A material handling rate includes a pool of costs related to supporting direct material - specification requirements, communications with vendors, QA, ordering, administration, etc - applied to direct materials (subcontractor costs may also be included in the base). The advantages of using such a rate are that higher recoveries of indirect costs can occur when the material costs as a percent of total costs climb. This results from the fact that primarily costs from the overhead pool that are applied to direct labor are reassigned to a pool that is applied to direct material, decreasing indirect costs applied to labor and increasing them for material. Also, if the client seeks a significantly lower G&A rate or, worse no G&A on material, they usually don't also go for a reduction or elimination of a material handling rate so your two ways of recovering on material costs (G&A and material handling) provides greater flexibility to recover more costs. For example, we have seen considerable effort to reduce and even eliminate G&A add-ons for material and subcontracting costs whereas on the same contracts, material handling add-ons are accepted if they are consistent with the contractors’ accounting practices.
The disadvantages of the material handling rate is that you need to (1) provide evidence and justification of the reassignment of costs (e.g. relevant personnel such as QA engineers, contract admin., accounting, etc.) in the form of timesheet visibility (2) alter your indirect rate model which likely will attract greater audit scrutiny and (3) possibly defend the new practice. Also note my assumptions in the sensitivity analysis of what costs can be included in the material handling pool may not be consistent with what you believe would be applicable. If my assumptions are inflated, then the amount of costs transferred out of overhead and into material handling decreases.
The key to a decision on Alternative 1 and 2 is what the future will likely be in terms of the percent of material over other costs that will be included in those contracts where the price is based on projected costs. If direct material costs are expected to exceed 40% of total costs of cost based contracts, the material handling rate becomes more desirable; less than that, forget it. The next question is what is the magnitude of the material handling pool you believe can be justified. If my assumptions are way off, then you would likely have a lower material handling rate so at some point the low rate would not be worth the effort. You do have considerable flexibility in what buckets (overhead, G&A, material) you dump your costs as long as the decision is reasonable, an audit trail is available (e.g. timesheets) and consistency is maintained.
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To discuss your needs, contact Bill Lennett, Principal, at 1-925-362-0712 or email him at
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