Contractors quite commonly find themselves in positions where they would like to alter the magnitude of costs included in their various indirect cost pools to achieve their cost and pricing objectives.  For example, one may want to shift costs to overhead to maximize recovery on direct labor or to lower their other rates because they are facing strict ceilings on their contracts; other may want to reassign costs to G&A to increase recovery on material, subcontracts or other indirect costs or their other rates may be perceived to be too high. It used to be a good idea to minimize G&A costs since Defense Department profit guidelines excluded profit from G&A costs when computing an acceptable fee but that has recently changed since the profit guidelines now provide for profit on G&A.

Last issue we addressed a question from a client who wanted some pros and cons for establishing a new indirect cost rate – material handling.   In this issue we will address  how certain costs in one pool may properly be reallocated to another pool without creating a new indirect cost rate.  Our client had an established practice of two indirect  cost rates – overhead applied on a direct labor base and general and administrative (G&A) costs applied on a total cost base – and was not interested in considering an alternative indirect rate structure.  They asked us to examine some of its G&A costs and tell them if some of the costs could properly be reallocated to overhead because it considered its G&A rate excessive while its overhead rate was on the low side. The following is an edited version of a short memo we sent them.

Practices for what costs are included in overhead versus G&A vary widely by contractors and you have a great deal of flexibility even if you are CAS covered (they are not).  The basic requirement is to have a reasonable rationale for your requirement and follow the practice consistently.  It is also a good idea to have your practices in writing (this is mandatory if you are CAS covered). Though disputes may arise and auditors may become aggressive in attempting to minimize allocable costs to government work, it is not up to the auditor to tell a contractor how to treat a cost - rather their job is to evaluate the reasonableness of the contractor's decision and ensure the practice is followed consistently.

As to your request for me to examine what costs can be reassigned from G&A to overhead the general criteria is that overhead costs are considered expenses in support of two or more projects while G&A is considered costs for operating the company as a whole.  Contractors commonly follow the above criteria for overhead and then consider G&A as "everything else."  Many costs that you are charging to G&A such as contract administration, marketing, IR&D, legal expenses and accounting may properly be considered overhead.  

Contract Administration.  Your contracts administration expenses consist of three people’s salary who are involved in administering contracts as well as purchasing primarily direct materials and supplies.  These tasks are closer to supporting projects and can easily be considered overhead.  

Marketing and Sales.   Marketing and sales are usually considered to be effort to expand the business base and hence are quite properly G&A.  However, my examination of the types of activities that you charge to marketing indicates the majority of expenses should be charged to other accounts which can then be assigned to overhead.  For example, much of the time not charged direct by normally direct employees are identified as “sales and marketing” when they are really kind of idle time.  Though “sales and marketing” seem somehow more productive than idle time, idle time is not considered unallowable and would more properly be assigned to overhead.  Or, for example, non-direct time spent with the client need not always be considered “sales and marketing” even though the effort hopefully results in expanded work on a contract.  The nature of this effort is usually discussions of either technical matters or various administrative matters where such costs can plausibly be charged to overhead.

Independent Research and Development.   IR&D is also commonly a G&A cost but many of the "IR&D" efforts you classify can be considered support of existing contracts (e.g. designing new technical solutions applicable to current jobs) and hence overhead.  I have included a detailed account of the activities you charge to IR&D and identified which ones can be considered overhead and what is clearly G&A IR&D costs (not included here).  

Legal Fees.  Many of the legal fees you incur can be properly assigned to overhead when they support projects (e.g. employee issues, opinions related to contracts, suits resulting from contract work, etc.) while those legal costs in support of the company as a whole (e.g. support of Board work, finance related, etc.) are charged to G&A.  It is quite common for contractors to erroneously assume that the same categories of costs must always be charged to the same pool.  Stemming from CAS 402, the criteria for consistent treatment is “costs incurred for the same purpose in like circumstances” need to be charged either direct or indirect.  There is no requirement to charge costs to the same pool.  Further, one can argue that legal costs related to administering contracts are not “like circumstances” to legal expenses for corporate board work.  

Accounting.  Many accounting costs are chargeable to overhead - it is common, for example, to include senior finance and accounting personnel in G&A (e.g. CFO, corporate controller, corporate audits) while all other accounting expenses are included in overhead, reasoning they primarily support contract work including employees.

Of course reassignment of the personnel costs from G&A to overhead discussed above would also entail a corresponding shift of fringe benefits, taxes as well as a proportionate share of "Other Operating Expenses" (primarily facilities and utilities related expenses).

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