As the Grant Thorton survey we discussed in the last issue of the GCA DIGEST shows, an increasing amount of contractors are using service centers to accumulate certain types of costs. We are finding in our consulting practice similar interests in creating service centers. They provide several benefits such as accumulating certain functional costs (e.g. HR, IT, Contracts) that can then be charged on a cost basis as ODCs or when accumulated at the home office, they provide a more acceptable basis to allocate certain corporate expenses to business units conducting business with the government. Perhaps the number one benefit lies in appearances – the appearance of having a lower G&A rate.

Let’s consider an example.

Cost Element     Co. A     Co. B

Direct Labor       $1.00    $1.00
Overhead              .80        .67
Subtotal               1.80     1.67
G&A                        .21       .34
Total Cost          $2.01    $2.01 

Company A: Overhead rate = 80%; G&A = 12%; Wrap rate = 2.01

Company B: Overhead rate =65%; G&A = 21%; Wrap rate = 2.01

In the example, both Company A and B have a combined overhead and G&A rate of 2.01 which is often referred to as a wrap rate or multiplier.  So, which of these two companies has a competitive edge? Since the total cost to the customer on $1 of direct labor will be the same, you may conclude that neither has an advantage. However, increasingly Company A will have the advantage in a cost competitive procurement even thought total costs are the same. Procurement agencies are being inundated with concerns from Congress, their inspector general offices and the GAO that the government is being billed for unnecessary “add-ons”, “fees” or just extra costs.  Contracting officers often consider G&A expenses as administrative “fluff.” (The DOD profit guidelines used to not allow profit calculations on G&A expenses but though that requirement has been eliminated the sentiment still lingers.)  The resistance to marking up travel costs, material, subcontracts and other direct costs at 21% rather than 12% is substantial in this environment.  So, there is a perception problem with Company B’s indirect rate structure.  It could very well be that Company B spends no more than Company A on its administrative functions but instead may simply have a different way of accumulating and allocating costs.  This is why it’s a good idea to critically evaluate Company B’s indirect rate structure, especially its G&A structure.

Though companies may treat different categories of costs differently, it is quite common to find such functional costs as human resources, security, MIS and contract administration charged to G&A . Can some of them be charged to overhead instead? Let take a look at a few functions separately.

• Human Resources

Company B accumulates within its G&A pool costs associated with HR which is certainly reasonable in as much as the department benefits the company as a whole. However, the HR group also benefits all employees in the company where the majority of employees are either direct or in the overhead pool. The HR resource group exists to provide a service and benefit to all employees.  As the company grows and the number of employees rise, the human resource group expenditures also increase to accommodate the recruiting and servicing of the employees. Though many companies consider HR to be a period cost and hence allocable to G&A one can argue quite persuasively that allocating most of these costs to overhead would provide a more equitable matching of cost to cost objective. Company B may take all of its human resources employees and their proportionate share of facilities and fringe benefits, training, travel, recruiting and publications and combine them all into a separate service pool.  Since the HR group benefits all employees the allocation basis for all incurred HR costs could be the total number of employees.  The total accumulated HR costs would then be allocated out of the service center back into both the overhead and G&A pools where the proportionate number of employees reside. Since most of the employees reside in the overhead pool – the overhead pool supports direct projects so support costs of direct employees and overhead employees are charged to overhead – most of the HR group costs would be allocated to the overhead pool. This shift of costs is consistent with the causal beneficial relationship that must be followed.

• Management Information Systems

Company B, like many companies, include the costs associated with the internal information systems (IT) group within their G&A expense pool. The types of costs frequently incurred here are salaries for technical support and IT support team members, associated facility and fringe costs, hardware and software related depreciation costs, web page support and other IT related expenses.  The services provided by this group generally benefit each individual who has a computer. An allocation base for this service center would be total number of computers or a more convenient measurement might be headcount if all heads have a computer.

• Contract Administration

It is quite common to have contract administrators handling multiple contracts and subcontracts on an ongoing basis and Company B assigns their salaries, fringe benefits, facilities costs to G&A. Like the other types of costs we have discussed, many companies believe it is simply more easy to have such costs lumped into G&A. The decision to accumulate these costs into a service center needs to be carefully considered to determine whether the costs are sufficiently material to maintain a separate service center.  The allocation base could be the number of contracts administered. Since the expenses are clearly in support of contracts, allocating contract administration costs to overhead should not pose significant obstacles.  Contract administration costs could simply be assigned to overhead or if there are multiple overhead pools then a service center approach makes greater sense.

• Security

There are numerous alternatives for treating security expenses.  Security costs are commonly considered to be a part of human resource and as such may be included in the HR service pool.  If significant, security may be separated into a separate service center where employee labor, fringe benefits, facilities and other indirect costs would be accumulated and allocated on an appropriate basis (e.g. headcount, facilities space are common).  If certain security employees work for the benefit of one cost objective they may be charged as a direct cost of that contract where care needs to be taken to exclude such costs from the indirect cost pool or center.  There is usually less opposition to such direct versus indirect costing practices since CAS 402 includes an example of security costs being charged both direct and indirect.

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