While the government is more tolerant of overhead costs it generally considers contractors’ G&A costs as fluff.  Many government agencies are taking steps to lower the G&A costs they pay such as conducting studies to determine specific industry G&A costs, putting caps on G&A rates, providing higher ratings to contractors demonstrating lower G&A rates and increasing use of Department of Defense profit guidelines that, in part, eliminate profit on G&A.   Reducing G&A rates by reallocating costs is becoming a hot topic and we thought it would be a good time to review some of the more common methods available to contractors to reallocate G&A costs elsewhere without actually eliminating the costs.

Unless contractors are quite small, they usually have at least two indirect cost pools – overhead and general and administrative.  Overhead costs are considered indirect costs incurred for producing goods or services and vary with level of producing products or services.  G&A expenses consist administrative costs of running the business and are commonly considered period costs largely unrelated to the level of production or service provision.  Contractors’ basis for distinguishing G&A from overhead also vary: all costs incurred at the home office location are lumped as G&A, it was always done this way and a change risks assertions of inconsistent accounting practices, etc.  Reallocation of costs from G&A to other indirect cost pools or direct costs may very well not alter the magnitude of costs charged to government contracts (e.g. a lower G&A rate offset by a higher overhead or greater direct costs) but the perception of lower G&A rates is key.  In addition, reassigning costs for contract pricing and costing purposes need not be consistent with the methods used for financial reporting.  When contract costing differs, usually by developing “memo” records, the practice is common and generally accepted by government auditors.  

In our experience there are numerous ways to reallocate G&A costs that are considered appropriate practices under contract costing rules:

1.  Reassign specific G&A costs to overhead.  G&A pools commonly include costs that can be considered support of products or services and hence allocable to overhead.  For example, personnel who work in such functions as contract administration, purchasing, human resources, accounting, quality control and information services (IS) are clearly in support of end products or services.  In addition, portions of functions normally charged to G&A such as legal and insurance costs do support product and services such as costs for labor disputes or third party suits and insurance charges like professional liability.  A portion of much of the remaining G&A costs (e.g. rent, utilities, depreciation, etc.) can be assigned to other indirect pools on some pro-rata basis such as square footage used by overhead versus G&A personnel.

2.  Create centralized service centers and allocate them to both G&A and other pools on an appropriate base.  Centralized service centers are accumulation of costs associated with distinct functions that are commonly performed at the home office.  Examples include personnel administration, centralized IS, centralized purchasing, centralized warehousing, etc.  Sometimes such costs are easily identifiable when a contractor accumulates these costs by departments or cost centers; otherwise, they need to be accumulated on a memorandum basis.  Once the costs of centralized service centers are identified, they can be allocated to other indirect pools such as overhead, material handling and even a fringe benefit pool.  The method of shifting the centralized service costs elsewhere is to use a base that has a “causal beneficial relationship” to the pool of costs.  If precision is desired, then each central service can use its own base such as headcount for personnel services, invoices for purchasing, terminals or CPU time for IS, number of contracts for contract administration, etc.  If simplicity is preferred, we find selection of one base (e.g. headcount) or at most two bases adequate and usually accepted by auditors.  If challenged, you can usually demonstrate that more precise methods do not yield significantly different results.

3.  Create service centers and allocate such costs to various indirect cost pools as well as directly to contracts.  Service centers are accumulation of costs of various functions that often are or can be allocated as an ODC (other direct cost).  Unlike centralized service centers, where they are most often identifiable at the home office/G&A pool, service center costs are more often spread across multiple indirect cost pools.  Examples include reproduction, vehicles, small equipment, CAD/CAM, etc.  Charge out rates are either established as fixed unit prices or for cost type work, established at provisional rates and sometime adjusted after actual costs are identified.  Costs related to these service centers (personnel, depreciation, portions of facilities, etc.) are also accumulated into the service pools and allocated either directly to cost objectives or other indirect cost pools on a usage basis (e.g. number of pages, hours of vehicles use, etc.).  Service center costs are extracted from all indirect pools and stand alone and are allocated back to indirect pools only on a usage basis.  Revenues from clients do not reduce other indirect cost pools but only reduce the service center costs.  The effect is to minimize G&A costs (few service center functions are used at the G&A level) and increase both direct and non-G&A indirect cost pools.

Contractors may be reluctant to make changes for fear they are changes to cost accounting practice that would entail onerous burdens of developing cost impact analyses not worth the effort.  For CAS covered contractors, the changes described above are cost accounting changes.  In our experience, however, the impact is usually not significant and burdensome cost impact proposals are usually not necessary.  There is a new emphasis on minimizing these administrative burdens (even proposals for formal change) and we find one page analyses of the overall impact on relevant government contracts to be sufficient.  For contractors not covered by CAS (an increasing population due to recent higher CAS covered thresholds from $25 million to $50 million), contractors are free to make accounting changes without the burden of cost impact statements.   

(Editor’s Note.  The comments in this article are necessarily broad and intended to get you thinking about alternatives.  If you have questions related to the article or want to discuss their relevance to your firm, feel free to call Bill Lennett at (925) 362-0712 or email him at This e-mail address is being protected from spam bots, you need JavaScript enabled to view it .)

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