GOVERNMENT CONTRACTING AND TREATING EXTENDED FIELD OVERHEAD AS A DIRECT OR INDIRECT COST

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Prime contractors working on federal government projects, or any project for that matter, have job site or field overhead / general conditions.  Incurring extended field office overhead on a federal government project happens and, in many instances, is due to differing site conditions or another impact  (e.g., design issue, change order work, etc.) caused by the government.  There are also times the government acknowledges the time impact and agrees to pay the prime contractor extended field office overhead. 

 

How is the prime contractor supposed to compute its extended field office overhead?

 

Federal Acquisition Regulation (F.A.R.) 31.105(d)(3) provides:

 

Costs incurred at the job site incident to performing the work, such as the cost of superintendence, timekeeping and clerical work, engineering, utility costs, supplies, material handling, restoration and cleanup, etc. [e.g. field office costs], are allowable as direct or indirect costs, provided the accounting practice used is in accordance with the contractor’s established and consistently followed cost accounting practices for all work.

 

Stated differently, F.A.R. allows the prime contractor to treat its field office overhead  as a direct cost or an indirect cost provided the prime contractor does so consistently throughout the project.  However, the prime contractor cannot change its methodology midstream because it learns it can better maximize its extended field office overhead damages by switching methodologies to compute its extended field overhead.

 

What is a direct cost versus an indirect cost? 

 

A direct cost is a cost that is identified specifically with a contract whereas an indirect cost is not identified specifically with a single contract, but identified with two or more contracts.

 

F.A.R. 2.101 defines both direct costs and indirect costs as follows:

 

Direct cost means any cost that is identified specifically with a particular final cost objective [e.g., contract]. Direct costs are not limited to items that are incorporated in the end product as material or labor. Costs identified specifically with a contract are direct costs of that contract. All costs identified specifically with other final cost objectives of the contractor are direct costs of those cost objectives.” See also F.A.R. 31.202.

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Indirect cost means any cost not directly identified with a single final cost objective [e.g., contract], but identified with two or more final cost objectives or with at least one intermediate cost objective.

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Indirect cost rate means 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 (see also “final indirect cost rate”).” See also F.A.R. 31.203.

 

When field office overhead is treated as a direct cost, it is computed on a per diem or daily rate (e.g., $10,000 per day for each day of delay). 

 

When field office overhead is treated as an indirect cost, it is computed based on a percentage markup (e.g., adding an overhead markup of 10% on the work). 

 

The key is that the prime contractor typically has to live or die with the methodology it chooses. 

 

An example of this “live or die” approach can be found in the Armed Services Board of Contract Appeals decision in Appeal of—Watts Constructors, LLC, 2015 WL 566315, ASBCA NO. 59602 (January 26, 2015).  Here, the government hired the prime contractor to relocate a sewer lift station at a Marine Corps base.  During construction, the prime contractor encountered a differing site condition. The government did not dispute the differing site condition and instructed the prime contractor to await a contract modification (change order) before proceeding with the additional work.  The prime contractor submitted a cost proposal to the government for the additional work.  The proposal included a percentage markup for overhead as the contractor had also done under a previous cost proposal for additional work. Thus, the contractor had treated its field overhead as an indirect cost.

 

However, the government did not immediately issue the contract modification (change order) to the prime contractor authorizing the contractor to proceed with the additional work due to the differing site condition.  For this reason, the prime contractor wanted to recover its extended field office overhead as a direct cost (as it would give the prime contractor an additional approximate $40,000 and cover its costs due to the government’s delay in issuing the contract modification).  The prime contractor’s position was that when it submitted its original proposal for the changed work with the overhead percentage markup it was not anticipating a time impact, but now that it realized a time impact caused by the government, it should be entitled to its direct costs associated with the impact.  The government, however, denied this request because by the contractor tacking an overhead markup percentage to its proposals it had treated its field office overhead as an indirect cost, not a direct cost. Thus, the prime contractor couldn’t switch its methodology during the course of the project. 

 

The prime contractor submitted a claim pursuant to the Contract Disputes Act; the contracting officer issued a final decision denying the claim.  The prime contractor then appealed the contracting officer’s final decision to the Armed Services Board of Contract Appeals.  The Armed Services Board of Contract Appeals agreed with the government concluding, “[W]e conclude the fact that the contract performance period was extended and that the use of the percentage mark-up might not fully compensate appellant [prime contractor] for all field office overhead costs incurred does not, per se, entitle appellant to change its distribution base.”

 

The underpinning issue regarding field office overhead and whether to apply an overhead percentage markup to modifications (change orders) that do not result in a time impact and a daily rate to modifications that do result in a time impact was the exact issue the Armed Services Board of Contract Appeals dealt with in Appeals of M.A. Mortenson Co., 1998 WL 151792, ASBCA No. 40750 (March 30, 1998). In this matter, the prime contractor tacked an overhead percentage markup for field office overhead for changes that did not result in a time impact and then tacked on a daily rate for changes that did result in a time impact.  Hence, for changes that did not delay the job, the contractor treated its field office overhead as an indirect cost and for changes that did delay the job, the contractor treated its field office overhead as a direct cost. 

 

The government did not challenge the contractor’s daily rate for changes that impacted time, rather, it challenged the overhead percentage the contractor applied on changes that did not actually impact the completion of the project (since the field office was not actually extended by these changes).  The Armed Services Board of Contract Appeals agreed with the government concluding the prime contractor “cannot recover the claimed job site overhead percentage markup in these appeals because, under the facts of these cases, such a markup is inconsistent with appellant’s [prime contractor] per diem distribution base for charging job site overhead on changes that extended the contract period.”

 

Prime contractors working on federal construction projects need to be wary of how to treat changes and if they apply an overhead percentage markup on their changes it could later impact their application of a daily rate for extended field office overhead and vice versa.   Sometimes, the overhead markup benefits the contractor because it is getting a markup for overhead when the job is not otherwise delayed.  However, if the job is delayed, the government may try to deny the extended overhead based on a daily rate methodology that better compensates the contractor for its actual costs since the contractor previously treated such overhead as an indirect cost.

 

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.

 

 

 

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