(As part of our series on claims, our focus on quantifying and presenting claims coincides with detailed guidance recently issued by the Defense Contract Audit Agency on auditing a significant part of claims – unabsorbed overhead. The guidance was put forth at this time to incorporate the results of numerous recent court and board decisions as well as provide clarity to the Eichleay formula. The following article summarizes the significant parts of this 18 page guidance. The guidance will be incorporated into Chapter 12 of the next issue of DCAA’s Contract Audit Manual (DCAM).

The guidance distinguishes between entitlement and quantum – entitlement relates to the right of a monetary adjustment which DCAA considers a legal question beyond its scope except to convey meaningful observations related to entitlements (e.g. delays did not cause actual extensions of time, contractor was unable to begin work or obtain replacement work due to bonding capacity). Quantum is the focus of the audit and relates to determining whether the proposed or claimed costs are acceptable as a basis of negotiation. The auditor should, at a minimum, evaluate if (1) the amount was incurred or estimated (2) the contractor has source documents justifying the incurred cost (3) the costs are correctly allocated to the claim and (4) the costs are allowable according to the contract and FAR 31.205 cost principles.

If a delay or suspension (we will refer to both as delay) of a contract was caused by the government, a contractor is entitled to recover the associated direct and indirect costs. Unabsorbed overhead is usually a significant portion of this recovery. It represents the fixed overhead cost whose allocation to the affected contract has been reduced by the reduction in the stream of direct costs caused by the delay. (The costs are not really unabsorbed – they are allocated in greater amounts to other contracts.) The unabsorbed overhead is recoverable only if the delay of work caused the contractor to stand ready to perform to the exclusion of other potential work for an indefinite period – "standby".

Recent court cases have addressed the proper way to measure unabsorbed overhead. In Wickham Contracting, the Court ruled the Eichleay formula is the exclusive means for calculating unabsorbed overhead in construction contracts. In Libby Corp., the appeals board ruled the Eichleay formula may be used in manufacturing and supply contracts where it is, in fact, commonly used. West vs. State Boiler identified the elements a contractor must show to recover unabsorbed overhead: (1) the delay was caused by the government (2) the government required the contractor to standby during the delay period (3) it was impractical for the contractor to take on other work and (4) the delay caused the contractor to be unable to complete the contract within the original contract performance period as extended by any modifications.

Once these requirements are met, the contractor has met the obligations for recovery under Eichleay. The Government can rebut the claim by showing: (1) it was impractical for the contractor to obtain replacement work (2) the contractor’s inability to obtain other work was not caused by the contractor or (3) the contractor was able to reduce fixed overhead expenses during the delay.

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