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Government Resources Using Service Pools to Reallocate Traditional G&A Costs to Overhead Pools Written by: R. Scott Butler In today's highly competitive government contracting environment you must position your company to be cost competitive. Over the years we have inquired of numerous contracting officers and have found that your General and Administrative (G&A) rate matters. G&A expenses consist of the administrative costs of running a business. To determine your G&A rate you simply divide your G&A expenses by the applicable G&A allocation base. For the purpose of this article we are assuming a "Total Cost Input" G&A base. This includes the total costs incurred by the company minus the G&A expenses. The G&A rate is applied to the total labor, overhead and other direct costs incurred on each contract.
The following table lists the records and retention times:
Figure 1. Computation of Contractor Wrap Rates
In the example (see Figure 1) Company A has a combined Overhead and G&A rate of 1.96 (sometimes referred to as a wrap rate). Company B has the same wrap rate of 1.96. Which of these two companies has the competitive edge? Since the total cost to the customer on $1 of direct labor will be the same, you might conclude that neither company has an advantage. However, we have found that in many instances, Company A will have an advantage in a cost competitive procurement even though the total costs are the same. Many contracting officers consider G&A expenses as administrative fluff. If this isn't enough to convince you, then consider that certain Department of Defense (DOD) profit guidelines do not allow a profit calculation on G&A expenses, but do allow them on overhead expenses. Also, depending on the type of G&A allocation base your Company maintains, you may have to assign G&A to all of your travel costs and maybe even all of your material and subcontract costs. No one wants to see those types of costs marked up at 22% when they could have been 12%. There is definitely a perception problem with Company B's rate structure. It could be that Company B spends no more than Company A on administrative functions, but instead has a different way of accumulating and allocating its costs. This is where some critical evaluation could be applied to your G&A rate structure, and definitely to Company B's structure. The following discussion assumes that Company B's G&A expense cost center includes all costs for human resource, security, management information system, contract and payroll departments. Evaluating G&A Costs: Do they Qualify as Overhead Expenses?Human Resources In our example above, Company B accumulates within its G&A expense pool costs associated with its human resource function. The human resource department obviously benefits the Company as whole, meeting the criteria as a G&A cost, but the group also benefits all employees of the Company. The fundamental costs of the majority of Company B's employees are maintained in the overhead pool, which is where these costs will be charged. The human resource group exists to provide a service and benefit to all corporate employees. As the Company grows and the number of employees rises, the human resource group expenditures increase with increased recruiting costs and the need for additional human resource employees to provide services to a growing work force. Although many companies still consider this function to be a period cost which is kept entirely within their G&A pool, one may argue that allocating the cost of this group to the entire Company provides a more equitable matching of cost to cost objective. Company B may take all of its human resource employees and their proportionate share of facilities and fringe benefits, training, travel, recruiting costs and publications and combine all of the costs into a separate service center pool. Since the human resources group benefits all employees of Company B then the allocation basis for all incurred human resource costs would be the total number of employees. The total accumulated human resource costs for the period 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 company's employees reside in the overhead pools then most of the human resource group costs would be allocated to the overhead pool. The shift is dramatic but consistent with the cost/benefit relationship, and must be consistently applied in a like manner each period. Security In certain circumstances the security function may be included with the human resources service center as long as you can prove that the relationship security bears to the total company mirrors that of the human resource group. If not, then you may create a separate service center for the security function and allocate the costs using another acceptable basis for allocation. The security employee's labor, fringes, facilities and other indirect costs associated with that function would be accumulated in this service center pool. Once you have accumulated all of the security pool costs, then you may allocate these expenses to final cost objectives. To determine the proper allocation base for the security function you must first look at the groups that directly benefit from this function. A typical security group in a DOD environment may be seen as benefiting all employees of the company. In this case you could justify using the same principle for allocation of these expenses as used in the human resource group allocation. If certain security employees work for the benefit of one cost objective and charge direct to a contract then the costs related to these employees would be excluded from the indirect cost pool. Management Information Systems Group Companies will often include the costs associated with the internal information system group within their G&A expense pool. The types of costs frequently incurred by this function are salaries for technical support and MIS support team members, associated facility and fringe costs, computer related depreciation expense, web page support, and other MIS related expenses. The service that this group provides generally benefits each individual who has computer access and receives support indirectly from this group. In determining the proper allocation base you should study this activity carefully to best determine the beneficiaries of their support. An allocation base for this service center pool could be the total computer terminals by cost pool, or some other means of determining the benefits provided to the end user. Contract Administration Similar to security personnel, you may have contract administrators who support specific contracts. Costs for these activities would not be included in any indirect cost pool. It is also common to have contract administrators who administer multiple contracts on an ongoing basis and have all of their costs and associated fringes, facilities, and training accumulated within the G&A pool. For the same reasons contractors have placed the human resource, management information system and security functions inside the G&A pool, many companies consider this type of administrative activity to be more easily accounted for as a G&A expense. The decision to group these costs within a service center must be approached with similar forethought and planning as was used in the human resource, security and MIS decisions. The materiality of the costs and the cost/benefit relationship of the accounting for these costs should play a major role in your decision. The allocation base for contract administration could be the total number of contracts administered and included within each overhead pool. If your company has only one overhead pool then this function may already be included as an overhead pool function rather than a G&A function. Payroll The size of your payroll staff and the costs associated with that effort would determine whether or not it is feasible to segregate this function from G&A and maintain it as a separate service center. The theory is the same as the human resource pool, and it stands to reason that the payroll function benefits all employees. The labor, fringe and facilities costs associated with the payroll function as well as publications, tax guides, associated supplies and other costs could also be broken out and allocated to the total number of employees. In our example above, Company A utilized these service center approaches to traditional G&A expenditures and had an approved accounting system for accomplishing their objectives. Company B continued to account for the costs of these functions as a G&A expense. There is no real difference in the two companies but there is a perceived difference among those evaluating the cost structures of the two. Considerations Before Establishing Service Centers for Traditional G&A Costs The allocability of costs has been the subject of government cost principles for many years, although the Armed Services Procurement Regulation, the Defense Acquisition Regulation (DAR), and the Federal Procurement Regulation contained little actual guidance on how to allocate costs. The FAR defines a "cost objective" as "a function, organizational subdivision, contract or other work unit for which cost data are desired and for which provision is made to accumulate and measure the cost to processes, products, jobs, capitalized projects, etc." (FAR 31.001). This definition may encompass as cost objectives administrative service centers such as computer services, human resources, security, contract administration and even the payroll function of a company. Many companies today include all of these activities within their G&A expense pools rather than segregating them into separate service centers and then subsequently reallocating them to the final cost objectives, which in our example above are both overhead and G&A pools. All indirect costs may ultimately be classified as overhead or G&A expenses. While overhead includes all indirect costs incurred for the production of goods and services, G&A expenses consist of the administrative costs of running a business. Overhead is allocated to products or services while G&A is allocated to cost accounting periods. For that reason, overhead and G&A costs should not be accumulated in the same indirect cost center; they are not considered homogeneous. Contractors have considerable discretion in deciding how to allocate costs to contracts. In numerous cases, the Board of Contract Appeals has established that a contractor-selected allocation method should not be altered by the government unless the method produces inequitable results. The contractor's method does not have to be the best alternative, but merely an equitable method. DOD auditors recognize that contractors may modify accounting systems to achieve this end. The basic restriction in making any accounting system modification is that proper procedures must be followed in notifying the government of the change and negotiating a cost impact. Because of the Cost Accounting Standard (CAS) requirement to compute a cost impact statement for accounting changes, the timing of a cost structure change should consider the status of existing contracts, the fiscal period, and expected date of significant new contracts. These restrictions do not apply to contractors that do not have any CAS-covered contracts. Your accounting system must be able to accommodate multiple service centers. The cross allocations can become complex. If two or more cost pools provide services to each other, determining the amount of costs to be allocated between the pools is a circular process. In theory, it is impossible to know the total costs of Pool A until it receives its allocation from Pool B, but the allocation from Pool B cannot be made until it has received its share of Pool A's costs. Several approaches can be used to solve this problem. We suggest you first look at your software capabilities and employ the use of a consultant familiar with cost allocation techniques as well as your particular software package. Summary To ensure your company maintains its competitive edge, you must continuously evaluate your cost structure and stay abreast of the cost trends in your industry. The G&A rate does matter and it is important to manage your G&A cost effectively. Creative strategies allocating traditional G&A cost to overhead pools must be well thought out. The impact these types of shifts have on your existing contract backlog and your forward pricing rate structures could be significant and you should carefully consider the impact of these potential changes on your business. Also see: |
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