4 minute read
Overhead Field Field Overhead
By: Nickolas Florez
Field overhead – direct or indirect cost?
For federal construction contracts, the Federal Acquisition Regulation (FAR) allows for certain field overhead costs to be chargeable as indirect or direct costs for contract modifications, provided that these costs are consistently applied. Specifically, FAR 31.105(d)(3) states,
“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., 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.”
While this is simple enough in concept, there remains confusion as to how this FAR requirement is actually applied in practice and an even greater misunderstanding of the significance of how accounting for field overhead costs as a direct cost versus an indirect cost will impact the total amount of recovery obtained on a given contract modification. The difference can be staggering, particularly where time-related changes are involved in the change. To demonstrate the difference in accounting for field overhead costs as a direct cost or an indirect cost, three examples are presented below.
Example 1: Add $100,000 in craft labor, material, equipment with no time added to the contract. For purposes of providing a simplified calculation, all examples below assume an indirect cost rate of 10% for the indirect cost calculation and a direct cost calculation of $1,000/day when a direct approach is used. Again, the FAR allows either a direct cost methodology or an indirect cost methodology.
Example 1 calculation with field overhead of 10% as an indirect cost:
Total cost = direct costs + indirect = $100,000 + ($100,000 x .10) = $110,000
Example 1 calculation with field overhead of $1,000/day as a direct cost:
Total costs = direct costs = $100,000 + ($1,000/day x 0 days) = $100,000.
In this case, where the change does not extend performance of the contract, the indirect cost methodology produces the highest return of total costs. Assuming that no additional field overhead staff is needed to execute the change, the contractor actually gains a slight windfall because field overhead is already accounted for in the base bid of the contract.
Example 2: Add $100,000 in craft labor, material, equipment with a
100 calendar days added onto the contract.
Example 2 calculation with field overhead of 10% as an indirect cost:
Total cost = direct costs + indirect = $100,000 + ($100,000 x .10) = $110,000
Example 2 calculation with field overhead of $1,000/day as a direct cost:
Total costs = direct costs = $100,000 + ($1,000/day x 100 days) = $200,000
In this case, where there are two components of direct costs, one associated with changed work and the other with the extension of time (extended field office overhead), the direct cost methodology can result in a significantly higher cost of the change. This will not always be true, depending on the specifics of the change, but this example does show the sensitivity of the total costs as a function of time.
Example 3: No additional craft labor, equipment or material, but 100 calendar days of time added onto the contract. Example 3 calculation with field overhead of 10% as an indirect cost:
Total cost = direct costs + indirect = $0 + ($0 x .10) = $0
Example 3 calculation with field overhead of $1,000/day as a direct cost:
Total costs = direct costs = $0 + ($1,000/day x 100 days) = $100,000
In this case, where the only contract change is time, the direct cost methodology is always the preferred choice because the indirect methodology will always result in zero total costs. The example above assumes that time extended on the project is compensable. If the time provided on the contract change is not compensable, either methodology produces the same result of zero costs.
Example 1, 2 and 3 Summary:
As can be seen from the table above, where there is no time added to the contract (Example 1), the indirect methodology will always result in higher recovery. Where both time and labor/material/equip is added (Example 2), the results will vary depending on the details of the change, but the total recovery is clearly very sensitive to time-related costs. As shown in example 2, the time-related costs can quickly exceed the labor/material/equipment costs. Where additional time is added to the contract, direct costs methodology will always result in a higher recovery of field overhead costs.
Relevant Case law:
Now armed with the understanding of how to account for field office overhead costs to provide for the best recovery depending on the change, one would be tempted to switch methodologies depending on the specifics of the change order; however, I would caution against this practice. In 2012, NAVFAC awarded a contract to Watts Constructors LLC. to relocate a sewer lift station. Shortly after award of the contract, the Navy informed Watts that they must employ a consistent methodology for computing field office overhead on all changes, either a percentage rate (indirect) or a per diem basis (direct). Watts responded that they would be using a percentage rate. During the course of the work, several modifications, which did not extend time on the contract, were bilaterally executed based on proposals utilizing an indirect cost rate for field overhead. On a later modification that did include a time extension to the contract, Watts provided a proposal with field overhead accounted for as a direct cost. The Navy denied the proposal on the basis that Watts was not allowed to switch methodologies. Watts submitted a claim and subsequent appeal citing that the indirect cost methodology does not allow for the recovery of the actual costs expended and those costs were due to government caused delay. The court, citing Mortensen in dicta, states:
“We see no convincing rationale for routinely using different job site overhead distribution bases on changes that extend or shorten contract performance, say, by one day (or one week, or one month), and changes that do not.... Even when a contractor proves it has failed to recover its entire overhead, that is insufficient justification for permitting an accounting change from one distribution base to another…”
The court denied Watts' appeal concluding that even if the percentage rate method for recovery of field overhead does not fully compensate Watts for all costs incurred, that fact in and of itself does not entitle Watts to change methodologies.
While the decision seems a bit harsh, it is entirely consistent with FAR 31.105(d)(3), which while allowing the contractor to select either a direct or indirect methodology for accounting for field overhead, the contractor cannot switch methodologies midstream.
About the Author: Nickolas Florez is a Certified Forensic Claims Consultant and former Contracting Officer with both NAVFAC and USACE with over 35 years of experience in construction and contracting with the federal government; Ph 671-682-9020.
