performance are

incurred at a reduced level, if at all. Multiplication of

the direct costs incurred during the delay period by the

contractor's indirect cost rate often does not compensate a

contractor adequately for its indirect costs. For this

reason, other methods are used to measure the indirect costs

recoverable as a result of delay. Delay related recovery of

indirect costs is discussed in Chapter 3.

E. Using a Standard Markup for Overhead

A standard markup for overhead often is used to determine

indirect costs when inadequate evidence exists as to a

contractor's actual or projected indirect cost rate. 1 9 1 When

available, actual indirect cost rates rather than a standard

markup are used to determine indirect costs. 192 Similarly,

when a projected indirect cost rate is properly supported, it

rather than the standard markup will be used to determine

19 3
indirect costs.

46

V,
Some board decisions state that the standard markup for
1 9 4
overhead on construction contracts is 10%, other board
1 9 5
I
decisions that the standard markup is 15%. The 10% rate

is more commonly used. 1 9 6

On occasion, boards have adjusted
4

the standard indirect cost

' rate upward or downward to i
,'a

accommodate unique circumstances. 1 97 For example, in Trans-

Eastern Constructors, the ASBCA, after hearing testimony from

a Government estimator that it was permissible to vary the
standard overhead rate upward or downward depending upon the ,

circumstances, raised the markup to 205% to compensate a

subcontractor for the delays, false starts, rework ard

reassembly caused by the change. 1 9 8

When a standard markup for indirect costs is used, boards

have not allowed contractors to charge overhead type items as

direct costs. 1 9 9 us

F. Clauses Limitin Recovers of Indirect Costs

Some contracting agencies supplement the Changes clause and

the Differing Site Conditions clause, placing limits on the

amount of overhead and profit recoverable. 2 0 0 The limits

apply only to equitable adjustments claimed under the Changes

clause or Differing Site Conditions clause. The supplemental

terms usually (1) limit overhead and profit, each, to 10% of

the direct costs of the change, 2 0 1 (2) establish who may

47
recover overhead, commission, and profit on changed work
performed by subcontractors, and (3) establish which costs

constitute direct costs of a change. 2 0 2 This practice has

been successful in limiting recovery of indirect costs

despite frequent litigation by contractors. 2 0 3 Contractors

often attempt to get around the limits by charging costs,

typically indirect in nature, as direct costs of the change.

These attempts are rarely successful. 2 0 4

II. How Volume Affects Indirect Cost Rates

A change order will not affect the amount of fixed costs

incurred by a contractor because these costs remain the same

(within the relevant range of production) regardless of

changes in volume. However, as volume increases the amount

of fixed cost per unit of production decreases. 2 0 5 For

example, a contractor buys a machine for $10,000 that will be

obsolete after one year. If the contractor produces 10 units

on the machine, the cost of the machine is $1000 per unit.

If the contractor produces 20 units, the cost is $500 per

unit; 50 units--$200 per unit, and so on. The amount of

fixed cost per unit of production varies in inverse

proportion to the number of units produced.

When a change substantially increases or decreases the volume

of production, use of indirect cost rates based on original

48
volume projections may lead to "over" or "under" recovery of

indirect costs.

Example:

Contractor A computes its projected indirect cost rate for

fiscal year 19X9 as follows. It estimates production of 10

million units, direct costs of $2 per unit, variable indirect

costs of $1 per unit, and fixed indirect costs of $20

million. Its projected indirect cost rate is calculated as

follows:

Indirect Cost Grouping

Variable indirect costs (10 million units X $1 per unit) $10 million
Fixed indirect costs $20 million
Total indirect costs $30 million

Distribution Base
Direct Costs (10 million units X $2 per unit) $20 million

Indirect cost Rate ($30 million/$20 million) 150%

At 10 million units of production, this indirect cost rate

fully distributes indirect costs to production. However, if

the volume is more or less than 10 million units, application

of the projected rate results in over or under recovery of

fixed indirect costs. For example, assume that receipt of a

change order adds 2 million units to the contractor's

estimated volume of 10 million units. This increase in

volume will cause the projected indirect cost rate to

decrease from 150% to 133%.206 Use of the originally

49
projected rate (150%) in costing the change results in the

change absorbing more than its proportionate share of fixed

indirect costs ($666,667 more). 2 07 Similarly, application of

the originally projected rate to a change reducing voluble

results in under recovery of fixed indirect costs.

Actual indirect cost rates should be calculated and used to

determine indirect costs whenever the cost data is available

to calculate them.2 0 8 When, however, a change is priced

before the end of the accounting period or prior to

performance of the change, a projected indirect cost rate

must be used. Professors Cibinic and Nash suggest

recomputation of the projected indirect cost rate, based on

20 9
new volume estimates, for major dollar changes.

III. DO EQUITABLE ADJUSTMENTS DO MORE THAN MAKE A

CONTRACTOR WHOLE?

Obviously, a contractor should be compensated for any

increased costs caused by an event entitling it to an

equitable adjustment. 2 1 0 As explained in Chapter 1, costs

which increase or decrease as volume changes are called

variable costs--entitlement to these is clear. The question

is whether a contractor should receive increased compensation

for its fixed costs which do not increase as volume changes.

50
The Court of Claims has stated that the objective of an
2 1 1 --to
equitable adjustment is "to keep a contractor whole"
"leave the contractor in the same financial condition as it
2 12
would have been if the change order had not been issued."

Variable costs alone increase or decrease in response to

changes in volume. 2 1 3 Therefore, if the purpose of an

equitable adjustment were, as has often been stated by the

boards of contract appeals, "to compensate the contractor for

the unanticipated and extra out-of-pocket expense it incurred

2 14
in performing the contract as a result of the changes,"

only variable costs would be considered in pricing a change.

Direct costing rather than full costing would be used to

2 15
price changes.

A. Effect of Using Full Costing Rather Than Direct

Costina

Assume a change increases a contractor's costs by $1500; the

Government adds $150 for profit (10% of costs) 2 1 6 and pays

the contractor $1650 for the change. It is hard to argue

that the contractor has not been made whole. 2 1 7 Using full

costing principles and assuming a fixed indirect cost rate of

100%, in the situation above, the contractor will receive

$3300 ($1500 variable costs + $1500 fixed indirect costs +

$300 profit). Receipt of $3300, when incremental costs of

performance were only $1500, is a lot more than simply being

made "whole."

51

-:Z k,
Assume instead the change decreased the contractor's costs of

performance by $1500. Using full costing principles, the

contract price will be reduced by $3300 ($1500 variable costs

+ $1500 fixed indirect costs + $300 profit). Again, it is

difficult to argue that the contractor has been kept whole by

a $3300 price reduction when its costs were reduced by only

$1500.

Full costing puts a contractor with excess production

capacity who would like to maximize its profit in a

particularly precarious position. 2 1 8 There is significant

risk in bidding a Government contract at less than full cost

for the purpose of maximizing profit. If after award, the

Government issues a change order deleting work or the

contractor encounters a differing site condition which

significantly reduces direct costs, the contractor could find

itself in a significant loss situation. Under full costing,

w%
the contract price is reduced by the full cost of the change

including a full share of fixed indirect costs even though

the bid amount was intended to maximize profit by allowing

full recovery of variable costs and some contribution toward

fixed costs.

The only time full costing places a contractor in the same

position as it would have been in but for the change is when

a contractor is working at full capacity and (1) the

52
additional work required by the change takes the place of
"other work" that could have been priced to permit recovery

of fixed overhead, or (2) deletion of work allows the

contractor to perform replacement work at a price permitting

recovery of fixed overhead. In sum, full costing puts a

contractor back in the position it would have been in absent

a change only when the contractor is working at full capacity

and substitute work is available that can be priced at a

level permitting full recovery of fixed overhead.

Despite the fact that full costing rarely results in a

contractor being put back in the position it would have been

in but for the change, it is the costing method used to price

adjustments. In fact its use is so well established that the

major texts on Government accounting do not even raise the

issue of whether direct costing provides a better measurement

2 19
of the parties' altered financial position.

B. Why Full Costina Is Used

The reasons full costing is used to price adjustments are:

(1) Full costing is the costing method used when the original

contract price is determined through negotiation. In

addition, it is used to determine cost for "cost

reimbursement" type contracts. 2 2 0 Familiarity with its use

53
probably led to the assumption that its use would be

appropriate for equitable adjustment purposes.

(2) Use of direct costing could lead to ridiculous results.

Assume, for example, a contract price of $22,000 (variable

costs $10,000, fixed overhead $10,000, and profit $2000 (10%

of total costs]). A change order deleting 80% of the

contract work reduces variable costs by 80%. An equitable

adjustment based on direct costing would reduce the contract

price by only $8800 ($8000 variable costs + $800 profit)

The Government would pay $13,200--60% of the original

contract price for 20% of the originally contracted for work

(probably an unreasonably high price for the work performed).

Assume on the other hand, a change order doubles the

contractor's work. Under direct costing, the contractor

would receive $11,000 additional compensation ($10,000

variable cost + $1000 profit). Although, the equitable

adjustment increased the contract price by $1000 more than

the contractor's costs increased, the added work includes no

amount for fixed overhead, and thus, may be priced much lower

than the contractor would ever consider pricing it.

(3) If direct costing were used to price equitable

adjustments, contractors with cost reimbursement type

contracts would be adversely affected. The amount of fixed

indirect cost properly allocable to cost reimbursement

contracts is governed by the Cost Principles. 2 2 1 The Cost

54
Principles require that indirect costs be allocated "on the

bases of benefits accruing to the several cost objectives" 2 2 2

and prohibit fragmentation of an accepted distribution base

by removal of individual elements of the base. 2 2 3 What this

means is that the direct costs of the changed work will not

be removed from the contractor's distribution base and a

proportionate share of the indirect cost grouping (including

fixed indirect costs) will be allocated to the work performed

under the equitable adjustment regardless of whether the

equitable adjustment was priced to include fixed indirect

costs.

C. The Real Objective of an Equitable Adjustment

The objective of an equitable adjustment is not to make the

contractor whole or put it in the position it would hbve been

in absent the change, despite the numerous cases so stating.

The objective of an equitable adjustment is to pay the

contractor the price that the contractor would have received

for the changed work, had the changed work been the subject

of a separately negotiated contract. If the true objective

of an equitable adjustment were to make the contractor whole

or put the contractor in the position it was in prior to the

change, the courts and boards would focus only on the

incremental costs of a change. In tort, where the objective

really is to put the injured party back in the position he or

55
she would have been in but for the tort, the focus is on the

injury suffered--the "but for" costs.

Note that no authoritative pronouncements exist on how

equitable adjustments are to be calculated. The question

concerning which method of costing should be used to price

equitable adjustments has not been addressed by regulation or

GAAP. Paul M. Trueger, in Accounting Guide For Government

Contracts, 2 2 4 comments on the failure of drafters of the

procurement regulations and the accounting profession to

develop cost determination principles for equitable

adjustment claims arising out of changes and delays. He

states that one can "probe deeply into procurement

regulations and accounting literature without finding any

authoritative or even informative guidance in these

areas. -225

I'
56

,..J

',p
 CHAPTER 3

UNABSORBED OVERHEAD

The purpose of this chapter is to discuss recovery of

indirect costs in delay situations where the normal method of

recovering indirect costs- -through use of an indirect cost

rate--does not equitably measure indirect cost. Chapter 3

begins by discussing how delay affects cost and then

discusses the concepts of unabsorbed and extended overhead.

I. HOW DELAY AFFECTS CONTRACTORS

Delay often increases the direct costs of performing a

contract. Increased direct costs may result from: (1) delay

until a time when labor and material prices are higher, (2)

standby of labor and equipment because the ability to perform

might be lost were these costs discontinued and because it is

impractical to make other use of the labor and equipment, and

(3) less efficient production after resumption of work due to

loss of personnel, learning curve interruption, performance

of work out of sequence, shift of work from good weather to

bad, shut-down and start-up costs, work area congestion, and

rehandling of materials.

Delays of the same aggregate number of days may vary in their

effect on direct cost depending upon the nature and timing

of the delay. Delays may be short and intermittent, partial

571
or complete, may occur before performance begins, in the

midst of performance, or near completion of performance. The

contractor's peculiar circumstances and the nature of the

contract itself determine the effect of a delay.

A contractor is entitled to recover its increased direct and

indirect costs caused by a compensable delay. 2 2 6 As

explained in Chapter 2, indirect costs are usually recovered

as a percentage markup on direct costs. 2 2 7 However, during a

delay, the relationship between incurrence of direct costs

and fixed indirect costs changes. During delay, direct costs

are incurred at a reduced level, if at all. 2 2 8 Variable

indirect costs also are incurred at reduced levels during

periods of delay. In contrast, fixed indirect costs are

unaffected by delay and continue to be incurred at normal

rates throughout the delay period. Recovery of fixed

indirect costs through methods other than the normal

percentage markup on direct costs is discussed below.

II. UNABSORBED/EXTENDED OVERHEAD

A. Definina Unabsorbed and Extended Overhead

1. Unabsorbed Overhead

Unabsorbed overhead is the amount of indirect expense

actually incurred that would have been allocated to
the contract had the delay not ocurred and is not
recovered in revenue from any other work. Thus what

58

A&Jt
 is involved here is a lower contract allocation base
(or none at all if the contract work has stopped) in a
situation in which indirect costs continue but no
other work is substituted for the contract work not
performed during the delay period. 2 2 9

This definition suggests that unabsorbed overhead exists only

when there is a delay. While unabsorbed overhead usually

arises as a result of delay, changes to a contract that

extend the period of contract performance can create

unabsorbed overhead also, as can differing site conditions.

For example, unabsorbed overhead results when a change

extends the period of contract performance, it is impractical

for the contractor to obtain other work during the period of

extension, and the direct costs generated by the change are

insufficient to absorb the contractor's fixed indirect costs

during the period of extension.

The term "underabsorbed overhead" is used as a synonym for

unabsorbed overhead.

2. Extended Overhead

A primary reason for the confusion surrounding recovery of

fixed indirect costs has been the failure to properly define

and distinguish the concepts of unabsorbed overhead and

extended overhead. 2 3 0 Despite the fact that the two concepts

are distinct 2 3 1 and the basis of recovery for each differs,

boards and commentators often use them synonymously. 2 3 2

59
S
Boards and commentators frequently comment that "extended

overhead has as its premise that mere extension of the

performance period increases overhead costs." 2 3 3 This

inartful comment has created a significant amount of

confusion. Extension of the performance period does not

increase the fixed costs for which recovery is sought. Those

costs would have been incurred had the contract not been

extended. Analytically, the basis for recovery of extended

overhead is that the Governinenc received a benefit in the

form of increased home office effort due to extension of the

period of contract performance.

B. Entitlement to Unabsorbed and Extended Overhead

To recover either unabsorbed or extended overhead, a

contractor must prove: (1) the Government caused a delay, (2)

the delay was not concurrent with a contractor-caused delay

or a delay caused by events for which the contractor is

responsible under the terms of the contract, and (3) the

contractor was injured by the delay (its costs were *4

increased) .234 The first two elements of proof, while

factually important to recovery, are easily understood. It

is the injury in fact element which creates conceptual

difficulties.

60

.II _J"
1. Unabsorbed Overhead

As explained above, delay does not increase fixed indirect

costs. Delay may, however, reduce the distribution base in

the accounting period in which the delay occurs. 2 3 5 If so,

each unit of work performed during the accounting period will

bear a higher proportion of fixed indirect cost than it would

have had the delay not occurred. Profit for the accounting

period will be reduced in the amount of the unabsorbed

overhead.

As a prerequisite to recovery of unabsorbed overhead, boards .

and courts generally have required proof that the delay "

reduced the contractor's distribution base. 2 3 6 Usually a

showing that it was impractical to obtain substitute work

and that substitute work, in fact, was not obtained is

sufficient. 2 3 7 Once the contractor shows that it would have

been impractical to have obtained substitute work during the

delay, the burden of going forward with proof that the

contractor suffered no loss or should have suffered no loss

shifts to the Government. 2 3 8 Contractors need not prove with

specificity what work they failed to bid on or would have

239
obtained but for the delay.

61
2. Entitlement Where Delay Does Not Ultimately Reduce

the Contractor's Distribution Base

A contractor, working at less than full capacity which

does not lose other work as a result of delay, will

experience unabsorbed overhead (a reduced distribution base)

in the period of delay and overabsorbed overhead (an

increased distribution base) in the following period when the

contract is completed. The delay merely shifts performance

from one accounting period to another. Over the life of the

contract (in contrast to individual accounting periods) the

contractor will experience no reduction in its distribution

base as a result of the delay. The delay does not reduce or

increase volume of production except as between accounting

periods. When the period of delay and period of completion

are viewed as a single period the contractor's profit/loss

position is unaffected by the delay. Thus, unless the

contractor was unable to take other work because of the delay

it should not be entitled to recover unabsorbed overhead. 2 4 0

As Professors Nash and Cibinic point out, the unabsorbed

overhead in the period of delay must be balanced against the

overabsorbed overhead in the period of completion to

accurately determine the effect of the delay. 2 4 1 When

unabsorbed overhead in the period in which a delay occurs is

off set against overabsorbed overhead in the period of

completion, this usually results in a "net" unabsorbed or

62
 3A

overabsorbed overhead. A contractor should not recover for

any net unabsorbed overhead it may experience. The reason

is that the net over or under absorption of overhead does not

effect cost except as between periods. Net over or under

absorption of overhead is caused by volume changes unrelated

2 42
to the delay.

3. Extended Overhead

A contractor that requests an adjustment for unabsorbed

overhead is seeking recovery for a decrease in its

distribution base. 2 4 3 In contrast, a contractor that

requests an adjustment for extended overhead cannot validly

claim that its distribution base has been reduced. 2 4 4 And,

although its home office personnel may have been involved

with additional monitoring and administration of the delayed

contract, its home office costs were not increased by the

delay because home office costs are normally fixed costs. 2 4 5

A contractor claiming extended overhead can show that because

of the delay the contract received more benefit from home

office costs than it would have had the delay not occurred.

Thus, a contractor claiming extended overhead really seeks

compensation for this increased benefit. 2 4 6

The issue, which is as yet undecided, 2 4 7 is whether a

contractor is entitled to an equitable adjustment merely

because its fixed indirect costs benefited the delayed

63
contract more than originally anticipated. Confusion exists

because the boards and courts have failed to analyze clearly

the concept of extended overhead. 2 4 8 Upon analysis, if

extended overhead is determined to be based on benefit rather

than increased cost its recovery will probably be denied.

The reason is that the parties have contractually agreed to

make adjustments to the contract price in only certain

circumstances--all of which are contingent upon delay

increasing the costs of performance. The oft-stated

purpose of an adjustment is to pay a contractor for any

increase in costs caused by the event necessitating the

adjustment--not to pay the contractor for the increased

benefit the Government may have received from its

services. 2 4 9 Not surprisingly, boards and courts have made

entitlement to unabsorbed overhead contingent upon a finding

of increased cost. 2 5 0 In the absence of such a finding,

entitlement has been denied. 2 5 1

Arguably, increased benefit can be expressed in terms of

increased cost so as to permit additional recovery. The

argument is made as follows. Although the contractor's fixed

indirect costs do not increase as a result of the delay, the

delayed contract's allocable portion of fixed indirect costs

becomes greater as the benefit it receives from fixed

indirect costs increases. Simply put: (1) the contractor's

bid includes an allocation for fixed indirect costs based on

the contract being performed without delay--this allocation

64
VW
is a contra-t cost, (2) the allocation is based on the

anticipated beneficial relationship between the contract and

fixed indirect costs; (3) because of the delay the contract

benefited more from fixed indirect costs than anticipated;

(4) therefore, more fixed indirect costs are associated with

the contract; (5) the more fixed indirect costs associated

with the contract the more the contract costs to perform.

Despite the arguable ability to equate benefit with cost the

fact remains that extended overhead unlike unabsorbed

overhead does not alter the contractor's financial

position. Although a contractor can contend that it would

have included more home office costs in its bid had it known

the contract would be delayed, the contention is strained due

to the number of speculations involved. First, would the

contractor, in fact, have increased its price--the extension

does not increase the contractor's out-of-pocket cost for

fixed indirect cost items nor is it the contractor's

established cost accounting practice to allocate indirect

costs to contracts based on their length. Second, if the

contractor had increased its bid would it still have obte*ned

the contract? The delay would not increase the fixed

indirect costs of any other bidder. Competition, probably,

would have kept the contractor from increasing its bid even

if it had known that the contract would be delayed. For this

reason, extended overhead should be denied--it does not

represent a real loss in contrast to unabsorbed overhead.

65
-W. - *..&. - I . .. -

Nevertheless, extended overhead is sometimes awarded. 2 5 2 For

example, in Able Contracting,2 5 3 the contractor was permitted

to recover home office overhead even though the contractor

could have performed another job during the period of delay.

The delay did not make it impractical for the contractor to

take on other work; other work was simply not available as

indicated by the contractor's large amount of unused

capacity. The question, left unanswered by the Capital

Electric decision 2 54 - -whether extended overhead is

recoverable- -was not addressed in the Able Contracting

decision. The Government failed to raise the issue.

Cases holding that fixed overhead costs are recoverable

absent proof that the contractor's distribution base has been

reduced are difficult to find. 2 5 5 Either the issue is not

raised or there is a finding that the delay made it

impractical for the contractor to perform other work.

Therefore, while some cases ostensibly permit recovery of

"extended" overhead, it is difficult to discern whether they

are permitting recovery of extended overhead or using the

word extended overhead as a synonym for unabsorbed

56
overhead. 2

Before the Federal Circuit Court of Appeal reversed Capital

Electric and Savoy Construction, in all but one of the board

cases in which the issue was raised, recovery of extended

66
overhead was denied. 2 5 7 However, the reversal in Savoy

Construction, has cast a shadow on their continuing

validity. 2 5 8 In a recent case, G.S. and L. Mechanical and

Construction, the DOT BCA rejected the Government's

contention that recovery of fixed indirect costs is

predicated upon proof that the contractor would have been

prevented from taking on additional work had there not been a

9
delay. 2 5

4. The Rationale Supporting Extended Overhead as a

Separate Basis of Recovery

Extended overhead is an attractive theory of recovery for

fixed indirect costs because it provides additional

compensation for fixed indirect costs every time the period

of contract performance is extended as a result of Government

caused delay. Unlike unabsorbed overhead, recovery of

extended overhead is not contingent upon proof that the

contractor's distribution base has been reduced--that the

delay prevented the contractor from taking on other work.

Extended overhead, if allowable, would enable contractors

with excess capacity to recover additional fixed indirect

costs merely because a Government-caused delay extended

contract performance.

Some commentators view extended overhead as a concept unique

to construction contracting and unabsorbed overhead, in

67
contrast, as a concept applicable only to manufacturers. 2 6 0

The basis for this distinction is that, in the short-run, a

manufacturer has only a fixed amount of factory space and, as

a result, limited capacity. A manufacturer whose contract is

delayed is enabled by the delay to take on other work.

Taking on other work in effect mitigates the loss. 2 6 1 In

contrast, a construction contractor's capacity to perform

work is not limited by the size of its facilities. 2 6 2 Its

jobsite can be anywhere. Theoretically, a construction

contractor can perform an almost infinite number of jobs.

Therefore, additional work performed during a delay is not

in substitution of the delayed contract--it would have been

performed had the contract not been delayed. Thus,

performance of such work does not mitigate the loss of other

work.

The distinction is faulty for two reasons. First,

contractors have a relatively fixed capacity the same as

manufacturers- -although perhaps to a lesser degree. Three

important limitations are (1) capital, (2) knowledge and

availability of quality subcontractors and (3) ability to
obtain bonding. 2 6 3 Second, extended overhead is not unique

to the construction industry. Even though a manufacturer

obtains substitute work, it also must administer the delayed

contract during the period of delay. Therefore, if extended

overhead is recoverable at all, it should be recoverable by

manufacturers as well as construction contractors. Singling

68
out construction contractors for this special remedy is

unsound. The contention that Government should provide a

special remedy for construction contractors merely because

they had the capacity to perform additional work prior to the

delay--unlike the manufacturer--is ridiculous.

Note that a construction contractor with excess capacity,

may incur unabsorbed overhead 2 6 4 in circumstances where a

manufacturer with a fixed capacity would not (such as when

a manufacturer is enabled by the delay to obtain substitute

work and does) .265 Even under these circumstances, the

construction contractor should not be singled out for a

special remedy. Any unabsorbed overhead the construction

contractor experiences during the accounting period in which

the delay occurs will be offset by overabsorbed overhead in

the accounting period in which the delayed work is

266
performed.

5. Entitlement Under Various FAR Clauses

Recovery of equitable adjustments is governed oy contractual

clauses contained in the FAR. A contractor's entitlement to

unabsorbed overhead is affected by which one of several FAR

clauses permits its recovery. Clauses under which unabsorbed

overhead may be recovered include: (1) Suspension of Work

clause, 2 6 7 Stop-Work-Order clause, 2 6 8 Government Delay of

69
 Work clause, 2 6 9 Changes clause, 2 7 0 Differing Site Conditions
27 2
clause, 2 7 1 and Termination for Convenience clause.

Under the Suspension of Work clause, a contractor is entitled

to unabsorbed overhead for unreasonable periods of delay

only and is not entitled to profit on unabsorbed

overhead; 2 7 3 similarly, under the Government Delay of Work

clause a contractor is not entitled to profit on unabsorbed

overhead. These limitations do not apply to other contract

clauses. Therefore, whenever possible, contractors will

attempt to recover unabsorbed overhead costs under the Stop-

Work-Order clause, Changes clause, Differing Site Conditions

27 4
clause, or Termination for Convenience clause.

Contractors usually do not experience unabsorbed overhead as

a result of a change or differing site condition and,

therefore, normally receive adequate compensation for their

fixed indirect costs through use of their normal percentage

markup on direct costs. 2 7 5 However, if a contractor proves

that its distribution base was reduced as a result of a

*change (that its normal percentage markup on direct costs

does not provide adequate compensation) recovery of

unabsorbed overhead is permitted. 2 7 6 Note that delays

preceding issuance of a change order (delays unrelated to the

actual performance of the changed work) are generally

recoverable under the Suspension of Work clause rather than

27 7
the Changes clause.

70
C. Measuring Unabsorbed Overhead

ell

1. A Parade of Formulas

The process of finding a substitute for the normal practice

of allocating indirect costs as a percentage markup on direct

costs has been a long one. Numerous formulas and variations

thereof have been used or recommended to approximate a

27 8
contractor's unabsorbed overhead cost including: Eichleay,
2 8 0 A.C.E.S.,2 8 1 Carteret, 2 8 2
modified Eichleay,2 7 9 Allegheny,

Allied Materials and Equipment,2 8 3 and simulation. 2 8 4 Each

formula is set out in Appendix 2. The formulas vary in their

ability to approximate true unabsorbed overhead. Only in

limited circumstances will any of the formulas correctly

approximate true unabsorbed overhead.

Unabsorbed overhead can be determined without resort to a

formula in much the same way that other increased costs are

determined. This chapter recommends such an approach.

2. The Eichleav Formula

a. Backaround

For over 25 years, boards and courts have used the Eichleay

formula or some variation thereof to calculate unabsorbed

71I
~Sa~
~ SI/~b ~ 1. ~ ~ * *~~SS ~ - ~
overhead costs. Other formulas have been used, but the

Eichleay formula is the prevailing method used by the boards

of contract appeals. 2 8 5 Contractors favor the Eichleay

formula for two reasons. First, it is simple to use; its

mechanical application frees a contractor from having to

prove actual unabsorbed overhead. Second, the Eichleay

formula generally provides a higher recovery than most other

formulas. In recent years there has been a growing

disenchantment with the Eichleay formula. There has been a

growing awareness that the formula does not accurately

286
measure actual unabsorbed overhead.

In Capital Electric, the GSBCA found that the common law of

construction contracts did not allow recovery of extended

287
overhead- -but did allow recovery of unabsorbed overhead.

Furthermore, the GSBCA found that the Eichleay formula was an

improper measure of unabsorbed overhead; it found the

fluctuating burden method the proper formula for measuring

unabsorbed overhead.288

The Court of Appeals for the Federal Circuit reversed the

GSBCA decision. 2 8 9 The Federal Circuit sidestepped the issue

of whether extended overhead was recoverable. It held that

Capital Electric had introduced unrebutted evidence of its

inability to take on substituted work during the various

delay periods. 2 9 0 Thus, Capital Electric had established its

entitlement to unabsorbed overhead, eliminating the need for

72
the Federal Circuit to decide whether extended overhead was

recoverable. The Federal Circuit also held that the Court of

Claims' decision in Fred R. Comb Co. v. United States2 9 1

holding that the Eichleay formula was a proper measure of

damages for unabsorbed overhead created binding precedent for

the boards of contract appeals. 2 9 2 The Federal Circuit then

commented that the Eichleay formula had been followed in so

many board decisions, that a determination that it was an

improper measure of damages should more properly be left to

293
Congress rather than the Federal Circuit.

On the same day that it reversed Capital Electric, the Court

of Appeals for the Federal Circuit also decided an ASBCA

case, Savoy Construction v. United States. 2 9 4 Here, a

construction contractor received change orders whicb

increased its contract performance time by 273 days. The

change orders generated additional direct costs of over

$600,000. The contractor contended that the 3.7 to 10

percent markups on the additional direct costs provided

insufficient compensation for its 273 days of additional

contract administration and sought to recover additional home

office costs under the Eichleay formula. Thc Board denied

such recovery holding that entitlement to unabsorbed

overhead was predicated on proof that the contractor's

distribution base had been reduced. 2 9 5 The Claims Court,

characterizing the claim as one for extended overhead, agreed

with the Board that proof that the contractor's distribution

73
I' U 3; L . 5. .9:. .--. .*L 6_ , .-., . .- - ... .. .. .. .J*

base had been reduced was a prerequisite to recovery. 2 9 6 In

an unpublished opinion, the Court of Appeals for the Federal

Circuit reversed. What the Savoy reversal means is unclear.

In Excavation-Construction,2 9 7 the ENG BCA addressed this

issue.

Unfortunately, it appears that the distinction between

the two different types of cases may not have been
brought to the attention of the United States Court of
Appeals for the Federal Circuit when the Capital
Electric and Savoy cases were reviewed by that Court
However, the Court's Savoy ruling is not citable
as precedent and the issue may yet receive a thorough
298
airing.

Commentators have not interpreted the reversals to mean that

the Court of Appeals for the Federal Circuit has endorsed the

automatic application of the Eichleay formula or as having

settled the criticisms leveled against use of the formula.

They see the Eichleay formula as remaining vulnerable to

attack and caution against its blind application,

299
particularly where entitlement is not clear.

Since Capital Electric and Savoy Construction, the boards and

courts have decided a number of cases in which contractors

have sought recovery under the Eichleay formula. 3 0 0 The

cases are mixed in their interpretation of Capital Electric

and Savoy Construction. For example, in G.S. and L.

Mechanical and Construction, the DOT CAB after seriously

questioning the validity of the Eichleay formula states:

74

4'
 It is in recognition of these failings that certain
Boards seem to have withdrawn from their earlier
endorsements of the Eichleay principle. Even the
majority opinion in Capital Electric, above, appears
to be inviting litigants, in an appropriate case to ,
have the Court of Appeals conduct an en banc review
3 01
of the Eichleay approach.

In contrast, in Don Cherry, Inc., the ASBCA treated the

matter as settled and summarily dismissed the Government's

arguments against use of the Eichleay formula commenting,

"Much of the steam has been taken out of the Government's

arguments by the Federal Circuit Court's decision in Capital

Electric Co. v. United States and the Board decisions

decisions which have followed.",3 0 2 In Ricway, Inc., the Board

went even further stating, "Failure to apply [the Eichleay

formula] has been strongly rejected by the Court of Appeals

for the Federal Circuit in Capital Elec. Co. v. United

States.,303

b. The Eichleav Formula

The Eichleay formula calculates an average daily amount of

fixed indirect cost ailocable to the delayed contract. This

per diem amount is then multiplied by tne number of days of

compensable delay to obtain the amount of unabsorbed

overhead. The Eichleay formula usually consists of the

following three steps:

1
(.... ........
75
 'S

Contract billings X Total overhead = Overhead

Total billings for the incurred during allocable to
actual contract peLiod period the contract

Allocable overhead = Overhead allocable

Actual days of to the contract
contract performance per day
Daily overhead X Number of = Unabsorbed
days delay overhead

c. Criticisms of Eichleav4

The Eichleay formula is based upon a number of presumptions,

the correctness of which determine the formula's accuracy and

usefulness. These presumptions are: (1) a proportional

relationship exists between contract billings and fixed

indirect costs; (2) the indirect cost pool includes only
fixed costs; (3) the contractor does not perform any
substituted work of value during the delay; (4) the

contractor was otherwise working at full capacity during the

entire period of contract performance; (5) the effect of a

delay on a contractor is the same regardless of when the

delay occurs; and (6) the period of contract performance is

an acceptable base period for accumulating fixed indirect

costs.

The first presumption- -that a proportional relationship

exists between contract billings and fixed indirect costs--is

questionable. Contract billings are seldom used as a

distribution base for indirect costs for good reason. A

76
'A
contract billings distribution base is simply a cost of

sales base plus a profit element and not surprisingly has

the same defects as a cost-of-sales base (discussed in

Chapter 1).304 However, billings are even less accurate than

cost-of-sales in distributing indirect costs in proportion to

the causal or beneficial relationship existing between a

contract and the indirect cost pool or in relation to the

total activity of the business as a whole. 3 0 5 This is

because the amount of profit included in billings varies by

contract and not necessarily in proportion to the beneficial

or causal relationship existing between the contract and the

.'
indirect cost pool or in proportion to the total activity of -

the business as a whole.

The second presumption--that the indirect cost pool does not

include any variable costs--should not be accepted without

verification. Even home office costs, normally thought of as

fixed, sometimes include variable elements. 3 0 6

"To the

extent that a claim includes expenses that vary over time,

the Eichleay formula does not reliably measure the

contractor's actual loss."'3 0 7 The fixed/variable issue has

not caused much litigation probably because home office costs

are fixed in most instances. 3 0 8 However, both the Government

and the contractor should be sensitive to this limitation of

the Eichleay formula and examine home office costs and other

indirect cost pools for which unabsorbed overhead is being

,',
.
'F"
calculated, prior to use of the formula, to identify and

remove variable indirect costs.

The third presumption--that the contractor, during the delay,

does not perform any substituted work of value--should be

carefully scrutinized whenever recovery is claimed under the

Eichleay formula. The fact that it was impractical for the

contractor to take on a project the size of the delayed

contract does not mean that the contractor's work force was

completely idle and provided no benefit to the contractor. 3 0 9

Substituted work mitigates a contractor's damages; it

reduces unabsorbed overhead. 3 1 0 The Eichleay formula does

not properly credit the delayed contract with this

mitigation. 3 1 1 Thus, its application results in over

recovery of unabsorbed overhead whenever substituted work is

performed. 3 1 2 The more substituted work performed, the

greater the over recovery. 3 1 3 For this reason, it is very

important for the Government to establish just what work was

performed during the delay period and to reduce the

contractor's recovery of unabsorbed overhead accordingly.

The fourth presumption- -that the contractor was otherwise

working at full capacity during the entire period of contract

performance- -also should be scrutinized carefully before

applying the Eichleay formula. Assume a contractor that has

already begun its work on a Government contract finishes one

large commercial contract and bids on, but fails to get, a

78
,e
replacement contract. The Government contract is then

delayed. Because the contractor failed to get a replacement

contract for its commercial project, the Government's share

of the contractor's total billings for the period of contract

performance is increased, perhaps substantially. And because

the Eichleay formula computes unabsorbed overhead as a ,.h

percentage of total billings, the contractor's recovery from

3 14
the Government is likewise increased.

Thus, the Eichleay formula permits recovery of unabsorbed

I
indirect costs in amounts that a contractor would never have _

been able to recover in a competitively priced bid.

Unabsorbed overhead, not caused by the Government, also

p
occurs when a contractor's commercial work is delayed for
-
reasons unrelated to the Government contract. Here again,

the Government's proportional share of the contractor's

billings is increased, resulting in the contractor recovering

under the Eichleay formula a greater amount of unabsorbed

overhead from the Government.

I

The fifth presumption--that the effect of delay on a

contractor is the same regardless of when the delay

I
occurs 3 1 5 --is unsound. 3 1 6 The timing of a delay determines

its impact on a contractor. A delay which occurs during the

winter, when a construction contractor is less productive and

I
probably has a smaller crew, will have less effect on the

contractor than a delay which takes place during the peak

79 .

..............................
' ...
summer months. Which members of a contractor's work force

and which equipment items are idled often depend on when the

delay occurs during contract performance. Nonetheless,

regardless of the timing of a delay, the Eichleay formula

provides the same measure of recovery. Similarly, the

Eichleay formula does not accurately measure the effects of a

delay from the standpoint of the administrative effort

expended by a contractor. The level of administrative effort

is not constant throughout contract performance. More home

office effort is usually needed at the beginning and end of a

contract performance than at other times. 3 1 7 And, during

periods of extended inactivity, although reports and certain

administrative tasks continue, a contract needs less home

office attention than during periods of peak performance. 3 1 8

The sixth presumption--that the period of contract

performance is an acceptable base period for accumulating

fixed indirect costs (i.e., is representative of normal

operations)--will be valid in most circumstances. Chapter 2

explained that a base period of one year is normally required

by the procurement regulations. 3 1 9 The reason is that

periods of less than one year are subject to seasonal and

other variations which do not accurately reflect the normal

operations of the contractor's business. 3 2 0 Periods longer

than one year can attenuate the relationship between indirect

costs and the direct costs which generated them, especially

when a significant change in the contractor's operations

80
occurs. 3 2 1 However, fixed indirect costs are less subject

to seasonal fluctuations and significant change than variable

costs. Nonetheless, the degree to which costs are fixed

vary 3 2 2 and both the Government and the contractor should be

sensitive to this limitation of the Eichleay formula.

The analysis above shows that use of the Eichleay formula

will often result in over recovery of unabsorbed overhead--a

windfall for the contractor. 32 3 However, when the

presumptions are valid use of the Eichleay formula will

result in under recovery of unabsorbed overhead. 3 2 4

The Eichleay formula employs a ratio reflecting the

relative value of a delayed contract to the value of
all work that the contractor performed during the
delayed contract's actual period of performance.
Thus, the ratio's denominator includes the value of
work performed between the delayed contract's
scheduled and actual completion dates. The numerator,
however, includes only the value of the delayed
contract. It does not include the value of projects
postponed because of the delay, projects that would,
but for the delay also bear a share of the
contractor's fixed home office expenses. 3 2 5

The Eichleay formula can be modified to avoid under

compensation. The following is one of several ways to modify

the Eichleay formula to avoid under compensation: 3 2 6

Delayed Contract's Value Total Fixed Allocable

for Normal Period X Home Office Home Office
Total Value of All Contracts Expenditures Overhead
for Normal Period For Period
of Delay

,-I
81
8 1 "U

U- ~ *.--..,..
The difference between the amount of recovery under the

Eichleay formula and the amount of recovery under the

modified version of the Eichleay formula can be substantial.

For example, the modified version would have allowed the

contractor in Capital Electric, to recover $466.52 in daily

overhead for each day of delay, rather than the $311 it did
3 27
recover under the Eichleay formula.

The boards and courts are reluctant to grant recovery under

the modified Eichleay formula. 328 Undoubtedly this

reluctance is caused, in part, by the strong criticism that

the Eichleay formula has attracted. Because the Eichleay

formula's ability to correctly measure unabsorbed overhead is

dependent upon the validity of a large number of

presumptions, any one of which if not valid will result in

over recovery, the modified Eichleay formula should be used

sparingly, if at all.

d. Alternative to Formulas Such as Eichleay

The assumption that a contractor cannot be expected to prove

actual unabsorbed overhead costs is implicit in the many

decisions using the Eichleay formula or other formulas to

measure unabsorbed overhead. Surprisingly, there is very

little analysis explaining why actual damages cannot be

proven. The task of proving actual damages is only slightly

more difficult than proving a projected indirect cost rate or

82
.~ *%
~.%
' .:d
-.. '%- .. **4.\~.,
~ ~ ~
the credit due the Government when work is deleted from a
32 9
contract.

(i). Unabsorbed Overhead. The steps necessary to

determine actual unabsorbed overhead are:

1. Estimate the amount by which the Government caused delay

reduced the distribution base.

2. Estimate the amount by which other events reduced the

distribution base.

3. Add the reductions to the actual distribution base for the

period to obtain the contractor's adjusted distribution base.

4. Divide fixed home office expense for the accounting period

by the adjusted distribution base to obtain the home office

overhead rate.

5. Multiply the home office overhead rate by the reduction in

the distribution base caused by the Government delay to

obtain the amount of unabsorbed overhead due the contractor.

Proof of actual unabsorbed overhead requires the making of

estimates in steps 1 and 2. Estimates are a legitimate means

of proving damages and are frequently used in pricing

adjustments330

The amount by which a contractor's distribution base was

reduced by delay can be estimated by comparing work performed

during the delay to work the contractor had scheduled for

83
performance prior to the delay. The reasonableness of the

contractor's schedule can be determined by comparing actual

performance to scheduled performance in periods before and

after the delay. Factors such as weather, the nature of the

contract, and the unique circumstances of the contractor also

can be considered in determining how much the delay reduced

the contractor's distribution base.

Because a contractor's actual distribution base is the

point of focus, rather than contract billings, the cau- and
effect relationship between delay and unabsorbed overhead is

clearer enabling the parties to tailor recovery to the actual

circumstances.

(ii) Extended Overhead. Entitlement to extended overhead

has not yet been authoritatively decided. 3 3 1 If, however, a

court or board were to find that a contractor was entitled to

an adjustment based on increased administration in the

absence of increased cost, the amount of the equitable

adjustment could be determined based on the actual value3 3 2

of the additional administrative services.

First, determine what additional administrative services were

required--what extra reports the contractor provided, what

additional time was spent on contract by home office

personnel. Second, determine the value of those services
based on what the reasonable cost of providing those services

84
 ,I

would be. 3 3 3 The amount of the equitable adjustment would be

the value of the additional administrative services less an 1*

3 34
adjustment to prevent double recovery of indirect costs.

3. Getting the Boards and Courts to Accept

Alternatives to Eichleav U.

a. Overcoming Capital Electric and Savov Construction

After the Court of Appeals for the Federal Circuit's decision

in Capital Electric3 3 5 and Savoy Construction,3 3 6 boards and

courts understandably have been reluctant to find the

Eichleay formula an improper method for measuring unabsorbed

overhead. The author believes this reluctance will continue.

However, these two opinions should not be interpreted as an

unqualified endorsement of the Eichleay formula by the C

Federal Circuit. 3 3 7 First, the Court did not support its

decision in Capital Electric with analysis of why the

Eichleay formula properly compensated the contractor.

Instead, the Court based its decision upon the formula's long

history of use, stating that overruling such long standing

precedent was an action more appropriate for Congress. 3 3 8

Likewise, Savoy Construction contained no analysis of why the

Eichleay formula properly compensated the contractor. 3 3 9

Second, while the Government argued in Capital Electric that

the Eichleay formula improperly measured the contractor's

increased costs, the Government did not provide an acceptable

,85
85 )
 N -0 N X*.-.

alternative. The Government merely offered another formula

which the Federal Circuit found equally imprecise. 3 4 0 Third,

neither case showed that the Eichleay formula clearly over

compensated the contractor.

Clear proof of over compensation can be presented in two

ways: (1) by estimating the actual effect of the delay on -he

contractor's distribution base, 3 4 1 or (2) by comparing the

facts of a particular case with the presumptions of the

Eichleay formula. 3 4 2 The presumptions that do not fit

represent areas of over compensation. As the DOT CAB stated

in G.S. and L. Mechanical and Construction:

[The goal of any formula] is to provide compensation

to a contractor which is reasonably equal to the
proportion of actual total overhead costs
allocable to [its] contract. . . However, if any
formula departs from this goal when applied to a
specific set of circumstances, then however acceptable
it may have been in other cases, it is not appropriate
343
for use when those specific circumstances exist.

Thus, a board or court, recognizing in a particular case that

one of the presumptions upon which the Eichleay formula rests

is invalid, may without overruling precedent choose not

to use the Eichleay formula. Similarly, a board or court

legitimately may reduce the amount recoverable under the

Eichleay formula to offset any over compensation that might

otherwise occur. This approach was used in Excavation-

Construction where the Board limited the contractor to 80% of

86
.'

86

".%
the per diem rate because the contractor's books were
344
unavailable for audit.

Had the Federal Circuit faced a case clearly showing over

compensation under the Eichleay formula or providing a more

appropriate method of computing unabsorbed overhead it is

possible that it would have considered the issue en banc on

appeal and reached a different result. 3 4 5 Precedent does not

mandate use of the Eichleay formula. On reconsideration of

the original Eichleay decision, the ASBCA stated:

There is no set formula for the determination of

[unabsorbed overhead]. In the instant case we were
persuaded that of the two methods advanced to us the
appellant's method produced an equitable adjustment
and that the Government's did not. The method to be
used in future cases will depend upon the record made
346
in those cases.

However, the frequency with which the Eichleay formula has

been used since the original Eichleay decision creates almost

a presumption that its use will provide an equitable

recovery. Therefore, the Government can expect to bear the

burden of proving that any alternate method of recovery will

better approximate unabsorbed overhead than the Eichleay

formula. 3 4 7 Nonetheless the issue is whether the Eichleay

formula reasonably measures unabsorbed overhead. 3 4 8 Recent

changes to the FAR state that "no presumption of

reasonableness shall be attached to the incurrence of costs

by a contractor" and upon challenge "the burden of proof

87
shall be upon the contractor to establish that such cost is

reasonable." 3 4 9 Thus, for contracts made after the effective

date of the FAR change, the burden of proving that the

Eichleay formula provides a reasonable measure of cost

arguably rests with the contractor.

b. Contractually Establishing the Method of Recovering

Unabsorbed Overhead

The Government, if it choses to eliminate the Eichleay

formula as a measure of unabsorbed and/or extended overhead,

can do so without the Federal Circuit overruling Capital

Electric and without Congressional action. The Government,

working together with the contracting community, can develop

an approach for compensating delayed contractors that is

equitable to both parties and can incorporate such an

approach into the procurement regulations. 3 5 0 In addition,

the Government has the option of unilaterally developing a

contract clause prescribing how unabsorbed overhead and/or

extended overhead damages are to be measured. A contract

clause could be drafted to require a contractor to prove the

actual amount by which its distribution base was reduced as

a result of Government-caused delay. Such a clause might

read:

Any claim for recovery of unabsorbed/extended overhead

will be determined based on the actual amount by which
the contractor's distribution base is reduced as a
result of Government caused delay. Formulas such as

88
 Eichleay and modifications thereof are not acceptable
measures of unabsorbed overhead and therefore will not
be used for this purpose.

As Chapter 2 explained the GSA, the VA, and the Postal

Service, insert in their construction contracts a clause

35 1
limiting overhead to 10% of the direct costs of a change.

These clauses have successfully limited claims for unabsorbed

and extended overhead. 3 5 2 Moreover, the Court of Appeals for

3 53
the Federal Circuit recently upheld their enforceability.
1i

Some Government agencies may not want to adopt a clause that

limits a contractor's total overhead recovery to 10% of the

direct costs of a change 3 5 4 but may want to limit the amount

of unabsorbed overhead that can be claimed as a result of

delay. Development of a contract clause limiting unabsorbed

overhead to 10% of the total contract price should prevent

recovery of unabsorbed overhead in amounts disproportionate

to the total contract price.

4. Preventina Double Recovery

a. Percentage Markup on Direct Costs

Double recovery of indirect costs becomes an issue when a

contractor, having already received a percentage markup 3 5 5 on

the increased direct costs of a change or delay, seeks to

recover unabsorbed overhead. Does receipt of both a

89
percentage markup on direct costs incurred during the delay

and unabsorbed overhead, in fact, constitute double recovery?

In almost all cases where this issue has been raised, the
percentage markup on direct costs has been either denied or

subtracted from the contractor's recovery of unabsorbed

overhead.356

Whether or not receipt of both unabsorbed overhead and a

percentage markup on the increased direct costs of a change

or delay constitutes double recovery depends upon the method '

used to determine unabsorbed overhead. Some methods of

computing unabsorbed overhead credit the Government with the
value of any additional work performed by the contractor

during the delay. 3 5 7 When such a method is used, recovery of

both unabsorbed overhead and a percentage markup on direct

costs does not constitute double recovery. However, a per

diem formula such as Eichleay inadequately allows for

substituted work performed during the delay period. 3 5 8 Thus,

when the Eichleay formula is used the contractor should be

limited to recovery under the Eichleay formula or the

percentage markup on direct costs, but not both.

To date, boards and courts have credited delayed contracts

with only the percentage markup paid to the contractor on

change orders for work performed during the delay period.

Delayed contracts have not been credited with the amount of

fixed indirect cost allocable to all substitute work

90
performed during the delay; specifically, the delayed

contract is not credited with work made possible by the delay

but performed on other contracts. Were it not for the delay,

the direct costs of this substituted work would not have been

generated. Failure to credit the delayed contract with the

fixed indirect costs absorbed by substituted work of whatever

type compensates the contractor for a loss that neverw

occurred.

When boards and courts subtract from the Eichleay computation

the percentage markup paid to the contractor on change orders

for work performed during the delay period, they erroneously

deduct the entire percentage markup. They fail to recognize

that the percentage markup may include both fixed and

variable elements of indirect cost. 3 5 9 Unlike unabsorbed

overhead, 3 6 0 the percentage markup on direct costs is

intended to compensate the contractor for its fixed and

variable indirect costs and for this reason includes elements

of both. Deduction of the total percentage markup results in

the contractor receiving nothing for variable indirect costs

incurred on work performed during the delay period.

b. Direct Recovery of Normally Fixed Indirect Costs

Receipt of unabsorbed overhead fully compensates a contractor

tor all fixed indirect costs incurred during the delay

period. Direct recovery of fixed indirect costs incurred

91

A ,C,%$ 'p
during the delay period and unabsorbed overhead constitutes

double recovery. 3 6 1 Only in the most unusual circumstances

would both direct recovery of a normally fixed indirect cost

and unabsorbed overhead be proper.

D. Unabsorbed Overhead in the Context of a Termination

for Convenience

Unabsorbed overhead in the context of a termination for

convenience is discussed in Chapter 4.362 Three areas are

examined: pre-termination unabsorbed overhead, post-

termination unabsorbed overhead, and unabsorbed overhead when -

a contract is partially terminated for convenience.

92

yei
 CHAPTER 4

TERMINATIONS FOR CONVENIENCE

I. TERMINATION SETTLEMENTS

A. Obi ctive

The objective of a termination settlement is to compensate

the contractor fairly for the work performed and the

preparations made for the terminated portions of the

contract 3 6 3 and to reimburse the contractor for its

reasonable costs of settling the terminated work. 3 6 4 If

possible, the parties should negotiate a settlement agreement

accomplishing these goals. 3 6 5 If an agreement cannot be

reached, then the contracting officer will unilaterally

determine fair compensation. 3 6 6 The contracting officer's

determination is a final decision from which the contractor

3 67
may appeal under the Disputes clause.

Cost is the dominant factor in determining fair compensation.

A contractor's costs of performing and preparing to perform

the terminated work are the basis of a termination

settlement. Exact measurement of cost is not, however, a

prerequisite to recovery. Fair compensation i: a matt r of

judgment and cannot be measured exactly. 3 6 8 -p

93
!'
 - i .. - - - ' ,J ... . .. r-v j vw

This goal of fair compensation plays an important role in

recovery of indirect costs. Boards and courts deviate from

strict accounting principles, 3 6 9 use jury verdicts, and

accept less precise measures of cost when necessary to assure

fair compensation. They are more willing to risk overpayment

when a contract is terminated for convenience than at other

times.

B. Complex Nature of Termination Settlements

A termination for convenience is a complex pricing action for

a number of reasons. First there are a number of costs

involved: pre-termination costs, continuing costs, and

settlement costs. Second, few accounting systems are

designed to measure cost at various stages of contract
completion. Thus, there are problems of proof. Third,

termination affects the ability of direct cost to serve as a

distribution base. Little direct cost is generated in the

early stages of contract performance; in contrast indirect

* effort may be substantial. Similarly, the contractor's

settlement effort generates little, if any, direct cost but

requires substantial indirect effort.

Contracts partially terminated for convenience present an

additional challenge in that costs of the terminated and

unterminated portions of the contract must be segregated.

Furthermore, the unterminated portion of the contract may

94
cost more to perform as a result of the partial termination

and require repricing (a cost measurement problem).

Some of the more challenging issues addressed in this chapter

are:

(1) How to fairly compensate a contractor in the absence of

adequate accounting records.

(2) Which normally indirect costs can be charged directly to

the terminated contract and which cannot.

(3) What adjustments to a contractor's indirect cost

groupings are necessary to prevent double recovery when costs

normally treated as indirect costs are charged directly to

the terminated contract.

(4) Whether normally indirect costs, charged directly to the

terminated contract, should be allocated a share of an

indirect cost grouping of which, but for the termination

settlement, they would be a part.

The answers are often fact specific and depend in part on the

category of termination cost involved. The specific

categories of termination cost are discussed separately in

paragraphs II through IV below. Post termination unabsorbed I

overhead is discussed in paragraph V and partial terminations k"

for convenience in paragraph VI.

95
L .. .' '4 . - , . % . . W. iJ p -.. .- S. rr:wjr ..

II. INDIRECT COSTS OF PERFORMING AND PREPARING TO

PERFORM THE TERMINATED CONTRACT

A. Indirect Cost Rates

Indirect costs of performing and preparing to perform the

terminated work are recovered, for the most part, in the same

manner as if the contract had proceeded to completion. The

contractor's normal indirect cost rate is multiplied by the

direct costs incurred in preparing to perform and in

performing the terminated contract to obtain recoverable

indirect costs. 3 7 0 In most instances, the contractor's

actual rather than projected indirect cost rate is used. 3 7 1

This is because termination settlements normally are priced

at a time when actual indirect cost rates are known. 3 7 2

The choice of base period can significantly affect indirect

cost rates and the amount of indirect cost allocated to the

terminated contract. 3 7 3 Normally, the contractor selects as

its base period its normal annual accounting period or the

V.

period of contract performance. 3 7 4 The Government will

contest the contractor's choice of a base period if it fails

to include or does not closely conform to the period of

contract preparation and performance. 37 5

'V
'V N!VV' ~~~
96
V'
V
B. Direct Charaina of Costs Normall? Treated as

Indirect Costs

When a contract is terminated before completion, a

contractor's established procedures for allocating indirect

costs, 3 7 6 in many instances, do not equitably measure the

indirect costs of the terminated contract. The reason is

that contractors often incur a significant amount of

nonrecurring indirect costs at the beginning of contract

performance, a time when direct costs--the normal

distribution base--are low. 3 7 7 When a contractor's normal

method of allocating indirect costs fails to equitably

compensate the contractor for its indirect costs of

performing the terminated contract, a departure from its

normal practice is proper. 3 7 8 In most instances, the

contractor continues to use its direct cost distribution base

but charges certain normally indirect costs directly to the

terminated contract.

1. Indirect Costs Specifically Permitted as Direct

Costs

The FAR specifically permits contractors to charge directly

to the terminated contract initial costs including starting

load and preparatory costs. 3 7 9 Starting load costs are

nonrecurring labor, material, and related overhead costs

incurred in the early part of production. 3 8 0 Starting load

9N

•.'
 I

costs result from factors such as: "(i) [e]xcessive spoilage

due to inexperienced labor; (ii) [ildle time and subnormal

production due to testing and changing production methods;

(iii) [training; and (iv) (lack of familiarity or

experience with the product, materials, or manufacturing

processes." 3 8 1 Preparatory costs are costs incurred in

preparing to perform the terminated contract. 3 8 2 They

include such costs as "those incurred for initial plant

rearrangement and alterations, management and personnel

organization, and production planning."'3 8 3 When initial

costs are charged as direct costs, FAR 31.205-42(c) (2)

specifically prohibits their inclusion in overhead but is

silent as to whether initial costs of other contracts must be

excluded from indirect cost pools prior to their allocation

to the terminated contract.

While the FAR specifically permits initial costs to be

recovered as direct costs it does not require direct

recovery. To recover initial costs directly the contractor

will have to specifically identify these costs to the

contract and show that they have not already been recovered V

through inclusion in indirect cost groupings. 3 8 4 V

98
2. Indirect Costs Not Specifically Permitted as Direct

Costs.

A substantial number of cases have permitted direct charging

of pre-termination indirect costs that FAR does not

specifically allow as direct costs. 3 8 5 The ASBCA stated in
3 6
Switlik Parachute Company: P

There is nothing objeztionable about charging any cost

directly, provided it is properly allocable to the
contract, and other costs of the same character are
excluded from indirect cost pools charged to the
contract, in order to avoid 'double screening' or
duplicate charging. In particular, in a termination
for convenience situation, it is common to remove some
or all types of indirect costs from overhead or G&A
and to charge them directly in order to achieve S
equitable allocation.

Direct charging of indirect costs other than those

specifically permitted to be charged directly is often
denied. 3 8 7 Refusal usually results when (1) the board finds

the contractor's normal method of recovering indirect costs

has fully compensated contractor for the costs incurred-- -

allowance would constitute double counting, or (2) the

contractor fails to prove that costs charged directly were

incurred specifically for the terminated contract. 3 8 8

99
 3. Consistency Issues Raised by Direct Charging of

Normally Indirect Costs

Direct charging of indirect pre-termination costs raises a i

number of questions:

(1) Whether direct charging is permissible under the Cost

3 89
Principles and CAS?
(2) What must be done to prevent double recovery? That is,

what adjustments to the indirect cost grouping are necessary

to ensure that the contractor does not recover the cost both

as a direct cost and as an indirect cost.

(3) Whether the normally indirect pre-termination cost should

itself be burdened with indirect costs.

These questions are discussed below.3 9 0

a. Is Direct Charging of Indirect Pre-termination

Costs Permissible Under the Cost Principles and the

CAS9?

Under the Cost Principles and CAS 402, "[n]o final cost

objective shall have allocated to it as a direct cost any a

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 cost objective." 3 9 1 The

question is whether a termination for convenience is a change

100

k, 5~ -' A ~ ' €V • A , ". , a.. . *' . - .. ;J.-.--a-.- . -. ...

in circumstance sufficient to allow direct charging of a cost

normally charged indirectly.

Obviously, the fact of termination does not change the

circumstances under which a cost was incurred. What changes

is the contractor's method of recovering its costs; the

circumstances of recovery--not of incurrence--change. Does a

change in the circumstances of recovery, one making recovery

under the contractor's established method of distributing

indirect costs inequitable, permit direct recovery of

normally indirect costs? Literally read, the Cost Principles

and CAS allow direct charging of costs normally charged

indirectly only when the circumstances of incurrence differ

from those of other costs incurred for the same purpose

charged indirectly.

The FAR specifically allows direct recovery of initial

indirect costs but does not address the consistency issue

with respect to their direct charging except to require that

initial costs claimed directly not be included in

overhead. 3 9 2 Nor have the boards and courts reconciled the N

consistency requirements of CAS 402 and the Cost Principles

with direct charging of pre-termination indirect costs. 3 9 3

Consistency, when raised is discussed in terms of double

charging.

101
( .~r - C - I

! i
Without exception, the commentators believe that some direct

charging of indirect costs is necessary and permissible in

the context of a termination for convenience; 3 9 4 however,

they differ on how to reconcile direct charging with the CAS

and Cost Principles' requirement for consistency. Several

commentators contend that pre-termination indirect costs are

not "costs incurred for the same purpose in like -

circumstances" as the indirect costs of other cost

objectives. 3 9 5 In contrast, Bedingfield and Rosen view
direct charging of pre-termination indirect costs as a

voluntary change in accounting practice, a one-time

special allocation of indirect costs. 3 9 6

Bedingfield's and Rosen's view of direct charging as a one-

time voluntary change in accounting practice is the better

view. A prerequisite to making any change in accounting

practice is proof that the established accounting practice is

inequitable. 3 9 7 When such proof is not present direct

charging of pre-termination indirect costs should not be

permitted. The mere fact that a contract has been terminated

for convenience is not sufficient reason to allow a

contractor, on a selective basis, to charge normally indirect

costs directly to the terminated contact. 3 9 8 The "voluntary

change" approach is consistent with CAS 402 and and the Cost

Principles requirements for consistency. 3 9 9 It is also

consistent with FAR 31.205-42(c) which specifically allows

certain initial costs to be charged directly. FAR 31.205-

102
 V

42(c), itself, limits direct recovery of initial costs to

those instances where recovery under the contractor's

4 00
established accounting practices is inequitable.

The Cost Accounting Standards clause and the Disclosure and

Consistency of Accounting clause seemingly would preclude

retroactive application of any change in accounting practice

including a voluntary change for CAS-covered and modified

CAS-covered contracts. 4 0 1 Nonetheless, it appears unlikely

that either of these clauses would prevent retroactive

application of a change in accounting practice necessary to

equitably distribute costs for purposes of a termination for

4 02
convenience.

b. Preventina Double Recovery

When a normally indirect cost is charged directly to a

terminated contract the direct charge must be removed from

the contractor's indirect cost pool before the pool is

distributed to the terminated contract to avoid over .J.

recovery. 4 0 3 The difficult question is what other costs, if

any, should be removed from the contractor's indirect cost

pool.

CAS 402 and FAR 31.203(a) state that indirect costs "shall

not be allocated to a final cost objective if other costs

incurred for the same purpose in like circumstances have been

103
included as a direct cost of that or any other final cost

objective." 4 0 4 Therefore, if costs remaining in the indirect

cost pool are costs "incurred for the same purpose in like

circumstances" as costs charged directly to the contract they

must be removed from the indirect cost pool. Several

commentators argue that removal is unnecessary in that the

termination is a change in circumstance--that other costs in

the indirect cost grouping are not "costs incurred for the

same purpose in like circumstances" within the meaning of CAS

4 05
402 and the Cost Principles.

Regardless of how the circumstances are characterized,

failure to remove other costs incurred for the same purpose

from an indirect cost grouping prior to its distribution to

the terminated contract results in overcharging the

terminated contract. For purposes of illustration, assume a

contractor charges initial costs directly to the terminated

contract and removes the direct charge from its indirect cost

pool. Failure to remove the initial costs of other contracts

from the indirect cost pool results in the terminated

contract bearing all of its initial costs in the form of a

direct charge and through allocation from the indirect cost

pool a portion of the initial costs of other cost

objectives. 4 0 6 Therefore, when a pre-termination cost is

removed from an indirect cost grouping and charged directly

to a terminated contract, indirect costs incurred for the w

same purpose for other cost objectives should be removed from

104

)1
 I

the indirect cost grouping before distribution is made to the

terminated contract.

Settlement costs are also charged directly to terminated

contracts. Clearly to avoid double recovery, a contractor

must remove settlement costs charged directly to the

terminated contract from indirect cost groupings prior to

distribution to the pre-termination effort. 4 0 7 The real

issue is whether a contractor must remove indirect costs

incurred for the same purpose as settlement costs from an

indirect cost grouping prior to distribution to the pre-

termination effort? The answer is no. Settlement costs are

incurred in different circumstances than nonsettlement

costs. 4 0 8 Thus, when settlement costs, such as attorneys

fees, are charged directly to a terminated contract, a

contractor is not required to remove non-settlement attorneys

fees from indirect cost groupings prior to distribution to

40 9
the terminated contract.

c. Whether Costs Normally Charaed Indirectly Should Be

Burdened with Indirect Costs

Direct cost is commonly used as a distribution base because

it provides an approximate measure of the relative benefits

received by the several cost objectives from an indirect cost

grouping. 4 1 0 When direct cost does not closely approximate

the relative benefits received by the several cost objectives

105
it is not used as a distribution base (i.e., burdened with

indirect costs).411 Thus, when indirect costs are treated as

direct costs for purposes of a termination settlement,

whether or not these new direct costs should be burdened with

indirect costs (added to the distribution base) depends upon

whether their incurrence marks an increase in benefits

received from the indirect cost pool. In most instances,

their direct charging does not mark such an increase. Common

sense dictates that direct charging of an indirect cost

signifies, if anything, that the terminated contract benefits

less from the costs remaining in the indirect cost grouping

than it did prior to the direct charging.

Boards and courts usually do not allow contractors to recover

indirect costs on costs that would be classified as indirect

but for the termination. 4 1 2 They reason that one cannot

charge overhead on overhead. 4 1 3 In effect, they characterize

the direct charge as an element of overhead or an indirect

cost even though it is charged directly.

C. Subcontractor Claims

The FAR provides the following guidance on burdening

subcontractor claims with indirect costs:

An appropriate share of the contractor's indirect

expense may be allocated to the amount of settlements
with subcontractors; provided, that the amount
allocated is reasonably proportionate to the relative -N
benefits received I . . . The indirect expense so

106
'*N' ~ N%
~ 'N~ItdNV'
~ ' ~ N,
RJ% ' N '~ . ** -~~ - -~.-'. -
 allocated shall exclude the same and similar costs
claimed directly or indirectly as settlement
expenses.414

Generally, this means that settlements with subcontractors

cannot be burdened with factory indirect costs (because the

subcontract effort did not benefit from such costs) but can

be burdened with G&A. 4 1 5 G&A on subcontractor settlements

may be allowed even when the Government settles directly with

4 16
the subcontractor.

Receipt of G&A on subcontractor settlements is not automatic.

For example, in Sunstrand Turbo v. United States the

contractor was not allowed to burden the settlement value of

terminated fixed price subcontracts with G&A. 4 1 7 The ASBCA,

in an earlier opinion, found no evidence that the contractor

had failed to recover all the pre-termination G&A it had

incurred through application of its G&A rate to other

work. 4 1 8 The ASBCA's decision was influenced by the fact

that the contractor's other work during the pre-termination

period included a substantial number of cost plus fixed fee

Government contracts. 4 1 9 The Court upheld the Board because

the contractor was unable to establish that the record did

not support the Board's finding.

In Worsham Construction Co., 4 2 0 the contractor was permitted

to recover home office overhead (G&A) at 50% of its standard

home office overhead rate. Although it was the contractor's

107

,~%-% ~ I V N, V.
normal practice to include subcontract costs in its direct

cost base, the contractor did not prove what relationship

existed between subcontract costs and the incurrence of home

office overhead. Thus, the Board did not allow the full

overhead rate to be applied.

D. Unabsorbed Overhead

Unabsorbed overhead occurring before termination is

42 1
recoverable under the Termination for Convenience clause.

Termination of a contract complicates recovery of pre-

termination unabsorbed overhead. For example, it raises

questions as to which costs should be included in Eichleay

formula "billings. ''4 2 2 In addition, termination, as

discussed below, may allow contractors to recover unabsorbed

overhead when delay is contractor caused. Excepting these

differences, quantum and entitlement are determined in the

same manner whether a contract proceeds to completion or is

423
terminated for convenience.

When a contract is terminated for convenience, unabsorbed

overhead is normally recovered under the Termination for

424
Convenience clause rather than another contract clause.

The Termination for Convenience clause may permit a

contractor to recover unabsorbed overhead where it would not

be so entitled had the contract proceeded to completion.

Specifically, a contractor may be entitled to pre-termination

108
 unabsorbed overhead where delay is contractor caused. 4 2 5 In

Worsham Construction Co., the ASBCA stated:

The parties are simply arguing the unabsorbed overhead

issue as if an equitable adjustment under a firm-
fixed-price contract is involved. The Government
assumes, that if the claimed event would not be
compensable if the termination had not occurred, costs
attributable to that claim event also are not
recoverable as part of the termination settlement.
This basic assumption underlying the Government
position is erroneous. Even assuming that the delayed
performance of the contract was caused in part by
appellant under the controlling TFC clause the
contractor is entitled to recover all allowable
costs.426

A recent Claims Court decision, Penberthy Electromelt Int'l

v. United States4 27 casts doubt on the extent to which

Worsham Construction Co. will be followed by other boards and

courts. In Penberthy the Court held that "[f or plaintiff to

recover, it must show that it. incurred reasonable and

unavoidable costs because of defendant's improper delay in

either finally terminating the contract, or giving notice to

proceed with the work. . . Plaintiff cannot meet this test

[because] the delay, at least initially, was caused by

plaintiff." 4 2 8 However, the Court did not refer to Worsham

Construction Co., decided the previous year; apparently the

case was not brought to its attention. The Court failed to

distinguish between recovery of delay damages under a

completed contract and recovery of delay damages under a

contract terminated for convenience; the issue simply was not

addressed.

109

SA
&Qnk r
E. Accountinq Records

It is often said that a termination for convenience turns a

4 29
fixed price contract into a cost reimbursement contract.

There is, however, a substantial difference between a fixed

price contract terminated for convenience and a cost

reimbursement contract--the availability of records from

430
which cost can be determined.

Cost accounting systems are designed to provide data for

specific, regularly occurring events. 4 3 1 A termination for

convenience is an unusual event in that contracts normally

proceed to completion. 4 3 2 For this reason, an accounting
V

system "adequate for allocating costs to final cost

objectives should all final cost objectives be completed may

'4 3 3
be inadequate when terminations occur."

When a contract is terminated for convenience one needs an

accounting system capable of measuring costs at varying

stages of contract completion. Unfortunately, only very -5

sophisticated cost accounting systems have this capacity, and

such systems are expensive to establish and maintain.

Because of the cost, few contractors performing fixed price

contracts have a cost accounting system capable of measuring

4 34
cost at varying stages of contract completion.

110I
While the FAR specifically states that contractors are not

required to maintain "unduly elaborate" cost accounting

systems for the purposes of measuring costs should the

contract be terminated for convenience, 4 3 5 a contractor has

the burden of proof with respect to termination costs 4 3 6 and

its settlement proposal must be supported in reasonable

detail by adequate accounting data. 4 3 7 Meeting this burden

of proof in the absence of a cost accounting system capable

of measuring cost at various stages of contract completion

presents problems. 4 3 8 The FAR has attempted to ameliorate

439
these problems by allowing contractors to estimate costs

and to use total cost as a basis for recovery. 4 4 0 Normally,

contractors will be compensated for their indirect costs

whenever a reasonable basis for measurement exists 4 4 1 -- I.

particularly for indirect costs incurred before

termination. 4 4 2 Nonetheless, the absence of adequate cost Il

records may prevent a contractor from recovering indirect

44 3
costs or reduce its recovery.

F. Cost Principles

indicate that allowability of cost becomes a

The cases

significant issue when a contract is terminated for

convenience. 4 4 4 The Government closely examines costs

included in indirect costs pools and is quick to question

their allowability even when the settlement amount claimed is

small. 4 4 5 With this in mind, it is important to note that

111 1
the Cost Principles may have less effect in determining

allowability when a contract is terminated for convenience

than at other times.

Although Termination for Convenience clauses state that the

Cost Principles shall be used as the basis for proposing,

negotiating, and determining costs under terminated

contracts, 4 4 6 the exact role of the Cost Principles is

unclear. 4 4 7 The Cost Principles are not applied to

terminations for convenience with the same rigor as they are

to other pricing actions. 4 4 8 Strict application of the Cost

Principles would make unallowable certain costs which a

4 49
contractor may have included in its fixed-price bid.

The FAR supports the position that the Cost Principles need

not be strictly applied: "The cost principles . . . shall,

subject to the general principles in 49.201, . . . be

used in asserting, negotiating, or determining costs relevant

to termination settlements." 4 5 0 The general principles of

FAR 49.201 stress fairness and judgment over strict

accounting rules in determining the amount of a termination

settlement. 4 5 1 Thus, a number of cases have adopted the view

that the Cost Principles need not be strictly applied to

terminations for convenience. 4 5 2 Nonetheless, it appears the

exception rather than the rule when a board or court decides

that application of the Cost Principles would result in a

4 53
contractor being compensated unfairly.

112
G. General Limits on Recovery of Indirect Costs

The FAR places a ceiling on recovery of termination costs. 4 54

The total amount payable (excluding settlement costs) to a
contractor with a fixed-price contract is the contract price
less payments made under the contract. 4 5 5 While this is a
general cost limitation, the ceiling may prevent recovery of
indirect costs to which a contractor would otherwise be
entitled. A contractor that cannot recover all of its costs
due to this general cost ceiling should ensure that:

(1) An unpriced constructive change 4 56 or differing site

condition 4 57 is not the reason that costs exceed conLract
price. Either would entitle a contractor to an equitable
adjustment and a corresponding increase in the cost ceiling.
(2) All direct and indirect costs, properly characterized as
settlement costs, are claimed as settlement costs rather than
4 58
as costs of performance.

Because they are not costs of "performing" the terminated

work, settlement costs are not subject to the price
ceiling.459

113

% . d, ,
 i/t

II. CONTINUING COSTS

The FAR makes continuing costs allowable, stating: "Despite

all reasonable efforts by the contractor, costs which cannot

be discontinued immediately after the effective date of

termination are generally allo,;able. ''4 6 0 Continuing costs

include salaries and other direct costs incurred after

termination related to de-activation of personnel, 4 61

severance pay, 4 6 2 work in progress, 4 6 3 continuing facilities

and equipment costs, 4 6 4 mitigation costs, 4 6 5 and post-

termination unabsorbed overhead. 4 6 6

Costs normally included in overhead can qualify as continuing

costs and be recovered directly. 4 67 Continuing costs, to the

extent they are incurred in performance of a direct cost

function, can be burdened with indirect costs. For example,

completion of work in progress is a direct cost function that

should be burdened with indirect costs. Severance pay, on

the other hand, is not a direct cost function and accordingly

4 68
should not bear any indirect costs.

IV. SETTLEMENT COSTS

A contractor whose contract is terminated for convenience has

a number of duties imposed upon it by the Termination for

Convenience clause. 4 6 9 These duties include preparing and

presenting a termination settlement to the contracting

114
 %. N

officer; terminating and settling subcontractor claims; and

storing, transporting, protecting and disposing of
termination inventory. 4 70 Settlement costs are not subject

to the price ceiling. 4 7 1 Contractors are entitled to full

reimbursement for the costs of settling a contract. An

*exception is made when the contract contains a "short-form"

termination for convenience clause. 4 7 2 Contractors are not

entitled to profit on settlement costs. 4 7 3

A. Direct Recovery of Normally Indirect Costs

d%

Settlement actions often involve labor for storage,

transportation, protection, and disposal of termination

inventory, considerable administrative effort executive

time, and legal and accounting effort--all of which are

normally indirect charges. 4 7 4 Despite their normally

indirect nature, these costs usually are charged directly to

47 5
the terminated contract.

As a prerequisite to direct charging a contractor must

present proof that the settlement costs were excluded from

its indirect cost groupings. 4 7 6 when settlement costs are

treated as indirect costs when incurred, their subsequent

removal from indirect cost groupings may be too late to
prevent over recovery and thus may preclude direct

charging. 4 7 7 The burden of proving that direct charging will

not result in double recovery (that the cost was removed from

115

W.4
JU .4L' )* 4 ~ ~ ~
 the indirect cost grouping prior to allocation) lies with the

contractor.478

Under the FAR, a contractor is limited in its ability to

burden settlement costs. 4 7 9 Usually, the only burden that

can be placed on settlement costs is payroll taxes, fringe

benefits, occupancy costs, and immediate supervision costs

related to salary and wages incurred as settlement

expenses.410

The probable reason for the FAR's limiting the burden on

direct settlement costs is:

481
(1) Potential double recovery;

(2) Perception that settlement costs are easily identified

and capable of being charged directly;4 8 2 and

(3) The settlement action usually benefits differently than

other cost objectives from the incurrence of indirect

costs-483

Because the ability to burden settlement costs is limited and .

because profit is not allowable on settlement costs,

contractors should not claim costs properly recoverable as

pre-termination or continuing costs as settlement costs.

The limitation imposed by FAR 31.205-42(g) (iii) on the

burdening of settlement costs is not absolute. The

116

.4..) .. '~.,* . . . '..~-.. ~ ~' % 1

limitation is prefaced by the word "normally" indicating

that it may not apply in all circumstances. 4 8 4 In numerous

cases, boards have not limited the burden on settlement

costs. 4 8 5 Generally, the nature of the settlement cost

determines whether or not the limitation will apply. 4 8 6

Normally, boards refuse to apply the limitation to settlement

work of direct labor employees but will not hesitate to limit

or disallow additional burden on indirect costs reclassified

48 7
as direct for purposes of settlement.
a

Bedingfield and Rosen suggest several alternatives to direct

charging that contractors can use to recover indirect

settlement costs other than those related to salaries and

wages incurred as settlement expenses. 4 8 8 First, they

suggest negotiating a "special indirect cost allocation in

the nature of the one-time allocation authorized under 4 CFR z

410.50(j) ."489 In the alternative, they suggest a

reconstitution of existing indirect cost pools so as to

allocate to the terminated contract only those indirect

expenses which provided services to settlement action.

B. Burden of Proof

490
A contractor bears the burden of proving settlement costs.

The lenient attitude that exists with respect to proof cf

pre-termination performance costs may not carry over into the

settlement area. Termination serves as notice to a

117
contractor that any future costs incurred for the terminated

contract must be recovered on what is, in effect, a cost

basis and that proof of their incurrence will be a

prerequisite to recovery. One would, therefore, expect more

record keeping.

To ensure full recovery, contractors would be well advised to

49 1
present accounting records detailing their actual costs.

Detailed accounting records cannot be developed after the

fact. To present detailed accounting records, most

contractors will have to modify their accounting systems upon

receipt of notice of termination. 4 9 2 In the absence of

detailed accounting records, contemporaneous written

documentation will aid recovery. 4 9 3 If settlement expenses

are expected to be significant contractors should obtain

expert accounting advice.

In order to obtain detailed cost data to substantiate the

direct charging of settlement costs 4 9 4 indirect costs must be

segregated and specifically identified to the settlement

action. In most instances, this is a three-step process.

First, the contractor's accounting system is modified by

establishing a separate cost account to specifically identify

and accumulate settlement costs. 4 9 5 Second, steps must be

taken to prevent double charging--to ensure that costs

claimed directly as settlement costs are removed from

indirect cost pools and that proof of their removal is

118
-w -. -. -. .
available for audit review. 4 9 6 Finally, to ensure that all

indirect settlement costs are identified for direct charging,

contractor personnel at all levels must keep time records

supporting their settlement efforts. Because persons

performing settlement work are usually people who do not keep

time records in the course of their normal duties some

4 97
training and behavioral modification is necessary.

C. Types of Settlement Costs

The FAR lists three categories of settlement costs, costs of:

(1) preparing and presenting the termination settlement, (2)

settling subcontractor claims; and (3) safeguarding,

inventorying, and disposing of terminated inventory and

special equipment. 4 9 8 Because settlement costs generally

would be charged indirectly but for the termination, selected

issues involving their recovery are discussed briefly below.

1. Costs of Preparing and Presenting a Termination

Settlement

The costs of preparing and presenting a termination

settlement typically include the salaries of the contractor's

administrative staff and executive personnel, legal fees,

accounting services, and the service of experts.

Surprisingly, these costs are the subject of frequent

litigation. The areas of contest are (1) adequacy of the

119
contractor's proof that it incurred such costs, 4 9 9 (2)

reasonableness of the claimed costs, and (3) whether such

costs were in fact incurred in the preparation and

presentation of the termination settlement rather than in the

prosecution of a claim against the Government.

a. Reasonableness

To be allowable, a cost must be reasonable both in nature and

amount. The Government closely reviews settlement costs and

frequently challenges the reasonableness of (1) attorney's

fees, 500 (2) use of outside experts, 5 0 1 (3) the number of

hours expended by the contractor in preparing and presenting

its termination settlement, 5 0 2 and (4) having professional

personnel do clerical work. 5 0 3 Reasonableness is determined

by analysis of the individual costs claimed and not by how

large settlement expenses are in proportion to the total

50 4
amount claimed.

b. Proving that Costs Claimed Were Not Costs of Making

a Claim Against the Government

Unlike costs of preparing and presenting a settlement

proposal to the contracting officer, costs of making a claim

against the Government (appealing a contracting officer's

final decision) are not allowable. 5 0 5 The Government will

challenge costs of contesting a termination for default

120
(whether or not successful) and of contesting the contracting

officer's final decision as to the amount of the termination

settlement. To avoid dispute and ensure recovery of

allowable costs, contractors should treat the costs of

preparing and presenting a termination settlement proposal to

the contracting officer and the Costs of challenging the

contracting officer's final decision as separate cost

objectives. 5 0 6 Furthermore, contractors must be prepared to

explain why certain costs were charged as costs of preparing

and presenting the termination settlement rather than as

costs of making a claim against the Government.507

Challenging a contracting officer's final decision as to a

default termination or the amount of a termination settlement

can be expensive and, as indicated above, is no t

reimbursable. Whenever possible contractors naturally try to

characterize such costs as costs of preparing and presenting

a settlement proposal to the contracting officer rather than

as costs of making a claim against the Government.

I
Generally, the boards of contract appeals have allowed such

characterization whenever a reasonable relationship to the

settlement proposal is proven. 5 0 8

1I
t

121
2. Costs of Safeguarding, Inventorying. and DisDosinc

of Terminated Inventory

The costs of safeguarding, inventorying and disposing of

inventory are costs normally included in overhead. 5 0 9

However, they are recovered as direct costs when incurred for

terminated inventory. 5 1 0 Attempts by contractors to recover

such costs through markups on the terminated inventory are

usually unsuccessful. For example, in Essex Electro

Engineers, the contractor unsuccessfully attempted to recover

costs of handling, restocking, and cancelling orders by

adding its normal overhead markup to the purchase price of

the cancelled and returned material. 5 1 1 Because it was

improper under the procurement regulations to include the

cost of cancelled and returned materials in the settlement

proposal the Board found it improper to include a markup on

such materials. 5 1 2 The Board noted that it was not the

contractor's usual accounting practice to add overhead on

items cancelled or returned to the vendor. 5 1 3 Absent proof

that the cancelled or returned materials generated the same

material handling costs as did materials used in

manufacturing and incorporated into the final product they

cannot be burdened with the contractor's standard markup for

material handling. 5 1 4

122
V. UNABSORBED OVERHEAD AFTER TERMINATION FOR

CONVENIENCE

When a contract is terminated for convenience, performance on

the terminated portion of the contract normally stops.

Despite work stoppage, the contractor's fixed indirect costs

continue. Indirect costs that would have been charged to the

terminated portion of the contract and are not picked up by

substituted work are "unabsorbed." 5 1 5 The boards of contract

appeals and the courts view these unabsorbed indirect costs

as ongoing business costs unrelated to the terminated

5 16
contract and not recoverable.

Several commentators 5 1 7 strongly believe that post-

termination unabsorbed overhead should be compensable,

"particularly where the terminated contract represents a

substantial portion of the contractor's work or where the

obtaining of contracts in the industry requires substantial

5 18
lead time."

Joseph and O'Donnell argue that post-termination unabsorbed

overhead should be recoverable because:

(1) Recovery is not prohibited by regulation or law.

(2) The regulatory objective of fairly compensating the

contractor is thwarted when denial of unabsorbed overhead

results in a loss to the contractor. 5 1 9

123
(3) Recovery of unabsorbed overhead is permitted by the

Government in analogous contexts such as partial terminations

and delay.

(4) Recovery of unabsorbed overhead incurred after contract

52 0
termination is permitted in commercial practice.

Paul Trueger devotes 18 pages of his text, Accounting Guide

for Government Contracts, to supporting his belief that such

costs should be compensable. 5 2 1 In his opinion, equity

requires compensation. The contractor deployed people,

space, and facilities to perform the Government contract and

when confronted with a unilateral decision to terminate

cannot immediately "swing into business on new business the

day after the abrupt Government action." 5 2 2 Furthermore,

from a cost accounting viewpoint, he believes there is no

basis to charge such costs to any cost objective other than

52 3
the terminated contract which caused their unabsorption.

Despite this criticism, boards and courts continue to deny

unabsorbed overhead except in unusual circumstances. 5 2 4 They

view ongoing fixed indirect costs as simply the contractor's

costs of remaining in business. The Government's obligation

to a terminated contractor is to compensate it fairly for the

work performed on the terminated contract and for its

settlement costs. 5 2 5 The Government's obligation stops

there--the Government is not a guarantor of new work. A long

line of cases supports denial of continuing overhead costs

124
 .

after contract termination. 5 2 6 If the law is to change,

boards and courts see it as the duty of Congress or the

drafters of the procurement regulations to make the

527
change.

The commentators' criticism that a contractor usually is not

as well off financially when a contract is terminated before

completion is valid. Not only does the contractor lose the

profit it would have made on the terminated work but also the

fixed indirect costs that the terminated work would have

absorbed (unless termination allows the contractor to obtain

substitute work that the contractor would not otherwise have

obtained) .528 Noting the validity of such criticism, does

not lead to the conclusion that contractors should recover

post-termination unabsorbed overhead. 5 2 9 A contractor's

financial position, while hurt by the termination, may have

been considerably enhanced by the unterminated portion of the

contract. Without this unterminated work the contractor

might have had even less work during the period to absorb

fixed indirect costs. Unless the contractor, in anticipation

of the performance of the terminated contract, forwent other

work which would have fully absorbed the continuing indirect

costs, its financial position has not been adversely affected

by acceptance of the contract.

4

But the question is not whether the contractor is as well off

after termination as it would have been had the contract

125
proceeded to completion. The question is whether the
Government should, or does, at the time of contracting,
guarantee to the contractor that in the event of contract

termination the contractor will recover its fixed indirect

costs the same as if the contract had proceeded to

5 30
completion.

If the Government were to so guarantee, a contractor's

recovery might be greater against the Government than against

a private party despite the fact that anticipatory profits

are not recoverable against the Government. At common law,

upon termination for breach of contract an injured seller is

entitled to recover as damages contract price less any costs

saved by the termination. In many states fixed indirect

costs incurred after termination are viewed as costs saved by

the termination and are unrecoverable. 5 3 1

Allowing contractors to recover post-termination unabsorbed

overhead would:

(1) Change a time-honored scheme of recovery.

(2) Make it more expensive for the Government to terminate

contracts for its convenience and significantly alter the

economics of a termination for convenience.

(3) Require the Government to pay anticipatory indirect

costs--a cost similar to, if not in fact, anticipatory

2
profit. 5 3

126

4rW
I

(4) Have the Government question a contractor's failure to

bid on and obtain additional work in mitigation of the

terminated contract.

How far the Government should go in making a contractor whole

for the effects of a termination for convenience is a

question that requires a complex balancing of interests and,

as recognized by the ASBCA, is an area better suited to

533
legislative change than judicial reform.

Since the Government does not compensate contractors for

unabsorbed overhead incurred after termination, Paul Trueger "I

recommends direct charging of any overhead costs that can be

characterized as continuing costs. 5 3 4 He indicates his

success in obtaining a substantial portion of unabsorbed

overhead through direct charging for reasonable periods of U.

5 35
time following termination.

VI. PARTIAL TERMINATIONS FOR CONVENIENCE

When the Government terminates only a portion of the work

called for under the c( tract, the contract is partially

terminated for convenience. Under the Termination for

Convenience clause, a contractor is entitled to its costs

incurred in preparing to perform and in performing the

terminated portion of the contract, reasonable profit

thereon, and its costs of preparing the termination

127
.-
. t w ~ ) .. - =_ B.- _=. - °

settlement proposal, plus an equitable adjustment for any

increased costs caused by the termination in performing the

unterminated portion of the contract. In principle, there is

little difference in pricing a contract partially terminated

for convenience and one entirely terminated for

convenience.536

Nonetheless, pricing a partial termination for convenience is

more difficult than pricing a contract entirely terminated

for convenience in that the parties must (1) segregate costs

incurred for the terminated and unterminated portions of the

contract, (2) determine the amount of contract price

applicable to the terminated portion of the contract, 5 3 7 and

(3) determine the amount by which the cost of performing the

unterminated portion of the contract increased as a result of

the partial termination.

A. Indirect Costs of the Terminated Portion of the

Contract

Indirect costs nf the terminated porLion of the contract are dP

determined just as if the contract had been completely

terminated, except that nonrecurring indirect costs (e.g.,

start-up costs) must be allocated between the terminated and

unterminated portions of the contract. 5 3 8 Had the contract

had been entirely terminated for convenience these

128
 nonrecurring costs would be recovered in their entirety as

part of the termination settlement.

.%
I.

B. Indirect Costs of the Unterminated Portion of the

Contract

The unterminated portion of the contract remains priced at

the original contract price. 5 3 9 However, a contractor is

entitled to an equitable adjustment for any increased

costs of performing the unterminated portion of the contract

A

caused by the termination. 5 4 0 The contractor's costs of

performing the unterminated portion of the contract may be

increased by a variety of factors including: inability to

take advantage of volume discounts on purchases,541 loss of

learning curve benefits, 5 4 2 unabsorbed nonrecurring direct

54 4
costs, 5 4 3 and unabsorbed fixed indirect costs.

1. Volume Discounts. Learninq Curve Benefits, and

5$

Unabsorbed Nonrecurring Direct Costs

A partial termination for convenience may reduce the quantity

of material needed for performance and the volume of

purchases made by the contractor. As a result of not buying

in quantity the contractor's unit cost of materials for the

unterminated portion of the contract may increase.

Similarly, the unit cost of the unterminated portion of the

contract may increase as a result of loss of learning curve

129

* -. ''V _' ' pS5 Z22€

C, C. .. ? ¢> J ,- 'v-., ... .o '. .' .S,,,,[. .~5
'¢ .- .4"%
benefits. 5 4 5 The first units of a lot produced often cost
I

substantially more to produce than the last units in that the .

people producing the units as they gain experience become

more proficient. A partial termination for convenience

deletes the latter less costly units of production, thereby

increasing the average cost of the unterminated units. The

unit cost of the unterminated work is also increased when

nonrecurring direct costs such as special tooling are

allocated over a smaller number of units.

The contractor is entitled to an equitable adjustment for its

increased costs of performing the unterminated portion of the

contract in each of the situations described above. For

purposes of an equitable adjustment the contractor first

determines how much the direct costs of performing the
unterminated portion of the contract were increased. The

indirect cost portion of the equitable adjustment usually is

determined by multiplying the contractor's normal indirect

6
cost rate by the increase in direct costs. 5 4

2. Unabsorbed Indirect Costs

A partial termination for convenience may reduce the volume

of work performed during an accounting period thereby causing

each of the contractor's cost objectives to bear an increased

portion of fixed indirect cost. When this happens, a

contractor is entitled to an equitable adjustment in the
13

130oS
price of the unterminated portion of the contract. 5 4 7 Note

that all partial terminations for convenience do not reduce a

contractor's distribution base--a contractor may be incapable

of performing even the unterminated portion of the contract

within the accounting period or may obtain substitute

work. 5 4 8 To obtain an equitable adjustment, a contractor

must prove that the partial termination for convenience in

54 9
fact reduced its distribution base.

The equitable adjustment compensates the contractor for the

unterminated portion of the contract's proportionate share of

the fixed indirect costs that would have been absorbed by the

terminated work. The computation is a five step process: (1)

remove variable indirect costs from the indirect cost

grouping; (2) determine the contractor's actual fixed a

indirect cost rate; (3) determine what the contractor's fixed

indirect cost rate would have been had the contract not been

partially terminated; (4) subtract this indirect cost rate

from the actual fixed indirect cost rate; and (5) multiply

the rate differential by the direct costs of the unterminated

work to obtain the unabsorbed overhead allocable to the

unterminated portion of the contract. 5 5 0 Reasonable profit

55 1
should be added to the unabsorbed overhead computation.

In several cases involving partial terminations for

convenience, the ASBCA erred in measuring unabsorbed

overhead. In Celesco Industries, Inc., the Board compared

131
N
[ L. 1 17 C.7 X.

the indirect cost rate used by the contractor in preparing

its bid to the contractor's actual indirect cost rate to

determine whether the partial termination had caused

unabsorbed overhead. 5 5 2 Because the actual indirect cost

rate was lower than the rate upon which the bid was based the

Board determined the contractor suffered no harm and denied

recovery of unabsorbed overhead. 5 5 3 The Board's comparison

of bid indirect cost rates to actual indirect cost rates

measures the amount by which the initial contract price would

have increased had the parties known at the time of

contracting what the contractor's actual indirect cost rate

would be--which is irrelevant. 5 5 4 The Board ignored the fact

that the partial termination increased the contractor's

costs of performing the unterminated portion of the contract

finding it inconsequential that actual indirect cost rates

were higher than they would have been had the contract not

been partially terminated.

In Wheeler Brothers, Inc., a requirements contract was

partially terminated for convenience (constructively) when

the Government purchased automotive parts from dealers other

than Wheeler Brothers. 5 5 5 The Board awarded Wheeler Brothers

a $398,687 equitable adjustment to the contract price of the

unterminated portion of the contract for unabsorbed overhead.

The questionable portion of the opinion was the Board's

assumption, in the absence of evidence by the Government to

the contrary, that the contractor's indirect costs would not

132

AN
a z
 have increased had the contract not been partially

terminated. 5 5 6 The Board assumed that actual overhead for

the period, $1,360,025, at a sales volume of $6,751,685 would

remain unchanged had sales volume increased by 40 percent to

$9,551,685. Rarely will any contractor's overhead costs be

entirely fixed costs (i.e., include no variable cost

elements) .557 The Board's decision is objectionable from

another perspective as well. It is the contractor who has

the burden of proof and must prove quantum. In the absence

of evidence as to what portion of an indirect cost grouping

is variable, boards should find that the contractor has not

met its burden of proof and limit or deny recovery

accordingly.

i 133
 CHAPTER 5

CONSISTENCY

The purpose of this chapter is to discuss the consistency

requirement as it applies to equitable adjustments and

terminations for convenience. Much of Chapter 5 discusses

consistency in seemingly general terms because (1)

consistency issues, to a large degree, are the same whether

it is a cost reimbursement or cost plus fixed fee contract,

an equitable adjustment or a termination for convenience that

is being priced; 5 5 8 (2) the case law arises primarily in the

context of cost reimbursement or cost plus fixed fee

contracts; and (3) the procurement regulations address

consistency in general terms. Separate discussion of general

but important consistency issues would be needlessly

repetitive.

Issues of consistency are more complex for equitable

adjustments and terminations for convenience than for cost

reimbursement and cost plus fixed fee contracts. This is

because equitable adjustments and termination settlement

agreements are pricing actions necessitated by change--it is

in the context of this change that issues of consistency

arise. Although the issues are more complex, the courts and

boards decide these issues with less explanation than they do

for a cost reimbursement or cost plus fixed contract. For

equitable adjustments consistency is usually a subsidiary

134

S-%r F r
 issue, the fact of inconsistency in many instances is

obvious, and dollar amount small in proportion to consistency

issues arising in the context of a cost reimbursement or cost

plus fixed fee contract. For terminations for convenience

(1) the procurement regulations specifically permit direct

charging of certain costs that otherwise would be charged

indirectly and (2) absent cost accounting systems capable of

measuring costs accurately at various stages of contract

completion, recovery does not depend upon accounting to the

degree that it does for cost reimbursement contracts, but

depends in substantial part on the board or court's

determination of fair compensation.

Consistency has been discussed in Chapters 2, 3, and 4, as it

applies to subject matter of those chapters. This chapter

addresses consistency in more general terms. It begins with

a discussion of the purpose and sources of the consistency

requirement and then discusses inconsistent classification of

costs as direct or indirect, assignment of costs to indirect

cost groupings, distribution base selection, base period

selection; changes in cost accounting practices; and

consistency as it applies to equitable adjustments and

termination settlements.

135

MZ ~ ~ ~ , ~ ~ ~ $ ~
%--* 1
~
1. REQUIREMENT FOR CONSISTENCY

A. Purpose of Consistency Reguirement.

Consistency in accounting for costs is a fundamental

accounting principle. 5 5 9 Consistency provides a common basis

for comparison. It enhances comparison of costs by period,

product line, and division. It also enhances comparison of

estimated with actual costs. The value of consistency is

that it eliminates differences caused by varying methods of

recording, measuring, and allocating costs leaving decision

makers with just differences important to the decision making

process.

Consistency in accounting for costs also reduces the

likelihood of error. As employees become more familiar with

accounting practices and procedures, they make fewer

bookkeeping errors. Furthermore, consistency increases the

likelihood that all costs of a particular cost objective will

be charged to that cost objective and that the cost objective

will not have the same cost charged to it more than once.

Consistency enhances the acceptability of an accounting

system for cost measurement purposes. It provides some

assurance that a contractor's accounting practices and

procedures were chosen for their ability to impartially

136
approximate cost rather than to maximize the cost charged to

a particular cost objective.

Consistency, however, is not always obtainable or desirable.

Accounting systems must change as the product mix,

organizational structure, and/or needs of the organization

change. Accounting practices that once equitably allocated

costs to the several cost objectives may no longer do so as

new products are added or new production techniques

implemented. The objective is to balance the need for

consistency with the need to change in response to changing

circumstances.

B. Source of the Consistency Requirement

Consistency is required by GAAP, the Cost Principles, and by

the CAS. Boards and courts seldom refer to these sources

when faced with consistency issues but instead address the

requirement for consistent accounting treatment in terms of

preventing over recovery of cost.

1. Generally Accepted Accounting Princivles

In Chapter 1, the usefulness of GAAP as a guide for

measuring, accumulating, and allocating costs was questioned

because GAAP were developed primarily for financial

reporting--not for cost accounting--purposes and because of

137
the large number of often conflicting sources of authority

for GAAP. 5 6 0 However, GAAP unquestionably require

consistency.5 6 1 Consistency is an absolute requirement of

accounting for both financial reporting and cost accounting

purposes.

2. The Cost Principles

The Cost Principles are mandatory for pricing equitable

adjustments and terminations for convenience. 5 6 2 Under the

Cost Principles, allowable costs are determined in accordance

with the CAS, if applicable, otherwise in accordance with

GAAP. 5 6 3 As explained in this Chapter, both the CAS and GAAP

require consistency.

In addition to incorporating the consistency requirements of

the CAS, if applicable, and if not, of GAAP, specific Cost I

Principle provisions require contractors to be consistent in

classifying costs as direct or indirect. 5 6 4 FAR Part 31

prohibits direct charging of any costs that have been

charged indirectly in like circumstances. "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." 565 Similarly, FAR Part 31 also prohibits

indirect charging of any costs that have been charged

138
I

directly in like circumstances. "An indirect cost shall not

be allocated to a final cost objective if other costs

incurred for the same purpose in like circumstances have been

included as a direct cost of that or any other final cost

objective. "566

The Cost Principles, literally applied, would preclude any

recovery of a cost (either directly or indirectly) if other

costs incurred for the same purpose in like circumstances had

been charged directly in one instance and indirectly in

another--even if the inconsistency did not involve the

Government and the cost were otherwise properly allocable to

a Government contract. In practice, boards and courts will

be hesitant to entirely deny recovery of a cost reasonably

567
incurred and otherwise allocable to the contract.

3. The Cost AccountinG Standards

The consistency requirements of the CAS are set forth in CAS

401 and 402. CAS 401 and 402 apply whenever a contract is
8
subject to either full or modified CAS-coverage. 5 6

Disclosure by a contractor of its accounting practices, at

the contract's inception allows the Government to ascertain

later whether or not the contractor is in fact being

consistent. 5 6 9 Under both CAS 401 and 402, contractors are

permitted to make changes in their accounting practices.

139
Such changes, however, must be accomplished through

initiation of a formal accounting change.

a. Cost Accountina Standard 401--Consistency in

Estimatina. Accumulatina. and Reportina Costs

CAS 401 requires contractors to follow consistent cost

accounting practices in estimating, accumulating and

reporting costs. 57 0 Specifically,

[Closts estimated for proposal purposes shall be

presented in such a manner and in such detail that any
significant cost can be compared with the actual costs
accumulated and reported therefor. In any event the
cost accounting practices used in estimating costs, in
pricing a proposal and in accumulating and reporting
costs on the resulting contract shall be consistent
with respect to:* (1) [t]he classification of costs as
direct and indirect; (2) the indirect cost pools to
which each element or function of cost is charged or
proposed to be charged; and (3) methods of allocating
57 1
indirect costs to the contract.

Consistency in estimating, accumulating and reporting costs

improves comparability of actual 5 7 2 with estimated costs.

The result is better financial control over costs during

contract performance and easier evaluation of a contractor's

estimating capabilities. 57 3 Note that CAS 401 permits a

contractor to use greater detail in accumulating and

reporting costs 5 7 4 than in estimating costs. 57 5 A contractor

violates CAS 401 when it does not use the same cost

accounting practices to determine the amount of a request for !%

payment (reporting costs) as it did to estimate its costs of

140
 .4
.4

performance. 5 7 6 Failure to follow consistent accounting

practices when preparing a request for payment results in

payment being disallowed to the extent that it exceeds what

would have been payable had the contractor followed

consistent accounting practices.577

For a prospectively priced change order, CAS 401 requires

contractors, subject to the CAS, to estimate costs using the

same cost accounting practices that will be used to

accumulate and report such costs. For a termination for

convenience, CAS 401, requires contractors, subject to the )

CAS, to accumulate and report, to the extent possible, pre-

5,

termination costs using the same cost accounting practices

that were used to originally estimate costs of performing the

contract.

To date, CAS 401 has not played a major role in the pricing

of equitable adjustments or termination settlements. CAS

401, if discussed, is mentioned in the context of defective

pricing. No case so far has discussed CAS 401 as it relates

to an equitable adjustment or a termination settlement.

Nonetheless, if the contract is CAS-covered, contractors are

required to follow CAS 401 when preparing proposals for

equitable adjustments or termination settlements.

.14

141
 b. Cost Accountina Standard 402- -Consistency in

Allocating Costs Incurred for the Same Purpose

"Whereas CAS 401 is concerned with consistency between

estimated and actual costs, CAS 402 is concerned with the

treatment of costs as direct or indirect." 5 7 8 The purpose of

CAS 402 is to ensure that "each type of cost is allocated

only once and on only one basis to any contract or other cost

obiective." 57 9 By requiring consistent treatment of costs as

either direct or indirect, CAS 402 eliminates a potential

means for overcharging Government contracts. 580 The

fundamental requirement of CAS 402 is:

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. No final cost objective shall have
allocated to it as an indirect cost any cost, if other
costs incurred for the same purpose, in like
circumstances, have been included as a direct cost of
that or any other final cost objective. Further, 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.581

Consistency is determined by comparing the cost accounting

practices employed by a contractor to its established

accounting practices as described in its Disclosure

Statement. 5 8 2 If a Disclosure Statement is not on file the

contractor's accounting practices in use at the time of

contract proposal are considered its established accounting

practices. 5 8 3 When use of a contractor's disclosed or

142

.-"-.
, . -". " "". "," "," "-" """ , . '" N
-,,?
i""
-'"" '...,i " ,.., ' " , i
established accounting practices will cause an inequitable

distribution of costs, contractors are permitted to change to

584
accounting practices that equitably distribute costs.

Once adopted, an accounting change must be followed

consistencly thereafter.
'
The key to applying CAS 402 is understanding what is meant by

the phrase "cost incurred for the same purpose in like

circumstances. '5 8 5 The meaning of this phrase is discussed

in the following section.

II. APPLICATION OF THE CONSISTENCY REQUIREMENT

Consistent accounting treatment is very important to the

recovery of indirect costs, whether recovered as part of an

equitable adjustment or termination settlement. Inconsistent

treatment of costs allows contractors to game their

accounting systems to maximize recovery of costs from the

Government, when instead their accounting systems should

impartially measure the amount of cost which Government

contracts and commercial cost objectives, respectively,

58 6
should bear.

Contractor's should be consistent in:

(1) Classifying costs as direct or indirect

(2) Assigning costs to indirect cost groupings

143
(3) Distributing indirect cost groupings to the several cost

objectives

(4) Selecting a base period.

Double counting or over recovery of cost may result from

failure to be consistent as explained below.

A. Classifying Costs as Direct or Indirect

Costs are classified as direct costs if (1) the beneficial or

causal relationship between incurrence of the cost and the

final cost objective is clear and exclusive, (2) the amount

of the cost is readily and economically measurable, and (3)

all other costs incurred for the same purpose in like

circumstances can be identified specifically with final cost

objectives and accounted for as direct costs. 5 8 7 Similarly,

costs are classified as indirect costs when these conditions

58 8
are not met.

The classification principles are general in nature 5 8 9

leaving room for contractors to exercise judgment as to which

costs can be economically identified with separate final cost

objectives. 5 9 0 Contractors exercise this judgment when they

initially establish their cost accounting practices. Once

cost accounting practices are established, the contractor has

limited discretion in reclassifying costs as direct or

indirect. 5 9 1 All costs must be classified in accordance with

144 ,
the contractor's established cost accounting practices until

such time as the contractor's established cost accounting

practices become inequitable and are changed. 5 9 2 An

exception occurs when a contractor's established cost

accounting practices classify costs as direct or indirect in

obvious conflict with the FAR or other regulatory

guidance. 5 9 3 Regulatory requirements for cost classification

take precedence over a contractor's established cost

accounting practices.

1. Overcharging Results from Inconsistent

Classification of Costs as Direct or Indirect

Inconsistent classification of costs as direct or indirect

causes overcharging in four ways.

(1) When a cost is charged directly to a government contract

and is also allocated as an indirect charge to the contract,

the contractor is recovering the same cost both directly and

indirectly.594

(2) When a normally indirect cost is charged directly to a

Government contract, failure to remove other costs incurred

for the same purpose in like circumstances from the indirect

cost grouping 5 9 5 causes the Government contract to bear, as a

direct cost, the total amount of a particular cost that it

145
generated plus, as an indirect charge, a portion of the

particular cost generated by other contracts.

(3) When a normally direct cost incurred for the benefit of a

commercial contract is included in an indirect cost grouping

and other costs incurred for the same purpose in like

circumstances are charged directly, a Government contract

will bear, as a direct cost, the total amount of a particular

cost that it generated plus, as an indirect charge, a portion

of the particular cost generated by the commercial

contract.596

(4) When a contractor reclassifies costs as direct or

indirect depending upon the type of contract and the economic

conditions experienced or expected during contract

performance overcharging is caused as illustrated below:

[A) contractor proposes to charge certain costs as

direct because the anticipated cost level is higher
than the historical cost level. On its next contract,
however, the contractor proposes to charge these costs
as indirect because the anticipated cost level is
lower than the historical level. E.g., the overhead
rate is 150 percent of direct labor dollars, and
travel is 10 percent of overhead (or 15 percent of
direct labor dollars). The contractor estimates that
the new contract travel will amount to 20 percent of
direct labor dollars. If it reclassifies travel as
"direct," its overhead rate will drop to 135 percent
of direct labor dollars, but it will also recover
travel in the amount of 20 percent of direct labor
dollars, or a total recovery of 155 percent of direct
labor dollars. On the next contract if travel is
estimated as 10 percent of direct labor dollars, the
contractor reclassifies travel as "indirect" and
recovers overhead at 150 percent of direct labor,
instead of at 135 percent plus 10 percent. 5 97

146
. . . i . i i -
2. uCosts Incurred for the Same Purpose in Like

Circumstances"

The Cost Principles and CAS 402 both require contractors to

be consistent in their classification of costs as direct and

indirect and they use similar language to do so. 5 9 8 The

language used to establish the requirement is:

No final cost objective shall have allocated to it as

an indirect cost any cost, if other costs incurred for
the same purpose, in like circumstances, have been
included as a direct cost of that or any other final
cost objective. Further, 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.599

The key to applying the consistency requirement of either the

Cost Principles or CAS 402 lies in determining what

constitutes "a cost incurred for the same purpose in like

circumstances." The Cost Principles offer no guidance other

than what can be inferred from their allowance of certain

normally indirect costs as direct charges. 6 0 0 Guidance is

provided by CAS 402 and by the boards and courts.

a. CAS 402 Guidance

CAS 402 establishes a two part test for determining whether a

contractor's classification of a cost as direct or indirect

is consistent with its classification of other costs. If a

147
cost is not "incurred for the same purpose" or if the

circumstances are different, the contractor is free to

classify it without regard to how other costs were

classified. CAS 402 briefly discusses both parts of the

test.

(i) Costs Incurred for the Same Purpose. CAS 402

provides two illustrations of "costs incurred for the same

purpose."'6 0 1 Illustration one: A contractor normally

charges all travel costs indirectly. For purposes of a new

proposal, the contractor intends to classify the travel costs

of personnel whose labor will be charged directly to the

contract as a direct cost. The travel costs of personnel

whose time is accounted for as direct labor working on other

contracts are "costs incurred for the same purpose" and may

no longer be included within indirect cost pools allocated to

any covered Government contract. 6 0 2 The illustration

suggests that the travel costs of direct cost employees and

travel costs of indirect cost employees are incurred for

different purposes. Restated, costs "directly associated"

with a direct cost are incurred for a different purpose than

costs directly associated with indirect costs. 6 0 3 A second

point is made as well: the fact that the type of cost

(travel) is the same does not, in and of itself, make the

purpose the same. Illustration two: "A contractor

normally charges planning costs indirectly and allocates U

these costs to all contracts on the basis of direct labor. A

148
proposal for a new contract requires a disproportionate

amount of planning costs."'6 0 4 The contractor may not charge

the planning costs as direct costs. 6 0 5 The illustration

demonstrates that the amount of cost incurred does not

change the purpose for which it was incurred.

CAS 402 also provides two illustrations of costs "not

incurred for the same purpose."'6 0 6 Illustration one: The

contractor's Disclosure Statement indicates that special

tooling and general purpose tooling serve different purposes

and that it is the contractor's practice to charge special

tooling as a direct cost and general tooling as an indirect

cost. Since the costs are not costs incurred for the same

purpose, the contractor does not violate the standard by

charging special tooling costs directly to the contract and

general purpose tooling costs indirectly. The illustration

shows that (1) special tooling is incurred for a different

purpose than general purpose tooling and (2) the fact that

the type of cost (tooling) is the same does not, in and of

itself, make the purpose the same. Illustration two: A

contractor proposes to perform a contract which will require

three fixed-post firemen for highly inflammable materials

used on the contract. The contractor presently employs ten

firemen for general protection of the plant. It intends to

charge to the contract the salaries of fixed-post firemen as

a direct cost and allocate to the contract a portion of the

salaries of general purpose firemen as an indirect cost.

149
This is permissible in that the function performed by the

fixed-post firemen--protecting highly flammable materials for

a specific contract--is different from the function of the

general purpose firemen-- providing overall plant protection.

(ii) Costs Incurred In Like Circumstances. The CAS

Board has issued an Interpretation discussing "costs incurred

in like circumstances" as applied to bid and proposal

costs. 6 07 The Interpretation states:

Under 30.402, costs incurred in preparing, submitting,

and supporting proposals pursuant to a specific
requirement of an existing contract are considered to
have been incurred in different circumstances from the
circumstances under which costs incurred in preparing
proposals which do not result from such specific
requirement. The circumstances are different because
the costs of preparing proposals specifically required
by the provisions of an existing contract relate only
to that contract while other proposal costs relate to
608
all work of the contractor.

Thus, under CAS 402, costs specifically required by an

existing contract provision are incurred under different

circumstances than costs not specifically required.

This interpretation is the only guidance issued by the CASB

explaining what constitutes a cost incurred in like

circumstances.

150

~. ~ .. ~ ~ ~ ~ 9
 W-, IlW
F?

b. Decisions of the Boards and Courts

Unfortunately, case law provides little guidance as to what

constitutes "other costs incurred for the same purpose in

like circumstances." Boards and courts seldom decide cases 44

by applying the language "other costs incurred for the same

purpose in like circumstances" to the facts of a particular

case. 6 0 9 They do not say, "this is a cost incurred for the

same purpose because. . . ." or "this is a cost incurred in

like circumstances because. . . ." Most decisions address

inconsistency where the cost in question obviously was

incurred for the same purpose and in like circumstances as

other costs- -explanation as to why the purpose is the same

61 0
and why the circumstances are like is unnecessary.

However, the case law has discussed consistency in two A

commonly occurring factual patterns where it is not self

evident that the cost was incurred for the same purpose and

in like circumstances as other costs. The factual patterns

are: (1) one of the several cost objectives requires more of

an indirect cost than other cost objectives and (2) direct

cost functions are performed by an employee or officer whose

salary is normally charged indirectly.

1516

-I V P4MV p , A~ . - '~~ -A~

(i One of Several Cost Objectives Reauires More of an

Indirect Cost than Other Cost Objectives

Often one contract requires more of a particular indirect

resource than do other cost objectives. In most cases, this

resource is the time of a supervisor, an officer of the firm,

or an administrative person. 6 1 1 When a contract requires

more of an indirect cost than other cost objectives require,

the contractor naturally wants to be compensated accordingly.

If the contractor's indirect cost base does not provide this

additional compensation, the contractor often attempts to

charge the cost directly to the contract. 6 1 2 Boards and

courts have not allowed contractors to charge these costs

directly even when the contractor specifically identifies the

cost to the contract and proves that its allocation system

does not fully compensate it for this indirect cost on this

contract.613

The case law is correct in denying direct recovery. Direct

recovery, if allowed, would create numerous opportunities for

overcharging the Government and significantly increase audit

and administrative costs. 6 1 4 To prevent overcharging the

following actions would be necessary: (1) direct charging of

indirect cost resources of which the Government contract used

a disproportionately small share; (2) treating commercial

cost objectives in a like manner as Government contracts;

i.e., identifying and charging as direct costs to commercial

152
contracts indirect cost resources of which they required more

of than other cost objectives; and (3) making certain that

the reclassified cost and other indirect costs incurred for

the same purpose are removed from indirect cost groupings

prior to distribution to the specially affected contract. As

a practical matter, it would be extremely difficult for the

Government to determine whether these actions in fact were

taken.

Obviously, the mere fact that a contract requires more of a

particular indirect cost than other cost objectives does not

effect the purpose for which the cost was incurred. The

pertinent question is whether the increase in quantity

constitutes a sufficient change in circumstances to permit

direct charging? As indicated above, boards and courts have

found that it does not. 6 1 5 This does not necessarily mean

that the contractor must suffer a loss on a contract

requiring a disproportionate amount of indirect cost effort.

The contractor can propose a change to its accounting

system 6 1 6 or in exceptional cases can obtain a special

6 17
allocation from the indirect cost grouping.

(ii) Direct Cost Functions Performed by an Employee or

Officer Whose Salary Is Normally Charaed Indirectly

When an employee or officer, whose salary is normally charged

as an indirect cost, performs direct cost functions, a

153

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.i~-** ~ ~ .~4 . ~
.. - ~* 4,* %**: ~ -b~a
contractor may try to recover part of the person's salary as

a direct cost. Boards and courts have allowed direct

recovery of time spent by an employee performing direct cost

functions and indirect recovery of the remaining portion. 6 1 8

A representative case is Airtech Services, Inc.6 1 9 For

services rendered as project managers, the contractor charged

directly to the contract a portion of the salaries of two

corporate executives; the remainder of the two salaries was

included in an indirect cost pool. The contracting officer,

relying on the procurement regulations, removed the two

salaries from the indirect cost pool, reasoning that because

a portion of the salaries had been charged directly, the

remaining portion must be charged directly as well. The

Board interpreted FPR 1-15.202(a) as not requiring that a

person's salary be charged entirely as a direct cost or

entirely as an indirect cost. 6 2 0 The consistency requirement

under FPR 1-15.202(a) was expressed in the following

language. "When items ordinarily charged as indirect costs

are charged to Government work as direct costs, the costs of

the like items applicable to other work of the contractor

must be eliminated from indirect costs allocated to

Government work." The question before the DOT CAB was

whether a persons time was a like item regardless of the

function being performed. The Board reasoned that a person's

time could be charged directly in one instance and indirectly

in another so long as different functions were performed.

154
Applying the functional test case, the Board expressed the

FPR requirement as follows: "if any part of the work effort

of these two executives during the base year can be

specifically identified with other projects of the

contractor, then recompense for that effort shall be charged

directly to these other projects and shall be eliminated from

the indirect costs allocated to this contract. " 6 2 1 The Board

found no evidence in the record that either executive had

acted as p:oject manager for any other project or that either

had become so actively engaged in any other projects that a

portion of their salary should be specifically identified

with such projects.

As Airtech Services illustrates, it is not necessarily

inconsistent to charge a portion of a person's salary as a

direct charge and the remainder indirectly. However, the

work for which the direct charge is permitted must vary

qualitatively from work normally performed.6 2 2 A direct

charge is not warranted simply because a contractor spends

significantly more time on one cost objective than on others.

B. Assignment of Costs to Indirect Cost Groupings

Contractors often have a number of indirect cost

groupings. 6 2 3 They must assign costs to these indirect cost

groupings in a consistent manner. 6 2 4 The indirect cost

grouping to which a cost is assigned determines how it is

155
 V. 50,71-7 VCR

distributed to the several cost objectives. Indirect cost

groupings are distributed using different distribution bases

and often to different cost objectives. 6 2 5 For example, a

cost included in a factory overhead pool usually is

distributed to those cost objectives that generate direct

labor and in proportion to the direct labor generated. On

the other hand, a cost included in a G&A pool usually is

distributed to cost objectives on the basis of cost input and

to cost objectives in addition to those that generate direct

labor. Inconsistent assignment of cost to indirect cost

groupings can significantly increase the amount of indirect

cost charged to a Government contract. 6 2 6 Consistency

requires (1) advance determination on how costs will be

assigned to indirect cost gioupings and (2) close adherence

to that determination.
:P

C. Distribution of Costs to the Several Cost

Objectives

Once a distribution base is selected for an indirect cost

grouping it must be consistently followed from accounting

period to accounting period. 62 7

Furthermore, this

distribution base must be used to allocate all costs within

an indirect cost grouping. 6 2 8 When a cost objective benefits

significantly more or less than other cost objectives from

the incurrence of indirect costs, there is incentive to

distribute indirect costs to this cost objective using a

156 '

'e I
separate distribution base. 6 2 9 However, doing so is an
63 0
inconsistent accounting practice and is not permissible.

If a cost objective consistently benefits more or less than

other cost objectives from an indirect cost grouping, the

contractor should consider changing its distribution base to

one that more equitably allocates costs to all cost

objectives.631

Consistency also requires that each unit of a contractor's

distribution base be burdened with a pro rata share of the

indirect cost grouping. 6 3 2 Thus, unallowable costs cannot be

excluded from a distribution base but must bear a pro rata

633
share of indirect cost.

D. Base Period Selection

Normally, a contractor will select a calendar or fiscal year

as its base period for accumulating indirect costs. 6 3 4 Once

adopted, a base period should be used consistently over time

and all of a contractor's costs should be accumulated using

5
that base period. 6 3

By selectively changing the length of its base period a

contractor can improperly increase i.7 recovery of indirect

costs. For example, significant fourth quarter indirect

costs might encourage a contractor to price a Government

change order performed during the fourth quarter by using

157
5-
 F

that quarter as its base period rather than its customary

base period of one year. 6 3 6 Such use would result in the

change order bearing more indirect costs than if the

contractor's customary one year base period were used.

Similarly, if a construction contract were terminated for

convenience in its second year, use of the period of contract

performance as the base period rather than each individual

year might result in over recovery of indirect costs if most

of the pre-termination work took place in a year when

637
indirect costs were low or volume high.

Selectively changing the time at which the period begins can

cause over recovery of indirect costs. For example, if a

contractor had little work in the last quarter of its prior

year, beginning the following base period to include that

last quarter would enable the contractor to assign the

indirect costs of that last quarter against Government change

orders occurring in the new base year. Selective changing of

this type is an inconsistent accounting practice and any

additional recovery of indirect costs generated should be

disallowed.

III. Chanae in Cost Accountinq Practice

Consistency is not always obtainable or desirable;

circumstances change and when they do, cost accounting

practices that were once equitable, may become

158 p

" -- " - . 5 - i. . . . .. - " /

 inequitable. 6 3 8 Either the Government or the contractor can

request a change in the contractor's established accounting

practices. Refusal of the other party to agree is not

necessarily determinative because a board or court will give

effect to a change if (1) the established accounting practice

is inequitable and (2) the new practice equitably distributes

cost. 6 3 9

A cost accounting practice becomes inequitable when it no

longer distributes indirect costs between the contractor's

commercial and Government work in reasonable proportion to

the benefits received. However, an accounting practice is

not inequitable because it does not distribute costs to a

particular cost objective in reasonable proportion to the

benefits received. 6 4 0 Nor is an accounting practice

inequitable merely because a different accounting practice

would decrease the Government's costs or increase the

contractor's recovery.641

Contractor's are not usually permitted to make accounting

changes that are applicable only to certain contracts or

portions of their business. 6 4 2 To be effective, the change

must apply to the contractor's entire business.

10

159

Y! -".-Y '
 -O VV---

A. Chanae Under the CAS

A contractor, subject to either full or modified CAS

coverage, 6 4 3 must follow its disclosed and/or established

cost accounting practices. 6 4 4 However, a change in cost

accounting practice 6 4 5 is permissible when changing

circumstances make established cost accounting practices

inequitable. 6 4 6 Changes to cost accounting practices can be

applied only prospectively to CAS-covered and modified-CAS-

covered contracts. 6 4 7 If a contractor has a Disclosure

Statement on file, the contractor must amend the Disclosure

Statement to reflect the change. 6 4 8 Contractors must notify

the contracting officer, in writing, of a proposed change 60

days before its proposed implementation. 6 4 9 Notification is

.4

to include a description of the accounting change and the

general dollar effect the change will have on all the

contractor's CAS-covered contracts and subcontracts. 6 5 0

After notification of the change, the contractor is required

to submit a cost impact proposal. 6 5 1 The contracting officer .

will analyze the cost impact proposal tc. determine whether

the proposed change will result in increased costs being paid

by the Government. 6 5 2 If the proposed change decreases

653
costs, a downward equitable adjustment will be negotiated.

However, the Government will allow a cost increase only if

the contracting officer determines that the change is

"desirable and not detrimental to the Government." 6 5 4

160
 If a contractor fails to follow its disclosed and/or

established accounting practices and as a result Government

costs are increased, the Government is entitled to a downward

adjustment of the contract price (fixed price contract) 6 5 5 or

cost allowance (cost reimbursement contract).656 The

contractor will be required to correct its noncompliance and

to submit a cost impact statement. 6 5 7 The amount of the

downward adjustment is the increase in costs paid by the

6 58
Government as a result of the inconsistency plus interest.

B. Change When the CAS Are Not Applicable

Contractors not subject to the CAS can also change their cost

accounting practices when such practices become

inequitable. 6 5 9 Likewise, when changing circumstances make

established cost accounting practices inequitable to the

Government, the Government will request that the contractor

make changes. If the contractor refuses to do so, the

contracting officer will disallow any costs above what, in

his/her opinion, equitable cost accounting practices would

allow.660

The regulations do not prescribe procedures for making

changes to non-CAS-covered contracts nor do they require

affirmative disclosure of such changes other than as required

by GAAP. 6 61 Despite the lack of formal procedures,

contractors should informally follow the procedures required

161

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for CAS-covered contracts; that is, contractors should

provide advance notice to the contracting officer explaining

the change, why it is necessary and how the change is

expected to impact cost. 6 6 2 Advance notice and "up front"

dealing will enhance a contractor's chances of having its

proposed change accepted.

C. Prospective Versus Retroactive ADplication of

Chances

For CAS-covered and modified CAS-covered contracts changes in

accounting practice can be applied prospectively only.

However, for non-CAS-covered contracts retroactive

application of a change in cost accounting change is

permissible in certain circumstances.

1. CAS-Covered Contracts

FAR 30.201-4 requires that a clause be included in CAS-

covered and modified-CAS-covered contracts precluding

retroactive application of a change in cost accounting

practice. 6 6 3 Thus, under the terms of the contract

retroactive change is not permissible and any increased costs

resulting to the Government from retroactive application are

unallowable.6 6 4 In those cases where a contractor can prove

that the Government acquiesced in or approved the retroactive

162
application of a change in accounting practice, boards and
6 65
courts probably will permit retroactive application.

Limiting changes in cost accounting practice to prospective

application seems harsh. By the time a contractor or the

Government recognizes that use of a contractor's established

cost accounting practices is inequitable due to a change in

circumstances, the contract may be substantially performed.

Because a change is prospective it is not effective as of the

date of the change in circumstances. Thus, for the period of

time between the change in circumstances and the date the

change in cost accounting practice is implemented, the

contractor either will be inequitably over or under

compensated. On the other hand, applying the change

prospectively adds certainty to the contractual relationship.

The Government is relieved of the risk of paying additional

compensation for work already completed; a contractor is

relieved of the risk of refunding payment received or

experiencing nonreceipt of expected payment. Prospective

application of a change allows the adversely affected party

to gage the future cost impact and plan accordingly.

b. Non-CAS-Covered Contracts

The terms of non-CAS-covered contracts normally do not

preclude retroactive application of a change in cost

163
accounting practice. 6 6 6 Even so, retroactive application is

permitted only in exceptional cases.

Absent compelling reason, sound accounting practice dictates

that contractors make changes to their accounting systems at

the start of their fiscal year. 6 67 A mid-year change creates

two inconsistent accounting practices for the same accounting

period and complicates cost measurement. 6 6 8 Thus, mid-year

changes in accounting practice are more difficult to justify

6 69
than changes at the start of a contractor's fiscal year.

Similarly, boards and courts have been reluctant to

67 0
retroactively apply changes in cost accounting practice.

A change 'in accounting practice can be retroactively applied

only "where unusual circumstances in a contractor's

operations do not become apparent until after completion of

one or several contracts, or until expiration of a

representative period of time." 6 7 1 The nature of commercial

transactions demands finality at some point in time; the

threat of a change in accounting practice being retroactively

applied diminishes the ability of both the Government and the

67 2
contractor to determine cost and act in reliance upon it.

When the Government seeks to change the contractor's cost

accounting practices, it is usually because such practices

distribute a disproportionately large share of the

contractor's indirect costs to Government cost reimbursement

164
and cost plus fixed fee contracts. Inequitable distribution

of indirect costs that occurred before the effective date of

the change can be corrected by giving the change retroactive

effect. However, boards and courts normally refuse to do

so.673 The reason is that the contractor would have to

refund to the Government the overpayment received on cost

reimbursement and cost plus fixed fee contracts and cannot

after the fact reprice its fixed-price contracts to recover

the refunded indirect costs. 6 7 4 On balance, the boards and

courts favor the contractor, preferring to have the

Government pay more than its fair share of indirect costs

than to force a "forfeiture" upon the contractor. 6 7 5

Retroactive application of a change does not force a

forfeiture upon the contractor despite the contractor's

inability to reprice its fixed price contracts. As Chapter 1
explained, most pricing decisions are based on the

interaction of supply and demand in the market--not on

cost. 6 7 6 Thus, it is rather unlikely that the contractor

would have increased its bid for fixed-price contracts had it

known at the time of bidding that less indirect costs would

be absorbed by cost reimbursement and cost plus fixed fee

contracts. 6 7 7 In most circumstances, the contractor obtains

a dollar for dollar increase in profit when cost

reimbursement and cost plus fixed fee contracts bear an

inequitably high share of indirect costs.

165
The real threat to the contractor from retroactively applying

a change in accounting practice is that the contractor may

have altered its financial position in reliance upon what it

perceived were its profits for the period. For example, it

may have paid out increased dividends, given bonuses, or made

investments that it otherwise would not have made.

Retroactive application of an accounting change may be

inequitable for this reason.

IV. CONSISTENCY IN THE PRICING OF EQUITABLE

ADJUSTMENTS

The usual method of determining indirect cost is by

multiplying the contractor's indirect cost rate by the

increased direct costs of performance caused by the event

necessitating the equitable adjustment. 6 7 8 When the

contractor attempts to recover normally indirect costs

through other methods consistency questions arise.

A. Direct Charging of Normally Indirect Costs

Boards and courts have not allowed contractors to reclassify

indirect costs as direct costs for purposes of pricing

equitable adjustments. 67 9 The event necessitating an

equitable adjustment is not viewed as a change in

circumstance sufficient to permit reclassification. In the

following two circumstances contractors often attempt to

166
J4
reclassify normally indirect costs as direct costs: (1) a

standard percentage markup (10-15% of direct cost) is used to

determine recovery of indirect cost or (2) the contract terms

limit the percentage markup for indirect costs. As Chapter 2

explains, the boards and courts have not permitted

68 0
reclassification in either instance.

Many costs normally charged indirectly could be specifically

identified to the several cost objectives if it were

economically feasible to do so. 6 8 1 A change to a contract

that entitles a contractor to an equitable adjustment may

make it economically feasible for a contractor to

specifically identify normally indirect costs with the

change, if by doing so, the contractor recovers these costs

directly rather than indirectly. The economic incentive to

recover normally indirect costs directly is greatest when a

change order benefits substantially more from the incurrence

68 2
of normally indirect costs than other cost objectives.

The economic incentive is lowest when the change order

benefits less from the incurrence of normally indirect costs

6 83
than other cost objectives.

The fact that a change order may have benefited more from a

particular indirect cost than other cost objectives does not

alter the purpose or the circumstances for which the indirect

cost was incurred. 6 8 4 Direct charging of such costs is

inconsistent with the contractor's established cost

167

.A j, *UA P 1 L L
accounting practices and results in over recovery. 6 8 5 If

reclassification is permitted and the reclassified cost is

then burdened with a markup for indirect costs, the over

recovery is compounded. 6 8 6 As indicated above, boards seldom

allow direct recovery of indirect costs even when the

contractor can prove that a particular change order benefited

6 87
more from an indirect cost than other cost objectives.

B. Methods of Recoverina Indirect Costs

1. Standard Markup for Indirect Costs

A contractor must use its normal indirect cost rate for

purposes of pricing equitable adjustments. 6 8 8 However, 1i

r

boards and courts have traditionally allowed use of a

standard percentage markup, usually 10 to 15%, on direct

costs of the change, in lieu of the contractor's indirect

cost rate. 6 8 9 Use of the standard markup has not been deemed

an inconsistent accounting practice. However, when actual

indirect cost rates are available or either party can prove a

projected overhead rate computed in accordance with the

contractor's established accounting practices such rates are

used rather than the percentage markup on direct costs. 6 9 0

168
1
2. Recovery of Indirect costs During Delay

When a fixed-price Government contract is delayed,

application of a contractor's indirect cost rate to the

direct costs of performance may inequitably allocate fixed

indirect costs to the delayed contract. 6 9 1 For this reason,

another method of allocating fixed indirect costs is often

used for the delay period; one such as method is the Eichleay
69 2
formula.

Use of an alternate method of assigning fixed indirect costs

to the delayed contract during the delay period is

permissible (i.e., is not an inconsistent accounting

practice) because the delay constitutes a sufficient change

693
in circumstances to permit use of changed procedures.

However, a contractor cannot recover its fixed indirect costs

during the delay period under a formula such as Eichleay and

also recover its fixed indirect costs by applying its normal

indirect cost rate to direct performance costs incurred

694
during the delay.

C. Bid and Proposal Costs

Under CAS 402, it is not an inconsistent accounting practice

for a contractor to (1) charge directly the costs of

preparing, submitting, or supporting proposals incurred

pursuant to a specific requirement of an existing contract

169
 = - - - - -- F 7-7- 7V -- -. -W

and to (2) charge indirectly the costs of preparing,

submitting, or supporting proposals not incurred pursuant to

a specific requirement of the contract. 6 9 5 "The

circumstances are different because the costs of preparing

proposals specifically required by the provisions of an

existing contract relate only to that contract while other

69 6
proposal costs relate to all work of the contractor."

The Preambles to CAS 402 state that proposals submitted under

the Changes clause can be charged directly to the affected

contract because such proposals are specifically required by

contract provision. 6 9 7 The cost of proposals submitted under

clauses other than the Changes clause, (e.g., Differing Sites

Conditions, Suspension of Work, Stop-Work-Order, Government

Delay of Work, and Termination for Convenience) can be

charged directly as well. 6 9 8 Direct charging is permissible

only when it is the contractor's established accounting

practice to recover bid and proposal costs specifically

required by existing contracts as direct costs. 6 9 9 However,

when a change is cancelled before the incurrence of any

direct costs, a contractor may be permitted to recover its

bid and proposal costs directly notwithstanding its

established accounting practices 700

170 '
-. - . - . .- .4 - - 4 .

.2

V. CONSISTENCY IN THE PRICING OF TERMINATIONS FOR

CONVENIENCE

When consistency is raised in the context of pricing a

termination for convenience, the issue is seldom whether

prior terminations for convenience were priced in the same

manner. Terminations for convenience are irregularly

cccurring events for which few, if any, contractors would

have established accounting practices.

The consistency requirement as it applies to terminations for

convenience is in most respects identical to that of a cost

plus fixed fee or cost reimbursement contra:t. 7 01 For

example, consistency in the assignment of costs to indirect

costs groupings and in use of the distribution base are

7 02
identical.

There are two major difference in the consistency requirement

between cost plus fixed fee/cost reimbursement contracts and

contracts terminated for convenience. First, under a

termination for convenience, many normally indirect cost ar

recovered directly. The consistency requirement and how it

affects reclassification of costs for terminations for

convenience is discussed in Chapter 4.703 Second, under a

termination for convenience, the period of contract

performance (a period other than the contractor's fiscal

171

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year) frequently is used as the base period for accumulating
70 4
indirect costs.

Use of the period of contract performance rather than the

contractor's normal fiscal year as the base period for

purposes of a termination for convenience should be

considered an inconsistent cost accounting practice although

it has not been recognized as such by the boards and courts.

Under GAAP, contractors must consistently follow their

established cost accounting practices (including choice of

705
base period) until such time as they become inequitable.

Although established cost accounting practices can be changed

or, in some instances, exceptions can be made, 7 0 6 proof that

an established cost accounting practice is inequitable and

that an alternative practice is equitable is a prerequisite

to a change or exception.7 0 7 The fact of termination does

not provide this proof. A termination for convenience seldom

makes the contractor's fiscal year inequitable as a base

period. 7 08 Furthermore, the period of contract performance

may be an inequitable alternative because as Chapter 2

explained, base periods of less than or greater than one year

frequently fail to represent the contractor's normal

operations. 7 0 9 Finally, allowing contractors to selectively

chose either their fiscal year or the period of contract

performance as their base period depending upon which yields

the most favorable result is inequitable to the

Government. 710

172

-.. NF- N.
 CONCLUSION

The accurate determination of indirect costs for purposes of

equitable adjustments and terminations for convenience

presents a challenge to the Government contracting community.

This challenge can be met only by understanding the cost

allocation process--its mechanics and limitations.

This thesis addressed several important principles that

affect recovery of indirect cost. First, changes in volume

do not increase or decrease the amount of fixed indirect

costs within the relevant range of production but do increase

or decrease the proportionate share of fixed indirect cost

absorbed by each unit of production. This is a fundamental

principle that must be understood. It explains why, when

volume changes, projected indirect cost rates fail to

distribute fixed indirect costs accurately to the several

cost objectives. It also provides the basis for unabsorbed

overhead. A second fundamental principle is the need for

consistency. Failure to follow consistent cost accounting

practices causes some cost objectives to bear an inequitable

portion of indirect costs. The illustrations in Chapter 5,

explaining how inconsistent classification of costs as direct

or indirect causes over recovery warrant careful study.

Indirect costs should be reclassified as direct only when

necessary to compensate the contractor equitably and then,

steps should be taken to prevent over recovery.

173

, .m % P U,~t % °pp
!~P%
 -~ ' ~ h..*- TV T 77 K17 K. , &-

In several areas the law is still developing. One such area

is recovery of extended overhead. The concept is distinct

from unabsorbed overhead. Analysis of extended overhead and

the basis for its recovery has been hindered by its use as a

synonym for unabsorbed overhead. The author's analysis shows

that extended overhead should not be recoverable for two

reasons: (1) the period of extended performance does not

increase fixed indirect costs and (2) it does not decrease

the volume of work performed by the contractor (i.e., has no

effect on the number of units of production available to

absorb fixed indirect costs). The second unsettled area of

the law is measurement of unabsorbed overhead. The Eichleay

formula has been used by the boards of contract appeals for

over 25 years and its use was affirmed in 1984 by the Court

of Appeals for the Federal Circuit. Notwithstanding, the

Eichleay formula infrequently measures unabsorbed overhead

correctly. Unfortunately, attempts to discredit the Eichleay

formula have been unsuccessful for two reasons: (1) an

acceptable alternative has not been off-ed and (2) the

presumptions upon which the formula rests have not been fully

analyzed. This thesis argues that unabsorbed overhead can be

measured more accurately through estimation than through use

of any formula including the Eichleay formula. The author

recognizes that formulas can measure unabsorbed overhead

accurately if the presumptions upon which they are based are

valid. Before using any formula to measure unabsorbed

174

2
 overhead, one must examine the presumptions upon which the

formula's validity depends, determine whether they are valid

under the circumstances, and if they are not valid, adjust

the formula's computation of unabsorbed overhead accordingly.

Chapter 3 identified six presumptions upon which the Eichleay

formula's validity rests.

This thesis explained the basic elements and problem areas

associated with the recovery of indirect costs for equitable

adjustments and termination settlements. The author's

purpose in clarifying these areas is to promote a better

understanding of how indirect costs are recovered with the

hope that this understanding will lead to more accurate cost

measurement.

. a-7
 FOOTNOTES
1
J. CIBINIC & R. NASH, ADMINISTRATION OF GOVERNMENT CONTRACTS, 267
(2d ed. 1985).
2 FAR
52.243-4.
3 Cibinic
& Nash, supra note 1, at 281.
4
-' Suspension of Work clause, FAR 52.249-10.
5
FAR 52.236-2.

6 Cibinic & Nash, supra note 1, at 350.

7 Defense
Contract Audit Pamphlet (DCAAP) 7641.45, AUDIT
GUIDANCE DELAY AND DISRUPTION CLAIMS, p.1 (1983)
8 L. ANDERSON, ACCOUNTING FOR GOVERNMENT CONTRACTS, COST ACCOUNTING
STANDARDS, 4-21 (1986).
9 BruceConstr. v. United States, 163 Ct.Cl. 97, 100, 324 F.
2d 516 (1963). Accord J. F. Shea Co. v. United States, 10
Cl. Ct. 620, 627 (1986); Varo, Inc. v. United States, 212
Ct. Cl. 432, 443 (1977); Nager Elec. v. United States, 194
Ct.CI. 835, 852-53 (1971); American Int'l Mfg., ASBCA 25816,
84-3 BCA 17,698 at 88,285; Jacobson Constr., VABCA 1811, 84-
3 BCA 17563 at 87,498; Holtzen Constr., AGBCA 413, 75-2 BCA
11378 at 54,160; Space Age Eng'g, ASBCA 18600, 74-2 BCA
10869 at 51,722-23; Historical Servs., DOT CAB 72-8, 72-8A,
72-2 BCA 9582 at 44,789.
1 0 Coley
Properties v. United States, 219 Ct.Cl. 227, 236
(1979), Ed Goetz Painting Co., DOT CAB 1168, 83-1 BCA 16134
at 80,142.

llBruce Constr. v. United States, 163 Ct.Cl. 97, 100, 324

F.2d 516 (1963).

Since the purpose underlying such adjustments is to

safeguard the contractor against increased costs
engendered by the modification, it appears patent that
the measure of damages cannot be the value received by
the Government, but must be more closely related to
and contingent upon the altered position in which the
contractor finds himself by reason of the
modification.

176
 &

Accord Xplo Corp., DOTCAB 1409, 86-3 BCA 19280 at 97,471.

1 2 General
Ry. Signal Co., ENG BCA 3970, 84-1 BCA 17014 at
84,728, 84,730; American Elec., ASBCA 15152, 73-1 BCA 9787 at
45,733.
1 3 See
J. F. Shea Co. v. United States, 10 Cl. Ct. 620, 627
(1986); Pacific Architects & Eng'rs v. United States, 203
Ct.Cl. 499, 508, 491 F.2d 734 (1974); Dick & Kirkman, Inc.,
VABCA 1545, 1581, 84-3 BCA 17662 at 88,082; Atlantic Elec.,
GSBCA 6061, 83-1 BCA 16484 at 81,956; Massman Constr., ENG
BCA 3660, 81-1 BCA 15049 at 74,453; Holtzen Constr., AGBCA
413, 75-2 BCA 11378 at 54,160; Space Age Eng'g, ASBCA 18600,
74-2 BCA 10869 at 51,722; Itek Corp., Applied Technology
Div., ASBCA 13528, 71-1 BCA 8906 at 41,393.
1 4 Dick
& Kirkman, Inc., VABCA 1545, 1581, 84-3 BCA 17662 at
88,082. Accord R & E Elecs., VABCA 2227, 85-3 BCA 18316 at
91,895; Unicom Sys., ASBCA 29468, 84-3 BCA 17675 at 88,164;
Armanda, Inc., ASBCA 27354, 27385, 84-3 BCA 17,694 at 88,242;
Fluor Utah, Inc., IBCA 1068-4-75, 81-1 BCA 14876 at 73,521;
Massman Constr., ENG BCA 3660, 81-1 BCA 15049 at 74,453; E.
Arthur Higgins, AGBCA 76-128, 79-2 BCA 14050 at 69,066;
Celesco Indus., ASBCA 22251, 79-1 BCA 13604 at 66,683; G & M
Elec. Contractors, GSBCA 4771, 78-1 BCA 13452 at 65,733;
Ocean Technology, ASBCA 21363, 78-1 BCA 13204 at 64,586;
Franchi Constr., ASBCA 16735, 74-2 BCA 10654 at 50,598;
Warren Painting, ASBCA 18456, 74-2 BCA 10834 at 51,531;
Frank Biscoe Co., GSBCA 345, 73-1 BCA 10008 at 46,958;
Historical Servs., DOT CAB 72-8, 72-2 BCA 9582 at 44,789;
Varo, Inc., ASBCA 15000, 72-2 BCA 9717 at 45,356; Bregman
Constr., ASBCA 15020, 72-1 BCA 9411 at 43,718; Hensel Phelps
Constr., ASBCA 15142, 71-1 BCA 8796 at 40,872; Itek Corp.,
Applied Technology Div., ASBCA 13528,13848, 71-1 BCA 8906 at
41,393.
1 5 Platt
and Sons, ASBCA 20349, 75-2 BCA 11511 at 54,912.
1 6 Under
both the Suspension of Work clause (FAR 52.249-10)
and the Government Delay of Work clause (FAR 52.212-15)
contractors are allowed adjustments rather than equitable
adjustments.
1 7 The
"short form" termination clause for fixed price
contracts of $100,000 or less is at FAR 52.249-1. The "long
form" termination clause, mandatory for fixed price contracts

177

% "_-
of over $100,0000, is at FAR 52.249-2. The termination
clause for cost reimbursement contracts is at FAR 52.249-6.
1 8 Cibinic & Nash, supra note 1, at 773.
1 9 FAR 49.201(a) (emphasis added).
2 0 FAR 31.205-42(b).
21 FAR 31.205-42(g).
2 2 FAR 52.249-2.
2 3 j.
BULLOCH, D. KELLER, & C. VLASHO, ACCOUNTANTS' COST HANDBOOK, A
GUIDE FOR MANAGEMENT ACCOUNTING, 19.12-13 (3d ed. 1983). See
also J. FREMGEN & S. LIAo, THE ALLOCATION OF CORPORATE INDIRECT
COSTS, 19-20 (1981)

[TIhe costs that are relevant to pricing are

opportunity costs. . . . [In economic theory] the role
of costs in pricing . . is to determine supply, both
for the market as a whole and for the individual
seller, not to determine prices directly. In pure
competition, prices are established by the interaction
of supply and demand in the market. The individual
seller has no discretion; it accepts the market price
as given. If a single firm has costs below normal for
the industry, its advantage will be short-lived, as
competitors will promptly bid up the price for
whatever factor of production gives the firm its cost
advantage. Conversely, if one firm's costs are above
normal for the industry, it must either reduce them or
eventually go out of business. It cannot raise its
own prices to compensate for higher costs.

[In an imperfectly competitive market] product

differentiation permits a seller to manipulate its
price within some range without fear of retaliation by
competitors or loss of customers to them. Within this
range of price discretion, the individual firm's costs
may be used to establish the price. Exactly how cost
helps to determine price is not entirely clear,
however. Often, costs are used to establish initial
target prices, but management may then deviate from
those prices to cope with market forces or with other
considerations, such as the danger of increased
competition in the long run or the threat of
regulation.

178

-~~~~~~~~~~~~~~~ ~ , , .. ' U S-5P S % . S ~ ' .I.' NS*'

,S' F
 2 4 Department
of Defense, ARMED SERVICES PRICING MANUAL, 10-1
(1986) (hereinafter ASPM].
2 5 Professor
Charles T. Horngren defines cost as "resources
sacrificed or forgone to achieve a specific objective." C.
HORNGREN, COST ACCOUNTING, A MANAGERIAL EMPHASIS, 21 (5th ed.
1982).
2 6 FAR Part 31, Contract Cost Principles and Procedures.
27 L. ANDERSON, ACCOUNTING FOR GOVERNMENT CONTRACTS, COST ACCOUNTING
STANDARDS, (1986) ; J. BEDINGFIELD & L. ROSEN, GOVERNMENT CONTRACT
ACCOUNTING, (2d ed.1985); M. RISHE, GOVERNMENT CONTRACT COSTS,
(1st ed. 1984); P. TRUEGER, ACCOUNTING GUIDE FOR GOVERNMENT
CONTRACTS,(8th ed. 1985).
2 8 The
CAS were issued by the Cost Accounting Standards Board
(CASB) created by P.L. 91-379 in January 1971. The purpose
of the CASB was to achieve uniform and consistent cost
accounting standards for national defense contracts and rules
and regulations implementing those cost accounting standards.
P.L. 91-379(g),(h). Although the CASB ceased to exist in
1980 because Congress failed to fund it, between the years
1971 and 1980, the CASB promulgated 19 standards which are
mandatory for most negotiated contracts over $100,000.
2 9 FAR
30.201-1(b) exempts the following categories of
contracts and subcontracts, among others, from all CAS
requirements:

,* (1) Sealed bid contracts.

(2) Negotiated contracts and subcontracts not in
excess of $100,000.
(3) Contracts and subcontracts with small businesses.
(4) Contracts and subcontracts in which the price is
set by law or regulation.
(5) Contracts and subcontracts when the price is based
on established catalog or market prices of commercial
items sold in substantial quantities to the general
public.
(6) Contracts and subcontracts of $500,000 or less if
the business unit is not currently performing any
national defense CAS-covered contracts.
(7) Nondefense contracts awarded based on adequate
price competition.

179
 (8) Nondefense contracts and subcontracts awarded to
business units that are not currently performing any
CAS-covered national defense contracts.
(9) Contracts awarded to labor surplus area concerns
pursuant to a labor surplus area set-aside.
(10) Contracts and subcontracts to be executed and
performed entirely outside the United States, its
territories, and possessions.
3 0 FAR30.202-1(b). The contractor must disclose information
sufficient to "(1) establish[] a clear understanding of the
cost accounting practices the contractor intends to follow,
(2) definte] costs charged directly to contracts and
disclos(e] the methods used to make such charges, and (3)
delineat[e] the contractor's methods of distinguishing direct
costs from indirect costs and the basis for allocating costs
to contracts." Department of Defense, DEFENSE CONTRACT AUDIT
MANUAL,8-202a (1983).
31
For contracts subject to full CAS coverage, FAR Subpart
30.3 is incorporated by reference into the contract. See FAR
52.230-3, Cost Accounting Standards clause. For contracts
subject to modified CAS coverage, the contractor is required
to comply with the provisions of FAR 30.401 and 30.402. See £

FAR 52.230-5, Disclosure and Consistency of Cost Accounting

Practices clause.
3 2 Department of Defense, DEFENSE CONTRACT AUDIT MANUAL, 8-202a
(1983).
33
FAR 30.408.
34
FAR 30.409.
35
FAR 30.411.
3 6 FAR 30.413.
37
FAR 30.414.
3 8 FAR 30.415.
39
FAR 30.416.
4 0 FAR 30.420.

41
.d.

180

V V.
....... ..
 42FAR Part 31, Contract Cost Principles and Procedure.
43
FAR 31.103(b) (3).
44
FAR 31.103(b) (6).
45
FAR 31.201-1.
4 6
Id.
47 See Bedingfield & Rosen, supra note 27, at 5-2; Bulloch,
Keller, & Vlasho, supra note 23, at 21.8; P. FISCHER & W.
FRANK, COST ACCOUNTING, THEORY AND APPLICATION, 6 (1985) . This is
true even though the accounting system may be in compliance
with Generally Accepted Accounting Principles (GAAP).
4 8 Bedingfield
& Rosen, supra note 27, at 14-18.
4 9 Id.
See e.g., National Mfg., ASBCA 18806, 74-1 BCA 10580
at 50,150.
5 0 Bedingfield
& Rosen, supra note 27, at 14-18. See e.g.
Leopold Constr., ASBCA 23,705, 81-2 BCA 15277. Because
contractor's accounting practices did not segregate costs in
a way that permitted actual costs of the change to be
determined, the contractor failed to carry its burden of
proof with respect to additional costs. Therefore, its
recovery was limited to the Government's estimate of
increased cost.
5 1ASPM,
supra note 24, at 3-8.
52A "cost objective" is an activity for which a separate
measurement of cost is desired. Horngren, supra note 25, at
58. FAR 31.001 defines "cost objective" as a "function,
contract, or other work unit for which cost data are desired
and for which provision is made to accumulate and measure the
cost of processes, products, jobs, capitalized projects,
etc."
53
FAR 31.001.

54
FAR 31.201-4.
55
FAR 31.201-1.

181

i. . .
5 6 Bedingfield
& Rosen, supra note 27, at 5-5. Anderson,
supra note 27, at 9-3, defines a direct cost in terms of
traceability. "If the thing (or object), whether tangible or
intangible, represented by a cost is traceable to individual
units of product produced or services performed, the cost is
a direct cost of the product or service; otherwise, the cost
is an indirect cost."
57FAR 31.202(a). A "final cost objective" is a cost
objective that has allocated to it both direct and indirect
costs and, in the contractor's accumulation system, is one of
the final accumulation points. FAR 31.001. A cost can be
"specifically identified" with a particular final cost
objective if (1) the beneficial or causal relationship
between the costs incurrence and the final cost objective is
clear and exclusive, (2) the amount of the cost is readily
and economically measurable, and (3) all other costs incurred
for the same purpose in like circumstances can also be
identified specifically with final cost objectives and
accounted for as direct costs. See Boeing Co., ASBCA 39224,
79-1 BCA 13708 at 67,248-49. Note that the FAR's definition
of "direct cost" differs from the commonly accepted cost
accounting definition of direct cost in its emphasis on
"final cost objectives." Bedingfield & Rosen, supra note 27,
beginning at 8-8, sharply criticize the FAR's definition for
failing to recognize that all costs can be direct costs at
some level; for example, "[a]ll costs are direct costs of a
company taken as a whole." As a practical matter, however,
the definitional difference appears unimportant.
5 8 FAR 31.202(a).
5 9 Bulloch,
Keller, & Vlasho, supra note 23, at 1.13.
60 Id.

6 1 FAR
31.203(a) defines "indirect cost" as any cost not
directly identified with a single, final cost objective, but
identified with two or more final cost objectives or an
intermediate cost objective. Anderson, supra note 27, at 9-3
to 9-4, defines an indirect cost as one which economically
cannot be traced to individual units of product or services.
For Government contracts, the focal point of cost
accumulation is by contract rather than by product.
Therefore, for Government contract purposes, an indirect cost 40

182
7. R I - 6 1 -1
- ' ..- - .-. W% W

is one which cannot be economically traced to an individual

contract.
6 2 FAR 31.203(a).
6 3 FAR 31.203(b):

Indirect costs shall be accumulated by logical cost

groupings with due consideration of the reasons for
incurring such costs. Each grouping should be
determined so as to permit distribution of the
grouping on the basis of the benefits accruing to the
several cost objectives. Commonly, manufacturing
overhead, selling expenses, and general and
administrative (G&A) expenses are separately grouped.
6 4 Bulloch,
Keller, & Vlasho, supra note 23, at 1.13.
6 5 R.
NASH & J. CIBINIC, FEDERAL PROCUREMENT LAW, VOLUME II, 1464
(3d ed. 1980). See FAR 31.202(a). Anderson, supra note 27,
at 9-3, explains the desirability of direct costing as
follows:

For purposes of cost reimbursement (in government

contract cost accounting) and for general ;ccuracy in
attaching costs to a given product or service, it is
desirable to classify costs as direct rather than
indirect. That is because direct costs are charged
directly to individual units, whereas indirect costs
are distributed in a roundabout, and hence usually
less accurate, process.
6 6 FAR
31.202(a). See Dynalectron v. United States, 545 F.2d
736, 738 (1976), (legal fees specifically identifiable with a
commercial venture were direct costs of that venture and were
not includable in G&A).
67 See FMC Corp., ASBCA 30130, 87-2 BCA 19791, at 100,137-38;
Peter Kiewit Sons' Co., ENG BCA 4742, 85-1 BCA 17911 at
89,708; Foster Constr., DOTCAB 71-16, 73-1 BCA 9869, where
in upholding a contractor's treatment of certain costs as
direct costs the board stated at 46,150-51:

First, as a general rule, cost accounting

procedures seek to identify in the most direct
possible way the cost of a particular item or a work
activity. In other words, the general rule is to
first segregate out all charges that can be identified

183
 with the specific objective in mind, leaving as
indirect charges only those where the identification
cannot be made. Indirect costs, therefore, are
residuals. Such a stance is not only in accord with
generally accepted accounting principles, it is also
consistent with the definitions embodied in [FAR
31.202(a)].
Secondly, where the essential task is to determine
the amount of an equitable adjustment flowing from a
changed condition, the terms of the contract clauses
call for a finding of the 'increase or decrease in the
cost of . . . performance of the contract' . . . . In
our view, this necessarily implies a preference for
costing out a change or changed condition in the most
direct manner possible. The alternative to this
approach which consists of lumping all disputed costs
into an overhead pool for allocation hardly seems to
be either a rational or a fair method of arriving at
I
equitable adjustment for specific claims.
6 8 Nash
& Cibinic, supra note 65, at 1457.
6 9 1d.
at 1464-65. Anderson, supra note 27, at 9-4 comments:
"it may not be economically feasible to charge the cost
directly--the costs of record keeping required for direct
charging may exceed the benefits."

7 0 FAR 31.202(b). CAS 402.50(e).

7 1 See
Bedingfield & Rosen, supra note 27, at 5-6; J. FULTZ,
OVERHEAD, WHAT IT IS AND How IT WORKS, 3 (1980) ; Bulloch,
Keller, & Vlasho, supra note 23, at 1-13; M. Rishe, supra
note 27, at 11-2. See also Tera Advanced Servs., GSBCA 6713-
NRC, 85-2 BCA 17940 at 89,888; Starks Contracting, VACAB
1339, 79-2 BCA 1448 at 68,848; Switlik Parachute Co., ASBCA
18024, 75-1 BCA 11434 at 54,443. Note, however, that the
nature of a cost will determine whether it will be classified
as direct or indirect when:
(1) indirect costs are applied to a change as a standard
percentage markup on direct costs. See infra note 199 and
accompanying text.
(2) the contract has a Changes clause that defines indirect
costs _ including supervisory costs, small tools, etc. See
infra note 204 and accompanying text.
(3) the parties for purposes of the adjustment have
negotiated an indirect cost rate. See e.g., F. F. Slocomb
Corp., ASBCA 20169, 76-2 BCA 12071 at 57,946.

184
),'
 - ~ v.. r *. . .
,-.. 4 Vd -.A- P rMS 7F-0 -7e . W%

7 2 Bedingfield
& Rosen, supra note 27, at 5-6.
73
Fultz, supra note 71, at 3.
7 4 1n
American International Manufacturing, ASBCA 25816, 84-3
BCA 17698 at 88,286, the Government argued that guard
services benefited more than just the contractor's
-manufacturing operations and therefore should be transferred
*from the service overhead pool to the much larger G&A pool.
The board found against the Government on the facts, but the
case demonstrates that inclusion of a cost in a cost pool
that is not distributed to all cost objectives benefiting
from the cost will result in over allocation to the cost
objectives to which the cost is distributed. Note, it is the
grouping (rather than the individual costs elements in the
grouping) which must bear a beneficial or equitable
relationship with the several cost objectives. See Cyro-
Sonics, Inc., ASBCA 13219, 70-1 BCA 13219 at 38,654.
75
FAR 31.203(b).
7 6 See
Anderson, supra note 27, at 9-14.

Pooling of costs for distribution to final cost

objectives is an averaging process. All averaging,
Ahowever, results in a loss of accuracy. Thus, in
determining the number of cost pools to be maintained,
contractors generally weigh the desired accuracy in
cost allocation against the cost of obtaining that
accuracy.
See also Bedingfield & Rosen, supra note 27, at 5-22 to 5-26;
-' Rishe, supra note 27, at 11-15.
77
Rishe, supra note 27, at 11-15. The expense and
inconvenience of establishing a separate pool is indicated in
* Savoy Construction Co., ASBCA 21218, 80-1 BCA 14392. Here
the contractor (believing it was spending a disproportionate
amount of time on owner-directed changed work) attempted to
*. establish a separate home office overhead pool for owner-
directed changes. Its home office personnel (in seven
departments: management, operations, estimating, purchasing,
accounting, payroll, and filing and mailing) kept records of
their time for one month placing particular emphasis on time
spent processing owner-directed changes. Because the method
used to establish the pool was not uniform and systematic
the contractor did not meet its heavy burden and, therefore,

185

9
v*.,*, . ~ .~
was unable to establish this as a separate pool for purposes
of pricing adjustments.
78
Horngren, supra note 25, at 515.
79
FAR 31.203(b).
8 OObviously,
a contractor's cost accounting system must be
capable of determining costs for purposes of progress
payments. However, the precision needed to justify progress
payments is significantly less than that needed to justify
compensation under an equitable adjustment or a termination
settlement.
8 1 FAR 31.203(b).
8 2 Bedingfield
& Rosen, supra note 27, at 8-26; ASPM, supra
note 24, at 6-5 to 6-14.
8 3 See
e.g., infra Chapter 2, Parts I.E and F. The standard
markup for indirect costs and clauses limiting recovery of
indirect costs both use the term "overhead" as a synonym for
indirect costs in general.
8 4 See TOUCHE Ross AND CO., GOVERNMENT COST RECOVERY, 36-A (1986) .
851d. See also FAR 30.410-30; Anderson, supra note 27, at
9-6.2.
I
8 6Aseparate CAS has been established for G&A. See FAR
30.410. Another CAS covers "indirect cost." See FAR 30.418.
Note that the CAS apply only to CAS-covered contracts.
87See FAR 30.403. A home office is "[an office responsible
for managing two or more, but not necessarily all, segments
of an organization." FAR 30.403(a)(2). See also Braude and
Kovars, Extended Home Office Overhead, Constr. Briefings, No.
84-6, 1-2 (June 1984).

Home office overhead costs usually include (1) rent

and depreciation, (2) licenses and fees, (3) property
taxes, (4) utilities and telephone, (5) salaries or
fees of directors, officers, management and clerical
personnel, (6) auto and travel, (7) data processing,
(8) insurance and bond premiums, (9) legal and
accounting expenses, (10) interest, (11) office
supplies and photo-copying, and (12) other costs

186

%~.1~ % % ~*af
 incidental to the general administration of the
company.
8 8 See FAR 30.403-40.
8 9 Horngren,
supra note 25, at 478-79.

9 0 FAR 31.203(b) (emphasis added).

See e.g., Elliot Machine
Works, ASBCA 16135, 72-2 BCA 9501, where the contractor
unsuccessfully argued that the total cost of labor and
materials should be used as the distribution base for
manufacturing overhead. The Board held that direct labor was
the proper base stating:
It is obvious that a job which requires 1,000 hours of
manufacturing labor benefits more from the
manufacturing plant and should bear a larger share of
the manufacturing overhead than another job involving
the same labor and material costs and requires only
100 hours of manufacturing labor. Considering the
nature of appellant's operations, where there was a
wide variance in the amount of labor required on the
jobs having the same amount of total labor and
material costs, it is obvious that direct
manufacturing labor is a more accurate measure of the
extent of use of the manufacturing plant than is total
labor and material costs.

Id. at 44,270 (emphasis added).

9 1 Rishe, supra note 27, at 11-17 (emphasis added).
9 2 This
does not mean that each and every cost element in a
cost pool must proportionately benefit each of the cost
objectives to which the pool is distributed, but that the
cost grouping as a whole must be distributed to cost
objectives in proportion to the benefits received. See
American Elec., ASBCA 16635, 76-2 BCA 12151 at 58495;
McDonnell Douglas Corp., ASBCA 12639, 69-2 BCA 8063 at
37,496; Daystrom Instrument, Div. of Daystrom, ASBCA 3438,
58-2 BCA 2050 at 8634.
93
See FAR 31.201-4.
9 4 Note
that FAR 31.202(b) provides that distribution bases
"should be selpcted so as to permit allocation of the
grouping on the basis of the benefits accruing to the

187
several cost objectives." (emphasis added) No mention is
made of any other distribution base. By implication, it is
only when allocation cannot be made on a relative benefit
basis that use of another basis is permissible.
9 5 See
Fultz, supra note 71, at 53; Horngren, supra note 25,
at 516-17.
96See FAR 30.403-40, Allocation of Home Office Expenses to
Segments; FAR 30.410-40, Allocation of Business Unit General
and Administrative Expenses to Final Cost Objectives; and FAR
30.418, Allocation of Direct and Indirect Costs.
97FAR 31.203(b) requires that cost be allocated on the basis
of benefits accruing to the several cost objectives. All
cost objectives benefiting from a cost must be allocated a
proportionate share of the cost. A cost of sales base is
objectionable because it does not consider the total
activity of the business unit during the period--only sales
activity. Thus, all cost objectives that benefit from
incurrence of a cost may not receive a proportionate
allocation. See e.g., Westinghouse Elec., ASBCA 25787, 85-1
BCA 17,910 at 89,676-81 (stating that CAS 410 "ruled out" use
of the cost of sales method of G&A allocation for CAS-covered
contracts); AC Elecs. Div., General Motors Corp., ASBCA
14388, 72-2 BCA 9558 at 44,521; Daystrom Instrument, Div of
Daystrom, ASBCA 3438, 58-1 BCA 1588 at 5,760, aff'd on motion
for reconsid. 58-2 BCA 2050, "The cost-of-sales basis of
allocation of G&A expense is proper only if . . . there is no
great disparity in the amount of inventory between the
beginning and the end of the allocation period." See
Curtiss-Wright Corp., Wright Aeronautical Div., ASBCA 9032,
65-2 BCA 4960 at 23,146. The Government questioned use of a
cost of sales method of allocation because it did not
allocate any G&A costs to a company-sponsored research and
development program. The Board did not reach this issue
because the amount involved was de minimis. See R. W.
Borrowdale Co., ASBCA 11362, 69-1 BCA 7564 at 35,036-37;
Litton Sys., ASBCA 10395, 66-1 BCA 5599. But see American
Int'l Mfg., ASBCA 25816, 84-3 BCA 17698 at 88,288, where the
Government made no objection to the contractor's use of a
cost of sales base for allocation of G&A.
9 8 FAR 31.204(e).

9 9 Rishe, supra note 27, at 14-7.

188

-w
p.. - ww p ..p w p. .p..- - g.~jP ~ ~ p I
1 0 0 FAR 31.204(e). Under FAR 30.302(a), "full CAS coverage"
applies to contractor business units that:

(1) Receive a single national defense CAS-covered

contract award of $10 million or more; (2) Received
$10 million or more in national defense CAS-covered
contract awards during its preceding cost accounting
period; or (3) Received less than $10 million in
national defense CAS-covered contract awards during
its preceding cost accounting period but such awards
were 10 percent or more of total sales.
1 0 1 FAR
30.406-40(a). CAS 406 permits use of a base period of
less than one year for (1) indirect functions existing for
less than one year, and for (2) the transitional period
created by a change in the contractor's fiscal year.
1 0 2 FAR 30.302(b) (1):
Modified, rather than full CAS coverage may be applied
to a covered contract of less than $10 million awarded
to a business unit that received less than $10 million
in national defense CAS-covered contracts in the
immediately preceding cost accounting period if the
sum of such awards was less than 10 percent of the
business unit's total sales during that period.
10 3 FAR 31.203(e). A base period shorter than one year is
permissible only when it equitably allocates cost. In
American Scientific, Corp., IBCA 576-666, 67-2 BCA 6670 at
30,955, the Board, acknowledged that use of a period shorter
than one year was a possibility under FPR and then denied its
use commenting, "the base period selected should be
representative of normal operations, and should be long
enough to protect against significant variations from the
overall situation of the company." (citations omitted).
1 0 4 See
Art Metal U.S.A., GSBCA 5898, 83-2 BCA 16881, where '
the board decided that the fourth quarter of the contractor's '
fiscal year should be the distribution base. The Government
objected to inclusion of "year-end" charges in the fourth
quarter cost grouping when the charges benefited the entire
year--not just the fourth quarter. The Board agreed and
eliminated year end charges from the cost grouping. %
1 0 5 See
Daystrom Instrument, Div. of Daystrom, ASBCA 3438, 58-
1 BCA 1588 at 5,761, aff'd on motion for reconsid. 58-2 BCA
2050 where the 45 month base period selected by the

189

4* - * -).
'. a~N WV
contractor was disallowed because it did not accurately
allocate G&A expenses to the operations which generated such 6
expenses. But see National Manufacturing, ASBCA 18806, 74-1
BCA 10580 at 50,160, where the Board found it more reasonable
to use a four year, composite, G&A rate in pricing a
defective specification claim than the annualized rate argued
for by the Government because direct costs were low and
overhead high during the initial years of the contract.
1 0 6 See Penberthy Electromelt Int'l v. United States, 11 Cl.

Ct. 307, 319 (1986).

107 FAR 42.701.

1 0 8 See
Bulloch, Keller, & Vlasho, supra note 23, at 17.12-13.
See also Fischer & Frank, supra note 47, at 27-31.
1 0 9 Bulloch, Keller, & Vlasho, supra note 23, at 17.12.
l1d, at 17.13.
iii Id.

1 1 2 j. ADRIAN, CONSTRUCTION ACCOUNTING, 257 (2d ed. 1986).

1 1 3 ASPM, supra note 24, at 6-19.
1 1 4 Bulloch,
Keller, & Vlasho, supra note 23, at 17.13.
1 1 5Also called mixed costs. See Fischer & Frank, supra note
47, at 30.
1 1 6 Bulloch,
Keller, & Vlasho, supra note 23, at 17.13.
1 17
Fremgen & Liao, supra note 23, at 18-23.

l8see ASPM, supra note 24, at 6-22; Bulloch, Keller, &

Vlasho, supra note 23, at 17.17-.20; Fischer & Frank, supra
note 47, at 63-79.
1 1 9 Bulloch,
Keller, & Vlasho, supra note 23, at 18.16 to
18.17. "Contribution margin is equal to sales minus variable
expenses." Horngren, supra note 25, at 45.

190
II

1 2 0 Horngren,
supra note 25, at 45. The formula used to
calculate the breakeven point is: fixed expense divided by
unit contribution margin.
1 2 1 "Period
costs" are listed in the income statement in their
entirety as expenses of the period . . . and are not charged
to the work-in-process inventory and not traced through the
finished-goods inventory into cost of sales." Bulloch,
Keller, & Vlasho, supra note 23, at 5.40.
12 2
See e.g., Bedingfield & Rosen supra note 27, at 5-15;
Horngren, supra note 25, at 52; S. MOSCOvE, G. CROWNINGSHIELD,
K. GORMAN, COST ACCOUNTING WITH MANAGERIAL APPLICATIONS, Chapter 12
(5th ed. 1985).

123"Full Costing" is the term used by Melvin Rishe in his

book, Government Contract Costs, supra note 27, at 11-3, and
by Touche Ross in their book, GOVERNMENT CONTRACT COST RECOVERY,
35-A (1986). The term "full cost" also is used by Professor
Horngren to refer to a product costing system where all costs
are distributed to products. See Horngren, supra note 25, at
369. It is used by other accounting experts as well. See
Ford Aerospace and Communications, Corp., ASBCA 23833, 83-2
BCA 16813 at 83,615.
1 2 4 American
Institute of Certified Accountants, Accounting
Research Bulletin no. 43.
1 2 5 Bedingfield
& Rosen, supra note 27, at 5-15 (emphasis
added).
126
Fremgen & Liao, supra note 23, at 18-19.

127 Id.
128
Rishe, supra note 27, at 11-3.
12 9
Anderson, supra note 27, at 9-6.

In the commercial environment, a product is assigned

the direct costs of materials and labor, and a portion
of the overhead costs of manufacturing; general and
administrative (G&A) expenses and any other indirect
costs are charged to the period in which they were
incurred. A government contract on the other hand,
includes all indirect costs of the contractor

191

al.
 including a portion of G&A expense; no costs are
charged to the period in which they were incurred.
1 3 0 More
properly stated, all costs are allocated to
"contracts." For Government contract purposes, the focal
point of cost accumulation is the contract rather than a
"product." See Anderson, supra note 27, at 9-6.
1 31
Rishe, supra note 27, at 11-3.
13 2
Bedingfield & Rosen, supra note 27, at 5-15.
13 3
d. at 5-16.
1 3 4 FAR 31.201-6(a).
1 3 5 FAR 31.201-1.
1 3 6 FAR 31.201-2.

137See supra Chapter 1, Parts IV.B. and IV.F.

1 3 8 FAR 31.201-3.
13 9
1d. In determining whether a specific cost is reasonable,
the contracting officer considers:

(a) Whether it is the type of cost generally

recognized as ordinary and necessary for the conduct
of the contractor's business or the contract
performance;
(b) The restraints or requirements imposed by such
factors as generally accepted sound business
practices, arm's-length bargaining, Federal and State
laws and regulations, and contract terms and
specifications;
(c) The action that a prudent business person,
considering responsibilities to the owners of the
business, employees, customers, the Government, and
the public at large would take under the
circumstances; and
(d) Any significant deviations from the established
practices of the contractor that may unjustifiably
increase the contract costs.
Id. 'A

192 J

~~~~~~~~~~~~~ d. P ~ Ps
01X ~ %\ ** ~%SV ~ ~ p ~ -
 lN

1 4 0 FAC
84-26 (July 30, 1987) amends FAR 31.201-3 as follows:
(1) "no presumption of reasonableness shall be attached to
the incurrence of costs by a contractor," and (2) upon
challenge "the burden of proof shall be upon the contractor
to establish that such cost is reasonable."
14 1
Bruce Constr. v. United States, 324 F.2d 516 (1963).
Inroads on the rule set forth by Bruce Construction were made
by Section 933 of the Defense Procurement Improvement Act of %
1985 (P.L. 99-145) which placed the burden of proof on the
contractor to establish that disputed costs were reasonable.
The statute did not, however, expressly state that actual
costs were not to be "presumed reasonable" and applied only
to proving the reasonableness of indirect costs and to DOD.
See Gov't Contr., Vol. 28, No. 6 (March 17, 1986).

L4 2 Franklin W. Peters and Assoc., ICBA 762-1-69, 71-1 BCA

8615.
1 4 3 Stanley
Aviation Corp., ASBCA 12292, 68-2 BCA 7081 at '
32,788.
1 4 4 ASPM, supra note 24, at 6-19.

The 90 percent can describe a manufacturing company

that still relies on hand labor and hand tools with no
automatic machines. As a result, its direct labor
base, against which its overhead is measured, is high
bcause of the greater amount of time needed to
perform the tasks. At the same time, overhead is less
than might otherwise be the case because it includes
little or no costs for depreciation of machinery.

Id.
1 4 5 "Although
the GAAP's do not appear in a single, definitive,
codified form, most public auditors agree on the majority of
the items they 'generally accept' as accounting principles."
Bedingfield & Rosen, supra note 27, at 4-11.
1 4 6 FAR 31.201-2(a)(3).
1 4 7 Bedingfield
& Rosen, supra note 27, at 4-4. See Celesco
Indus., ASBCA 22402, 80-1 BCA 14271 at 70,297. "Such r%
principles have been developed for asset valuation and income I%
measurement, and 'are not cost accounting principles' as
such, although cost accounting principles (may] evolve out of
I

193

W, IlkA V 1. dm lll I
them." Id. (citations omitted). See also Wolf Research and
Dev., ASBCA 10913, 68-2 BCA 7222 at 33,546.
14 8 See
F. ALSTON, F. JOHNSON, M. WORTHINGTON, L. GOLDSTEIN, & F.
DEVITO,CONTRACTING WITH THE FEDERAL GOVERNMENT, 161 (1984)
[hereinafter Alston)i.
1 4 9 Trueger,
supra note 27, at 430-31. See also Gould Defense
Sys., ASBCA 24881, 83-2 BCA 16676 at 82,390.
1 5 0 Trueger,
supra note 27, at 431. See Boeing Co., ASBCA
11866, 69-2 BCA 7898 at 36,753. See also Daystrom
Instrument, Div. of Daystrom, ASBCA 3438, 58-1 BCA 1588 at
5756, aff'd on motion for reconsid., 58-2 BCA 2050. " [Ijt
should be recognized that many public accountants and many
well-managed business firms follow accounting principles and
practices that do not conform to the A.I.A. bulletins, and
such accounting principles and practices must also be
recognized as being "generally accepted."
1 51
FAR 31.109.
1 5 2 FAR 31.109(h) .
1 5 3 FAR 31.109(b) .
1 54
FAR 31.109(c).
1 5 5 Limiting
clauses are often included in construction
contracts. Agencies that commonly use such clauses include
the General Services Administration, the Postal Service, the
Veterans Administration, and the Navy. See Cibinic & Nash,
supra note 1, at 519-23.
1 5 6 See
Samuel S. Barnett Co., GSBCA 4855, 80-1 BCA 14355 at
70,768-69; Jack Picoult, GSBCA 2351, 69-1 BCA 7678, aff'd on
motion for reconsid., 69-2 BCA 7820.
1 57
See Central Mechanical, Inc., DOT CAB 1234, 83-2 BCA 16642
at 82,753; ACS Constr., ASBCA 23471, 79-2 BCA 23471 at
69,388 and 69,390.
1 58 See infra Chapter 2, Part I.F.
1 5 9 FAR 31.205.

194
S

1 6 0 FAR
31.201-6.
161FAR 31.201-6(c).

16 2
FAR 31.201-6(a). "A directly associated cost is any cost
which is generated solely as a result of incurring another
cost and which would not have been incurred had the other
cost not been incurred." Id.
1 6 3 See e.g., J.W.
Bateson Co., ASBCA 22337, 78-2 BCA 13523 at
66,265.
1 6 4 FAR 31.201-6(d) provides the following exception:

If a directly associated cost is included in a cost

pool which is allocated over a base that includes the
unallowable cost with which it is associated, the
directly associated cost shall remain in the cost
pool. Since the unallowable costs will attract their
allocable share of costs from the cost pool, no
further action is required to assure disallowance of
the directly associated costs.

1 6 5 1d.
If a fragmented distribution base were used for
allocation purposes, the excluded portion of the base would
not absorb the overhead costs it purportedly generated or
benefited from. For example, assume that certain direct
material costs, having been unreasonably incurred, were
deemed unallowable and assume that the distribution base for
material overhead is direct material cost. The purchase of
the unallowable material gen'erated the same material
acquisition and handling effort as did any other purchase.
Its removal from the distribution base establishes a
distribution base in the amount it would have been had the
unallowable costs not been incurred, but leaves in the
overhead pool for distribution the increased material
overhead costs generated by the unreasonable purchase. .
1 6 6 Because
the unallowable cost portion of the distribution
base is not linked to a cost objective, the indirect cost
grouping will not be totally distributed to the several cost
groupings. The remaining portion of the indirect cost
grouping is in effect allocck.ea to the unallowable costs. In
sum, although not a cost objective, unallowable costs in the
distribution base are treated like one.
1 67
FAR 31.203(c) provides:

195

ft.. %. t . .% '.=....t* *f
4 - -; - - -. - . .- , , , .. -. . . ,. - ' - - . " -.. .-

$3

Once an appropriate base for distributing indirect

costs has been accepted, it shall not be fragmented by 4.

removing individual elements. All items properly

includable in an indirect cost base should bear a pro
rata share of indirect costs irrespective of their
acceptance as Government contract costs. For example,
when a cost input base is used for the distribution of
G&A costs, all items that would properly be part of
the cost input base, whether allowable or unallowable,
shall be included in the base and bear their pro rata
share of G&A costs.
1 6 8 Kenyon
Magnetics, Inc., GSBCA 5264, 80-2 BCA 14624 at
72,135 (allowing as a direct cost a fixed percentage of the
salary of contractor's president and clerical staff,
telephone and postage charges, and travel costs).
169 Id.

1 7 0 The
distribution base normally used in pricing changes is
direct labor dollars or another direct cost of the change.
As noted in chapter 1, distribution bases other than direct
costs are occasionally used. See supra note 95 and
accompanying text.
1 7 1 See
Cal-Tom Constr., VABCA 85-3 BCA18211 at 91,407 (the
equitable adjustment was a lump sum figure including all
markups); E. Arthur Higgins, AGBCA 76-128, 79-2 BCA 14050 at
69,067; Datametrics, Inc., ASBCA 16086 BCA 74-2 10742 at
51,103 (jury verdict did not separately show the amount
allocated to individual cost elements such as G&A); Webber
Constructors, IBCA 72-6-8, 69-2 BCA 7895; Geris, Inc., DOT
CAB 67-6, 69-1 BCA 7450 at 34,577-78.
17 2
Estimates "if they are supported by detailed
substantiating data or are reasonably based on verifiable
experience" form an acceptable starting point for computing
an equitable adjustment. Celesco Indus., ASBCA 21928, 81-2
BCA 15260 at 75,547-48.
17 3Aprojected overhead rate is developed through a five step
process: (1) select a base period, (2) estimate production
volume for the period, (3) estimate indirect expenses for the
period, (4) estimate the distribution base for the period,
and (5) divide estimated indirect expenses by the estimated
distribution base. See Fultz, supra note 71, at 32.

196
Ii'

17 4
See Alston, supra note 148, at 367. U

17 5 1d. See also Cibinic & Nash, supra note 1, at 513-14.

17 6
See infra Chapter 2, Part II.
17 7
See American Electric, ASBCA 15152, 73-1 BCA 9787 at
45,730, where the Board went so far as to relieve the
Government from an earlier stipulation that overhead rates
were 123.3% when actual rates were 172.6%. See also National
Mfg., ASBCA 18806, 74-1 BCA 10580 at 50,157; Elliot Machine
Works, ASBCA 16135, 72-2 BCA 9501 at 44,269; Keco Indus.,
ASBCA 15061, 72-2 BCA 9575 at 44716. But see infra note 190,
discussion of CRF-A Joint Venture of Cemco and R. F.
Communications; and Massman Constr.
178See e.g., CRF-A Joint Venture of Cemco and R. F.

Communications, ASBCA 17340, 76-1 BCA 11857 at 56,803-04;

American Elec., ASBCA 15152, 73-1 BCA 9787 at 45,730; Keco
Indus., ASBCA 15061, 72-2 BCA 9575 at 44716.
17 9
FAR 15.809(a).

1 8 0 FAR 15.809(b).
181FAR 15.809 (c).

1 8 2 Assuming
that the contractor uses direct cost as its
distribution base. If a distribution base other than direct
cost is used, the indirect cost portion of the adjustment is
determined by multiplying the contractor's indirect cost rate
by the increase in that distribution base.
18 3
See e.g., Stewart Avionics, ASBCA 23161, 78-1 BCA 13130
(because the contractor was unable to prove in which fiscal
year the retrofit took place the Board applied the lower of
the overhead rates for the two years--270% as compared to
661%).
18 4Achange deleting work, particularly if major, may be
treated as a partial termination for convenience rather than
a change. If so, settlement would be handled under the
Terminations for Convenience clause rather than under the
Changes clause. See Cibinic and Nash, supra note 1, at 784.
See generally Ideker, Inc., ENG BCA 4389, 87-3 BCA 20145 at
101,974.

197
V
1 8 5 Assuming
that the contractor's distribution base is direct
cost. If a distribution base other than direct cost is used,
the indirect cost portion of the downward equitable
adjustment is determined by multiplying the contractor's
indirect cost rate by the estimated decrease in that
distribution base.
1 8 6 See
e.g., Fordel Films West, ASBCA 23071, 79-2 BCA 13913
at 68,298.
1 87
See Algernon Blair, Inc., ASBCA 10738, 65-2 BCA 5127 at
24,141, where the contractor claimed that deductive changes
caused additional expenses--preparing estimates, securing
prices and subcontractor proposals, preparing and submitting
proposals for the changes and additional contract
administration. It argued therefore, that its overhead was
not reduced by the deductive change. The Board rejected this
reasoning but stated in dicta that if a contractor could show
"special circumstances" the credit due the Government might
be reduced. See also Sun Elec. Corp., ASBCA 13031, 70-2 BCA
8371. Here, the contractor unsuccessfully argued that the
Government was not due a credit for material handling charges
because the costs of ordering the material and cancelling the
order had already been incurred. The Board reasoned:

The ordering for material purchases, in the first

place, represents only a beginning of company
operations for which, upon the whole, costs are
covered under the burden and G&A expense; and without
some particular showing, routine cancellation could
not be supposed as adding expense sufficient or so
substantial as to bring all costs incurred in respect
of appellant's partial cancellation into any
approximation with the whole distributive cost share
($5,216.71), which amounts to very nearly one-third
the direct cost.

Id. at 38,395.
1 8 8 See Pacific Contractors, ENG BCA PCC-29, 79-2 BCA 13998 at
68,720.
1 8 9 See
Dawson Construction, GSBCA 5364, 82-1 BCA 15701 at
77,661 where the Board stated "deductive and additive changes
must be priced in the manner dictated by the Equitable
Adjustments provision of the contract's general conditions,
that is, by applying the markups to the net increases in

198
direct costs." See also J. F. Shea Co. v. United States, 10
Cl. Ct. 620, 628 (1986); Glover Constr., ASBCA 29194, 85-2
BCA 18093 at 90,809-10; J. Harvy Crow, GSBCA 41423, 75-2 BCA
11423 at 54,390-91.
1 9 0 1d.
But See CRF-A Joint Venture of Cemco and R. F.
Communications, ASBCA 17340, 76-1 BCA 11857 at 56,803-04,
where different indirect costs rates were used to determine
indirect costs of the deleted and the added work. The board
held that when the "plus-and-minus changes net out on the
plus side" current overhead rates are used to price both--but
when the change is a net deductive change it is proper to
price the additive portion of the change using the
contractor's higher actual overhead rates and the deductive
portion of the change using the contractor's lower projected
rates. The Board reasoned that the deletion reduced the
quantity of the contractor's work, thereby increasing the
contractor's overhead rates and that the Government, who had
the burden of proof with respect to the deductive portion of
the change, had failed to prove that the contractor's
projected rates were not reasonable. The reasoning f this
decision has not been applied in any subsequent cases. See
also Massman Construction, ENG BCA 3660, 81-1 BCA 15049 at
74,454-55, where indirect costs of the substituted work were
determined using the contractor's bid rather than actual
indirect cost rate. The event necessitating the equitable
adjustment was the Government's substitution of a more
expensive cement. The Board reasoned that since the
contractor's original bid did not adequately provide for
recovery of indirect cost it was necessary to use the
original bid's indirect cost rate to preserve the loss
position of the contractor. The Board was incorrect in
holding that application of the originally bid indirect cost
rate to the net increase in direct cost was necessary to
preserve the contractor's profit/loss position on the
unchanged work. The profit/loss position on the unchanged
work is unaffected by the indirect cost rate applied to the
net increase or decrease in direct costs caused by a
substitution. The Board simply forced the contractor to
perform the net change at a loss.
1 9 1 See
e.g., Flores Drilling and Pump Co., AGBCA 82-204-3,
83-1 BCA 16200. The contractor claimed overhead at a rate of
114%. Because the contractor did not submit evidence
substantiating that rate the Board used a standard overhead
rate (15%). See also Forest Rd. Constr., AGBCA 84-221-3, 85-
2 BCA 18160 at 91,188; ACS Constr., ASBCA 23471, 79-2 BCA
23471 at 69,390. The contractor "not know[ing) what its

199
I
actual overhead was doing" claimed overhead at 10%; its most
recent year's corporate overhead rate was 16%.
19 2
See C. N. Flagg & Co., ASBCA 26444, 84-1 BCA 17120
(holding that the contractor's actual indirect cost rate of
10.3% should be used rather than 15% standard markup used to
price change orders prior to the actual rate being
available); Brezina Constr., IBCA 757-1-69, 73-1 BCA 10195
at 48,062 (holding that the contractor's actual indirect cost
rate of 6.5% should be used rather than the 10% standard
markup used to price change orders prior to the audited rate
being available). See also Arnold M. Diamond, Inc., ASBCA
20667, 77-2 BCA 12769. The contractor originally proposed a
10% overhead rate for a change. The proposal was not
accepted. After a DCAA audit found the contractor's overhead
rate to be 30.5% the contractor revised its claim
accordingly. The Board awarded overhead at the 30.5% rate.
See also supra note 177.
1 9 3 See
American Federal Contractors, PSBCA 1359, 87-1 BCA
19595 at 99,119, where the board stated, "A contractor, upon
a proper showing with specific evidence can recover overhead
costs beyond the standard allowance."
1941Id.

1 9 5 See
Flores Drilling and Pump Co., AGBCA 82-204-3, 83-1 BCA
16200 at 80,487; Urban Plumbing and Heating Co., ASBCA 9831,
71-2 BCA 8980 at 41,744.
1 9 6 Cases
in which a 10% rate was adopted include: Salem
Eng'g and Constr. v. United States, 2 Cl. Ct. 803, 809
(1983); American Fed. Contractors, PSBCA 1359, 87-1 BCA
19595 at 99,119; Arctic Corner, ASBCA 29545, 86-3 BCA 19304
at 97,605-06; KenCom, Inc., GSBCA 7717, 86-2 BCA 18900 at
95,341; Steven E. Jawitz, ASBCA 31164, 86-1 BCA 18620 at
93,555 (allowed both field office overhead of 10% and a
separate charge for G&A of 3%); 3A/Magnolia-Ju, IBCA 1885,
85-3 BCA 18202 at 91,370; R & E Elecs., VABCA 2227, 85-3 BCA
18316 at 91,897; Glover Constr., ASBCA 29194, 85-2 BCA 18093
at 90,810; Forest Rd. Constr., AGBCA 84-221-3, 85-2 BCA
18160 at 91,188; Fred A. Arnold, Inc., ASBCA 20150, 84-3 BCA
17624; ACS Constr., ASBCA 23471, 79-2 BCA 23471 at 69,390;
Alps Corp., ASBCA 19632, 75-1 BCA 11260 at 53,672; Detweiler
Bros. ASBCA 17897, 74-2 BCA 10858 at 51,644; Cecil Pruitt,
Inc., ASBCA 18344, 73-2 BCA 10213 at 48,150-51; Varo, Inc.,
ASBCA 15000, 72-2 BCA 9717 at 45,360; Bregman Constr., ASBCA
15020, 72-1 BCA 9411 at 43,718; Framlau Corp., ASBCA 15516,

200
71-2 BCA 9145 at 43298; Ray D. Bolander Co., IBCA 331, 70-1
BCA 8200 at 38,133-34; Algernon Blair, Inc., ASBCA 10738,
65-2 BCA 5127 at 24,141.

Cases in which a 15% rate was adopted include: Hoyer

Constr., ASBCA 31241, 86-1 BCA 18619 at 93,553; Long Floor
Co., ASBCA 29319, 84-3 BCA 17688 at 88,203; Flores Drilling
and Pump Co., AGBCA 82-204-3, 83-1 BCA 16200; Warren
Painting Co., ASBCA 18456, 74-2 BCA 10834 at 51,525, 51,533;
Foster Constr., DOT CAB 71-16, 73-1 BCA 9869 at 46,152; Cen-
Vi-Ro of Texas, IBCA 718-5-68, 73-1 BCA 9903 at 46,411;
P.M.W. Constr., ASBCA 11121,66-2 BCA 5901 at 27,371.

19 7 See Urban Plumbing and Heating Co., ASBCA 9831, 71-2 BCA
8980 at 41,745 (the Board lowered the contractor's recovery
of overhead to 13% after stating that 15% was standard);
Trans-Eastern Constructors, Inc., ASBCA 13612, 70-2 BCA 8453
at 39,325.
1 9 8 Trans-Eastern
Constructors, Inc., ASBCA 13612, 70-2 BCA
8453 at 39,325.
1 9 9 1n
American Federal Contractors, PSBCA 1359, 87-1 BCA
19595 at 99,119, the board held that:

To recover labor costs of supervisory employees . .

a contractor must show that the officers performed
other than normal supervisory duties and devoted
themselves exclusively to the work directed by the
modification. See Bell v. United States,404 F.2d
975,982-83 (Ct. Cl. 1968). In this instance,
Appellant has not demonstrated that the officers
actually directed the labor, or that the coordination,
negotiation and inspectional activities were unusual.
Thus, there is no basis for considering the costs as
direct labor costs, or as additional overhead for the
modification.

See also Hoyer Constr., ASBCA 31241, 86-1 BCA 18619 at 93,553
(construction manager, project manager, and secretary's
salaries were not allowable as direct costs but included in
15% markup for overhead); ACS Constr., ASBCA 23471, 79-2 BCA
23471 at 69,390 (supervisor's salary was not allowable as a
direct cost but was included in the 10% markup); Fred A.
Arnold, Inc., ASBCA 20150, 84-3 BCA 17624 at 87,838 ("impact
labor costs" to review change, orient crew to change, prepare
estimate, negotiate change, and perform clerical work were
not allowed as direct costs--"including such costs in the

201
direct cost base while using the standard . . . markup rates,
would result in a duplicative recovery of such costs"); A.
Geris, Inc., DOT CAB 67-6, 69-1 BCA 7450 at 34,577, (clerical
expenses were held to be a minor general expense includable
in the 15% markup for overhead and profit).
2 0 0 For
over 20 years the General Services Administration
(GSA) has used a clause limiting overhead recovery. Most of
the cases testing the validity of clauses limiting overhead
recovery, even today, involve GSA contracts. The Veterans
Administration and the Postal Service also use a limiting
clause.
2 0 1 Such
terms have been interpreted as permicting a
contractor to compound overhead and profit and thus recover a
combined 21% for overhead and profit. See Tutor-Saliba-
Parini, PSBCA 1201, 87-1 BCA 19775 at 100,079.
2 0 2 The
current GSA and Veterans Administration clauses are
set out in Appendix 1.
2 0 3 See
Santa Fe Eng'rs v. United States, 801 F.2d 379 (Fed
Cir. 1986) (10% limitation included delay overhead on the
change so contractor was precluded from making a separate
claim for this item); Pipe Installation Co., VABCA 2157, 86-
3 BCA 19055 at 96248 (the Changes clause defined overhead to
include insurance, field and office supervisors and
assistants, incidental job burden, and general home office
expense and effectively limited contractor's recovery to 10%
of direct costs); Jack Cooper Constr., VABCA 1663, 84-3 BCA
17703 at 88,341-42; Gulf-Tex Constr., VACAB 1341, 83-1 BCA
16355 at 81,279-80; Colton Constr., VABCA 1574, 83-1 BCA
16220 at 80,601; West Land Builders, VABCA 1664, 83-1 BCA
16235 (successfully limiting recovery of extended overhead);
Biscayne Constr., GSBCA 3827, 74-1 BCA 10637 at 50,514; J.
Harvy Crow, GSBCA 41423, 75-2 BCA 11423 at 54,389-91; Elec.
& Missile Facilities, GSBCA 2306, 69-2 BCA 7787 (contractor
was denied increased field office overhead and home office
overhead on unchanged work--10% commission fully compensated
contractor); Jack Picoult, GSBCA 2351, 69-1 BCA 7678, aff'd
on motion for reconsid., 69-2 BCA 7820 (successfully limiting
the number of markups on subcontracted work). But see Jervis
B. Webb, PSBCA 420, 78-2 BCA 13544 where the Board allowed
the contractor to recover engineering overhead at 105%, shop
overhead at 303%, and installation overhead at 25% rather
than at the 10% rate specified in the contract. A long
history of prior contracts disclosed the parties' intent that S

the clause would not be applied. More importantly, the

202

.° .
 i !. -

Government received the contractor's proposal for the change

before the work was performed and failed to notify the
contractor of the Government's intent to strictly apply the
overhead limitations. The contractor was prejudiced in that
had it known of the Government's intent it could have
subcontracted the work instead of performing the work itself.
2 04See e.g., Spruill Realty/Constr., ASBCA 28650, 85-3 BCA
18395 (disallowing sole proprietor's time as a direct cost);
J.C. Edwards Contracting and Eng'g, VABCA 1047, 85-2 BCA
18064 (disallowing supervisory costs as a direct cost);
Rysean Corp., VABCA 2021, 84-2 BCA 17505 (disallowing
supervision as a direct cost); Dawson Constr., GSBCA 5364,
82-1 BCA 15701 at 77,662 (although the contractor's job-site
staff spent 80% of its time on the change order, it could not
be charged as a direct cost because the contract defined
indirect costs to include job-site staff); Samuel S. Barnett
Co., GSBCA 4855, 80-1 BCA 14355 (disallowing supervisory
costs as direct costs); Pyramid Constr., GSBCA 4882, 78-1
BCA 13215, aff'd on motion for reconsid., 78-2 BCA 13422;
Detweiler Bros., ASBCA 17897, 74-2 BCA 10858 at 51644
(disallowing telephone calls and executive time as direct
costs); James P. Purvis, GSBCA 905, 74-2 BCA 10959, at
52,144-45 (disallowing excess supervision, and utilities as
direct costs); Jack Picoult Constr., GSBCA 3516, 72-2 BCA
9621, aff'd, 207 Ct.Cl. 1052 (1975) (contractor
unsuccessfully argued that supervisory work preformed by its %
first tier subcontractor on labor and materials furnished by
a second tier subcontractor were direct costs); Blake
Constr., GSBCA 2908, 70-1 BCA 8095, aff'd on motion for
reconsid., 70-1 BCA 8258, at 37,609. But see Tele-Security,
Inc., GSBCA 7037, 84-2 BCA 17360. Here, the contractor was
permitted to charge directly costs of administering a
deductive change order; specifically, 167 hours of its
president's time, 10 hours of its job-site supervisor's time
and $343.44 in telephone charges plus a markup for G&A on
those costs. The Board reasoned that these costs could be
specifically identified with a particular contract and thus
could be charged directly. Had the Changes clause defined
overhead to include home office expense, the contractor
probably would not have recovered these costs as direct
costs.
205
The converse is true as well. When volume decreases, the
amount of fixed cost per unit of construction increases.

203
2 0 6 Calculation
of indirect cost rate at 12 million units

Variable indirect costs (12 million units X $1 per unit) $12 million
Fixed indirect costs $20 million
Total indirect costs $32 million
Direct costs (12 million units X $2 per unit) $24 million
Overhead rate ($32 million/$24 million) 133%

2 0 7 Calculation
of the amount of over absorbed indirect cost

1. Amount of indirect cost assigned to the change at the originally projected overhead rate:

Direct costs (2 million units X $2 per unit) $4 million

Originally projected indirect cost rate 150%
Amount of indirect cost assignable to the change $6 million

2. Amount of indirect cost properly assignable to the change:

Variable indirect cost (2 million units X $1.00 per unit) $2 million

Fixed indirect cost per unit ($20 million/l 2 million units) $1.67
Fixed indirect cost allocable to the change
($1.67 X 2 million units) $3.33 million
Indirect cost assignable to change
($2 million + $3.33 million) $5.33 million

3. Amount of over absorbed indirect cost:

($6 million - $5.33 million) $.67 million

2 0 8 Generally,
a contractor is expected to prove its costs
through the best evidence available. Thus, "[tihe preferred
method for establishing the amount of an adjustment is
through the introduction of the actual cost data for the
additional work" (as opposed to estimates). Cibinic & Nash,
supra note 1, at 462. See also ACS Constr., ASBCA 33550,
87-1 BCA 19660 at 99,550; American Elec., ASBCA 15152, 73-1
BCA 9787 at 45,733.
209
Cibinic & Nash, supra note 1, at 514.
2 1 0 Assuming
such costs are not unallowable.
2 1 1 Bruce
Constr. v United States, 163 Ct.Cl. 97, 100, 324
F.2d 516 (1963); J. F. Shea Co. v. United ftatcz, C1I.Ct.

204

Q~V'~ 44., %.%.'%\ - '4~ .#-~- - . .

 I

620, 627 (1986); Varo, Inc. v. United States, 212 Ct.Cl.

432, 443 (1977); Nager Elec. v. United States, 194 Ct.Cl.
835, 852-53 (1971).
2 1 2 ACS Constr., ASBCA 33550, 87-1 BCA 19660 at 99,550.

2 1 3 Bulloch,
Keller, & Vlasho, supra note 23, at 19.8, point
out that "[iln estimating the impact of a change in activity
on departmental overhead, only the variable component is
considered. The fixed overhead does not change within the
relevant range."
2 1 4 M.
Rishe, supra note 27, at 6-15 (1st ed. 1984), citing
Coley Properties v. United States, 593 F.2d 380 (Ct.Cl.1979).
See supra notes 15 and 16, the cases cited therein, and
accompanying text.
2 15
Underdirect costing only variable manufacturing costs
are allocated to products. To properly keep a contractor
whole, all variable costs, not just manufacturing costs, have
to be recovered. Therefore, "direct costing" as used in this
section is a method of costing that allocates all variable
costs to cost objectives. The concepts of full and direct
costing are discussed at supra Chapter 1, Parts VI.B. and
VI.C.
2 1 6A
profit rate of 10% is often treated as a standard. See
Cibinic & Nash, supra note 1, at 518.
2 17
Assuming
of course that the change did not prevent the
contractor from obtaining work priced at a level permitting
recovery of fixed indirect costs.

21BNo revenue is generated by unused capacity. If job

opportunities are available that will not allow recovery of
"full" cost but will generate revenue in excess of variable
cost, the contractor can maximize short term profit by taking
advantage of these opportunities.
2 1 9 L. ANDERSON, ACCOUNTING FOR GOVERNMENT CONTRACTS, COST ACCOUNTING
STANDARDS (1986); J. BEDINGFIELD & L. ROSEN, GOVERNMENT CONTRACT
ACCOUNTING (2d ed.1985); M. RISHE, GOVERNMENT CONTRACT COSTS (1st
ed. 1984); P. TRUEGER, ACCOUNTING GUIDE FOR GOVERNMENT CONTRACTS
(8th ed. 1985).
22 0A"cost reimbursement" type contract is often used when a
fixed price contract is impracticable because performance

205
lop*

* ~~
W ~ %p ~q Saa~V ~ . .~%,
 * I !r. a Kr XF V

costs cannot be estimated accurately. Under a cost

reimbursement type contract, the Government reimburses the
contractor for its full costs of performance. The contractor
is then paid a separate fee for profit. See J. CIBINIC & R.
NASH, FORMATION OF GOVERNMENT CONTRACTS, (1986) Chapter 7,
Sections III and IV.
221FAR 31. 103(b) .

2 2 2 FAR 31.203(b).
223 FAR 31.203(c).
224
Trueger, supra note 27, at 95-96.

221.at 96.

Note 226 begins on page 207.

.
'.."
'I

206S

206

'I.

U ~ ? * v-,EV ~ ~ ~ 'T h,' 4

2 2 6 Whether
or not the Government will compensate a contractor
for its increased costs of performing a fixed price contract
depends upon the cause of the delay. In general terms, delay
is compensable if it is caused by the Government and not
compensable otherwise. See Cibinic and Nash, supra note 1,
Chapter 6. Where both parties contribute to the delay, the
contractor cannot recover damages unless the contractor can
establish its delay apart from that attributable to the
Government. See Volk Constr., IBCA 1419-1-81, 87-3 BCA
19968, at 101,102 (citing Klingensmith v. United States, 731
F.2d 805, 809 (C.A.F.C. 1984)).
2 27
1ndirect costs are usually determined by multiplying the
direct costs of performance by a contractor's actual or
projected indirect cost rate or by a standard mark-up for
overhead. See supra Chapter 2, Part I.
22 8 When performance is resumed, direct costs may be increased
as a result of the delay. But during the delay itself,
I
direct costs are incurred at a reduced level. The reason is
that most direct costs are variable in nature. When a direct
cost is itself a fixed cost, it will continue to be incurred
at normal rates during the delay. An example of a fixed,
direct cost is a facility leased and used exclusively for one
contract.
2 2 9 Bedingfield
and Rosen, supra note 27, at 14-27. Stated
differently, "'Unabsorbed overhead' exists when the direct
cost base is not large enough to absorb the fixed overhead
at the contractor's 'normal' absorption rate." Irwin,
The Return of Eichleay: Is It Here to Stay? Part II, Constr.
Claims Monthly, Vol. 6, No. 7, at 1 (July 1984). See also
Kurz and Root Co., ASBCA 14665, 72-2 BCA 9552 at 44,841;
Allied Materials and Equip., ASBCA 17318, 72-2 BCA 11150 at
53,089.
2 30
See e.g., Kent and Walters, Recovering Indirect Costs,
Constr. Briefings, No. 80-6, at 2 (Nov. 1980). After stating
that "[tihe distinction between the terms 'extended overhead'
and 'unabsorbed overhead' has become blurred over the years"
and criticizing the boards' inconsistent use of the terms,
Kent and Walters incorrectly define the concepts:

The conceptual difference between the two terms may be

stated as follows: Unabsorbed overhead focuses on the
period of suspension during contract performance--and

207 ):

-=.-. i i i ss i i l i iT - " . .. . ..
 the additional costs generated during that period.
Extended overhead focuses on the extended period of
contract performance at the end of a project, which
results from delays during performance--and the
additional costs created by extension of the contract
period.

This definition does not accurately describe the injury

suffered by the contractor and therefore is meaningless. The
conceptual difference between the two terms is that
unabsorbed overhead focuses on the amount by which the base
used for distributing fixed indirect costs is reduced whereas
extended overhead focuses on the benefit received by the
Government in the form of increased home office effort due to
extension of the period of contract performance.
2 31
See Capital Elec., GSBCA 5316, 83-2 BCA 16548 at 82,311,
rev'd on other grounds, 729 F.2d 743 (C.A.F.C. 1984).
2 3 2 For
example, in a recent opinion the GSBCA stated, "the
terms 'extended' and 'unabsorbed' overhead are often used
virtually interchangeably, as in the court's opinion in
Capital Electric. . . ." Stevenson Assoc., GSBCA 6573, 86-3
BCA 19071 at 96,350.
2 33
See e.g., Capital Elec., GSBCA 5316, 83-2 BCA 16548 at
82,311, rev'd on other grounds, 729 F.2d 743 (C.A.F.C. 1984);
McGovern, Compensating Contractors for Delay-Related Costs,
Cont. Mgmt., 13 (Oct. 1984).
2 34
See supra note 226. But see Worsham Constr., ASBCA 25907,
85-2 BCA 18016 at 90,369 (holding that when a contract is
terminated for convenience, entitlement to unabsorbed
overhead for pre-termination delay is not contingent on
whether or not the delay was caused by the Government).
235
See Allied Materials and Equip., ASBCA 17318, 75-1 BCA
11150.

The claim for unabsorbed burden expense bears no

direct relationship to the direct and indirect
expenses incurred on a particular contract, but arises
because of a decrease in the allocability of the
burdens [of] a particular contract due to a reduction
in the direct cost base in that contract during a
period of disruption and delay and consequently causes

208
 other work in the plant to sustain an increased
allocation of the burdens over what would have been
experienced if there had been no delay and disruption.

Id. at 53,089.
2 3 6 See
R. W. Contracting, ASBCA 24627, 84-2 BCA 17302 at
86,219; Switlik Parachute Co., ASBCA 18024, 75-1 BCA 11434
at 54,445:

Such under-absorption of [fixed overhead or G&A] as

qupport for a delay claim cannot exist unless
productive facilities are tied up on the contract, or
at least held available for it and not otherwise used
for a longer period than they would have been absent
the delay; or unless available direct labor personnel
are under-utilized due to the delay. (citing Therm-
Air Mfg., ASBCA 15842, 74-2 BCA 10818 at 51,441-42).

237See Capital Elec. v. United States, 729 F. 2d 743, 746

(C.A.F.C. 1984)
2381d.

2 39
See e.g., Excavation-Constr., ENG BCA 3858, 83-1 BCA 16338
at 81,209. See also Fred R. Comb Co. v. United States, 103
Cl. Ct. 174, 184 (1945):

If as in this case, the delay which postpones the

completion of existing work occurs at the very
beginning of that work it would be an invitation to
the merest guess work to require the contractor to
give evidence as to what he would have done next after
this work was completed, if it had been completed at
an earlier time when he knew it would not be
completed. . . . We think that the Government, having
breached its contract, has no right to say, in effect,
that its breach shall go uncompensated unless the
contractor proves, with precision, what is usually not
susceptible of such proof.
2 4 0 However,
recovery of extended overhead may be permissible
and is discussed infra notes 242-66 and accompanying text.
24 1 See Nash & Cibinic, supra nc'( 65, at 1409. r

209

ALy . ." " -" . .4". "..' - . - - . . '-

 . ..

2 4 2 Net
under absorption of overhead occurs when delay shifts
work into a later, more active accounting period. Because
production is greater in the later accounting period, the
delayed work will absorb less fixed indirect cost per unit of
production than it would have in the earlier period. In
contrast, net over absorption of overhead occurs when delay
shifts work into a later, less active accounting period.
Because the volume of work is less in the later accounting
period, the delayed work will absorb more fixed indirect cost
per unit of production than it would have in the earlier
period. For a criticism of the concept of over absorbed
overhead see Walters, Capital Electric--Eichleay's Swan Song,
19 Pub. Cont. Newsl. 3, at 12 (Winter 1984).
243
See Capital Elec., GSBCA 5316, 83-2 BCA 16548 at 82,311,
rev'd on other grounds, 729 F. 2d 743 (C.A.F.C. 1984).
2 4 4A
claim for unabsorbed overhead, could be framed as a
claim for extended overhead as well. However because
entitlement to extended overhead has not yet been
authoritatively decided, an assumption is made that a
contractor would attempt to recover unabsorbed overhead
rather than extended overhead if entitlement to unabsorbed
overhead could be proven.
2 4 5 The
Claims Court in Savoy Construction v. United States, 2
Cl. Ct. 338,341-42, rev'd, unpublished decision, Appeal No.
83-1029 (C. A. F. C. 1984), explained it this way:

[Tihe concept of awarding additional home office

overhead on a per diem basis simply because the
performance time on a project has been extended
presents logical difficulties. As noted, this
overhead cost is not related to contract performance.
The cost will continue regardless of when any one
contract is completed. Having a contract in progress
for an additional period of time does not necessarily
increase or decrease home office costs. Only if an
extended performance period on one contract served to
preclude the receipt of new revenue would the
contractor actually suffer a loss of sums otherwise
available to offset its continuing home office
overhead expense.
2 4 6 Richard
Walters, correctly recognizing the difference
between extended overhead and unabsorbed overhead, argues

210
that a contractor should recover extended overhead because
the Government benefits from the extended home office
efforts and that the Government should not get a "free ride"
in the period of contract extension.

Because no provision is made in a contractor's bid for

home office efforts beyond the original contract
performance period, the contractor is entitled to
recover all the home office overhead costs properly
assignable to that contract during the period of
extended performance. It should not matter that most
of those costs are fixed and would theoretically have
been incurred by the contractor even absent the
government delay. There is no doubt that the
government is benefited by those extended home office
costs, and there is no reason why the government
should not be liable for an adjustment consonant with
the benefit received based upon a fair proportion of a
contractor's home office costs.

Capital Electric--Eichleay's Swan Song, 19 Pub. Cont. Newsl.

3, at 13 (Winter 1984). Accord Ernstrom and Essler, Beyond
the Eichleay Formula: Resurrecting Home Office Overhead
Claims, The Constr. Law., Vol. 3, No.1 (Winter 1982). "[Iun
most cases, the contractor will not actually experience a
significant net increase in home office overhead expense.
Instead, there is a disproportionate -ommitment of relatively
fixed home office resources and expenses. . . to the delayed
project to the prejudice of the contractor's other projects
and opportunities." Id. at 8.
2 4 7 Despite
comments to the contrary by some commentators.
See e.g., Braude and Kovars, Extended Home Office Overhead,
Constr. Briefings, No. 84-6, at 3 (June 1984). "The law is
well established that extended home office overhead is a
recoverable element of delay damages." (citing Capital Elec.
and Savoy Constr.) Accord Constr. Law Adviser, (No. 6, June
1984). The Federal Circuit Court of Appeals in Capital
Electric v. United States, 729 F. 2d 743, 744 (C.A.F.C.
1984), did not decide whether extended overhead was
recoverable--it sidestepped the issue. It found that Capital
Electric had introduced unrebutted evidence of its inability
to take on substitute work during the various delay periods.
Thus, entitlement to unabsorbed overhead was established,
eliminating the need to decide whether 'extended overhead'
was recoverable.

211
V - . .' 5 .
248
See e.g., Capital Elec., GSBCA 5316, 83-2 BCA 16548 at
82,311, rev'd on other grounds, 729 F. 2d 743 (C.A.F.C.
1984). Here, in a very thorough and scholarly opinion, the
GSBCA attempted to distinguish unabsorbed and extended
overhead and show why extended overhead was not recoverable.
While the Board easily defined unabsorbed overhead, it was
unable to define the basis of extended overhead. Its
comments were limited to the statement that extended overhead
has as its premise that extending the performance period will
increase overhead costs.
2 4 9 See
Bruce Constr. v. United States, 163 Ct.Cl. 97,100
(1963).

Equitable adjustments in this context are simply

corrective actions utilized to keep a contractor whole
when the Government modifies a contract. Since the
purpose underlying such adjustments is to safeguard
the contractor against increased costs engendered by
the modification, it appears patent that the measure
of damages cannot be the value received by the
Government, but must be more closely related to and
contingent upon the altered position in which the
contractor finds himself by reason of the
modification.

Id. See also supra notes 15-16 and the cases cited therein.
250
"[C]ourts have yet to develop a rationale to support a
recovery, absent an increase in overhead expenditures or
postponement of future work." Note, Home Office Overhead for
Construction Delays, 17 Ga. L. Rev. 761, 774 n.28 (1983).
See also A.C.E.S., INC., ASBCA 21417, 79-1 BCA 13809 at
67,721; Fischbach & Moore Int'l, ASBCA 18146, 77-1 BCA 12300
at 59,224, "It is axiomatic that a contractor asserting a
claim against the Government must prove not only that it
incurred the additional costs making up its claim but also
that such costs would not have been incurred but for the
Government action."
2 5 1 See
e.g., B. J. Lucarelli & Co., ASBCA 8768, 65-1 BCA
4655, at 22,257, where the Board stated:

There is no evidence that the [delay] caused any

increase in appellant's home office expense or that it
in any way affected appellant's capability of taking
on other work. In the absence of evidence that the

212
 (delay] caused any increase in home office expense, we
do not even reach the question of how to compute the
amount of the increase.

Accord Ricway, Inc., ASBCA 30056, 86-3 BCA 19139, at 96,741;

Ricway, Inc. ASBCA 29983, 86-2 BCA 18841 at 94,955
(application of the Eichleay formula is not automatic every
time a suspension of work occurs--a prima facia showing that
the contractor had to stand by is required under Capital
Electric); Vepco, Inc., ASBCA 26993, 84-2 BCA 17255;
Bromley Contracting, DOT CAB 1284, 83-2 BCA 17233; R. W.
Contracting, ASBCA 24627, 84-2 BCA 17302 at 86,223 (no
decrease in the base over which appellant's overhead was
allocated); Seckinger & Co., ASBCA 26233, 82-1 BCA 15793, at
78,230 (failed to show that any other work was burdened with
an increased home office expense rate); Therm-Air Mfg.,
ASBCA 15842, 74-2 BCA 10818, at 51,441-42 (no evidence of
under utilization of available production labor for which the
Government was responsible).
2 5 2 Extended
overhead is used here to mean recovery of fixed
indirect costs in the absence of any showing that the
contractor's distribution base was reduced by a Government-
caused contract extension.
2 5 3 Able
Contracting, ASBCA 27411, 85-2 BCA 18017 at 90,385.
Accord Charles W. Schroyer, Inc., ASBCA 21859, 78-1 BCA 21859
at 66,227 (Government's contention that the contractor was
able to use its work force elsewhere was considered
irrelevant).
2 5 4 See
Capital Elec. v. United States, 729 F.2d 743, 746
(C.A.F.C. 1984).
2 5 5 But see supra note 231.
2 56
See
e.g., Fortec Constructors v. United States, 8 Ct. Cl.
490, 499 (1985). See also George Hyman Constr., ENG BCA
4541, 85-1 BCA 17847. Here the Board found the contractor
was entitled to extended overhead, stating:
The manifest unfairness of keeping a contractor
engaged on, or liable to perform, a job but postponing l
or extending his performance well beyond what he had a
right to expect and upon which he bid, demands a means
of compensating him for this costs of operating his

213

:-.-,-
-.
u - , ..-.-.-.
...
.,. .. ,- -.. -... , ....
•..-k' " , -,.-...
,. -',,k ' - k del
 home office during such extended period. Eichleay
represents such a method. Id. at 89,354.

This is the basis normally used to justify entitlement to

extended overhead absent proof of a reduced distribution base
justifying entitlement to unabsorbed overhead. The case was
tried de novo in the Federal District Court. See George
Hyman Constr. v. Washington Area Transit, 621 F.Supp. 898
(D.C.D.C. 1985). The court first commented that the D.C.
Circuit Court of Appeals did not recognize extended overhead
as a basis of recovery and then found that the delay had
prevented the contractor from taking on additional work, thus
entitling it to recovery of unabsorbed overhead.
2 57
See B.J. Lucarelli & Co., ASBCA 8768, 65-1 BCA 4655 at
22,257; R.W. Contracting, ASBCA 24627, 84-2 BCA 17302 at
86,223 (decrease in the base over which appellant's overhead
is calculated is a prerequisite); Seckinger & Co., ASBCA
26233, 82-1 BCA 15793 at 78,230; L & H Constr., ASBCA 23620,
81-1 BCA 14823 at 73,60-61; Savoy Constr., ASBCA 21218, 80-1 T
BCA 14392, motion for reconsid. denied 80-2 BCA 14724, aff'd,
2 Cl.Ct. 338 (1983), rev'd, unpublished opinion, Appeal No.
83-1029 (C.A.F.C.1984); Therm-Air Mfg. Co., ASBCA 15842, 74-
2 BCA 10818, at 51,441-42. Charles W. Schroyer, Inc., ASBCA
21859, 78-1 BCA 21859 at 66,227, is the only case that
permits recovery.
2 5 8 See Savoy Constr., ASBCA 21218, 80-1 BCA 14392, motion for
reconsid. denied, 80-2 BCA 14724, aff'd, 2 Cl.Ct. 338 (1983),
rev'd, unpublished opinion, Appeal No. 83-1029
(C.A.F.C.1984). Although the reversal was unpublished and of
no precedential value, the Federal Circuit Court of Appeals
did overrule a decision where both the GSBCA and Claims Court
held extended overhead was not recoverable.
2 5 9 G.S.
and L. Mechanical and Constr., DOT CAB 1640, 86-3 BCA
19026 at 96,094-95. However, the Board then found that the
delay had kept the contractor from beginning performance of a
Navy contract it had been awarded. Thus, the Board's
endorsement of extended overhead was not necessary for
contractor's recovery--entitlement to unabsorbed had been
shown.
2 60
See e.g., Kent and Walters, Recovering Indirect Costs,
Constr. Briefings, No. 80-6, at 2 (Nov. 1980). "The concept
of 'extended overhead' is unique to construction contracting.
By comparison 'unabsorbed overhead' is a manufacturing

214
accounting concept." Accord Braude and Kovars, Extended Home
Office Overhead, Constr. Briefings, No. 84-6, at 2 (June
1984). "Extended overhead is unique to construction
contracting, while unabsorbed overhead is only appropriate to
manufacturing." Accord Capital Elec., GSBCA 5316, 83-2 BCA
16548 at 82,311, rev'd on other grounds, 729 F. 2d 743
(C.A.F.C. 1984). "Extended overhead is a concept unique to
construction contracting. It has as its premise . . . that
extending the performance period will increase overhead
costs." Accord Recovery of Extended Home Office Overhead--
The Latest Chapter, Constr. L. Advisor (June 1984).
2 6 1 See
R.G. Beer Corp., ENG BCA 4885, 86-3 BCA 19012.

Where it is practicable for the contractor to shift

its work force productively and efficiently to other
contracts, part or all of the otherwise unabsorbed
indirect costs will be allocable to direct costs
expended in the performance of the other work.
Accordingly, good faith, successful reassignment of
qualified workers during periods of suspended work
effectively mitigates the contractor's damages and
generally reduces the unabsorbed indirect cost
recovery.

Id. at 96,027. -S

2 62
See Kent and Walters, supra note 260, at 12. "A delay, or
suspension of work, generally does not influence [a
construction contractor's] decision to take on additional
projects because--unlike a manufacturing company--a
construction company's ability to take on new work is limited
only by its bonding capacity and the availability of its
managerial personnel." Accord Braude and Kovars, supra note
260, at 2. "[Tlhe construction contractor simply opens up a
new 'plant' at each jobsite on which he works ... .
2 6 3 See
e.g., Stephenson Assocs., GSBCA 6573, 86-3 BCA 19071.
2 6 4 As
distinguished from extended overhead.
2 6 5 Performance of the substituted work maintains the
integrity of the distribution base so there is no unabsorbed
overhead. In contrast, the construction contractor's
distribution base is reduced by the delay resulting in
unabsorbed overhead in that period. However, this unabsorbed

9'

215
LI
 overhead will be offset by overabsorbed overhead in the
following period. See supra Chapter 3, Part II.B.2.
2 66
Entitlement
to recovery of any "net" unabsorbed overhead
is discussed at supra note 242 and accompanying text.
2 67
FAR 52.212-12. The Suspension of Work clause is a
mandatory clause for fixed-price construction contracts. It
permits the contracting officer to suspend work for a
reasonable period of time. Under the Suspension of Work
clause, a contractor is entitled to recover only its
increased costs of performance (no profit) for the
unreasonable portion of any delay. See FAR 12.502.
2 6 8 FAR
52.212-13. The Stop-Work-Order clause is an optional
clause for supply, services, and research and development
contracts. It permits the contracting officer to order the
contractor to stop contract performance. Under the Stop-
Work-Order clause, a contractor is entitled to an equitable
adjustment for its increased costs caused by the stop work
order. See FAR 12.503.
2 6 9 FAR
52.212-15. The Government Delay of Work clause is a
mandatory clause for most fixed price supply contracts and
optional for fixed price service contracts. It allows
compensation for delays and interruptions in the contract
work caused by the acts, or failures to act, of the
contracting officer. Under the Government Delay of Work
clause, a contractor is entitled to recover only its
increased costs of performance caused by the delay or
interruption (no profit). See FAR 12.504.
2 7 0 FAR
52.243-4. The Changes clause is a mandatory clause for
fixed-price contracts. It permits the contracting officer to
make changes in the work within the scope of the contract at
any time. Under the Changes clause, a contractor is entitled
to an equitable adjustment for its increased costs of
performance caused by the change. See FAR 43.201(a).
4
2 7 1 FAR
52.236-2. The Differing Site Conditions clause is a
mandatory clause for fixed-price construction contracts when
the contract amount is expected to exceed the small purchase
limitation. It provides an equitable adjustment whenever
subsurface or latent conditions at a site differ materially
from those indicated in the contract or when the contractor
encounters unknown physical conditions at the site, of an

216

eter- er 4
EM
 unusual nature, that differ materially from those ordinarily
encountered in work of the type specified in the contract.
Under the Differing Site Conditions clause, a contractor is
entitled to an equitable adjustment for its increased costs
of performance caused by the differing site condition. See
FAR 36.502.
2 7 2 FAR
52.249-2. The Termination for Convenience clause is a
mandatory clause for all fixed-price contracts. See supra
note 17. Under the Termination for Convenience clause,
contractors can recover pre-termination unabsorbed overhead
plus reasonable profit. See infra notes 421-428 and
accompanying text. They also can recover an equitable
adjustment for the increased costs of performing the
unterminated portion of the contract caused by the
termination. Recovery of unabsorbed overhead under partially
terminated contracts is discussed infra notes 547-554 and
accompanying text.
2 7 3 See
e.g., Federal Contracting, ASBCA 28957, 84-2 BCA
17481. Here the contractor was entitled to recover a portion
of its unabsorbed overhead claim under the Differing Site
Conditions clause and a portion under the Suspension of Work
clause--recovery was computed using the Eichleay formula.
Under the Suspension of Work clause, the contractor was
entitled to an adjustment for the unreasonable period of
delay only (7 days of delay were considered reasonable) and
was not entitled to any profit on the amount recovered. In
contrast, the contractor was entitled to an adjustment for
the entire period of delay attributable to the differing site
condition and profit as well.
2 7 4 Cases
permitting recovery of unabsorbed overhead under the
Changes or Differing Site Conditions clause include Savoy
Construction v. United States, unpublished opinion, Appeal
No. 83-1029 (C.A.F.C., Feb 7, 1984); Fortec Constructors v.
United States, 8 Cl. Ct. 490 (1985); Cieszko Construction,
ASBCA 34199, 88-1 BCA 20223 at 102,419; Roberts
Construction, ASBCA 34062, 87-3 BCA 20117; Excavation-
Construction, ENG BCA 3837, 86-1 BCA 18638; E. Patti & Sons,
Inc., PSBCA 1024, 85-2 BCA 18144; Savoy Construction ASBCA
21218, 85-2 BCA 18073; George E. Jenson Contractor, ASBCA
29772, 85-1 BCA 17833; Excavation-Construction, ENG BCA
3851, 84-3 BCA 17646; Federal ContractingASBCA 28957, 84-2
BCA 17482; Therm-Air Manufacturing, ASBCA 16543, 73-1 BCA
9983. For cases permitting recovery of unabsorbed overhead

217 0

pI
I

7 ~ ~~~~~~~~~~~~~~~
a*~~* .{ I, J LU * ~ ~ ~ 'V ~ %lm~'%
 -- ~ I, . I n p -

under the Termination for Convenience clause see infra notes

423 and 544.
27 5
See
R. G. Beer, Inc., ENG BCA 4885, 86-3 BCA 19012, where
at 96,025-26, the Board stated:

In most instances involving changed work the

percentage markup on direct costs is used and no
further or alternative extended overhead award is
considered necessary or appropriate, even where there
is an extension of the completion date. . . .Only in
unusual circumstances is compensation for
unabsorbed/extended overhead recoverable for new work
added pursuant to the 'Changes' clause.

See also Daly Constr., ASBCA 32427, 87-3 BCA 20182 at

102,150-51; Excavation-Constr., ENG BCA 3851, 84-3 BCA 17646
at 87,930; R. W. Contracting, ASBCA 24627, 84-2 BCA 17302 at
86,220; L&H Constr., ASBCA 23620, 81-1 BCA 14828 at 73,161.
2 7 6 See
Excavation-Constr., ENG BCA 3851, 84-3 BCA 17646 at
87,930; George E. Jenson Contractor, Inc., ASBCA 29772, 85-1
BCA 17833 at 89,252. Award of unabsorbed overhead is not
automatic. See Bromley Contracting v. United States, 14 Cl.
Ct. 69, 81 (1987) (denying unabsorbed overhead on a 148-day
increase in the work performance period because contractor
failed to prove that costs incurred during that period
exceeded the markups for overhead and profit already
awarded).
27 7
See R. G. Beer, Inc., ENG BCA 4885, 86-3 BCA 19012 at
96,026.
2 7 8 Eichleay
Corp., ASBCA 5183, 60-2 BCA 2688 at 13,568, aff'd
on motion for reconsid., 61-1 BCA 2894.
2 7 9 Schindler
Haughton Elevator Corp., GSBCA 5390, 80-2 BCA
14671, at 72,352.
2 8 0 Allegheny
Sportswear Co. ASBCA 4163, 58-1 BCA 1684 at
6364. This method and variations of it also are known as the
burden fluctuation method.
2 8 1 A.C.E.S., INC., ASBCA 21417, 79-1 BCA 13809 at 67,722.

218

H I.,U
2 8 2 Cateret
Work Uniforms, ASBCA 1647, 6 CCF 61561 (1954), at
52,254.
2 83
Allied Materials and Equip. Co., ASBCA 17318, 75-1 BCA
11150 at 53,089-90. This is considered a variation of the
Allegheny method. See Capital Electric, GSBCA 5316, 83-2 BCA
16548 at 82,313, rev'd on other grounds, 729 F.2d 743
(C.A.F.C. 1984).
2 84
See Bedingfield and Wright, supra note 27, at 14-30 to 14-
36.
2 8 5 See
Capital Elec. v. United States, 729 F.2d 743, 744
(C.A.F.C. 1984).
286
See e.g., Berley Indus. v. City of New York, 412 NYS2d
589, 592 (1978). "(T]he mathematical computations under the
'Eichleay formula' produce a figure with at best a chance
relationship to actual damages, and at worst no relationship
at all." (characterizing the daily overhead rate calculated
under Eichleay as a "harsh daily penalty"). Accord Kansas
City Bridge Co. v. Kansas City Structural Steel Co., 317
S.W.2d 370, (1958); General Ins. Co. v. Hercules Constr., 385
F.2d 13 (8th Cir. 1967); W. G. Cornell Co. v. Ceramic Coating
Co., 626 F.2d 990 (5th Cir. 1980); Guy James Constr. v.
Trinity Indus., 644 F.2d 525 (5th Cir. 1981).
2 8 7 Capital
Elec., GSBCA 5316, 83-2 BCA 16548 at 82,315, rev'd
on other grounds, 729 F.2d 743 (C.A.F.C. 1984).
2 8 8 1d. at 82,313-14.
2 8 9 Capital
Elec. v. United States, 729 F.2d 743 (C.A.F.C.
1984).
29 0 1d. at 745-46.
2 9 1 Fred
R. Comb Co. v. United States, 103 Ct.CI. 174 (1945).
29 2
Capital Elec. v. United States, 729 F.2d 743, 746
(C.A.F.C. 1984).
29 3 1d. at 746-47.

219
 -.. Me - -. •. - - -:- , - 7 .

2 9 4 Savoy
Constr., ASBCA 21218, 80-1 BCA 14392, motion for
reconsid. denied, 80-2 BCA 14724, aff'd, 2 CI.Ct. 338 (1983),
rev'd, unpublished opinion, Appeal No. 83-1029 (C.A.F.C.
1984).
29 5 1d. at 70,970.
29 6 1d. at 341-42.
297 Excavation-Constr., ENG BCA 3851, 84-3 BCA 17646.

2981d. at 8730.
29 9
See e.g., Irwin, The Return of Eichleay: Is It Here to
Stay? Constr. Claims Monthly, Vol. 6, No. 6 (June 1984)
(stating that the Court failed to address the very real
criticisms of the Eichleay formula and suggesting that the
Eichleay formula will not be around long); McGovern,
Compensating Contractors for Delay-Related Costs, "Hichleay"
After Capital Electric, Cont. Mgmt. J., 14 (Oct. 1984);
Melton, Common Sense About Home Office Overhead--Part I & II,
Constr. Claims Monthly, Vol. 7, Nos. 5 and 6 (May & June
1985).
3 0 0 Bromley
Contractors v. United States, 14 CI.Ct 69, 81
(1987); Fortec Constructors v. United States, 8 Cl.Ct. 490
(1985); Cieszko Constr., ASBCA 34199, 88-1 BCA 20223 at
102,419; Stephenson Assocs., GSBCA 6573, 86-3 BCA 19071;
R.G. Beer Corp., ENG BCA 4885, 86-3 BCA 19012; Ricway, Inc.
ASBCA 30056, 86-3 BCA 19138; G.S. and L. Mechanical and
Constr., DOT CAB 1640, 86-3 BCA 19026; Ricway, Inc. ASBCA
29983, 86-2 BCA 18841; Wickham Contracting, IBCA 1301-8-79,
86-2 BCA 18887; Excavation-Constr., ENG BCA 3837, 86-1 BCA
18638; Don Cherry, Inc., ASBCA 27795, 85-2 BCA 18150; Able
Contracting, ASBCA 27411, 85-2 BCA 27411; E. Patti & Sons,
Inc., PSBCA 1024, 85-2 BCA 18144; Savoy Constr., ASBCA
21218, 85-2 BCA 18073; Worsham Constr., ASBCA 25907, 85-2
BCA 18016; Shirley Contracting, ASBCA 29848, 85-1 BCA 17858,
aff'd on reconsid., ASBCA 29848, 85-2 BCA 18019; George
Hyman Constr., ENG BCA 4541, 85-1 BCA 17847, aff'd, 621 F.
Supp. 898 (D.C.D. 1985); George E. Jenson Contractor, ASBCA
29772, 85-1 BCA 17833; Excavation-Constr., ENG BCA 3851, 84-
3 BCA 17646; Federal Contracting, ASBCA 28957, 84-2 BCA
17482; Vepco, Inc., ASBCA 26993, 84-2 BCA 17255; R. W.
Contracting, ASBCA 24627, 84-2 BCA 17302.

220

AL ~:.* *4. ~ ,IJe~/w .~ %~~% t q~ "N

3 0 1 G.S.
and L. Mechanical and Constr., DOT CAB 1640, 86-3 BCA
19026 at 96,099. The Board then permitted the contractor to
recover under the Eichleay formula coimenting, "It may well
be that the Eichleay formula is inaccurate, and a gross
distortion, too related to time to the exclusion of other
factors, and too premised upon the false presumptions that we
have noted above. However, respondent has not given us any
more realistic method of performing a computation of home
office overhead for the suspension period."
3 0 2 Don
Cherry, Inc., ASBCA 27795, 85-2 BCA 18150 at 91,118.
303
Ricway, Inc. ASBCA 29983, 86-2 BCA 18841 at 94,955.
3 04
See supra note 97 and accompanying text. See also Charles
W. Schroyer, Inc., ASBCA 21859, 78-1 BCA 21859. Here, the
Government correctly argued that the contractor's failure to
include in billings two contracts (on which it worked during
the 67-days of delay but did not bill during the contract
performance period) distorted the Eichleay computation.
Incredibly, the Board disagreed.
3 0 5 Unabsorbed
overhead is most often thought of in connection
with home office costs. CAS 403 requires that home office
expenses be distributed on the basis of the beneficial or
causal relationship existing between the home office costs
and the receiving activities or on a basis reflecting the
total activity of the business as a whole. See 4 CFR
403.40(a) (1) and (c). Thus, under CAS 403, billings would
not be an acceptable distribution base for home office
expense.
3 0 6 The
CAS recognize home office expenses are not always
fixed and that a causal relationship may exist. CAS 403
states "h]ome office expenses shall be allocated on the
basis of the beneficial or causal relationship between the
supporting and receiving activities." 4 CFR 403.40(a) (1)
(emphasis added).
307
Note, Home Office Overhead as Damage for Construction
Delays, 17 Ga. L. Rev. 761, 794 (1983). See Salt City
Contrs., VABCA 1362, 80-2 BCA 14713 at 72,559, "The equitable
result sought by utilization of the Eichleay formula may be
distorted by including in the computations home office
expenses which vary substantially with the degree of
performance of work." See also R. NASH, GOVERNMENT CONTRACT

221
CHANGES, 394 (1st ed. 1975), 648 (1981 Supplement); R.G. Beer
Corp., ENG BCA 4885, 86-3 BCA 19012 at 96,029-30; Kemmons-
Wilson, Inc., ASBCA 16167, 72-2 BCA 9689 at 45,254-55.
3 08 "In
the construction contract environment there is a
presumption, rebuttable by the Government, that home office
costs are fixed and no reduction to eliminate variable costs
is necessary." R.G. Beer Corp., ENG BCA 4885, 86-3 BCA 19012
at 96,030. See also Salt City Contractors, VACAB 1366, 80-2
BCA 14713 at 72,559; Braude and Kovars, supra note 260, at
7; Nash, supra note 307, at 648.
3 09 1n
addition to other contract work, idle crew members may
perform routine cleaning of tools and other housekeeping
functions, obtain needed training, or take accrued vacation
time- -all necessary for the contractor's continued existence
as a business entity.
3 1 0 5ee
R.G. Beer Corp., ENG BCA 4885, 86-3 BCA 19012 at
96,027.
3 1 1 Several
recent board cases have incorrectly stated that
the Eichleay formula has a built in corrective mechanism to
reflect the extent of other work performed. See George
Hyman Constr., ENG BCA 4541. 85-1 BCA 17847 at 89,354; R.G.
ENG BCA 4885, 86-3 BCA 19012 at 96,028:
Beer Corp., hd.%~
~ hihi~ *'@f*K ~ f%**.',~ * ~ *~~*
(Tihe Eichleay formula has a built-in corrective
mechanism to reflect the extent of other projects
performed during the delay period. To the degree
other work is performed and billed, the billings ratio
denominator is decreased, automatically shifting
overhead costs from the delayed contract to such other
work proportionate to the amount billed.

The proposition that overhead costs are "automatically"

shifted from the delayed contract in proportion to the amount
of other work billed is incorrect. Under the Eichleay
formula the mitigatory effect of substituted work is shared
proportionately by all of the contractor's contracts. Only
the delayed contract which enabled the substituted work to be
performed should be credited with the mitigatory effect of
the substituted work.

3See T. Edem, Claims for Unabsorbed Overhead on Defense

Contracts, unpublished thesis on file at Air Force Institute

222

-..
of Technology Library, Wright-Patterson AFB, Ohio, at 120
(Sept. 1985). See also McDonald, Recovery of Home Office
Overhead--A Different Point of View, Constr. Claims Monthly,
Vol. 5, No. 12 (Dec. 1983).
31 3
See Edem, supra note 312, at 120.
3 1 4 See
Able Contracting, ASBCA 27411, 85-2 BCA 18017 at
90,385, where the contractor recovered only half its
unabsorbed overhead as calculated under the Eichleay formula
because the Board found it was capable of doing two jobs at
the same time. "The Government-responsible delay was not
responsible for [the contractor's) failure to obtain other
work." Id.
3 1 5 With
respect to unabsorbed overhead, the presumption is
that the contractor's distribution base is decreased by the
same amount regardless of when during contract performance
the delay occurs or at what time during the year that the
delay occurs. With respect to extended overhead, the
presumption is that a contract receives benefits from home
office costs at a constant rate throughout the contract .

performance period. CC.

3 1 6 This
criticism of the Eichleay formula was acknowledged 21
years ago in Fullerton Construction, ASBCA 11500, 67-2 BCA
6394 at 29619. The ASBCA held that the Eichleay formula "is
not always an appropriate formula" and refused to apply it to
a delay occurring after substantial completion of the
contract. See also Seckinger & Co., ASBCA 26233, 82-1 BCA
15793.
.4
3 17
See e.g., Worsham Constr., ASBCA 25907, 85-2 BCA 18016.
Here the contractor claimed its "overhead largely was
'incurred' at the beginning of the project rather than evenly
throughout the project because most of the overhead is
expended in setting the job in motion including negotiating
with subcontractors, determining delivery dates, submittals,
scheduling the project, reviewing the plans and
specifications, meetings with the superintendent, site
visits, preconstruction conferences, etc." Id. at 90,365.
Likewise, the end of a construction project often requires
considerable home office attention; final inspection must be
scheduled, punch list items must be monitored, and clean up
efforts must .e made. See Capital Electric--Eichleay's Swan

223

'00 P 0 _F vi N w r r rsp r f
 Song? R. Walters, 19 Pub. Cont. Newsl. 3, at 4 (Winter
1984).
3 18
See G.S. and L. Mechanical and Constr., DOT CAB 1640, 86-
3 BCA 19026.

This presumption is false because most assuredly there

is less home office activity with regards to a
contract that is inactive under a suspension, than
with regard to one which is proceeding at full steam,
with payrolls to be prepared, supply orders to be
processed, and subcontracts to be administered.

Id. at 96,097-98.
3 1 9 See
supra notes 100-05 and accompanying text.
32 0
See supra note 99 and accompanying text.
3211d".-

3 2 2 For
a discussion of how costs respond to change see supra
notes 108-118.
3 2 3 See
e.g., Allied Materials and Equip., ASBCA 17318, 75-1
BCA 11150 at 53,089, where recovery of unabsorbed overhead
using the Eichleay formula would have allowed a recovery of
$145,915 more than the contractor's actual unallocated
residual manufacturing overhead and G&A expense.
32 4
Note, Home Office Overhead as Damage for Construction
Delays, Ga. L. Rev., 799-809 (1983).
325Id., at 800. See also Therm-Air Mfg., ASBCA 16453, 73-1
BCA 9983 at 46,865.
326 Note, Home Office Overhead as Damage for Construction
Delays, Ga. L. Rev., 804 (1983).

32 7 Capital Elec. v. United States, 729 F. 2d 743, 747

(C.A.F.C. 1984).
328
The Federal Circuit summarily denied Capital Electric
recovery under the modified version of the Eichleay formula
stating that the record did not support its use. Id. See

224

i 224

***4 m~~ | ..... .. 4..~*S ~~ 44J 4 i~

 -' - - - - - -~J -- - - - - - - - - - - - -.

!/

also R. G. Beer Corp., ENG BCA 4885, 86-3 BCA 19012 at I

96,026; G.S. and L. Mechanical and Constr., DOT CAB 1640,
86-3 BCA 19026 at 96,098; Dawson Constr., GSBCA 4956, 79-2
BCA 13989 at 68,635. But see Schindler Haughton Elevator
Corp., GSBCA 5390, 80-1 BCA 14681 at 72,352, where the Board
on its own initiative applied an unusual variation of the
modified Eichleay formula.
32 9
Projected indirect cost rates and changes deleting work
are discussed supra Chapter 2, Parts I.A and I.D.2,
respectively. J
3 30
Estimates form an acceptable starting point for computing
an equitable adjustment "if they are supported by detailed
substantiating data or are reasonably based on verifiable
experience." Celesco Indus., ASBCA 21928, 81-2 BCA 15260, at
75,547-48. Cf. Targarelli Bros. Constr., ASBCA 34793, 88-1
BCA 20363 at 102,989.
3 31
See supra Chapter 3, Part II.B.3.
3 32
Because the contractor has not incurred additional costs,
increased cost is not the basis of its entitlement. The
Government has obtained a benefit, something of value, from
the contractor and it is that value that is being measured. -
S-

3 3 3 The
reasonable cost of providing the additional home
office services can be determined in the following manner.
Multiply the number of hours worked by each home office
employee to provide the additional services by the employee's
hourly wage rate. Then determine a proportionate share of
other fixed home office costs based on the ratio of home
office labor dollars of the increased administrative effort "5-
to total home office labor dollars of the period. The sum of
the two computations equals reasonable cost.

334To compute the adjustment necessary to prevent double

recovery:
(1) Determine that portion of the contractor's indirect cost
groupings allocable to the contract before the value of the
services provided the contract during the period of extension
are removed .

(2) Determine that portion of the contractor's indirect cost .

groupings allocable to the contract after the value of

225
 services provided the contract during the period of extension
have been removed therefrom.
(3) Subtract the allocable portion of the indirect cost
grouping as determined in step 1 from that as determined in
step 2 to obtain the adjustment necessary to prevent double
recovery.
3 3 5 Capital
Elec. v. United States, 729 F. 2d 743 (C.A.F.C.
1984).
3 3 6 Savoy
Constr. v. United States, unpublished opinion,
Appeal No. 83-1029 (C.A.F.C. 1984).
3 37The Government Contractor, No. 84-2, 13 (Feb. 1984), after
noting that the Court of Appeals for the Federal Circuit had
reversed Capital Electric and Savoy Construction stated:
"This means that the Eichleay formula is not dead. However,
the circumstances under which it can be applied are not yet
perfectly clear."
3 3 8 Capital
Elec. v. United States, 729 F. 2d 743, 746
(C.A.F.C. 1984).
3 3 9Also
note that the Federal Circuit's decision in Savoy
Construction is an unpublished opinion. See Savoy Constr.
v. United States, unpublished opinion, Appeal No. 83-1029
(C.A.F.C. 1984). Unpublished opinions have no precedential
value.
3 4 0 Capital
Elec. v. United States, 729 F. 2d 743, 746
(C.A.F.C. 1984).
34 1
See supra Chapter 3, Part II.C.2.d.
3 42 See supra notes 304-22 and accompanying text.
3 4 3 G.S.
and L. Mechanical and Constr., DOT CAB 1640, 86-3 BCA a"

19026 at 96,101. Accord Bromley Contracting, DOT CAB 1284,

83-2 BCA 17233. In Bromley Contracting the DOT CAB
commented: "The Eichleay formula and formulas similar to it,
are used as guides for equitable adjustments (sic)
calculations, but must be used with care sufficient to ensure
that the results somewhat comport to reality." Id. at
85,825.

"

226

.-. S J a. f/a . N - ',', . ' * v'J J

3 4 4 Excavation
Constr., ENG BCA 3858, 82-1 BCA 15770 at
78,071. See also Miles Const., VABCA 1674, 84-1 BCA 16967 at
84,374 (using jury verdict approach limited recovery to 90%
of per diem rate).
3 4 5 See
G.S. and L. Mechanical and Constr., DOT CAB 1640, 86-3
BCA 19026 at 96,099, where the Board commented "[T]he
majority opinion in Capital Electric, above, appears to be
inviting litigants in an appropriate case to have the Court
of Appeals conduct en banc review of the Eichleay approach."
3 4 6 Eichleay
Corp., ASBCA 5183, 61-1 BCA 2894, at 15118
(emphasis added). See also Allied Materials and Equip.,
ASBCA 17318, 72-2 BCA 11150 at 53,089.
347 See Braude and Kovars, supra note 260, at 7.
3 4 8 See
Essex Electro Eng'rs, ASBCA 21066, 79-2 BCA 14035, at
68,952, where the Board decided to use the Eichleay formula
as a measure of damages rather than the burden fluctuation
method recommended by the Government reasoning, "We are
persuaded that the appellant has computed its claim in a
reasonable manner and on a reasonable basis. This
presumption of reasonableness has not been rebutted." See
also G.S. and L. Mechanical and Constr., Inc., DOT CAB 1640,
86-3 BCA 19026, at 96,101. "The ultimate test of any formula
to compute the amount of home office overhead chargeable to a
contract during a suspension period remains that of
reasonableness, and it is a contractor's task to convince us
that its proposed method of computation is reasonable." Id.
(emphasis added).
34 9
FAC 84-26 (July 30,1987) amending FAR 31.201-3.
3 5 0 This
approach was commended to the committees that draft
procurement regulations by the Board in G.S. and L.
Mechanical and Construction,DOT CAB 1640, 86-3 BCA 19026 at
96,100.
3 51
See supra notes 200-04 and accompanying text.
3 5 2 See
Sante Fe Eng'rs v. United States, 801 F.2d 379
(C.A.F.C. 1986); West Land Builders, VABCA 1664, 83-1 BCA
16235.

227
 3 93
See Sante Fe Eng'rs v. United States, 801 F.2d 379
(C.A.F.C. 1986).
354
GSA has used a clause limiting recovery of overhead on
construction contracts for over 20 years. Only two Federal
agencies have followed GSA's lead--the Postal Service and the
VA. Notably, DOD has not adopted a similar clause.
355
A percentage markup for indirect costs can be at either
the contractor's normal indirect cost rate or at the standard
markup for indirect costs (normally 10% or 15%).
356
See Luria Bros. & Co. v. United States, 177 Ct. Cl. 676,
693 (1966); J. D. Hedin Constr. v. United States, 171 Ct.
Cl. 70, 108 (1965); R. G. Beer Corp., ENG BCA 4885, 86-3 BCA
19012 at 96,031-32; Excavation-Constr., ENG BCA 3837, 86-1
BCA 18638 at 93,669 (crediting the Government with $40,647 of
home office expense already recovered by the contractor as a
percentage markup on direct costs incurred during the delay);
Able Contracting, ASBCA 27411, 85-2 BCA 18017 at 90,386;
Savoy Constr., ASBCA 21218, 85-2 BCA 18073 at 90,723; George
Hyman Constr., ENG BCA 4541, 85-1 BCA 17847 at 89,355, aff'd,
621 F. Supp. 898 (D.D.C. 1985); Excavation-Constr., ENG BCA
3851, 84-3 BCA 17646 at 87,930; R.W. Contracting, ASBCA
24627, 84-2 BCA 17302 at 86,223; Sovereign Constr., ASBCA
17792, 75-1 BCA 11,251 at 53,611; Eichleay Corp., ASBCA
5183, 60-2 BCA 2688, aff'd on reconsid., 61-1 BCA 2894 at
13,576 (a percentage markup on increased direct costs
resulting from the delay was denied as duplicative of
unabsorbed overhead). See also Stephenson Assoc., 86-3 BCA
19071 at 96,354 (to compensate for duplication in overhead
between change orders already priced out by mutual agreement
of the parties and Eichleay unabsorbed overhead allowed by
the Board, profit on the unabsorbed overhead was disallowed).
But see Shirley Contracting, ASBCA 29848, 85-1 BCA 17858, P

aff'd on reconsid., ASBCA 29848, 85-2 BCA 18019 at 89,404

(allowing both Eichleay unabsorbed overhead and a 15% markup
on work performed during the delay--the Government did not
know what the 15% overhead markup was for); Charles W.
Schroyer, Inc., ASBCA 21859, 78-1 BCA 21859 at 66,226
(duplication was de minimis); Canon Constr., ASBCA 16142,
72-1 BCA 9404 (based on testimony that it was not
duplicative, a 10% markup on direct costs was not deducted
from recovery of extended overhead).

228

.q V . p :-P
 3 57
The formula used in Cateret Work Uniforms, ASBCA 1647, CCF
61,561 (1954) is one example. Here unabsorbed overhead is
computed by multiplying the excess rate of overhead by total
base costs during the period of delay. Any additional work
performed by the Contractor during the delay will reduce the
excess rate of overhead.
3 58
See supra notes 309-13 and accompanying text.

359In some instances, home office expense will consist of

almost all fixed indirect cost. This is particularly true in
the construction industry. See supra note 308 and
accompanying text. On the other hand, manufacturing overhead
is likely to include a significant percentage of variable
indirect costs.
3 6 0 Unabsorbed
overhead includes no variable indirect costs.
Variable indirect costs are removed from the indirect cost
pools before computation of unabsorbed overhead. See supra
note 307 and accompanying text.
3 6 1 See
A.C.E.S., Inc., ASBCA 21417, 79-1 BCA 67,711. The
contractor unsuccessfully sought recovery of both unabsorbed
overhead and storage costs of Government items being
repaired. The Board denied such recovery, finding storage to
be a fixed indirect cost already recovered in the allowance
for unabsorbed overhead. See also Worsham Constr., ASBCA
25907, 85-2 BCA 18016 at 90,377 (disallowing as a direct cost
the time spent by contractor's executives in handling
problems in that such cost was already recovered in the
allowance for unabsorbed overhead).
3 62
See infra Chapter 4, Parts. II.D, V, and VI.B.2.

Note 363 begins on page 230.

229

I'-P!. I I..**
'ew*~~~~~~~~~ ~ * .~ L6~a
 36 3
FAR 49.201(a). Stated somewhat differently, "the purpose
of a settlement agreement is to make the contractor
'financially whole for all the direct consequences' of the
termination, anticipated profits aside." Tera Advanced
Servs., GSBCA 6713-NRC, 85-2 BCA 17940 at 89,882 (citations
omitted).
3 64 FAR 52.249-2(f) (3) .
365
FAR 49.201(b).
3 6 6 FAR 49.109-7(a).
3 67 FAR 49.109-7 (d).
3 6 8 FAR
49.201(a). "In a given case, various methods may be
equally appropriate for arriving at fair compensation. The
use of business judgment, as distinguished from strict
accounting principles, is the heart of a settlement." Id.
3 69 See Celesco Indus., ASBCA 22460, 84-2 BCA 17264 at 86,162.
37 0
See e.g., Agrinautics, ASBCA 21512, 79-2 BCA 14149 at
69,647-48; Allied Materials and Equip., ASBCA 17318, 75-1
BCA 11150 at 53,085; Bell and Howell Co., ASBCA 18464, 75-1
BCA 10993 at 52,348; Cresent Precision Prods., ASBCA 18705,
74-2 BCA 10898 at 51,870; Algonac Mfg., ASBCA 10534, 66-2
BCA 26,718 at 26,726.
37 1
See e.g., Worsham Constr., ASBCA 25907, 85-2 BCA 18016 at
90,378 (actual audited rate); Hewitt Contracting, ENG BCA
4596, 83-2 BCA 16816 at 83,640-41 (audited rate); Paul E.
McCollum, Sr., ASBCA 23269, 81-2 BCA 15311 at 15,311-12;
Globe Air, Inc., AGBCA 76-119, 78-1 BCA 13079 at 63,877;
Henry Spen & Co., ASBCA 20766, 77-2 BCA 12784 at 62,172
(audited rate); Varo, Inc., ASBCA 16606, 72-2 BCA 9720 at
v 45,395-96; Manuel M. Liodas, ASBCA 12829, 71-2 BCA 9015 at
41,879; Nolan Bros., ENG BCA 2680, 67-1 BCA 6095 at 28,219.
But see Rossen Builders, ASBCA 32305, 87-1 BCA 19538 at
98,727-28 (prior year's G&A rate was used by Government and
accepted by Board in lieu of unsupported rate claimed by
contractor).
3 7 2 Termination settlements because of their complexity and
* because not all costs are known at the time of contract
termination, take time to prepare and negotiate. The
contractor's accounting period normally ends well before a

230
settlement agreement is reached. The cost of safeguarding
and disposing of the terminated inventory is an example of a
cost not knrown at the time of termination.
37 3
See generally supra notes 98-106 and accompanying text.
37 4
Surprisingly, the choice of base period is infrequently
litigated or discussed in Board cases. Chapter 5 argues that
use of the period of contract performance as the base period
rather than the contractor's normal base period is an
inconsistent accounting practice. See infra notes 705-09 and
accompanying text.
37 5
See
Penberthy Electromelt Int'l v. United States, 11
Cl.Ct. 307, 319 (1986) . In Penberthy the Court denied
contractor's use of a four year average G&A base period
holding that the base period "must be a period during which
contract costs are incurred." Id. See also R-D Mounts,
Inc., ASBCA 17422, 75-1 BCA 11077 at 52,741-42 (allowing the
six month base period proposed.by the Government because it
was longer, more representative, and included a portion of
the performance period whereas the base period proposed by
the contractor did not). See also Francis Assoc., ASBCA
14100, 70-2 BCA 8493 at 39,474-76. The contractor
unsuccessfully argued that year ending prior to the period of
contract performance should be the base period used for the
termination because it constituted a fair representation of
normal operations as evidenced by previous acceptance on this
contract and others by the Government. The Government had
audited the indirect cost rates of the prior period and had
approved their use for progress payment purposes for the
terminated contract. Nonetheless, the Board adopted the 18
month period of contract performance as the base period. Use %

of the year ending prior to the period of contract

performance as the base period would have resulted in a
manufacturing overhead rate of 105.95% and an engineering
overhead rate of 98.65%; use of the period of performance
resulted in a combined rate of 31.15%.
37 6 1ndirect
costs allocable to a contract are normally
determined by multiplying the contractor's indirect cost rate
times the direct costs generated by the contract. When the
contract proceeds to completion, this accounting practice
usually will permit full recovery of indirect costs.
37 7See Alston, supra note 148, at 389; Bedingfield and
Rosen, supra note 27, at 15-11 through 15-13; A. JOSEPH & N.
O'DONNELL, TERMINATION OF GOVERNMENT CONTRACTS, XII-20 (Fed. Pub.

231
I

1987); W. Petit and L. Victorino, Post-Termination Costs II,

Gov't Contractor, Briefing Papers, No. 84-6, at 4 (June
1983); Rishe, supra note 27, at 15-11. Trueger, supra note
27, at 772-73, comments:

For example, if most of the material has been

purchased and received, and very little direct labor
applied, and if purchasing and receiving expenses are
in the manufacturing overhead pool, it is obvious that
an allocation of factory overhead as a percentage of
direct labor will not produce an equitable
apportionment of such costs to the terminated
contract. The circumstances of early termination
described above is quite common. When it is
encountered, appropriate and equitable costing demands
a departure from the contractor's usual accounting
procedures.
37 8
See Worsham Constr., ASBCA 25907, 85-2 BCA 18016:

[I]t is important to recognize that allocation bases

normally are necessary, but artificial, surrogates
designed to approximate the benefits received by a
contract (or other cost objective) from the incurrence
of indirect costs. To the extent that a base fails to
fulfill its function of measuring equitable, causal
and/or beneficial relationships reasonably accurately
it should be discarded unless its use otherwise is
required, for example by contract, law or regulation.

Id. at 90,375

379FAR 31.205-42(c). See Bedingfield and Rosen, supra note

27, at 15-12 and 15-20.
38 0
See FAR 31.205-42(c) (1).
381 Id.

38 2
See FAR 31.205-42(c) (2)
38 3 Id.
38 4
See e.g. Dunbar Kapple, Inc., ASBCA 3631, 57-2 BCA 1448 at
4890. Cf. infra notes 476-77.

232

-~~ ~~~~ V . . . .~%'9.

./
. .iS
 38 5
See e.g., Tera Advanced Servs., GSBCA 6713-NRC, 85-2 BCA
17940 at 89,888 (allowing as a direct cost freight, equipment
rental, postage, telephone, data processing); Agrinautics,
ASBCA 21512, 79-2 BCA 14149 at 69,648 and 69,650 (allowing
reclassification of president's time from engineering
overhead and G&A to direct engineering labor cost); Okaw
Indus., ASBCA 17863, 77-2 BCA 12793 at 62,229-31 (allowing
reclassification as a direct cost: supervisory time, freight
charges, equipment repairs, small tools, travel, telephone,
and other office expenses); R-D Mounts, Inc., ASBCA 17422,
75-1 BCA 11077 at 52,738 (allowing as a direct cost the cost
of revising contractor's accounting system to better
substantiate progress payment requests); Allied Materials
and Equip. ASBCA 17318, 75-1 BCA 11150 at 53,806 (allowing as
a direct cost legal fees of negotiating equitable adjustments
during contract performance); Douglas Corp., ASBCA 8566, 69-
1 BCA 7578 at 35,145-56 (allowing as a direct cost a
percentage of officers' salaries and office rent, telephone
expense, legal and accounting fees, travel, and insurance).
See also General Elec., ASBCA 24111, 82-1 BCA 15725, motion
for reconsid. denied, 82-2 BCA 16207.

It is axiomatic that certain costs normally treated as

overhead expenses may, upon termination of the
contract with which those costs are associated,
properly be allocated directly to the termination
contract and be recoverable in a termination
settlement. . . . Such direct allocation of otherwise
indirect costs is singularly appropriate in situations
where, as here, no end items have been produced or
delivered and no direct labor costs, against which
overhead rates may be applied, have been incurred.

Id. at 77,801(citations omitted).

3 8 6 Switlik
Parachute Co., ASBCA 18024, 75-1 BCA 11434, at
54,443.
3 87
See e.g., Rossen Builders, ASBCA 32305, 87-1 BCA 19538 at
98,727 (holding bid estimator's time and delivery costs were
already in G&A--allowance as direct costs would permit double
recovery); Fiesta Leasing and Sales, ASBCA 29311, 87-1 BCA
19622 at 99,292 (disallowing marketing expenses associated
with obtaining the contract--no indication officer's salary
was removed from G&A and evidence was too speculative as to
the amount of the proposed direct charge); Arctic Corner,
Inc, VABCA 2393, 86-3 BCA 19278 at 97,457 (holding that bid
preparation costs are normally a part of overhead; also

233

~~ .m a n-n m ~ l~ n . ... ~ %. . ...... ..•

 finding a lack of credible evidence as to what it cost to bid
the contract); Worsham Constr., ASBCA 25907, 85-2 BCA 18016
at 90,377 (salary of owners allowed only as an indirect cost-
-Board had allowed unabsorbed overhead and considered direct
recovery duplicative); Tera Advanced Servs., GSBCA 6713-NRC,
85-2 BCA 17940 at 89,888 (outside services and
subscriptions/publications were so inherently overhead in
nature that they were disallowed as direct costs in the
absence of a specific explanation as to why they were charged
directly); Robert M. Tobin, HUD BCA 79-388-C20, 84-3 BCA
17,651 at 87,971 (disallowing work force recruitment as a
direct cost); Starks Contracting, VACAB 1339, 79-2 BCA 1448
at 68,847-48 (contractor's accounting system was inadequate
to allow reclassification of indirect costs--identification
of costs with contract was based on contractor's estimates
which the Board found speculative); Systems & Computers
Information, Inc., ASBCA 18458, 78-1 BCA 129456 at 63,137
(costs of persuading the contracting officer not to default
terminate contractor and of the merits of changes claimed by
contractor were already included as indirect charges); R-D
Mounts, Inc., ASBCA 17422, 75-1 BCA 11077 at 52,733-34
(disallowing freight costs as a direct cost because the
amount was unsubstantiated and could not be specifically
identified with the terminated contract); Cyro-Sonics, Inc.,
ASBCA 13219, 70-1 BCA 8313 at 38,640 (disallowing as a direct
cost the cost of small tools because they were used on other
jobs after termination).
3 8 8 Id. Cf. infra notes 476-77.
3 8 9 Both
the Cost Principles and CAS require contractors to be
consistent in their classification of costs as direct or
indirect. See FAR 31.202(a) and FAR 30.402. The question
of whether direct charging of indirect pre-termination costs
is an inconsistent accounting practice is particularly
important when direct recovery is not specifically authorized
by the FAR.
3 9 0 Consistency,
as it applies to the recovery of indirect
costs is also discussed in Chapter 5 of this thesis. Chapter
5 discusses classification of costs as direct or indirect in
greater depth but the discussion is not specific to
terminations for convenience. Nonetheless a careful reading %
of Chapter 5, Part I.B and II.A will be helpful in
understanding the importance of consistently classifying
costs as either direct or indirect. Chapter 5's discussion "
of consistency is not limited to classification of costs as

234

V. - ~~ . ~ ~
. ~
*II. . .11I
0 A
 direct or indirect but discusses consistency in other
contexts as well.
3 9 1 FAR 31.202(a); FAR 30.402-40.
392
See FAR 31.205-42(c).
3 9 3 The
ASBCA in Kollmorgen Corp., Electro-Optical Division,
ASBCA 18,919, 86-2 BCA 18919 at 95,409-10, declined to decide
the issue of whether CAS 402 precluded direct charging of
time spent on termination settlement activities by in-house
accounting, legal, clerical, and supervisory personnel (G&A
expense pool type costs). The reason for the Board's
refusal was the small dollar amount ($3,879) at stake.
Kollmorgen involved post-termination costs rather than pre-
termination costs, but the issue is similar.
39 4
See supra note 377.

395See e.g., Alston, supra note 148, at 390; Joseph &

O'Donnell, supra note 377, at X-14; Petit and Victorino,
supra ncte 377, at 4. These commentators contend that CAS
402 and FAR 3i.202(a) look beyond the circumstances of a
cost's incurrence in determining whether "like circumstances"
exist and consistency is required. They so not interpret the
consistency requirement of CAS 402 and FAR 31.202(a) as
restrictively as do Bedingfield and Rosen.
3 9 6 See
Bedingfield and Rosen, supra note 27, at 15-13 through
15-15. Bedingfield and Rosen view the one-time allocation as
a voluntary accounting change rather than a noncompliance
with CAS 401 and 402. The CAS permit a one-time allocation
under the special allocation provision of CAS 410. See FAR
30.410-50(j).
397
See infra note 639 and accompanying text.
3 9 8 Selective
charging of costs as direct or indirect for
purposes unrelated to the termination for convenience results
in overcharging. See infra note 597 and accompanying text.
3 9 9 CAS
402 has not been interpreted to prevent change in
accounting practice if otherwise appropriate; similarly, FAR
31.202(a) does not prevent change in accounting practice if
otherwise appropriate. See infra Chapter 5, Part III.

235

,~ .~.
Up, .. r or. C %*%
t~,I 9. - -r . -r 9
%~%U r o rN,
4 0 0 FAR
31.205-42(c) does not specifically allow all initial
costs to be charged directly--only those starting load costs
"not fully absorbed because of termination." FAR 31.205-
42(c) (1) (emphasis added). The language "not fully absorbed
because of tcrmination" evidences an intent to limit direct
charging to instances where the contractor's normal method of
recovering such costs is inequitable.
401
See FAR 52.230-3 and 52.230-5. See infra notes 663-65.
for a discussion of the permissibity of retroactive change in
accounting practice for CAS-covered and modified CAS-covered
contracts.
4 0 2 As
explained in Chapter 4, Part I.A, supra, the overriding
objective of a termination settlement is to compensate a
contractor fairly for its costs of performing and preparing
to perform the terminated contract. Fair compensation rather
than strict accounting principles form the heart of a
termination settlement. See FAR 49.201(a). When necessary
to allow fair compensation boards and courts have allowed
costs that would not be allowable under the cost principles.
See infra notes 444-53 and accompanying text. This principle
should apply by analogy to each of these two clauses.
Further, it is difficult to argue that either of the two
clauses were intended to exclude direct charging of pre-
termination costs that FAR 31.205-42(c) specifically allows.
Finally, the clauses seldom have been used as a basis for
prohibiting retroactive change even when apparently
applicable. See infra note 663.
4 0 3 The
need to remove the direct charge from the indirect
cost pool is obvious to all commentators and to courts and
boards. See e.g., Joseph & O'Donnell, supra note 377, at X-
13. "Clearly the cost reallocated from indirect to direct
must be removed from the overhead pool." See also Robert M.
Tobin, HUD BCA 79-388-C20, 84-3 BCA 17651 at 87,971;
Agrinautics, ASBCA 21512, 79-2 BCA 14149 at 69648; Okaw-
Indus., ASBCA 17863, 77-2 BCA 12793 at 62,235; Allied
Materials & Equip., ASBCA 17318, 75-1 BCA 11150 at 53,087;
Dunbar Kapple Inc., ASBCA 3631, 57-2 BCA 1448 at 4,890. Cf.
Tera Advanced Servs., GSBCA 6713-NRC, 85-2 BCA 17940 at
89,890. "[If we were shown that some of the costs in
appellant's G&A pool were also claimed as settlement costs,
we would disallow them instantly."
4 0 4 FAR
31.203(a). CAS 402 uses slightly different language
but the meaning is identical. See FAR 30.402-40.

236

r r A
i
4 0 5 See
e.g., Alston, supra note 148, at 390; Joseph &
O'Donnell, supra note 377, at X-14; Petit and Victorino,
supra note 377, at 4. But see Bedingfield and Rosen, supra
note 27, at 15-21. As discussed at supra Chapter 4, Part
II.B.3.a, a termination for convenience changes neither the
purpose for which a cost was incurred nor the circumstances
of its incurrence--it changes only the circumstances of its
recovery.
4 06
Note that if this were to happen, the terminated contract
would not be "double" charged, although the term "double
counting" is commonly used to describe this effect. The
amount of cost allocated to the terminated contract, directly
and indirectly, would be less than twice its properly
allocable share. First, the amount charged directly is
subtracted from the indirect cost pool before its
distribution. Second, and more importantly, the amount of
direct cost generated by the terminated contract is probably
small enough that the terminated contract will not pick up a
significant amount of an indirect cost grouping containing
other costs incurred for the same purpose. The reason direct
charging is permitted is that the direct costs of the
terminated contract are such that the contractor's normal
indirect cost rates as applied thereto do not fairly
compensate the contractor. Therefore, although the
terminated contract will be overburdened if costs incurred
for the same purpose are not removed from the indirect cost
pool, the Government will not pay twice the amount properly
chargeable.
4 07
See e.g., Tera Advanced Servs., GSBCA 6713-NRC, 85-2 BCA
17940 at 89,890; General Elec., ASBCA 24111, 82-1 BCA 15725
at 77,802, motion for reconsid. denied, 82-2 BCA 16,207;
Bailfield Indus., Div. of A-T-O, ASBCA 20006, 76-2 BCA 12096
at 58,114-15.
4 0 8 Settlement
costs are not incurred in performance of the
contract but are costs directly .resulting from termination-- ,
costs specifically required by the Termination for
Convenience clause. The CASB has interpreted differing
circumstances to exist under CAS 402 when a cost is incurred
pursuant to a specific requirement of an exiting
* contract. The CASB Interpretation involved bid and proposal
costs required by specific contract provisions--an analogous
situation. See FAR 30.402-61:

Under 30.402, costs incurred in preparing, submitting,

and supporting proposals pursuant to a specific

237
 requirement of an existing contract are considered to
have been incurred in different circumstances from the
circumstances under which costs are incurred in
preparing proposals which do not result from such
specific requirement. The circumstances are different
because the costs of preparing proposals specifically
required by the provision of an existing contract
relate only to that contract while other proposal
costs relate to all the all the work of the
contractor.
4 0 9 Removal
of attorney fees, unrelated to the termination
settlement and otherwise properly includable in the indirect
cost base, is not necessary to prevent double recovery and
would result in the terminated contract not bearing a fair
share of such costs. The pre-termination work benefited from
the incurrence of attorneys' fees in the same general way as
did other cost objectives and for this reason should bear a
proportionate share of such costs. See e.g., Hewitt
Contracting, ENG BCA 4596, 83-2 BCA 16816 at 83,645.
4 10
See supra notes 90-94 and accompanying text.
4 111d.
Instead, machine hours, square footage, number of
employees, or some other factor which more closely
approximates the relative benefits received by the several
cost objectives than direct cost is used.
4 12
See e.g., Sunstrand Turbo, ASBCA 9112, 65-1 BCA 4653 at
22,227; Dunbar Kapple Inc., ASBCA 3631, 57-2 BCA 1448 at
4,895. Compare Agrinautics, ASBCA 21512, 79-2 BCA 14149 at
69647-48 (allowing engineering overhead and G&A on
president's salary reclassified as a direct engineering labor
cost--the Board did not discuss why it allowed the markup for
engineering overhead or G&A--it may have believed that the
President was performing direct cost functions). While
manufacturing overhead on a cost normally classified as
manufacturing overhead or G&A on a cost normally classified
as G&A cannot be recovered, G&A can be recovered on a cost
normally classified as manufacturing overhead which for
purposes of the termination has been reclassified as a direct
cost. See e.g., Allied Materials & Equip., ASBCA 17318, 75-1
BCA 11150 at 53,087-88.
4 13
id. In Sunstrand Turbo, ASBCA 9112, 65-1 BCA 4653 at
22,227, the Board held that the contractor could not recover
additional G&A allowance on costs of a general and

238

..
. .. .. . . . . .. . ." ,,7a , , '" .. . .. . . . ... . ..
."N'.N
administrative nature for which it was reimbursed directly
reasoning as follows:

To allow additional G&A expense on termination

settlement expense would involve the granting of
administrative expense on administrative expense.
Had [the administrative costs recovered directly]
been included in the base, the result would have been
to reduce the rates substantially below the rates now
claimed by appellant. Obviously appellant is not
entitled to a G&A allowance on its post-termination
costs at a rate which has been inflated by the
exclusion of such costs from the allocation base.
4 1 4 FAR 31.205-42(h).
4 1 5 See
e.g., Metadure Corp., ASBCA 21183, 83-1 BCA 16208 at
80,536; American Elec., ASBCA 16635, 76-2 BCA 12151 at
58,492-93; Thiokol Chem. Corp., ASBCA 17544, 76-1 BCA 11731
at 55,940; Bolinders Co., ASBCA 5740, 60-2 BCA 2746 at
14,017-18.
4 1 6 See
e.g., Worsham Constr., ASBCA 25907, 85-2 BCA 18016, at
90,376. The contractor had incurred no direct costs because
the Government settled directly with the subcontractor.
Therefore, the ASBCA applied the contractor's G&A rate to the
reasonable value of the terminated subcontract.
4 17 Sunstrand Turbo v. United States, 182 Ct.Cl. 31, 57-60
(1968).
4 1 8 Sunstrand
Turbo, ASBCA 9112, 65-1 BCA 4653 at 22,228. -

419 Id.

If the subcontract costs had been billable costs prior

to the terminations, such costs would have been
included in the G&A allocation base for such periods
and would have resulted in a redistribution of the G&A
pool, causing an increase in the G&A allocated to
Contract -27 and Contract -73 with a corresponding
reduction in the amount of G&A allocable to
appellant's other contract, (sic) but no significant
change in the amount of G&A recoverable under all the
Turbo Division's CPFF contracts.
4 2 0 Worsham
Constr., ASBCA 25907, 85-2 BCA 18016 at 90,374-76.

239
 S

42 1
Pre-termination unabsorbed overhead should be
distinguished from post-termination unabsorbed overhead
which is no- allowable. Entitlement to post-termination
overhead is discussed infra Chapter 4, Part V.
42 2
See e.g., Worsham Constr., ASBCA 25907, 85-2 BCA 18016 at
90,362. The Board excluded subcontract costs of the
terminated contract from "billings" and "total billings" when
computing Eichleay damages. Subcontract costs were excluded
to prevent over recovery of home office costs. The cause of
the Board's concern was the contractor's failure to establish
the degree to which the subcontract had benefited from home
office costs. The Board had already allowed home office
costs to be applied to the subcontract but at 50% of the
contractor's normal rate. The Board was concerned that
inclusion of subcontract costs in the Eichleay formula
"billings" would result in the contractor's being
overcompensated for home office costs with respect to the
subcontract. See also Marlin Assoc., GSBCA 5663, 82-1 BCA
15,738 at 77,881(finding that Eichleay formula "total
billings" included the Board's award for completed work,
termination inventory, labor, subcontractor work, overhead,
and profit; and excluded settlement preparation costs).
42 3
See e.g., Worsham Constr., ASBCA 25907, 85-2 BCA 18016 at
90,362; Marlin Assoc., GSBCA 5663, 82-1 BCA 15,738 at
77,881; Racquette River Constr., ASBCA 26486, 82-1 BCA 15769
at 78,053; Agrinautics, ASBCA 21512, 79-2 BCA 14149 at
69,648-49; A.C.E.S., INC., ASBCA 21417, 79-1 BCA 21417 at
67,722; Allied Materials & Equip., ASBCA 17318, 75-1 BCA
11,150 at 53,089-90.
4 2 4 See
Worsham Constr., ASBCA 25907, 85-2 BCA 18016 at
90,369.
4251d"
426 Id"

4 27 Penberthy Electromelt Int'l v. United States, 11 Cl. Ct.

307 (1986).
4281d. at 324.

429See Alston, supra note 148, at 392; H. Andrews and R.

Peacock, Terminations: An Outline of the Parties' Rights and

240
Remedies, 11 Pub. Cont. L. J. 269, 278 (1980); Cibinic &
Nash, supra note 1, at 795; Joseph & O'Donnell, supra note
377, at X-5; W. KEYES, GOVERNMENT CONTRACTS UNDER THE FEDERAL
ACQUISITION REGULATION, 725 (1986); Halifax Eng'g, ASBCA 34779,
88-1 BCA 20,227 at 102,430; Fiesta Leasing and Sales, ASBCA
29311, 87-1 BCA 19622 at 99,292; Worsham Constr., ASBCA
25907, 85-2 BCA 18016 at 90,369; Robert M. Tobin, HUD BCA
79-388-C20, 84-3 BCA 17651 at 87,970; Racquette River
Constr., ASBCA 82-1 BCA 15769 at 78,051; Paul E. McCollum,
Sr., ASBCA 23,269, 81-2 BCA 15311 at 75,822; Southland Mfg.,
ASBCA 16830, 75-1 BCA 10994; International Space Corp.,
ASBCA 13883, 70-2 BCA 8519; Caskel Forge, Inc.; ASBCA 7638,
1962 BCA 3318.
4 3 0 Determining
costs incurred in performance of the
terminated contract is a major issue in most fixed priced
settlement negotiations. In contrast, when a cost-
reimbursement contract is terminated, establishing what
performance costs were incurred is seldom a problem. See
Andrews and Peacock, supra note 429, at 277. The reason is
that the Government will not issue a cost reimbursement
contract to a contractor whose accounting system is incapable
of tracking costs. See FAR 16.301-3(a). See also Rishe,
supra note 27.

[Negotiating a termination settlement] can be quite a

task when the terminated contract is of the fixed-
price type, because such contracts do not require the
keeping of detailed cost records as do cost-
reimbursement contracts. Such records are of vital
importance in determining the cost recovery for a
convenience termination.

Id. at 6-43. See also Algonac Mfg., ASBCA 10534, 66-2 BCA
5731 at 26,724. "This settlement would have been made much
more easily if appellant's books had been kept in conformity
with the regulations and forins of the Government concerning
termination settlements. They were not, however, and there
was not reason nor requirement that they should be." Id.
4 3 1 See
Trueger, supra note 27, at 738. "Terminations cause
unique accounting problems. All cost accounting systems rely
on assumptions of normality and continuity." See also
Alston, supra note 148, at 387; Bedingfield and Rosen, supra
note 27, at 15-11.
43 2
"Terminations are aberrations." Bedingfield and Rosen,
supra note 27, at 15-11.

241

~ "r~%
4
q~w ~ ~ ~ ~ '.4'\ ~ ..*..~ -~ ~ . - . ~ 4or
 4 3 3 Bedingfield
and Rosen, supra note 27, at 15-13. See also
Trueger, supra note 27, at 729. Paul Trueger comments: "If
most [preparatory] expenses are generally charged to overhead
accounts, without segregation by contract, there may be
considerable difficulty in finding and supporting their
applicability to the satisfaction of the government auditors.
Somewhat similar problems obtain with respect to starting-
load costs. .. ." Id. at 761.
4 34
See Rishe, supra note 27, at 6-23; Joseph & O'Donnell,
supra note 377, at X-12. Maintenance of such a system on the
outside possibility that the Government will terminate a
contract for convenience is not economically sound. See
e.g., Racquette River Constr., ASBCA 82-1 BCA 15769 at 78,050
(books consisted of a cash receipts journal, cash
disbursements journal, and a general journal--common among
small contractors in Northwest Florida); Metered Laundry
Serv., ASBCA 21573, 78-2 BCA 13451 at 64,601 (ledger did not
even allocate costs to particular jobs because doing so could
not be cost justified); Starks Contracting, VACAB 1339, 79-2
1448 at 68,847-48 (contractor's books not oriented towards a
cost system).
435
FAR 49.206-1(c).
4 3 6 See
Arctic Corner, Inc. VABCA 2393, 86-3 BCA 19278 at
97,456-57 ("while comprehensive documentation" is not
required the contractor "still must meet the burden of
proving the costs were incurred and offer some explanation as
to just how those costs were treated (direct or indirect) in
its normal business operation"). See also Tagarelli Bros.
Constr., ASBCA 34793, 88-1 BCA 20363 at 102,989; Humphrey
Logging Co., AGBCA 84-359-3, 85-3 BCA 18433 at 92,572; H&H
Reforestation, AGBCA 84-311-3, 85-3 BCA 18255 at 91,637;
Tera Advanced Servs., GSBCA 6713-NRC, 85-2 BCA 17940 at
89,883-84; Celesco, Indus., ASBCA 22460, 84-2 BCA 17295 at
86,160; R.G. Robbins & Co., ASBCA 27516, 83-1 BCA 27516 at
81,692; Paul E. McCollum, Sr., ASBCA 23,269, 81-2 BCA 15311
at 75,822; Allied Materials and Equip., ASBCA 17318, 75-1
BCA 11150 at 53,085; Dairy Sales Corp., ASBCA 21193, 75-2
BCA 11613 at 55,455, aff'd, 219 Ct. Cl. 431 (1979); Clary
Corp., ASBCA 19274, 74-2 BCA 19247 at 52,103.
4 37
FAR 49.206-1(c).
4 3 8 See
e.g., R-D Mounts, Inc., ASBCA 17422, 75-1 BCA 11077 at
52,744, aff'd on motion for reconsid., (disallowing 10%

242

" "---- J t-- " ------

- -----s. -. " -
-- "
charge for labor and handling of purchased parts because
contractor presented no evidence to substantiate the
incurrence of these costs in connection with this contract;
recognizing that some handling costs must have been incurred,
the Board by jury verdict allowed $250 of the $1,201
claimed); Herbert R. Button, ASBCA 17281, 73-1 BCA 9780 at
45,689 (holding that burden of proof is not carried by
unsupported allegations).
4 3 9 FAR
49.206-1. See also Arnold H. Leibowitz, GSBCA CCR-1,
76-2 BCA 11930 at 57,189 (estimate accepted--the contract did
not require the keeping of work time records). Note however,
that "[w]hile estimates may be used in the absence of
accounting records whose unavailability is not the fault of
the contractor, the contractor has the burden of proving the
basis for and the accuracy of such estimates." Robert M.
Tobin, HUD BCA 79-388-C20, 84-3 BCA 17651 at 87,971
(citations omitted).
440
FAR 49.206-2(b) (ii).
4 4 1 See
e.g., Chesterfield Assoc., DOT CAB 1028, 80-2 BCA
14580 at 71,898 (G&A expense estimated based on the number of
letters written to contracting officer-- $12.50 per'page);
The Douglas Corp, ASBCA 8566, 69-1 BCA 7578 at 35,144
(allowing factory overhead in the absence of auditable
accounting records because the amount claimed was rea-onable
relative to contract price and the work done).
4 4 2 Termination
serves as notice to a contractor that any
future costs incurred for the terminated contract must be
recovered on what is, in effect, a cost basis and that proof
of their incurrence will be a prerequisite to recovery.
Thus, consistent with the principles of fairness, a
contractor often will be held to a higher burden of proof for
costs incurred after termination. See infra footnote 491.

443See e.g., Tagarelli Bros. Constr., ASBCA 34793, 88-1 BCA

20363 at 102,989 (allowing only 20 of 120 hours claimed in
bid preparation, none of the 140 hours claimed in production
planning, no standby supervision, and no unabsorbed overhead
for the 88 days of delay--total lack of documentary support);
Concord Elec., ASBCA 31012, 85-3 BCA 18484 at 92,843
(allowing neither overhead nor G&A--contractor failed to
present evidence of overhead or G&A rates for the pertinent
period); Herbert R. Button, ASBCA 17281, 73-1 BCA 9780. See
also L.&H. Constr., ASBCA 22193, 79-2 BCA 13950. In the
absence of accounting records supporting this sole

243

y- -
 proprietor's settlement claim, the Board assumed that the
contractor had included overhead cost in the $27 cost per
labor hour apparently used in computing its fixed price bid.
Therefore, a termination settlement based upon this $27 per
hour figure adequately compensated contractor for its
indirect costs. See also Andrews and Peacock, supra note
429, at 278; Rishe, supra note 27, at 6-46; Petit and
Victorino, supra note 377, at 5. To protect the Federal
purse, the Government closely reviews termination settlements
to ensure that the costs claimed are adequately supported.
Cost proposals of $25,000 or more are submitted to the
appropriate audit agency for audit. See FAR 49.107(a).

444See e.g., Okaw Indus., ASBCA 17863, 77-2 BCA 12793 at

62,233 (questioning inclusion of interest in G&A); Big Three
Indus., ASBCA 16949, 74-1 BCA 10,483 at 49,599 (questioning
aircraft expense in G&A); Cyro-Sonics, Inc., ASBCA 13219,
70-1 BCA 8313 at 38,643-49, (examining every major category
of indirect cost); Nolan Bros., ENG BCA 2680, 67-1 BCA 6095
at 28,217 (questioning officer's salaries, depreciation,
completed project expense, insurance).
4 4 5 See
e.g., Cyro-Sonics, Inc., ASBCA 13219, 70-1 BCA 8313 at
38,653-54. The Government challenged inclusion of $112 of
organizational expense in an indirect cost pool of $212,821.
Note that FAR 49.107(a) requires that termination proposals
of over $25,000 be submitted to the appropriate audit agency
for review.
4 4 6 See
e.g., FAR 52.249-2, Termination for Convenience of the
Government (Fixed-Price), Oct 74, paragraph (h). "The cost
principles and procedures of Part 31 of the Federal
Acquisition Regulations, in effect on the date of this
contract, shall govern all costs claimed, agreed to, or
determined under this clause."

447See Rishe, supra note 27, at 6-45. Rishe cites Codex

Corp. v United States, 226 Ct. Cl. 693 (1981) as authority
for this position. The Court held that the Cost Principles
alone are not the sole basis of determining allowability when
a fixed price contract is terminated for convenience, that
the Government must consider the fairness of strictly
applying the Cost Principles. See also Alston, supra note
. 148, at 394; Joseph & O'Donnell, supra note 377, at X-7,
Petit and Victorino, supra note 377, at 2.
• 448 Id.

244
 -a- J% J J!P . 7r

4 4 9 For
example, costs incurred before contract award are not,
except in limited circumstances, allowable under the Cost
Principles. See Codex Corp., ASBCA 17983, 75-2 BCA 11554 at
55,154, rev'd on other grounds, 226 Ct. Cl. 693 (1981).
4 5 0FAR 49.113 (emphasis added).
4 5 1 "A
settlement should compensate the contractor fairly for
the work done and the preparations made for the terminated
portions of the contract. . . . Fair compensation is a matter
of judgment. . . The use of business judgment, as
distinguished from strict accounting principles is the heart
of a settlement." FAR 49.201(a).
4 5 2 See
Codex Corp. v. United States, 226 Ct. Cl. 693 (1981);
Fiesta Leasing and Sales, ASBCA 29311, 87-1 BCA 19622 at
99,292; Arctic Corner, Inc. VABCA 2393, 86-3 BCA 19278 at
97,456-57; Huskie Oil NPR Operations, IBCA 1792, 86-1 BCA
18568; H &H Reforestation, AGBCA 84-311-3, 85-3 BCA 18,255
at 91.637: Kalser Elec., DOTCAB 1425, 84-2 BCA 17343;
Celesco Indus., ASBCA 22460, 84-2 BCA 17295 at 86,162;
General Elec., ASBCA 24111, 82-1 BCA 15,725 at 77,803, motion
for reconsid. denied, 82-2 BCA 16,207; Marlin Assoc., GSBCA
5663, 82-1 BCA 15738 at 77,876; American Elec., ASBCA. 16635,
76-2 BCA 12151 at 58,512-13. But see Allied Materials and
Equip., ASBCA 17318, 75-1 BCA 11150 at 53,084 (Cost
Principles were not "guide" but mandatory for Board); Big
Three Indus., ASBCA 16949, 74-1 BCA 10,483 at 49,593-94 (Cost
Principles mandatory).
453
Bedingfield and Rosen, supra note 27, at 15-7, comment
that the Cost Principles will be applied except in very
limited circumstances. They credit changes in the Cost
Principles and the increasing influence of DCAA for this
result. See e.g., Penberthy Electromelt Int'l v. United
States, 11 Cl. Ct. 307, 319 (1986). Court did not use the
overhead rates which best reflected the average overhead
costs of contractor. "[P]laintiff's concept of 'equity'
flies squarely in the face of the principle of cost
allocability." Id.
4 54
FAR 49.207.
4551d".

4 5 6A
constructive change occurs when a contractor performs
work beyond the contract requirements without a formal change

245
order and such work was informally ordered by the Government
or caused by Government fault. See Cibinic & Nash, supra
note 1, at 304-5.
4 57 A
differing site condition exists when (1) subsurface or
latent physical conditions at the site differ materially from
those indicated in the contract or (2) unknown physical
conditions, of an unusual nature, differing materially from
those ordinarily encountered and generally recognized as
inhering in work of the character provided for in the
contract, are encountered. See FAR 52.236-2 and Cibinic &
Nash, supra note 1, at Chapter 5.
4 5 8 Normally,
it is the Government and not the contractor who
is concerned that costs properly characterized as settlement
costs are not claimed as performance costs. The reason is
twofold. First, profit is allowed on costs of performance
but not on settlement costs. Second, FAR 31.205-42(g) limits
the indirect cost markup applied to settlement costs.

459See FAR 49.207.

4 6 0 FAR 31.205-42(b)-.
461
See Systems Dev., ASBCA 16947, 73-1 BCA 9788; Nolan
Bros., Eng. BCA 2680, 67-1 BCA 6095.
462
See Trustees of Columbia Univ., ASBCA 15578, 73-1 BCA
9777; Telecomputing Servs., ASBCA 10644, 68-1 BCA 7023.
4 6 3 Completion
of work in progress is allowable when necessary
to prevent a total loss of the items. See Development and
Technical Assocs., IBA 150-8-81, 85-3 BCA 18314; Kinn
Elecs., ASBCA 16440, 72-1 BCA 9299.
4 6 4 For
example rental costs under unexpired leases. See
Joseph & O'Donnell, supra note 377, at X-34, 35, and 46.
4 6 5 Mitigation
costs include such as advertising to sell
special equipment idled by the termination. See Fiesta
Leasing & Sales, ASBCA 23911, 87-1 BCA 19622.
4 6 6 post-termination
unabsorbed overhead, unlike other
continuing costs is normally not recoverable. Post-
termination unabsorbed overhead is discussed at infra Chapter
4, Part V.

246
 4 67
See Rishe, supra note 27 at 6-52; Trueger, supra note 27
at 757-58. But see Detroit Diesel Allison Div., General
Motors Corp., ASBCA 20199, 77-1 BCA 20199 at 60,115,
(disallowing severence pay as a direct cost because the
contractor's established accounting practice was to recover
abnormal as well as normal separation costs through
overhead).
468But see Systems Dev., ASBCA 16947, 73-1 BCA 9788 (allowing
G&A on severance pay).
4 6 9 See
FAR 49.104 and FAR 52.249, Termination for Convenience
of the Government (Fixed-Price), paras. (b) through (d).
470 Id.

471
See FAR 49.207.
47 2
See FAR 52.249-4. See also Maibens, Inc., ASBCA 25915,
82-1 BCA 12668 at 77,478-79; Mrs. Landscaping and Nursery,
HUD BCA 76-29, 78-1 BCA 13077 at 63,860-61; American Maint.
and Mgt Servs., ASBCA 19556, 76-2 BCA 11,960 at 57,341;
Contract Maint., ASBCA 21186, 76-2 BCA 12,102 at 58,143. The
short-form termination for convenience clause allows recovery
for zervices rendered before the effective date of
termination only. It is included in service contracts when
it is anticipated that the only claim made would be for
services rendered prior to termination if the contract were
terminated for convenience. The boards have shown some
willingness not to enforce the provisions of the clause when
doing so would deny fair compensation to the contractor. See
*Tefft, Kelly and Motley, Inc., GSBCA 6562, 83-1 BCA 16177 at
80,388.
47 3 FAR 49.202(a).

474See D. ARVANAS AND W. RUBERRY, GOVERNMENT CONTRACT GUIDEBOOK,

16-15 (1st ed. 1986); Bedingfield and Rosen, supra note 27,
at 15-27; Joseph and O'Donnell, supra note 377, at X-48 to
49; Petit and Victorino, supra note 377, at 8.
4 7 5 See
FAR 31.205-42(g). Direct charging is one way to
ensure full recovery of settlement costs. A settlement
action usually does not generate sufficient direct costs of
its own to compensate the contractor fully through
application of the contractor's normal indirect cost rates to
the direct costs generated. Inclusion of these indirect

247
costs in indirect cost groupings distributes a portion of
such costs to the terminated contract through allocations to
the pre-terminated work. However, such distribution is not
proportional to the relative benefits received from the
indirect cost grouping by the terminated contract. But see
Fiesta Leasing and Sales, ASBCA 29311, 87-1 BCA 19622 at
99,292. In Fiesta Leasing, the Board disallowed, as a direct
settlement cost, a salaried employee's time spent in
preparation and presentation of the settlement proposal
reasoning that no additional employees were hired to free him
from performance of his normal duties--therefore, his salary
was recoverable through G&A and not as a direct cost. The
Board limited direct recovery to incremental costs only. See
also infra note 489 and accompanying text where Bedingfield
and Rosen suggest a one time special indirect cost allocation
as an alternative to direct charging. d

47 6
See
e.g., Fiesta Leasing and Sales, ASBCA 29311, 87-1 BCA
19622 at 99,295 (disallowing direct recovery of utility,
computer and copy expense and of office rental and painting
in the absence of proof that an adjustment to overhead was
made to prevent double counting); Bob Tucker and Assoc., LBCA
83-BCA-16, 86-2 BCA 18990 at 95,902 (disallowing accounting,
supplies, and telephone services charged as direct costs
because they may have been included in contractor's indirect
cost rate; finding it reasonable for the contractor to
produce documents evidencing their specific authorization as
a direct cost and subsequent removal from the indirect cost
grouping); Celesco Indus., ASBCA 22460, 84-2 BCA 17295 at
86,167-68; Marlin Assoc., GSBCA 5663, 82-1 BCA 15738 at
77,880 (labor costs of manager and president were included in
overhead and therefore could not be charged directly as a
mobilization cost); Bermite Div. of Tasker Indus., ASBCA
18280, 77-1 BCA 12349, aff'd on motion for reconsid., 77-2
BCA 12731 at 61,883 (disallowing employee salary expense that
had been included in G&A). Boards have allowed direct
recovery of costs included in an indirect cost grouping on
occasions where such costs make up only a small and
insignificant amount of the indirect cost grouping or where
the factual pattern is such that duplicate recovery is not
present. See Celesco Indus., ASBCA 22460, 84-2 BCA 17295 at "A

86,167-68.
4 7 7 1n
Bermite Div. of Tasker Industries, ASBCA 18280, 77-1
BCA 12349, aff'd on motion for reconsid, 77-2 BCA 12731 at
61,883, the double recovery threat was stated as follows:

248 p
 Expenses carried as an element of G&A are assumed to
be recovered in the year they are incurred and
recorded, absent persuasive evidence to the contrary,
and this recovery is derived from the totality of the
contractor's then on-going business. Expenses so
recorded and presumably recovered cannot
retrospectively be removed from the indirect expense
pool. Such 'relief' can be done only prospectively,
i.e. before the expenses are recorded or, more
importantly, before they are allocated to and
recovered from the on-going business. In a situation
such as is present here, we are faced with recovery
which has already taken place. Thus, we are not
concerned with 'relieving the G&A pool'
retrospectively but we are concerned with and faced
with the fact that recovery as a direct settlement
expense now would result in double recovery of these
expenses.
47 8
See infra notes 490-97 and accompanying text.

479See FAR 31.205-42(g) (iii)

4 80 Id.
4 8 1 See
e.g., Contract Maint., ASBCA 20689, 77-1 BCA 12446 at
60,294 (disallowing post-termination G&A because many of the
items appearing in G&A had been charged directly as
termination costs); Big Three Indus., ASBCA 16949, 74-1 BCA
10483 at 49,606; Sunstrand Turbo, ASBCA 9112, 65-1 BCA 4653
at 22,227, aff'd, 182 Ct. Cl. 31 (1968) (to allow G&A on
termination settlement expense recovered as a direct charge
would be grant administrative expense on administrative
expense). In Big Three Industries, the contractor's G&A rate
of 183% was not applied to direct settlement labor because
the Board found that the contractor had already recovered its
G&A expenses through G&A charges to other work performed
during the period--the Board did allow a markup on direct
settlement labor for fringe benefits and support factor
charges.
4 8 2 If
the drafters of the FAR had believed that contractors
would be unable to identify the costs incurred in settling a
terminated contract, undoubtedly they would have adopted a
different reimbursement approach. The FAR evidences the
drafters' overriding concern that contractors be fairly
compensated. See FAR 49.113.

249
4 8 3 The
relationship of the settlement action to indirect cost
groupings differs from that of other cost objectives. For
example, a termination action usually benefits much more from
the incurrence of attorney and accounting costs than do other
cost objectives. Also it benefits less than other cost
objectives from the incurrence of certain indirect costs.
'[N]ormal factory burden cannot be applied to settlement
expense direct labor. To do so would allocate depreciation
on factory machinery to a nonproducing cost objective."
Bedingfield and Rosen, supra note 27, at 15-26. 4,

.4
4 84
"Settlement expenses including the following, are
generally allowable . . . (iii) Indirect costs related to
salary and wages incurred as settlement expenses . .
normally, such indirect costs shall be limited to payroll
taxes, fringe benefits, occupancy costs, and immediate
supervision costs." FAR 31.205-42(g) (iii) (emphasis added).
4 8 5 See
Celesco Indus., ASBCA 22460, 84-2 BCA 17295 at 86,166-
68 (direct manufacturing labor was allocated normal indirect
costs--labor of indirect employees was allocated only fringe
benefits); Essex Electro Eng'rs, DOT CAB 1025, 81-1 BCA
14838 at 73,247, aff'd on motion for reconsid., 81-1 BCA
73,251 (adding normal indirect burden to direct labor costs
of assembling the residual inventory for storage); Okaw
Indus., ASBCA 17863, 77-2 BCA 12793, at 62,229 (normal
overhead and G&A allowed on post-termination packaging);
Thiokol Chem., ASBCA 17544, 76-1 BCA 11731 at 55,933-39
(adding normal indirect burden to direct labor required to
shut down activities, to conduct final audit, and to
negotiate a settlement agreement); Condec Corp., ASBCA
14324, 73-1 BCA 9808 at 45,844; Varo, Inc., ASBCA 16606, 72-
2 BCA 9720 at 45,396 (although not convinced the contractor
was entitled to one-half its normal burden on settlement
costs, the Board was hesitant to question the contracting
officer's decision allowing it); Boeing Co., ASBCA 12685,
69-2 BCA 7795 (allowing direct settlement labor to be
burdened with an indirect cost rate developed specifically
for special service work orders--only indirect costs related
to special service work orders were included in the indirect
cost grouping). In a number of cases the board has, without
discussion, allowed recovery of indirect costs at the
contractor's normal indirect cost rates. See e.g., Penberthy
Electromelt Int'l v. United States, 11 Cl. Ct. 307, 327
(1986) (allowing G&A on time spent by settlement negotiator);
Agrinautics, ASBCA 21512, 79-2 BCA 14149 at 69,648 (allowing
manufacturing overhead and G&A); Allied Materials and

25

250

CVd. C. W
C.C. .., U.... W..
 Equip., ASBCA 17318, 75-1 BCA 11150 at 53,084 (allowing
indirect expense and G&A).
4861d. See Okaw Indus., ASBCA 17863, 77-2 BCA 12793 at
62,229. "The nature of the work was such that we believed in
order to adequately to compensate the appellant for the work
performed it would be inappropriate not to allow the
appellant's overhead and G&A in effect during the post-
termination period."
4 87
See supra note 485-86.
4 8 8 See
Bedingfield and Rosen, supra note 27, at 15-28.
489 1d.
490 See supra note 436-43 and accompanying text.
491 See Petit and Victorino, supra note 377, at 2. Failure of
proof is a common cause of disallowance. See Acme Process
Equip. v. United States, 171 Ct. Cl. 251, 313-14 (1965), (no
breakdown or justification--allowing only 440 of the 1332
hours claimed); Arctic Corner, Inc., VABCA 2393, 86-3 BCA
19278 at 97,459-60 (in the absence of probative documentation
allowing $1,356 of $12,900 claimed); Worsham Constr., ASBCA
25907, 85-2 BCA 18016 at 90,367 and 90,378 (in the absence of
documentation allowing only 80 of 280 hours claimed in
connection with post-termination settlement action;
disallowing indirect costs related to salaries and wages
incurred as settlement expenses because the contractor failed
to put on evidence of such costs); Racquette River Constr.,
ASBCA 82-1 BCA 15769 at 78,054 (no records--limiting recovery
ato what the Government had allowed); Chesterfield Assoc.,
DOT CAB 1028, 80-2 BCA 14580 at 71,900 (no documentation,
jury verdict allowed $450--63 page settlement proposal);
Henry Spen & Co., ASBCA 20766, 77-2 BCA 12784 at 62,178-83
(lack of documentary foundation--allowing of hours claimed
for: president 272 of 848 hours, vice-president 184 of 750
hours, sales engineer 40 of 302 hours, production engineer 64
of 345 hours, purchasing agent 160 of 1,014 hours, original
contract administrator 150 of 656 hours, successor contract
administrator 368 of 1,863 hours); H & J Constr., ASBCA
18521, 76-1 BCA 11903 at 57,085 (unsupported claim--allowing
$1500 of $35,607.64 claimed); Bell and Howell Co., ASBCA
18464, 75-1 BCA 10993 at 52,348 (settlement costs
unsupported--allowing $250 of $3,909 claimed); Clary Corp.,
ASBCA 19274, 74-2 BCA 19247 (allowing $231.70 of $4,339 of
costs claimed--no accounting records--proof consisted of

251
- -
-31,
- 6%
- '.
% %j~%
" " " "'."" '. "J.." J ", " ." " % - " k" '- " " " -- - -"--- .
.4-
estimates); Francis Assoc., ASBCA 14100, 70-2 BCA 8493 at
39,477 (lack of records--allowing $5,411 of the $42,126.31
claimed); Dunbar Kapple Inc., ASBCA 3631, 57-2 BCA 1448 at
4,895. But see Codex Corp., ASBCA 17983, 74-2 BCA 10827,at
51,499 (allowing all of $2825 claimed--costs were supported
by affidavits of persons concerned); Dunbar Kapple Inc.,
ASBCA 3631, 57-2 BCA 1448 at 4,897-98 (allowing all time
claimed in preparation of termination claim based on
estimates).
49 2
See Alston, supra note 148, at 390. "Contractors must
abandon their usual accounting methods for the allocation of
indirect costs. They must directly identify all the cost
elements concerned . . . to ensure that they will recover all
the expenses incurred." See also Bedingfield and Rosen,
supra note 27, at 15-26; Trueger, supra note 27, at 765-66.
493
See Petit and Victorino, supra note 377, at 5.
4 9 4 Note
that FAR 31.205-42(g) (iii), in effect, mandates
direct recovery of settlement costs. See supra notes 474-89
and accompanying text.
4 9 5 Normally,
a contractor's accounting system is not -et up'
to segregate and specifically identify indirect costs to any
one cost objective. FAR 31.205-42(g) (2) requires
establishment of a cost account or work order to separately
identify and accumulate settlement costs when settlement
expenses are expected to be significant.

4 9 6 Contractors
should be prepared to negate the possibility
of double charging. "Salaries of personnel preparing the
termination claim may be unallowable as direct charges to the
terminated contract, where they are included in the
contractor's general and administrative expense pool and
charged on a prorated basis to ongoing business, if the
evidence is insufficient to negate possible double counting."
Andrews and Peacock, supra note 429, at 288 (citing Bermite
Div., Tasker Indus., ASBCA 18280, 77-1 BCA 12349).
4 9 7 Petit
and Victorino, supra note 377, at 5, comment:

A difficult problem in recovering these indirect costs

is identifying all the costs. Because the people who
are usually involved in these activities (often
including officers of the company) are frequently not
accustomed to keeping accurate time records, the

252
 ,-

accounting records supporting their efforts may be I

spotty or nonexistent.
4 9 8 FAR 31.205-42(g).
4 9 9 Discussed
at supra notes 489-97 and accompanying text.
5 00
The reasonableness of attorney's fees depends upon "the
fee customarily charged in the locality for similar services.
. the novelty and difficulty of the question involved,
the skill required to perform the legal services properly,
the amount involved, and the reputation and experience of the
lawyer performing the services." Cyro-Sonics, Inc., ASBCA
13219, 70-1 BCA 8313 at 38,658 (citing Rule 2-106 of the
American Bar Association Code of Professional Ethics). See
Switlik Parachute Co., ASBCA 18024, 75-2 BCA 11433; Ace I

Barber Shop, ASBCA 17292, 73-2 BCA 10052; American Packers,

Inc., ASBCA 14275, 71-1 BCA 8846; Douglas Corp., ASBCA 8566,
69-1 BCA 7578. Despite Government challenges, boards appear
reluctant to find that the hourly fee charged by an attorney
is excessive--probably because of the complexity of a
termination settlement. In each of the above cited cases the :j
Board found the fees reasonable. But see Tagarelli Bros.
Constr., ASBCA 34793, 88-1 BCA 20363 at 102,990 (finding
attorneys fees of $125 per hour unreasonable and allowing $75
per hour). Reasonable compensation for work performed by an
in-house attorney is at the attorney's normal salary rate
rather than the value of the services performed. See Fil-
Coil Co., ASBCA 23137, 79-1 BCA 13618; Rockwell Steel Co.,
ASBCA 5034, 79-1 BCA 13845.
5 0 1 The
boards of contract appeals have been hesitant to find
the use of experts unreasonable--even when the amount of the
termination settlement is small. Contractors unfamiliar with P
terminations for convenience who do not obtain expert advice
risk not obtaining full compensation for their costs in that
these actions are complex and require significant expertise.
5 0 2 The boards of contract appeals have on several occasions
determined that the number of hours spent in preparation of a
termination settlement by the contractor's executive and
clerical personnel was unreasonable. See e.g., Celesco _
Indus., ASBCA 22460, 84-2 BCA 17295 at 86,166; Kleinschmidt
Div., SCM Corp., ASBCA 22809, 78-2 BCA 13363 at 65,316;
Contract Maint., ASBCA 20689, 77-1 BCA 12446 at 60,293;
Clary Corp., ASBCA 1927c. 74-2 BCA 19247 at 52,102. After
deciding that the hours claimed are unreasonable, the boards'
by jury verdict determine a reasonable number of hours. It S

253
appears probable that the decisions are influenced, at least
in part, by disbelief that the contractor spent the number of
hours claimed preparing its settlement proposal. See e.g.,
Celesco Indus., ASBCA 22460, 84-2 BCA 17295, at 86,166
(finding a lack of supporting documentation or testimonial
evidence); Clary Corp., ASBCA 19274, 74-2 BCA 19247, at
52,102 (finding the claim unsupported); Bailfield Indus.,
ASBCA 20006, 76-2 BCA 12096 (finding the number of hours high
but not excessive--good records).
5 0 3 The
boards of contract appeals find it unreasonable to
have professional or executive personnel perform clerical
work and limit reimbursement accordingly.
5 04 See Celesco Indus., ASBCA 22640, 84-2 BCA 17295 at 86,165.
5 0 5 See
FAR 31.205-34(d): "Costs of legal, accounting, and
consultant services and directly associated costs incurred in
connection with . . . the prosecution of claims or appeals
against the Government . . . are unallowable" The
proscription is not limited to outside services but includes
any cost incurred in prosecuting a claim against the
Government including management and clerical costs. See
e.g., American Elec., ASBCA 16635, 76-2 BCA 12151, at 58,501-
02; Bailfield Indus., ASBCA 20006, 76-2 BCA 12096 at 58,103;
Lieb Bros., ASBCA 10007, 74-1 BCA 10509; Frigitemp Corp.,
VABCA 646, 68-1 BCA 6766; Q.V.S., Inc., ASBCA 7513, 1963 BCA
3699.
506
"When allowable and unallowable claimed costs are
commingled and there is not sufficient proof to segregate the
allowable from the unallowable, the entire claim must be
rejected." Paul E. McCollum, Sr., ASBCA 23,269, 81-2 BCA
15311 at 75, 824, aff'd, 6 Ct.Cl. 373, 380 (1985).
507" [It is the responsibility of an appellant seeking to
recover legal expenses allegedly incurred in the settlement
of a terminated contract to separate legal fees into proper
categories or show some reasonable basis for separating
settlement charges from charges for other work." Henry Spen
& Co., ASBCA 20766, 77-2 BCA 12784 at 62,187. See Nolan
Bros. v. United States, 194 Ct. Cl. 1, 36-37, 437 F.2d
1371(1971); H &H Reforestation, AGBCA 84-311-3, 85-3 BCA
18,255 at 91,640 (disallowing $750 consultant fee because it
was unclear whether or not the fee was incurred in litigation
of a claim against the Government); Robert M. Tobin, HUD BCA
79-388-C20, 84-3 BCA 17,651 at 87,971 (denying all settlement
preparation costs because contractor failed to explain the

254
nature and purpose of costs claimed); A-American, Inc.,
ASBCA 28823, 84-2 BCA 17479 at 87,088 (allowing only $500 of
$8000 in legal fees claimed because the Board was unable with
reasonable assurance to determine the amount of effort
expended by the legal firm in settlement of the termination
claim); R.G. Robbins & Co., ASBCA 27516, 83-1 BCA 27516 at
81,693; Contract Maint., ASBCA 20689, 77-1 BCA 12446 at
60,294; Cyro-Sonics, Inc., ASBCA 13219, 70-1 BCA 8313 at
38,658 (in the absence of an explanation as to why they were
incurred accounting fees were considered as incurred in the
prosecution of a claim against the Government); Western
States Painting, ASBCA 13843, 69-1 BCA 7616 at 35,375
(denying recovery of all legal fees for failure to properly
segregate the legal costs of preparing and presenting the
settlement proposal to the contracting officer from those of
making a claim against the Government); Algonac Mfg., ASBCA
10534, 66-2 BCA 5731 at 26,729 (allowing only $10,000 of
$275,000 claimed for legal, accounting, and clerical
expenses--not shown to relate to preparation or negotiation
of the settlement agreement).
5 08 See Bailfield Indus., ASBCA 20006, 76-2 BCA 12096.

Inherent in virtually every settlement effort

involving a complex Government contract claim is
research into the facts and applicable law performed
by one or both parties, which research would prove
useful in the event of litigation. One might question
the magnitude of legal expenses exceeding $22,000 for
a settlement effort alone. However, the Government
does not contend that these particular expenses were
unreasonably high.

Id. at 58,104. See e.g., Kalvar Corp. v. Unites States, 211 'V

Ct.Cl. 192, 205-06, 543 F.2d. 1298 (1976); E. A. Cowen

Constr., ASBCA 10669, 66-1 BCA 6060 at 28,012, modified on
other grounds, 67-1 BCA 6273; Sunstrand Turbo, ASBCA 9112,
65-1 BCA 4653 at 22,229. Compare Racquette River Constr.,
ASBCA 82-1 BCA 15769 at 78,052; Frigitemp Corp., VACAB 646,
68-1 BCA 6766 at 31,296-98.
5 0 9 See
e.g., Dunbar Kapple, Inc., ASBCA 3631, 57-2 BCA 1448
at 4,895. See also supra notes 474-89 and accompanying text.
5 1 0 See
FAR 31.205-42(g) (iii). But see Sunstrand Turbo, ASBCA
9112, 65-1 BCA 4653 at 22,226-28, aff'd, 182 Ct.Cl. 31, 57-60
(1968). Here, parties agreed that the direct costs of
settling the subcontract did not cover home office expenses

L"
255
*** -: 1F WI X W I r -

and that the home office had substantially contributed to the

subcontract settlement. The parties agreed to apply a 5%
rate for G&A to the settlement amount of the subcontracts to
compensate the contractor for this home office effort. The
5% rate was substantially less than the contractor's normal
G&A rate.
5 1 1 Essex
Electro Eng'rs, DOT CAB 1025, 81-1 BCA 14838 at
73,247, aff'd on motion for reconsid., 81-1 BCA 15109.
5 1 2 FPR
1-8.505-2 specifically stated, "Contractors shall not
include in their settlement proposals the cost of property
returned to suppliers. . . . Contractor's may include in
their settlement proposals as 'other costs' the
*, transportation, handling, and restocking charges with respect
to the property so returned." Current regulations, while not
as specific would also prohibit adding an indirect charge to
property returned to vendors. Under FAR 31.205-42(g) (1), a
contractor is normally required to charge such costs
directly. See supra notes 474-89 and accompanying text.
5 1 3 Essex
Electro Eng'rs, DOT CAB 1025, 81-1 BCA 14838 at
73,247, aff'd on motion for reconsid., 81-1 BCA 15109.
5 14 See Sun Elec., ASBCA 13031, 70-2 BCA 8371 at 38,925.

The ordering for material purchases, in the first

place, represents only a beginning of company
operations for which, upon the whole, costs are
covered under the burden and G&A expense; and, without
some particular showing, routine cancellation could
not be supposed as adding expense sufficient or so
substantial as to bring all costs incurred in respect
of appellant's partial cancellation into any
approximation with the whole distributive cost share
($5,16.71), which amounts to very nearly one-third the
direct cost.
5 1 5 The
indirect costs are unabsorbed because the contractor's
distribution base has been reduced as a result of the
termination.
5 1 6 See
Chamberlain Mfg., ASBCA 16877, 73-2 BCA 10139.

The measure of recovery for the exclusive remedy

afforded by the termination for convenience clause is
costs incurred plus a reasonable profit on the work
performed. . ... The claimed post-termination overhead

256

p. -.. _ . . 4 '
. . -' ... - . . . * ' ? ..
" . . -.. . . . '- "
 I p l

costs were neither incurred as a result of the work

performed on the contract nor generated directly by
the termination action. The termination action merely
reduced the direct labor base against which
appellant's overhead could be applied. In essence,
appellant's plea is that fairness and equity require
the Government to reimburse a terminated contractor
who has been unable to recover its overhead by the
acquisition of sufficient new business to generate
enough labor to compensate for the labor lost because
of the termination. However its arguments and
analogies are not persuasive.

Just as anticipatory profits are not allowable, so a

loss of business, whether in the guise of post-
termination G&A or otherwise is not recoverable in a
termination claim.

Id. at 47,678. See also Nolan Bros. v. United States, 194

Ct.Cl. 1, at 34-35, 437 F.2d 1371(1971); Arctic Corner,
Inc., VABCA 2393, 86-3 BCA 19278 at 97,458; Celesco Indus.,
ASBCA 22640, 84-2 BCA 17295 at 86,164; Hewitt Contracting,
ENG BCA 4596, 83-2 BCA 16816 at 83,653; Metadure Corp.,
ASBCA 21183, 83-1 BCA 16208 at 80,535-36; General Elec.,
ASBCA 24111, 82-1 BCA 15725 at 77,803, motion for reconsid.
denied, 82-2 BCA 16207; Pioneer Recovery Sys., ASBCA 24658,
81-1 BCA 15059; A.C.E.S., Inc., ASBCA 21417, 79-1 BCA 13809
at 67,725; KDI Precision Prods., ASBCA 21522, 79-1 BCA
13640, at 66,899-00; Systems & Computer Information, ASBCA
18458, 78-1 BCA 12946 at 63,139; Henry Spen & Co., ASBCA
20766, 77-2 BCA 12784 at 62,183; Allied Materials and
Equip., ASBCA 17318, 75-1 BCA 11150 at 53,093; Technology
Inc., ASBCA 14083, 71-2 BCA 8956 at 41,625, motion for
reconsid. denied, 72-1 BCA 9281. Compare Racquette River
Constr., ASBCA 82-1 BCA 15769 at 78,J51 (allowing unabsorbed
overhead during four-month period between work stoppage and
termination--unabsorbed overhead ceased at termination).
5 1 7 Joseph
and O'Donnell, supra note 377, at X-36 to X-41;
Trueger, supra note 27, at 745-760. Bedingfield and Rosen,
supra note 27, at 15-16 to 15-20 also present arguments
supporting allowability but do not argue as strongly for the
proposition as do other commentators.
5 1 8 Joseph
and O'Donnell, supra note 377, at X-36.
5 1 9 Joseph
and O'Donnell misstate the regulatory objective.
FAR 49.201(a) reads "A settlement should compensate the

257
 contractor fairly for the work done and the preparations
made for the terminated portions of the contract including a
reasonable allowance for profit. . . ." (emphasis added).
Unabsorbed overhead, like anticipatory profits, represents an
opportunity cost and is neither work done nor preparations
made for the terminated portion of the contract.
5 2 0 Joseph
and O'Donnell quote UCC Section 2-708(2) for this
proposition:

If the (difference between the market price and

contract] is inadequate to put the seller in as good a
position as performance would have done then the
measure of damages is the profit (including
rpasonable overhead) which the seller would have
made from full performance by the buyer, together with
any incidental damages . . . due allowance for costs
reasonably incurred and due credit for payments or
proceeds of resale. (emphasis added).
52 1 See Trueger, supra note 27, at 745-60 and 805-06.
52 2
1d. at 756. He therefore argues that unabsorbed overhead
should be recoverable for a reasonable period of time after
termination.
5 2 3 "(Unabsorbed
overhead] bear[s] an obvious and precise
causal relationship to the government's action in terminating
the contract for its convenience. From a cost accounting
viewpoint, there is no basis to charge such costs to any cost
objective other than the terminated contract." Id. at 760.
Trueger's observation is incorrect. These indirect costs
were not caused by the terminated contract nor does the
terminated contract exclusively benefit from their
incurrence. Such costs should be distributed equally among
all the cost objectives of the base period in which the costs
were incurred.
5 2 4 0ne
unusual circumstance, warranting recovery of
unabsorbed overhead after contract termination, exists when a
contractor is forced out of business by an erroneous default
termination. In Southland Manufacturing Corp., ASBCA 16830,
75-1 BCA 10994 at 52,360-1, unabsorbed overhead was allowed
from the effective date of termination, Dec. 22, 1964 until
Jul. 1, 1965. The Board considered this a reasonable period
for the contractor to finish work in process and wind up its
business and disallowed the contractor's requests for
unabsorbed overhead for a longer time period.
I.

258 '"

N,..
5 2 5 The
regulatory objective of fair compensation may not be
as broad as Joseph and O'Donnell assert. FAR 49.201(a) reads
"A settlement should compensate the contractor fairly for
the work done and the preparations made for the
terminated portions of the contract. . . ." (emphasis added).
The regulations do not state as a goal nor define fair
compensation in terms of putting the contractor in the same
position it would have been in had the contract not been
terminated. Recovery of anticipatory profits would be
necessary to put the contractor back in the position it would
have been in but for the termination. Nonetheless, the
regulations expressly prohibit anticipatory profits. See FAR
49.202(a).

526See supra note 516.

5 27 See Metadure Corp., ASBCA 21183, 83-1 BCA 16208 at 80,536.
528Pioneer Recovery Systems, Inc., ASBCA 24658, 81-1 BCA
15059 at 74,493, described the loss as follows:

The termination of the subject contract, along with

the inability of having additional work that could be
immediately substituted . . . caused Pioneer's
actual overhead rate for 1979 to increase and those
contracts whose prices were determined based on those
overhead forecasts experienced a loss of
profitability.
5 2 9 1d.
at 74,494, where the Board recognizing the potential
effect a termination can have reasoned:

[A] contractor must decide for itself whether its

negotiated prices and business forecasts warrant
accepting the risk of such contingencies; and, in
doing so, will necessarily have to consider the fact
that the potential contract, to the extent not
terminated, will absorb some overhead with which its
other business would otherwise be burdened. Although
convenience terminations are relatively rare, the risk
of unabsorbed overhead in termination cases is
essentially no different than in cases of a
contractor's failure to obtain other business which it
anticipates obtaining during the accounting period.

". ~. - V. N~r~~,;qw
N -. ' ~
* 5 N* N. ,

259
530Or as Paul Trueger would put it for a "reasonable" period
of time after contract termination. See supra note 27, at
756.
5 3 1 See
Note, Home Office Overhead for Construction Delays, 17
Ga. L. Rev. 761, 765 at note 15 (1983). Reasearch conducted
by the author of the Note discloses that when computing lost
profits most state courts characterize fixed overhead as a
deductible cost of performance and, therefore, have not
allowed its recovery.
53 21d. at 764-68. Unabsorbed overhead is convincingly
analogized to lost profits. At footnote 15, the author cites
Vitex Manufacturing Corp. v. Caribtex Corp., 377 F.2d 795,798
(3 Cir. 1967): "Although there is authority to the contrary,
we feel the better view, is that normally, in a claim for
lost profits, overhead should be treated as a part of gross
profits and recoverable as damages, and should not be
considered as part of the seller's costs." The Uniform
Commercial Code also defines lost profit to include
unabsorbed fixed overhead. See UCC 2-708(2), quoted at supra
note 520. Thus, arguably unabsorbed overhead after contract
termination is unallowable as anticipatory profit.
53 3
See Metadure Corp., ASBCA 21183, 83-1 BCA 16208 at 80,536.
534 See Trueger, supra note 27 at 757-58. See also Rishe,
supra note 27, at 6-52. "[A]lthough the costs of unabsorbed
overhead . . . normally are unallowable in a terminaticn
settlement, normal cost components of unabsorbed overhead may
be recoverable if separately identified and proven to be
continuing costs of the termination. Id. (citing Chamberlain
Mfg., ASBCA 16877, 73-2 BCA 10139 and Technology, Inc.,
ASBCA 14083, 71-2 BCA 8956).
53 5
Trueger, supra note 27, at 758.
5 3 6 See
Andrews and Peacock, supra note 429, at 288; Rishe,
supra note 27, at 6-64.
5 3 7 1t
is sometimes difficult to determine the amount of the
original contract price applicable to the terminated
contract. See Ideker, Inc., ENG BCA 4389, 87-3 BCA 20145 at
101,982-84. For purposes of illustration assume that one of
several separately priced line items is terminated. Reducing
;h%:.ntract price by the unit price of the terminated line
item may not be appropriate if the line items are not of

260
average profitability. For example, assume an item costing
$1000 direct labor and $250 in indirect costs were deleted
from the contract under a partial termination for
convenience. Reduction of the contract price by item's unit
price of $1000 is improper. The contract price should be
reduced by $1250 plus reasonable profit (assuming the
contract as a whole is profitable). Further, in some
instances, the work terminated will be part of a lump sum
bid. To determine the amount by which the contract price
should be reduced the parties may have to estimate the direct
costs of performing the terminated work, the indirect cost
markup and reasonable profit on the terminated work.
5 38
See Alston, supra note 148, at 389; Andrews and Peacock,
supra note 429, at 294; Bedingfield and Rosen, supra note
27, at 15-20.
5 39
See e.g., Marlin Assoc., GSBCA 5663, 82-1 BCA 15738 at
77,873.
54 0
FAR 49.104(d) and FAR 52.249-2(k).
5 4 1 SeeVaro,
Inc., ASBCA 16606, 72-2 BCA 9720 at 45,393;
Continental Elec, Mfg., ASBCA 14749, 71-1 BCA 9108 at 42,206.
5 42 See
Seirracin/Sylmar, ASBCA 27531, 85-1 BCA 17875 at
89,551-52; Capital Elec., GSBCA 5300, 81-2 BCA 15281 at
75,679-80; Celesco Indus., ASBCA 21928, 81-2 BCA 15260;
Varo, Inc., ASBCA 16606, 72-2 BCA 9720 at 45,396;
Continental Elec., Mfg., ASBCA 14749, 71-1 BCA 9108 at
42,208; International Aircraft Servs., 65-1 BCA 4793.
5 4 3 See
Varo, Inc., ASBCA 16606, 72-2 BCA 9720 at 45,394-95
(finding that nonrecurring tooling costs of $10,503 were
absorbed by 135 units rather than the 200 units called for in
the original contract).
5 4 4 See
e.g., Celesco Indus., ASBCA 22640, 84-2 BCA 17295 at
86,164; Askenazy Constr., HUD BCA 78-2, 78-2 BCA 13402 at
65,526; Henry Spen & Co., ASBCA 20766, 77-2 BCA 12784 at
62,178-83; American Maint. and Mgt Servs., ASBCA 18348, 74-2
BCA 18348; Dunbar Kapple Inc., ASBCA 3631, 57-2 BCA 1448 at
4,883-84.
5 4 5 Computation
and use of learning curves are discussed in
the Armed Services Pricing Manual, supra note 24, at 3-28 to
3-29.

261
 I

54 6
See e.g., Seirracin/Sylmar, ASBCA 27531, 85-1 BCA 17875 at
89,552 (adding both manufacturing burden and G&A); Capital
Elec., GSBCA 5300, 81-2 BCA 15281 at 75,679-80; Bermite Div.
of Tasker Indus., ASBCA 18280, 77-1 BCA 12349 at 59,762,
afff'd on motion for reconsid., 77-2 BCA 12731; Varo, Inc.,
ASBCA 16606, 72-2 BCA 9720 at 45,396.
547
See supra note 544.
5 4 8 See
e.g., Robert M. Tobin, HUD BCA 79-388-C20, 84-3 BCA
17651 at 87,969-70 (holding that unabsorbed overhead was
unrecoverable despite a large reduction in volume of work
because the contractor failed to perform the unterminated
work within the contractually specified completion date--the
partial termination did not cause the decreased distribution
base); R.G. Robbins & Co., ASBCA 27516, 83-1 BCA 27516, at
81,692-93 (disallowing unabsorbed overhead because evidence
was lacking as to how the partial termination affected G&A);
Chamberlain Mfg., ASBCA 14759, 71-1 BCA 8837 at 41,094
(disallowing unabsorbed overhead because no evidence was
introduced as to the plant's activity or lack of activity on
new business after termination).
54 9 Id.

5 50
See Dunbar Kapple Inc., ASBCA 3631, 57-2 BCA 1448 at
4,883-84. Variations of the above computation sometimes
appear in board decisions. See e.g., Henry Spen & Co., ASBCA
20766, 77-2 BCA 12784 at 62,180-81. Also other approaches
are sometimes used. For example, in Marlin Associates, GSBCA
5663, 82-1 BCA 15,738 at 77,874, the parties agreed to a 15%
loss-of-volume surcharge applied to the direct costs of the
completed portion of the contract.
5 5 1 See
FAR 49.208 allowing the contractor an equitable
adjustment for its increased costs of performing the
unterminated portion of the contract. *

5 5 2 Celesco
Indus., ASBCA 22640, 84-2 BCA 17295 at 86,164
(citing Fairchild Stratos Corp., ASBCA 9169, 67-1 BCA 6225,
aff'd on motion for reconsid., 68-1 BCA 7053).
5 5 3 The
212% indirect cost rate used for contract pricing was
substantially higher than the actual indirect cost rate.
Thus, either more work was performed during the period than
anticipated despite the partial termination or fewer indirect

262
costs were incurred than anticipated, or both. The Board's
rationale for finding that the contractor suffered no loss is
that the contractor prepared its bid using a cost rate that
was higher than it actually experienced. Had the contractor
known in advance what its actual indirect cost rate would be
the contract price would have been lower, not higher.
5 5 4 The
amount of an equitable adjustment is based on "the
difference between what it reasonably would have cost to
perform the work as originally required and what it
reasonably cost to perform the work as changed" not on what
the parties would have agreed to at the time of contracting
had they known what actual costs would be. See supra note 13
and accompanying text.
5 5 5 Wheeler
Bros., ASBCA 20465, 79-1 BCA 20465.
5 5 6 1d. at 66,919.
557 A
40% increase in the sales volume of almost any business
is going to substantially increase indirect costs. More
administrative, clerical, and warehousing time are needed to
process additional sales. Similarly more paper, machine time
and clerical supplies are needed. The effect of increased
volume on cost is discussed at supra notes 108-16 and
accompanying text.

Note 558 begins on page 264.

263

• " i l l "l 'i l"'n l .... .. . .. .. .

5 5 8 Equitable
adjustments and terminations for convenience are
both priced on a cost basis as are cost reimbursement and
cost plus fixed fee contracts.
5 59
"Perhaps the most important principle of accounting is
consistency." Bruce Constr., ASBCA 5932, 60-2 BCA 2797, at
14,388 (citations omitted). See also Rishe, supra note 27,
at 13-2.
5 6 0 See
supra notes 146-150 and accompanying text.
5 6 1 It
is a "generally accepted accounting principle that
accounting practices, once adopted, be adhered to over time.
As such, any accounting changes must be justified by the
circumstances, and only when they will reflect more
accurately the actual costs of the contractor." Rishe, supra
note 27, at 13-6. See also Scientific Am. Corp., IBCA 576-
666, 67-2 BCA 6670 at 30,957.
5 6 2 The
contracting officer is required to incorporate by
reference the Cost Principles in contracts with comnercial
organizations as a basis for proposing, negotiating, or
determining costs under terminated contracts, and for pricing
changes and other contract modifications. FAR 31.103(b)(3),
and (6).
5 6 3 FAR 31.201-2(a) (3). %
5 64See FAR 31.202(a) and 31.203(a). See also Bethlehem Steel
Co., ASBCA 9263, 65-1 BCA 4676 at 22,339.
5 6 5 FAR
31.202(a). What constitutes a "cost incurred for the'
same purpose in like circumstances" is discussed infra notes
598-622 and accompanying text.
5 6 6 FAR 31.203(a). 5..

5 6 7 Denial
of recovery is in essence a forfeiture and boards
and courts seldom enforce forfeitures. The most likely
result is that recovery would be allowed but in the manner
least favorable to the contractor.
568
See supra Chapter 1, para. IV.B. If the contract is
subject to the CAS, then any modification to the contract or r
termination of the contract is likewise subject to the CAS.
Similarly if a contract is not subject to the CAS, any
modification or termination of the contract is not subject to

264
the CAS, unless of course the modification independently
meets the dollar thresholds of the CAS.
56 9ADisclosure Statement is not required of all contractors
performing CAS-covered contracts. Only contractors receiving
(1) a negotiated national defense contract or subcontract of
$10 million or more, or (2) net awards of negotiated national
defense contracts and subcontracts totaling more than $10
million in their most recent cost accounting period are
required to submit Disclosure Statements. See FAR 30.202-1.

57 0
FAR 30.401-40.
5 7 1 FAR 30.401-50(a).
57 2 Anderson,
supra note 27, at 10-4, describes "actual cost"
as follows:

The term "actual cost" suggests a degree of accuracy

in a cost computation that would not be implied by the
use of such terms as "appraised," "average,"
"estimated," or "standard." The implication of
accuracy is misleading, however, because of the need
for arbitrary assumptions and prorations in the
determination of cost. It is nonetheless clear that
actual cost has meaning only with respect to completed
transactions and should not be used with respect to
the future.
57 3
FAR 30.401-20.
57 4
"'Reporting of costs' refers to (1) data presented in
reports required by the contract such as budget and
management reports for cost control purposes and (2) the data
contained on public vouchers or any other request for
payment." DCAA Audit Manual, 8-401.2a (1983).
57 5
FAR 30.401-40(c). See also DCAA Audit Manual, 8-401.1b
and c (1983).
57 6 See
Dayton T. Brown, Inc., ASBCA 22810, 80-2 BCA 14543 at
71,691 (holding that the contractor's request for bid and
proposal costs on a basis different from that used in
estimating such costs violated CAS 401).
577
1d. at 71,692.

265

",.4 . "-.
f :
57 8
Rishe, supra note 27, at 13-13.
57 9
FAR 30.402-20.
5 8 0 See
FAR 30.402-20. See also supra notes 594-97 and
accompanying text.
58 1
FAR 30.402-40.
5 8 2 FAR
30.402-50(b).
5 8 3 FAR 30.402-50(c).
58 4
FAR 30.402-50(d). Change is accomplished through the
process of formally proposing a change in accounting practice
and obtaining Government acceptance.
58 5
See DCAA Audit Manual, 8-402b (1983).
5 8 6 For
example, without a consistency requirement a
contractor could shift costs among cost pools or between
accounting periods in order to increase its recovery of cost
on Government contracts
587
See Boeing Co., ASBCA 19224, 79-1 BCA 13708 at 67,248-49
(citing proposed but withdrawn CAS 417, Distinguishing
between Direct and Indirect Costs).
5 8 8 See
e.g., Starks Contracting, VACAB 1339, 79-2 BCA 14018
at 68,848 (stating that costs not specifically identifiable
with a contract cannot be charged to that contract as a
direct cost).

5 8 9 See
Peter Kiewit Sons' Co., ENG BCA 4742, 85-1 BCA 17911
at 89,708; Foster Constr., DOT CAB 71-16, 73-1 BCA 9869.
"It is rarely an easy task to determine whether a particular
cost should be classified as direct cost or an indirect one.
. . . Clearly, the procurement regulations provide no more
than very broad, general definitions in differentiating
between the two categories." Id. at 46,150.
59 0
See Kleen-Rite Corp., GSBCA 5893, 83-2 BCA 16582.
"Ultimately, 'direct' and 'indirect' are arbitrary
categories, and the decision whether to call a given cost
direct or indirect is to a great extent a matter of
convenience." Id. at 82,467 (citation omitted).

266
,.
". .. .. .% . . .. . . . . . ... . . ,. ' -. - -. . . % . . -, % . < '.

| g .
5 9 1 See
e.g., Peter Kiewit Sons' Co., ENG BCA 4742, 85-1 BCA
17911 at 89,708 (holding that the procurement regulations
prefer "non-field labor be charged directly to a final cost
objective whenever possible, but permit such labor to be
treated as overhead, provided, in either case, that such
treatment is consistently observed").
5 9 2 Change
in accounting practice is discussed supra Chapter
5, Part III.
59 3
See FMC Corp., ASBCA 30130, 87-2 BCA 19791. Here a
contractor attempted to include the costs of prosecuting a
claim against another contractor in its G&A. The Board held
that legal fees and other costs incurred prosecuting contract
claims were direct costs of the contract from which they
arose. Despite the contractor's established practice of
including such costs in G&A the Board denied recovery
stating:

To the extent [appellant's] CAS disclosure statements

supported the indirect cost allocation of the claim
expenses, they were inconsist-nt with the ASPR and CAS
definitions of direct cost. ASPR 15-201.2 states that
where disclosed practices are inconsistent with ASPR
Section XV, Part 2, costs resulting from such
inconsistent practices shall not be allowed in excess
of the amount that would have resulted from the use of
practices consistent with this Part 2.

Id. at 100,138. See also American Elec.,ASBCA 15152, 73-1

BCA 9787 at 45,734 (regardless of contractor's general
practice, the lease costs of a facility devoted exclusively
to one contract were direct costs of that contract--
therefore, upon cancellation, the Government was entitled to
a deductive credit in for the full direct cost savings).
5 9 4 See
e.g., Norris Indus., ASBCA 15442, 74-I BCA 10482 at
49,561-62 and 49,578; Hurd-Darbee, Inc., ASL2A 12928, 68-2
BCA 7402 at 34,418. This type of overcharging occurs when
indirect cost rates remain the same despite direct charging
of a normally indirect cost (the direct charge is not removed
from indirect cost groupings) .
5 9 5 Anderson,
supra note 27, at 11-3, provides an example of
this particular form of overcharging.

267
-~ ~ *
 [A] contractor charges contract administration
directly to contracts if a contract requires a full-
time administrator. Contract administrators that
handle more than one contract are charged to the G&A
expense pool. Thus, the contract with a full-time
administrator gets charged with its own contract
administration plus a share of the contract
administration performed for contracts that do not
require a full-time administrator.

See also Volk Constr., IBCA 1419-1-81, 87-3 BCA 19,968 at

101,101 (characterizing as "serious overcharging" the
claiming of supervisory costs as direct costs rather than
overhead); McDonnell Douglas Corp., NASA BCA 873-10, 75-2
BCA 11568 at 53,993.
5 9 6 This
form of overcharging is more difficult to detect than
other forms of overcharging in that it requires detailed
knowledge of what costs are included in a contractor's
indirect cost grouping--knowledge often obtainable only by
audit. -V

597See Anderson, supra note 27, at 11-3.

5 9 8 The
drafters of the FAR adopted the language of CAS 402 in
establishing the Cost Principles' requirement for
consistency. There are some minor differences in wording but
the key language is the same.
5 99
FAR 30.402-40.
6 0 0 For
example, when a contiact is terminated for
convenience, FAR 31.205-42 permits direct charging of initial
costs and settlement expenses.
601
See FAR 30.402-60(a).
6 0 2 FAR
30.402-60(a)(1). Further, the contractor's Disclosure
statement must be amended for the proposed change in
accounting practices. Id.
6 0 3 "A
directly associated cost is any cost which is generated
solely as a result of incurring another cost, and which would
not have been incurred had the other cost not been incurred."
FAR 31.206 (a).
6 04 FAR 30.402-60 (a) (2).

268
 60 5
1d. If the direct labor base inequitably distributes
planning costs to the several cost objectives, the contractor
should propose a change in its method of allocating such
costs. The proposed change must be for all planning costs.
The illustration suggests using the number of planning
documents processed rather than direct labor as a allocation
base.
60 6
p.I See FAR 30.402-60(b).
607
FAR 30.402-61.
6 0 8 This
language has been the subject of a recent ASBCA
decision, Boeing Co., ASBCA 29793, 88-1 BCA*** (decided Dec.
3, 1987). Boeing had been awarded a Phase I design contract
specifically requiring it to submit a proposal for the Phase
2 production contract. Because it was Boeing's disclosed
accounting practice to classify bid and proposal costs as
direct costs if required by a specific contract task, bid and
proposal costs for the Phase 2 contract were properly charged
as direct costs. The question before the Board in Boeing was
classification of proposal costs not specifically required
by the Phase I contract but incurred by Boeing to enhance its
chances of obtaining the follow-on contract--proposal costs
incurred before the Government issued the detailed proposal
instruction package and costs incurred after submission of
the proposal in preparation of a best and final offer. The
Board held that the Interpretation's rationale for permitting
proposal preparation costs to be treated as direct costs
applied with equal force to these costs. They were incurred
for the same purpose and in like circumstances as the bid and
proposal costs the contractor was specifically required to
incur (both sets of proposal costs were incurred to obtain
the follow-on contract). Therefore, the Board required that
they be classified as a direct cost.
6 09
See e.g., Hurd-Darbee, Inc., ASBCA 12928, 68-2 BCA 7402 at
34,418.

6 10
In many cases the contractor is trying to recover the same
cost twice, directly and as part of an indirect charge. The
duplication and inconsistency are obvious requiring little
discussion. Even when it is not the same cost that is being
claimed twice, the consistency issue is obvious in most
circumstances. See e.g., Volk Constr., IBCA 1419-1-81, 87-3
BCA 19,968 at 101,107 (reclassifying supervisory salaries
from a direct cost to an indirect cost); Webster-Martin,

269

. . ~
.a . - . - - . .- -
 - I - --. I - j

Inc., IBCA 778-5-69, 70-1 BCA 8120 at 37,729 (removing travel

expense and mobile and fixed laboratory expense from indirect
costs because costs of the same nature were charged to the
contract as direct costs); Stanley Aviation Corp., ASBCA
12292, 68-2 BCA 7081 at 32,780 (denying as a direct cost the
travel costs of six individuals whose salaries where charged
indirectly because the contractor's established accounting
practice was to charge travel costs in the same way that the
employee's salary was charged); Telecomputing Servs., ASBCA
10644, 68-1 BCA 7023 at 32,469-72 (denying employee moving
expenses after job completion as a direct costs because the
contractor's established practice was to charge such costs
indirectly). But see Bethlehem Steel Co., ASBCA 9263, 65-1
BCA 4676, aff'd on motion for reconsid., 65-2 BCA 5004 at
23,597 (finding that excess short term power expense and
utility expense were similar enough to require like
classification as indirect costs)
6 1 1 Problems
arising during contract performance may require
the full time of a person whose salary is normally charged
indirectly.
6 12
For example, if problems arise requiring full-time
supervisory effort but no additional direct labor hours and
the contractor uses direct labor hours as its distribution
base, the contractor will not recover any additional indirect
cost as compensation for devoting a supervisor full time to
the job.
6 13
See e.g., J.M.T Machine Co., ASBCA 23928, 85-1 BCA 17280
at 89,183 (denying chief engineer's salary as a direct cost
of a constructive change even though he devoted 416 hours of
his time to finding a solution); L&H Constr., ASBCA 23620,
81-1 BCA 14823 at 73,160 (despite spending significantly more
supervisory time on a Government contract than on its other
seven jobs, contractor was not allowed to charge a portion of
its president's time directly to the Government contract and
the remainder as an indirect cost); Platt Mfg., ASBCA 25077,
81-1 BCA 14894 at 73,688 (denying as a direct charge to a
change order the time spent by administrative personnel
correcting errors in a Government data package); Optimal
Data Corp., NASA BCA 976-8, 79-1 BCA 1362, at 66,828-29 and
66,837 (denying as a direct cost time spent by contractor's
president administering the contract during completion and
subsequent closure). But see Walter Motor Truck Co., ASBCA
8054, 66-1 BCA 5365 at 25,172 (allowing contractor to charge
normally indirect accounting costs as a direct cost because
problems arising during performance required accounting

27
~270
services way out of proportion to contractor's normal
accounting patterns).
6 1 4 The
various forms of overcharging are discussed supra
notes 594-97 and accompanying text.
6 1 5 Note
that CAS 402 uses this same factual pattern to
illustrate a "cost incurred for the same purpose." See FAR
30.402-60(a) (2). See also supra notes 603-604 and
accompanying text. However, Rishe, supra note 27, at 11-7
and 11-10, comments that quantitative differences do
constitute a sufficient change in circumstances to justify
direct charging so long as similar costs are eliminated from
the distribution base.
6 1 6 For
a discussion of accounting changes see supra notes
638-77 and accompanying text.
6 1 7 CAS
410, Allocation of Business Unit General and
Administrative Expenses to Final Cost Objectives, permits a
"special allocation" from the G&A expense pool when a
particular final cost objective in relation to other final
cost objectives receives significantly more or less benefit
from G&A expense than would be reflected by the allocation of
such expenses using a cost input base. See FAR 30.410-50(4). p
A special allocation is allowable only in exceptional
circumstances. See Boeing Co., ASBCA 19224, 79-1 BCA 13708
at 67,241-42. Many of the earlier cases state in dicta that
deviation from a contractor's established accounting
practices is allowable in exceptional circumstances. Note
that in each of the cited cases exceptional circumstances
were found not to exist. See e.g., Telecomputing Servs.,
ASBCA 10644, 68-1 BCA 7023 at 32,472; American Scientific
Corp., IBCA 576-666, 67-2 BCA 6670 at 30,957 (permitting
deviation if the usual practice causes inequitable results);
Reynolds Metals Co., ASBCA 7686, 1964 BCA 4312, motion for
reconsid. denied, 1964 BCA 4477. "It might under some
circumstances be proper to make exceptions to appellant's
ordinary accounting methods in order to meet special
circumstances and more accurately reflect the costs of
performing a particular contract and we have frequently so
held." Id. at 20,856.
6 18
See Kleen-Rite Corp., GSBCA 5893, 83-2 BCA 16582 at 82,464
(finding no inconsistency in directly charging time spent as
project manager and indirectly charging time spent as an area '.

supervisor); Electronics Corp., ASBCA 4770, 61-2 BCA 3134

at 16,275 (ten supervisory, clerical, or administrative

271
 personnel were removed for periods of time from
administrative duties to direct labor functions; it was
consistent to charge a portion of these salaries as a direct
cost and the remainder indirectly).
6 19
Airtech Servs., DOT CAB 68-19, 68-2 BCA 7209.
6 2 0 Under
the current procurement regulations, FPR 1-15.202(a)
is now FAR 31.202(a).
62 1
Airtech Servs., DOT CAB 68-19, 68-2 BCA 7209 at 33,905.
62 2
See American Fed. Contractors, PSBCA 1354, 87-1 BCA 19595
at 99,119 (holding that to recover labor costs of supervisory
employees directly, contractor must show that they performed
other than normal supervisory duties and directed themselves
exclusively to the work directed by the modification). See
also Electronics Corp., ASBCA 4770, 61-2 BCA 3134. The Board
reasoned that no inconsistency existed: 5
In none of these instances is there attempted to be
charged direct any supervisory, administrative,
clerical or other activity of an indirect nature. In
every case it was as though the employee resigned his
position and accepted employment as a direct laborer.
The production supervisors picked up tools and joined
the army of direct production workers.

Id. at 16,275. Accord Kleen-Rite Corp., GSBCA 5893, 83-2 BCA

16582 at 82,464; Kenmore Garment Co., ASBCA 14142, 71-1 BCA
8768 at 40,698-99; Airtech Servs., DOT CAB 68-19, 68-2 BCA
7209 at- 33,905-06.
62 3
For a discussion of indirect cost groupings see supra
notes 74-88 and accompanying text. The larger the number of
cost groupings the more precisely a contractor can allocate
indirect costs to cost objectives. See supra notes 75-78 and
accompanying text.
62 4
Consistency is required under GAAP. See supra notes 560-
61 and accompanying text.

* 6 2 5 See
supra notes 74-88 and accompanying text.
62 6
See e.g., American Scientific Corp., IBCA 576-666, 67-2
BCA 6670 at 30,956 (not allowing contractor to segregate the
manufacturing overhead and labor costs of its two facilities

272
 because it had established an accounting practice that
combined such costs) N

627Consistency is required under GAAP. See supra notes 560-

61 and accompanying text. See also Kinn Elecs., DOTCAB 69-
25, 70-1 BCA 8176 at 37,986 (contractor trying unsuccessfully
to exclude unbilled engineering labor costs from its cost of
sales base in variance with its established practice of
including such unbilled costs).
62 8
See Litton Sys. v. United States, 449 F.2d 392, 397-98
(Cl.Ct. 1971) (holding that a contractor using a cost of
sales distribution base must define a "sale" for fixed price
and cost reimbursement contracts similarly and could not
treat progress payments under fixed price contracts
differently than billings under cost reimbursement
contracts); Frederick Burk Found., ASBCA 15728, 73-1 BCA
9959 at 46,738-39 (holding that a contractor could not
selectively use a different distribution base for one of its
several contracts--any change had to apply to all).
62 9
See e.g., Celesco Indus., ASBCA 22402, 80-1 BCA 14271 at
70,298 (refusing to allow special treatment for discontinuing
segment of contractor's business that no longer benefited
from G&A to the same degree as did other cost objectives);
Wolf Research and Dev., ASBCA 10913, 68-2 BCA 7222 at 33,546-
47 (disallowing a separate allocation base for one set of
fixed price contracts that allegedly benefited less from G&A
than other contracts--would have allowed a separate
allocation base if contractor had proved its use was
reasonable); Bruce Constr., ASBCA 5932, 60-2 BCA 2797 at
14,389 (refusing to allow a special overhead allocation for a
change order that required more G&A effort than was
recoverable under the contractor's established method of
recovering indirect costs).
6301d. I

6 3 1 Change
in cost accounting practice is discussed infra
notes 638-677.
6 32
See FAR 31.202(c). "Once an appropriate base for
distributing indirect costs has been accepted it shall not be
fragmented by removing individual elements. All items
properly includable in an indirect cost base should bear a
pro rata share of indirect costs irrespective of their
acceptance as Government contract costs." Id. See also
Celesco Indus., ASBCA 22402, 80-1 BCA 14271 at 70,299.

273 .

%.... -,. -... "N2.". ".. .. . .- 'NN", 4.NN.N

U

6 33
See FAR 31.202(c). For a discussion explaining that
unallowable costs should not be excluded from the
distribution base see supra notes 165-67. Although the FAR
prohibits removal of unallowable costs from a distribution
base, not all authorities agree that removal of such costs is
necessarily an inconsistent accounting practice or results in
Government contracts being burdened with costs properly
attributable to the unallowable costs. See e.g., Martin
Marietta Corp., ASBCA 14159, 71-1 BCA 8793 at 40,794-95.
6 3 4 Base
periods are discussed supra notes 98-106 and
accompanying text.
6 35
See Nash-Hammond, Inc., ASBCA 15563, 71-1 BCA 9166 at
42,529 (finding that the contractor properly used its fiscal
year for its distribution base despite the fact that during
the last six months of its fiscal year (1) no work was done
on the Government contract and (2) production volume
substantially declined); EMR-Aerospace Sciences, NASA BCA
269-2, 70-2 BCA 8381 (finding that it was a departure from
established accounting practice for contractor to use a two
year base for start-up costs); Electronics Corp., ASBCA
4770, 61-2 BCA 3134 at 16,287-89 (not permitting contractor
to use the period of contract performance--1 Oct 1954 to 31
Aug 1956--as its base period because this period was
inconsistent with contractor's normal accounting practice);
Daystrom Instrument, ASBCA 3438 at 5772, modified on other
grounds, 58-2 BCA 2050 (not permitting contractor to use the
45-month period of contract performance as its base period
because, among other things, such use was inconsistent with
its established accounting practices). But see Itek Corp.,
NASA 27, 1963 BCA 3967 at 19,641. Only the last eight months
of contractor's fiscal year were used as the base period.
Use of the entire year was considered inequitable because it
was contractor's first year in business and the first four
months in existence were not representative of its normal
operations.
6 3 6 The
propriety of using a base period shorter than one year
is discussed supra note 103.
6 3 7 Base
period selection for terminations settlements is
discussed supra notes 373-75 and accompanying text.
Surprisingly, the contractor's choice of the period of
contract performance as a base period rather than its normal
base period has not been challenged as an inconsistent
accounting practice.

274
6 3 8 Change
in product mix, organization, volume of business,
among others factors may make a once equitable cost
accounting practice inequitable. FAR 31.203(d) describes
three sets of circumstances under which a contractor should
examine its accounting practices including (1) substantial
differences in the cost patterns of work under the contract
as compared to the contractor's other work, (2) changes in
the nature of the contractor's business, and (3) application
of cost groupings developed for the contractor's primary
location to off site locations. See also Rishe supra note
27, at 13-16 to 13-19.
6 3 9 Both
requirements must be demonstrated. See Celesco
Indus., ASBCA 23165, 80-1 BCA 14455 at 71,246; Celesco
Indus., ASBCA 22402, 80-1 BCA 14271 at 70,297-98; Optimal
Data Corp., NASA BCA 976-8, 79-1 BCA 13624 at 66,834; Unidex
Sys., PSBCA 24, 75-2 BCA 11,549 at 55,108; Frederick Burk
Found., ASBCA 15728, 73-1 BCA 9959 at 44,738; Plasmadyne
Corp., ASBCA 7731, 1962 BCA 7731 at 17684; Hardy Mfg., ASBCA
4201, 58-1 BCA 1789 at 6941. But see McDonnell Douglas
Corp., NASA BCA 873-10, 75-1 BCA 11337 at 53,995 and 54,000,
motion for reconsid. denied, 75-2 BCA 11568. The Board
refused to require a contractor to demonstrate that its
established cost accounting practices produced inequitable
results as a prerequisite to its making a change. The
contractcr had only to prove that the change produce
equitable results. In contrast the Board would require the
Government to demonstrate that the contractor's established
cost accounting practices were inequitable as a prerequisite
to imposing an accounting change upon the contractor.
6 4 0 1n
Celesco Industries, ASBCA 22402, 80-1 BCA 14271 at
70,298, the Board recognized that the contractor's
established method of distributing G&A disproportionately
allocated G&A to the discontinuing Marine Systems segment of
the contractor's business yet denied the change because other
segments of the contractor's business had borne a
disproportionately large share G&A during the start up period
for the Marine Systems segment.
6 41
See General Dynamics Corp., ASBCA 7963, 1964 BCA 4133 at
20,162, stating that "the sole fact that it would favor the
Government does not justify a change in the circumstances to
which these procedures are applied" (citations omitted).
See Boeing Co., ASBCA 11866, 69-2 BCA 7898 at 36,752, stating
that "ordinarily, a contractor cannot change accounting
practices merely for the purpose of obtaining the greatest

275
reimbursement on the basis of events that have previously
occurred" (citations omitted). See also General Dynamics
Corp., ASBCA 22461, 78-2 BCA 13270 at 64,886; Federal Elec.,
ASBCA 11324, 67-2 BCA 6416 at 29,733; Borg-Warner Corp.,
ASBCA 9144, 1964 BCA 4507 at 21,630 (stating that the
Government cannot require a change merely because it would
produce a more favorable dollar result for the Government).
6 42
See Unidex Sys., PSBCA 24, 75-2 BCA 11549 at 55,109;
Industrial Research Assocs., CAB WB-5, 71-1 BCA 8680 at
40,319; Telecomputing Servs., ASBCA 10644, 68-1 BCA 7023 at
32,472; Reynolds Metals Co., 1964 BCA 4312 (not permitting a
change in accounting practice that affected only 1 of 16
plants).
It is not permissible . . . to establish a company-
wide system of accounting, including a company-wide
item of cost, and then to revise this system with
respect to a single plant or program in order to
revise the allocation of cost so as to charge it to
that plant or program, contrary to its established
method.

Id. at 20,856. See also Daystrom Instrument Div. of

Daystrom, ASBCA 3438, 58-2 BCA 2050 at 8629.
6 4 3 For
background information and a definition of full and
modified CAS coverage see supra notes 28-32 and accompanying
text.
6 44
See FAR 52.230-3(a)(2) and FAR 52.230-5(a)(3)(i). FAR
30.302-1 defines a cost accounting practice as "any disclosed
or established accounting method or technique which is used
for allocation of cost to cost objectives, assignment of cost
to cost accounting periods, or measurement of cost."
6 4 5 Change
to a cost accounting practice is defined at FAR
30.302-2. The "initial adoption of an accounting practice
for the first time a cost is incurred or a function is
created is not a change in cost accounting practice." FAR
30.302-2(a). Similarly, the "revision of a cost accounting
practice for a cost which has previously been immaterial is
not a change in cost accounting practice." FAR 30.302-2(b).
Changes which meet the definition of a change to a cost
accounting practice are illustrated at FAR 30.302-3.
6 4 6 See
FAR 30.401-50(b) and FAR 30.402-50(d).

276

- J *d-I
647Prospective versus retroactive application of changes to
cost accounting practices is discussed generally and with
respect to CAS-covered contracts infra notes 663-77 and
accompanying text.
64 8
See FAR 30.401-50(b) and PAR 30.402-50(d).
64 9
See FAR 30.602-3.
6 50
See FAR 30.602-3(a).
6 51
See FAR 30.602-3(b). The cost impact proposal must be
sufficiently detailed to allow evaluation and negotiation of
the cost impact on each CAS-covered contract and subcontract.
6 52
See FAR 30.602-3(c) .
6 53 See Anderson, supra note 27 at 4-17. 3
6 54
1d. If the contracting officer determines that the change
is desirable and not detrimental to the Government, an
equitable adjustment to contract price is negotiated under
the Changes clause of the contract. See FAR 52.230-
3(a) (4)(iii) and FAR 52.230-5(a) (3)(ii).
6 55
A downward equitable adjustment to a firm fixed-price
contract is warranted if as a result of the change the
contractor allocates less cost to a fixed-price contract than
would have been allocated by use of its disclosed cost
accounting practices on which the contract negotiation was
based. See Anderson, supra note 27, at 4-23 for a discussion
of downward equitable adjustments to firm fixed-price
contracts.
6 56 See FAR 52.230-3(a) (5) and FAR 52.230-5(a) (4).

657See FAR 30.602-2. See also Anderson, supra note 27, at 4-

31.
658 Id. •"

6 59 See Boeing Co., ASBCA 11866, 69-2 BCA 7898. 'N

Ordinarily, a contractor cannot change accounting

practices merely for the purpose of obtaining the
greatest reimbursement . . . . Yet the [procurement

27
277
 regulations] recognize, by implication the possibility
of changes arising out of circumstances peculiar to
the business of the contractor. In addition, the
Board has also recognized the right of the contractor
to change its accounting methods when it can show a
valid basis therefor.

Id. at 36,752 (citations omitted). See also Salisbury &

Dietz, Inc., IBCA 20107, 87-3 BCA 2090 at 101,814 (no
absolute prohibition against change); AC Elecs. Div.,
General Motors Corp., ASBCA 14388, 72-2 BCA 9558 at 44,521;
Federal Elec., ASBCA 11335, 67-2 BCA 6416, at 29733; Coleman
Eng'g, ASBCA 9478, 65-1 BCA 4695 at 22,420 (no inflexible
rule that a contractor must follow the same accounting
practice, if to do so distorts the results of business
operations).
6 60
See e.g., Chrysler Corp., NASA BCA 107501, 77-1 BCA 12482
at 60,511; AC Elecs. Div., General Motors Corp., ASBCA
14388, 72-2 BCA 9558. However, the Government cannot
require a change "merely because such a change would produce
a more favorable dollar result for the Government." Borg-
Warner Corp., ASBCA 9144, 1964 BCA 4507 at 21,630.
6 6 1 See
Salisbury & Dietz, Inc., 87-3 IBCA 20107, 87-3 BCA
20107 at 101,814. See Rishe supra note 27. "Under the Cost
Principles, there is no affirmative disclosure requirement,
except in the case of accounting changes that warrant
disclosure pursuant to generally accepted accounting
principles. The Government's right to audit the contractor's
books constitutes its chief means of supervision." id. at
13-7.
6 62
Failure to give advance notice of a change in accounting
practice does not necessarily prevent the change from being
given effect by a court or board but does increase the
likelihood of Government challenge. See Salisbury & Dietz,
Inc., 87-3 IBCA 20107, 87-3 BCA 20107. Here, the Government
challenged an accounting change of which it had not been
given notice even though, as the Board found, it was not
prejudiced by the change. The Board gave effect to the
change despite lack of notice to the Government:

[Tihere is no absolute prohibition against a change

regardless of failure to notify and secure
approval . . . in any event, existence of an
unapproved change is not grounds for denying all
costs, tribunals should give consideration to

278

'
 .VVt.- %T _ ,If 7. -
I.h- -

the equities of the situation and investigate whether

giving effect to the change would result in the
allowance of 'an item of cost to the prejudice of the
other' party.

Id. at 101,814.
6 6 3 The
Cost Accounting Standards clause, FAR 52.230-3 is a
mandatory clause for CAS-covered contracts. The limitation
is set forth as follows: "If any change in cost accounting
. practice is made for the purposes of any contract or
subcontract subject to CAS requirements, the change must be
applied prospectively to this contract and the Disclosure
Statement must be amended accordingly" (emphasis added).
The Disclosure and Consistency of Cost Accounting Practices
clause, FAR 52.230-5 is a mandatory clause for contracts
subject to modified CAS coverage. Its limitation is set
forth as follows: "After the terms and conditions underwhich
such change is to be made have been agreed to, the change
must be applied prospectively to this contract and the
Disclosure Statement, if affected, must be amended
accordingly" (emphasis added). Although these clauses have
been mandatory since at least 1978 (See DAR 7-104.83(a)),
they have not been used by courts or boards as a basis for
denying retroactive application of changes in cost accounting
practices. See e.g., Data-Design Laboratories, ASBCA 27245,
86-2 BCA 18830 (refusing to allow the Government to
retroactively apply a change in cost accounting practice,
discussing retroactive application from the viewpoint of the
CAS, but not mentioning the prospective application language
included in the Cost Accounting Standards clause of the
contract).
6 6 4 Under
the Cost Principles, the terms of the contract are
one of five factors considered in determining whether a cost
is allowable. See FAR 31.201-2(a) (4). When a contractor's
cost accounting practices are inconsistent with the terms of
the contract, the costs resulting from such inconsistent
practices are not allowable in excess of the amount that
would have resulted from consistent practices. See FAR
31.201-2(c). Compare FMC Corp., ASBCA 30130, 87-2 BCA 19791
at 100,138 (denying costs in excess of the amount that would
have resulted from the use of accounting practices consistent
with the Cost Principles).
6 65
See e.g., FMC Corp., ASBCA 30130, 87-2 BCA 19791 at
100,139.

279

Po0
6 66
For CAS-covered contracts, the requirement for prospective
application is contained in the Cost Accounting Standards
clause, FAR 52.230-3 and the Disclosure and Consistency of
Cost Accounting Practices clause, FAR 52.230-5. There are no
similar clauses that apply to non-CAS-covered contracts.
6 6 7 Celesco
)J Indus., ASBCA 20569, 77-1 BCA 12445 at 60,287-88.
6 68Amid-year change in effect reduces the base period into
two shorter base periods. Use of base periods shorter than
one year may yield cost allocation rates which do not
accurately reflect the normal operations of a contractor's
business. See supra notes 98-104 and accompanying text.
6 69
See Celesco Indus., ASBCA 23165, 80-1 BCA 14455 at 71,2467
(applying a more stringent test applied to mid-year
accounting changes than to changes in accounting practices
proposed to begin at the beginning of a year).
67 0
See Blue Cross and Blue Shield Ass'n, ASBCA 26529, 86-2
BCA 18,571 at 94,427; Celesco Indus., ASBCA 20569, 77-1 BCA
12445 at 60,287; Stanwick Corp., ASBCA 18083, 76-2 BCA
12,114 at 58,179; Unidex Systems, Inc., PSBCA 24, 75-2 BCA
11,549 at 55,109; Peninsular Chemresearch, Inc., ASBCA
14384, 71-2 BCA 9066 at 42,054-55; Reynolds Metals Co.,
AqBCA 7686, 1964 BCA 4312 at 20,856; Daystrom Instrument
Div. of Daystrom, ASBCA 3438, 58-2 BCA 2050 at 8628-29.
6 7 1 Zero
Mfg., ASBCA 14558, 70-2 BCA 8489 at 39,460 (emphasis
added). See also Celesco Indus., ASBCA 20569, 77-1 BCA 12445
at 60,287.
67 2
See Blue Cross and Blue Shield Ass'n, ASBCA 26529, 86-2
BCA 18,571. The Board denied the contractor's claim that
certain indirect costs should be allocated on a retroactive
basis to the contractor's Government as well as commercial
business. "Neither appellant or the Government (in the
absence of some possible peculiar circumstance not present
here) may retrospectively change the accounting treatment of
an item of cost to the prejudice of the other. The
commercial havoc which could otherwise ensue is obvious."
Id. at 94,427 (citations omitted).
67 3 See
e.g., Litton Sys. v. United States, 449 F.2d 392, 398-
401 (Cl.Ct. 1971); Data Design Laboratories, 86-2 BCA 18830
at 94,889; Falcon Research & Dev., ASBCA 19784, 77-1 BCA
12312 at 59,484; AC Elecs. Div., General Motors Corp., ASBCA

280
 14388, 72-2 BCA 9558 at 44,521-22; Martin Marietta Corp,
ASBCA 14159, 71-1 BCA 8783 at 40,794; Zero Mfg., ASBCA
14558, 70-2 BCA 8489 at 39,460 (allowing a change to be given
retroactive effect based in part on finding no evidence that
the contractor's fixed price contracts would have been lower
priced had the new practice been in effect at their
inception).
67 4
Obviously,
a contractor cannot reprice any of its
commercial fixed-price contracts. Repricing of fixed-price
Government contracts raises the question of whether the
contractor would have received the contract in the first
instance had its price been higher.
6 7 5 See
e.g., Litton Sys. v. United States, 449 F.2d 392, 398-
401 (1971); Data Design Laboratories, 86-2 BCA 18830, at
94,889; Falcon Research & Dev., ASBCA 19784, 77-1 BCA 12312
at 59,484; AC Elecs. Div., General Motors Corp., ASBCA
14388, 72-2 BCA 9558 at 44,521-22. Compare Chrysler Corp.,
NASA BCA 107501, 77-1 BCA 12482 at 60,511. The Board
retroactively changed the contractor's method of accumulating
and allocating costs from a single pool to a multiple pool
method. The contractor, in accordance with its established
accounting practices, had charged all of an off-site
facility's rental, occupaiiy, and other costs to the single
burden pool. When the character of work at this off-site
location changed from bid and proposal to commercial
production type work, the contractor continued to charge such
costs to the single pool for distribution to all the
contractor's work even though such work was only marginally
beneficial to Government contracts and specifically
identifiable with a commercial venture. Chrysler Corp. can
be distinguished from the other cases involving retroactive
application of change in that the costs sought to be
retroactively applied were specifically identifiable with
commercial work. The contractor's ability or inability tu
reprice fixed-price contracts was not discussed.
67 6
The role of cost in the pricing of commercial and
Government contracts is discussed at supra notes 23-24, and
accompanying text. In the absence of competition, cost
plays a dominant role in pricing Government contracts. Thus,
forfeiture is a possibility to the extent that the
contractor's business, during the period for which
retroactive application is sought, included sole source
Government contracts, modifications to fixed-price Government
contracts, or terminations for convenience of Government
contracts.

281

V% 111 %.- Vq* -*9 .*-% *~**S

6 7 7 The
converse is true if the the contractor's fixed-price
contracts were priced through negotiation and in reliance on
cost or pricing data submitted by the contractor.
67 8
See
supra note 170 and accompanying text. Most
contractors use a direct labor dollar distribution base,
although other bases are used occasionally.
6 7 9 See
e.g., Fidelity Constr., ENG BCA 4322, 83-2 BCA 16710
at 83,118 (denying manager's salary as a direct cost of the
equitable adjustment); Propserv Inc., ASBCA 23617, 81-2 BCA
15,182 at 75,138 (denying contractor's vice-president's
salary as a direct cost of an equitable adjustment); L&H
Constr., ASBCA 23620, 81-1 BCA 14823 at 73,160 (denying
contractor's president's salary as a direct cost despite his
becoming a "full-time supervisor" on the job due to numerous
Government changes and differing site conditions--contractor
could not charge a portion of his time directly to Government
modifications and the remainder indirectly); Machinery
Assocs., ASBCA 20039, 77-1 BCA 12503 at 60,617 (denying
contractor's president's salary and its chief engineer's
salary as direct costs of the equitable adjustment); F.F.
Slocomb Corp., ASBCA 20169, 76-2 BCA 12071 at 57,923 and
57,926 (denying as a direct cost the following expenses that
contractor normally-classified as indirect costs: travel,
freight, and trucking); A. Campo, Inc., ASBCA 14830, 72-1
BCA 9377 at 43,542 (denying as a direct charge to the delay
claim the salary of an employee performing administrative and
supervisory services whose salary was otherwise charged
indirectly); Keko Indus., ASBCA 12729, 71-1 BCA 8713 at
40,478 (finding that the contractor normally charged per diem
and travel as G&A, these costs were not permitted to be
charged directly to a constructive change); Industrial
Research Assocs., CAB WB-5, 71-1 BCA 8680 at 40,319
(disallowing contractor's reclassification of its principal
officers' salaries from a direct to an indirect cost--motive
for the reclassification was the instant claim); P.M.W.
Constr., ASBCA 11121, 66-2 BCA 5901 at 27,370 (disallowing
nonspecific items termed "expendables" and "supervision" as
direct costs).
6 8 0 See
supra notes 199 and 204 and cases cited therein.
6 8 1 It
is economically feasible to specifically identify costs
to the several cost objectives only when the benefits flowing
from the increased accuracy achieved in assignment of costs
outweighs the expense of specific identification.

282
6 82
See supra note 597 and accompanying text.
6831d.

6 84 See supra notes 604-05 and 611-17 and accompanying text.

685
See Bruce Constr., ASBCA 5932, 60-2 BCA 2797 at 14,389.
The contractor argued unsuccessfully for a special overhead
allocation for a change order that required more G&A effort
than was recoverable under the contractor's established
method of recovering indirect costs. The Board reasoned that
duplication would occur unless recovery of overhead was
reduced on those change orders where less overhead was
required than was recovered under the contractor's
established accounting practices. The Board recognized that
on some change orders more indirect cost effort will be
expended than is recoverable under the contractor's
established accounting practices and on others, less indirect
cost effort will be incurred than is recoverable.
686
See supra notes 410-13 and accompanying text.
6 87
See e.g., J.M.T. Machine Co., ASBCA 23928, 85-1 BCA 17280
at 89,183 (disallowing chief engineer's salary as a direct
cost of a constructive change even though he devoted 416
hours of his time to finding a solution); Platt Mfg., ASBCA
25077, 81-1 BCA 14,894 at 73,688 (time spent by
administrative personnel correcting errors in a Government
data package could not be charged directly for purposes of an
equitable adjustment); L&H Constr., ASBCA 23620, 81-1 BCA
14823 at 73,160. Because of changes and differing site
conditions, contractor's president spent significantly more
supervisory time on a Government contract than on its other
seven jobs. Nevertheless, contractor was not allowed to
charge a portion of its president's time as a direct cost for
purposes of an equitable adjustment because it had not
removed other portions of the president's salary from
overhead and charged them directly to the contractor's other
jobs to the extent he spent time on them. Compare Kenmore
Garment Co., ASBCA 14142, 71-1 BCA 8768 at 40,698-99
(allowing as a direct charge to the equitable adjustment the
time of a supervisor who devoted 30 hours per week for 15
weeks exclusively to non-supervisory duties) . In Kenmore
Garment the supervisor did not just devote more time to the
contract, he exclusively performed direct cost functions.
When the work performed is qualitatively different from work
normally performed by the employee, direct charging of the

283
employees time is often permitted. See supra notes 614-18
and accompanying text.
68 8
See e.g., Metro Eng'g, AGBCA 77-121-4, 83-1 BCA 16143 at
80,187. Absent evidence by contractor as to its established
method of distributing indirect costs, the Board used the
distribution base recommended by the Government, "proportion
of job income" (12% markup) rather than the distribution base
recommended by the contractor, direct labor (25% markup).
68 9 See supra notes 191-98 and accompanying text.
69 0 See supra notes 192-93 and accompanying text.
69 1
See supra note 235 and accompanying text.
6 92
See supra notes 282-88 and accompanying text.
6 9 3 The
change in circumstance is that the delay has made
recovery of fixed indirect costs using the contractor's
normal accounting practices inequitable. See supra note 639
and accompanying text.
6 9 4 Doing
so results in over recovery of fixed indirect costs
for the delay period. See supra notes 356-59 and
accompanying text.
6 9 5 See
supra notes 598-99 and accompanying text.
6 9 6 FAR 30.402-61.

697See Preambles to Cost Accounting Standard 402, Preamble C,

para. (1). Note that factors other than consistency may
dictate whether or not bid and proposal costs can be charged
directly to a particular cost objective. A specific Cost
Principle has been established to govern allowability of bid
and proposal costs. See FAR 31.205-18.
698See Preambles to Cost Accounting Standard 402, Preamble C,
para. (1). The preamble makes it clear that proposals
submitted under contract provisions "such as the requirement
in the Changes clause . . . are considered to specifically
incurred under the interpretation." Id. (emphasis added).
69 9 See FAR 30.402-61.

284
7 00
See Moloney & Rubien Contr., ASBCA 22280, 78-1 BCA 13000
at 63,401.
7 01Atermination for convenience in effect turns a fixed-
price contract into a cost reimbursement contract. See supra
note 429 and accompanying text.
7 02
Consistency
as it applies to assignment of costs to
indirect costs groupings was discussed supra notes 623-26,
and as it applies to distribution base supra notes 627-33.
7 0 3 Reclassification
of costs for purposes of terminations for
convenience is discussed at supra Chapter 4, Parts II.B and
IV.A. Part II.B discusses reclassification as it applies to
pre-termination costs; Part IV.A discusses reclassification
as it applies to settlement costs. Classification of costs
as direct or indirect, including overcharging caused by
inconsistent classification, is discussed generally supra
Chapter 5, Part II.A.
704See supra notes 374-75 and accompanying text.
7 0 5See
supra notes 560-63, 634-37, and accompanying text.

7 06 See supra notes 638-42 and accompanying text.

7 07 Id.

7 0 8 Few
events other than the contractor going out of business
will make accumulation of indirect costs over the
contractor's fiscal year inequitable.
7 09
See supra notes 99-105.
7 1 0 Likewise,
allowing the Government to selectively chose
either the contractor's fiscal year or the period of contract
performance as the base period depending upon which yields
the most favorable result to the Government is inequitable.

285
 I

VA OVERHEAD LIMITATION CLAUSE

S8-7.650-21 Contract changes.

Clause 3, Changes and Clause 4, Differing Site Conditions, of General Provisions, SF

23A, are supplemented as follows:

(a) ....

(d) Allowances not to exceed 10 percent each for overhead and profit for the
party performing the work will be based on the value of labor material, and use of
construction equipment required to accomplish the change. As the value of the
change increases, a declining scale will be used in negotiating the percentage of
overhead and profit. Allowable percentages on changes will not exceed the following.
10 percent overhead and 10 percent profit on first $20,000; 7 1/2 percent overhead
and 7 1/2 percent profit on next $30,000; 5 percent overhead and 5 percent profit on
balance over $50,000. Profit shall be computed by multiplying the profit percentage
by the sum of the direct costs and computed overhead costs.

(e) The Prime Contractor's or upper-tier subcontractor's fee on work performed

by lower-tier subcontractors will be based on the next increased cost to the Prime
Contractor or upper-tier subcontractor, as applicable. Allowable fee on changes will
not exceed the following: 10 percent fee on first $20,000; 7 1/2 percent fee on next
$30,000; and 5 percent fee on balance over $50,000.

(f) Not more than four percentages, none of which exceed the percentages
shown above, will be allowed regardless of the number of tiers of subcontractors.

(g) Where the contractor or subcontractor's portion of a change involves credit

items, such items must be deducted prior to adding overhead and profit for the party
performing the work. Where a change involves credit items only, such items will be
net, i.e., overhead, profit, and fee are excluded. The contractor's fee is limited to
the net increase to contractor of subcontractor's portions cost computed in
accordance herewith.

(h) Cost of Federal Old Age Benefit (Social Security) tax and of Workmen's
Compensation and Public Liability insurance appertaining to changes are allowable.
While no percentage will be allowed thereon for overhead or profit. Prime
Contractor's fee will be allowed on such items in subcontractor's proposals.
I
(i) Overhead and Contractor's fee percentages shall be considered to include
insurance other than mentioned herein, field and office supervisors and assistants,
watchmen, use of small tools, incidental job burdens, and general home office .
expenses, and no separate allowance will be made therefor.

() Bond premium adjustment, consequent upon changes ordered, will be made as

elsewhere specified at the time of final settlement under the contract and will not be
included in the individual change.

[34 FR 15470, Oct. 4, 1969, as amended at 38 FR 5478, Mar. 1, 1973; 39 FR 13263,

Apr. 12, 1974; 41 FR 48519, Nov. 4, 1976; 45 FR 15930, Mar. 12, 19801

41 CFR Jul 80
286
 GSA OVERHEAD LIMITATION CLAUSE

552.243-71 Equitable Adjustments.

As prescribed in 543.205(b), insert the following clause in solicitations and contracts

for (a) dismantling, demolition, or removal of improvements; and (b) construction, when a
fixed-price contract is contemplated and the contract amount is expected to exceed the
small purchase limitation:

Equitable Adjustments (April 1984)

(a) The provisions of the "Changes" clause prescribed by FAR 52.243-4 are
supplemented as follows:

(1) .

Overhead, Profit and Commission

(2) The allowable overhead shall be determined in accordance with the contract cost
principles and procedures in Part 31 of the Federal Acquisition Regulation (48 CFR Part
31) in effect on the date of this contract. The percentages for profit and commission shall
be negotiated and may vary according to the nature, extent and complexity of the work
involved, but in no case shall exceed the following unless the contractor demonstrates
entitlement to a higher percentage:

Profit Commission
Overhead (percent) (Dercent)

To contractor on work performed

by other than his own forces 10

To first tier subcontractor on

work performed by his subcon-
tractors 10

To contractor and/or the sub-

contractors for that portion
of the work performed with
their respective forces (1) 10

- 1
To be negotiated.

Not more than four percentages will be allowed regardless of the number of tier
subcontractors. The Contractor shall not be allowed a commission on the commission
received by a first tier subcontractor. Equitable adjustments for deleted work shall include
credits for overhead, profit and commission. On proposals covering both increases and
decreases in the amount of the contract, the application of overhead and profit shall be on
the net change in direct costs for the Contractor or subcontractor performing the work.

(3) ....
(b) The provisions of the "Differing Site Conditions" clause prescribed by FAR 52.236-
2, are supplemented as follows: The Contractor shall submit all claims for equitable
adjustment in accordance with, and subject to the requirements and limitations set out in,
paragraph (a) of this "Equitable Adjustments" clause.

(End of Clause)

48 CFR 552.243-71 287

.!": *LS, S._.. *~~*

,~k~ -. V A '
 APPENDIX TWO
FORMULAS FOR RECOVERY OF UNABSORBED OVERHEAD
1. Eichleay
Contract billinas X Total overhead - Overhead allocable to
Total billings for the the contract
actual contract period
Allocable overhead - Overhead allocable to
Actual days of contract performance the contract per day
Daily overhead X Number of Days = Unabsorbed overhead
2. Modified Eichleay
Original contract Drice X Fixed overhead Fixed overhead
Total billings for original for the orignal allocable to
contract period + Contract contract period contract
billings for extended period
Fixed overhead allocable to contract Daily contract fixed overhead
Original days of performance
Daily contract fixed overhead X Days delay - Unabsorbed Overhead
3. Allegheny

Incurred overhead Incurred overhead rate - Excess rate of

rate during actual for projected performance overhead
period period
Excess rate of overhead X Contract base costs = Unabsorbed overhead
4. A.C.E.S.
Fixed overhead costs = Fixed overhead rate
Total overhead
Overhead cost X Fixed overhead rate - Fixed overhead cost per hour
per hour
Hours delay X Fixed overhead rate = Unabsorbed overhead

3. Carteret

Incurred overhead - Normal overhead - Excess rate of

rate during delay rate overhead
period
Excess rate of overhead X Total Base Costs Unabsorbed overhead
during delay period

288 '
* - - -. - - .
6. Allied Materials and Equipment (Burdc, Fluctuation Method)

Actual overhead rate - Bid overhead rate - Fluctuation in overhead rate

Total contractor direct labor - Direct labor attributable - Residual direct labor
during period of contract to the contract
performance
Residual direct labor X Fluctuation in overhead rate - Unabsorbed overhead

7. Simulation
Contract billings Average contract billings per day worked
Actual days worked
Average contract billings X Number of days = Simulated additional work
per day worked of delay
Simulated additional + Contract billings - Simulated contract billings
work
Simulated contract billings + Total billings = Simulated total billings
Simulated contract billings X Total home office = Overhead allocable
Simulated total billings overhead during to contract
contract period

Overhead allocable - Overhead actually Unabsorbed overhead

to contract allocated to contract

2'_

I..

289