Cost Accounting

Q. Can you give an illustrated example regarding the treatment of direct vs. indirect costs when avoiding duplication of costs?  You mentioned that if the cost of a salaried general foreman is included in the consultant's field overhead pool, then a change order claim cannot propose this foreman's salary as a direct labor cost because the cost is already included in the field overhead markup which is applied to direct labor costs.  Can you give an example?
        
A. A duplication of cost and billings can occur when a contractor charges a customer for a service or cost as a direct charge and also includes the same cost or service as part of the overhead pool. Let us assume that an A&E firm submits a price proposal to design a facility. The price breakdown includes Computer Aided Design (CAD) as a direct charge. Let us also assume that CAD is normally charged as an overhead expense and that the overhead pool includes CAD costs that are allocated to all customers on the basis of the direct labor costs incurred by the customer. We would then have the following picture:

Fixed Price Proposal to You  
Direct Labor: 

$ 65,000

Overhead @ 75%: 

48,750

Travel:

7,400

CAD: 

9,000

Price

$130,150

   
The A&E Firm' Annual Overhead Pool  
Management Salaries    

$200,000

Legal Expenses

50,000

Travel                    

45,000

Advertising

15,000

Proposal Expense        

65,000

Printing

10,000

CAD  

20,000

Annual Direct Labor Base 

$405,000 (a)

Overhead Rate (a) divide by (b) 75 percent

 $540,000 (b)

If the contractor has duplicated costs for CAD, as shown above, you will pay $9,000 as a direct charge when in fact the overhead rate of 75% already includes CAD costs. The contractor will recover CAD twice and the $9,000 he is charging you directly will be profit, not a reimbursement of cost incurred. The only way to prevent this duplication is to review the contractor's overhead pool as part of an audit process prior to award so that you can negotiate a fair price by removing the $9,000 charge for CAD. The audit will add to the pre-award time for processing the procurement and will also represent an administrative cost to the agency, but for larger awards the pre-award audit may be critical in order to ensure there is no duplication of billing in the proposal.  The example assumes a fixed price contract not subject to later audit. If this were a cost plus contract and it was subject to a final cost audit, the auditor should detect the duplicate pricing of CAD when the final costs are audited, but this does not always happen. It would be advisable, if this were a cost plus fixed fee contract, to include an "advance agreement" in the contract stating that CAD will not be billed directly but be recovered as an indirect cost through overhead. (Reviewed: June 2010)

Q. How can the unit cost of a valve steel casting be arrived?

A.  We regret we cannot help you with this cost accounting question. We have no expertise in this area.