6.1 INTRODUCTION

The Criteria do not specifically state that all of a contractor's overhead costs must be subject to the Criteria. Criteria Planning & Budgeting 9 and Accounting 4 refer to indirect costs that will be allocated to the contract. In a complex structure it may be impractical to review the total overhead system and, depending on the type of contract and the contribution of overheads to the contract cost or price, total examination of overhead structure may not be justifiable. In the event that not all overheads are allocated to a contract, but are treated as deduction from fee, they may be excluded from examination during a Review. However, any acceptance or validation arising from such Reviews must necessarily be limited to contracts of similar type where the same constraints on overheads will be observed.

6.1.1 Accounting. The contractor should charge indirect costs to appropriate overhead pools by methods as described in the System Description and procedures and these methods must be acceptable to Defence.

6.1.2 Control. Controls of indirect costs are required and should include:

a. Establishment of realistic time-phased budgets or forecasts by organisation; for example, department or cost centre.

b. Placement of responsibility for indirect costs in a manner commensurate with a person's authority.

c. Variance analyses and appropriate action to eliminate or reduce costs where feasible.

d. Review of budgets at least annually and when major unforeseen variations in workload or other factors affecting indirect costs become known.

6.1.3 Level of Accounting. After indirect costs are accumulated and allocated to contracts, they are applied at the level selected by the contractor. There is no requirement in the Criteria to apply indirect costs at either the work package or the cost account levels, although some contractors may choose to do so. However, it must be possible to summarise indirect costs from the applied level to the contract level without the need for further divisions.

6.2 CRITERIA

6.2.1 General. The remainder of this CHAPTER is devoted to discussion of the Criteria that concentrate on Indirect Cost Management. The objective is to clarify the requirements of the Criteria as an aid to interpretation for both Review Teams and contractors. Further amplification is found in the Evaluation/Documentation Review Checklist in ANNEX D which contains check-list questions used by Review Teams to evaluate performance measurement systems.

IDENTIFY THE MANAGERIAL POSITIONS RESPONSIBLE FOR CONTROLLING OVERHEAD (INDIRECT COSTS).

Indirect costs must be managed and controlled in much the same way as direct costs. However, where direct cost managers have as their main goal effective cost control for the objectives of only a single contract, overhead cost managers must establish goals based upon the contractor's total business base (ie. all the contracts that comprise his business volume). The way in which contractors attempt to control and manage the indirect cost effort may vary tremendously from one contractor to another. One may prefer a segregated control system where different managers provide checks and balances over one another with regard to indirect costs; other contractors may have unified or centralised overhead control systems.

Because of the diversities in overhead control philosophies, and because of the large portion of total contract costs which are indirectly incurred, and because of the difficulty in measuring overhead performance, it is extremely important to examine the contractor's overhead management system and their control procedures. The first step in this examination is to identify which managerial positions the contractor has identified to control indirect costs. Secondly, it is important to ascertain the extent of responsibility afforded each of these managers.

Regardless of whether overhead control is centralised or segmented, a clear assignment of responsibility is paramount.

ESTABLISH OVERHEAD BUDGETS FOR THE TOTAL COSTS OF EACH SIGNIFICANT ORGANISATIONAL COMPONENT WHOSE EXPENSES WILL BECOME INDIRECT COSTS. REFLECT IN THE CONTRACT BUDGETS
AT THE APPROPRIATE LEVEL, THE AMOUNTS IN OVERHEAD POOLS THAT WILL BE ALLOCATED TO THE CONTRACT AS INDIRECT COSTS.

Indirect costs account for a major portion of the costs of any contract. As such, the budgetary control and management of this category of cost cannot be overlooked or minimised. Indirect costs exist in essentially three different modes.

a. First are over-head costs for services that benefit more than a single contract. Routine machine maintenance on the manufacturing lines, for example, is a service or type of effort that must be done to keep the machines operational. But while this maintenance activity may be accomplished in a time-frame when only one contract is being worked-on, all of the contracts using those machines benefited from that maintenance service. So this type of indirect cost must be shared by all of the benefiting contracts.

b. A second type of indirect cost is the burden that all contracts must share for such commonly used commodities as electricity and other utilities, employee fringe benefits, superannuation taxes, office supplies, and off-the-shelf nuts and bolts.

c. A third type of indirect cost is classed as "general and administrative" expenses (G&A). G&A is most commonly termed the expenses of the corporate offices (salaries of the chief, corporate executives and their staffs, their office facilities, and their general operating expenses) that all of the contracts must bear a portion of paying.

Regardless of the type of indirect cost involved, they must be budgeted for like any other cost requirement anticipated on a contract, they must be budgeted for. Without this budgeting requirement, no baseline can be constructed against which contractor performance/progress may be measured. As a matter of administrative ease, most contractors collect and budget for indirect costs by pools, or burden centres. Such pools are nothing more than the lumping together of similar indirect costs into homogenous groupings. Once indirect costs are collected in pools, the contractor must identify and substantiate the pro-rata share of each pool that each contract must bear. This Criteria does not dictate the structure of the contractors overhead pools or attempt to standardise what costs those pools must collect. It does however, attempt to force the contractor to clarify how his overhead budgeting procedures work and requires the contractor to ensure that his employees do, in fact, follow these prescribed overhead budgeting procedures.

RECORD ALL INDIRECT COSTS WHICH WILL BE ALLOCATED TO THE CONTRACT.

The intent of this Criterion is to ensure that the contractor has a formal (written) system description that not only requires the recording of all allowable indirect costs, but also explains, procedurally, how these indirect costs are to be recorded. Since we are dealing with a category of cost that is expended to benefit more than a single contract, it is not sufficient for the contractor to state simply that he will record all indirect costs. Defence wants to know how the overhead accumulation system works; it wants assurance that all of the contracts benefiting from an indirect cost expenditure will bear their fair share of that indirect cost.

IDENTIFY ON A MONTHLY BASIS, IN THE DETAIL NEEDED BY MANAGEMENT FOR EFFECTIVE CONTROL, BUDGETED INDIRECT COSTS, ACTUAL INDIRECT COSTS, AND VARIANCES ALONG WITH THE REASONS.

Just as a performance measurement is needed for all directly costed effort on a contract, so also is it important to measure the progress of all overhead efforts attributable to the contractor's business base. Unfortunately, since overhead effort is not attributable to a single contract, it is almost impossible to measure the progress of overhead tasks on a contract-by-contract basis. Any performance measurement of overhead tasks must be done on a total facility basis. But while this is important in the contractor's efforts to control overhead cost growth, it does not make for very good monthly identification of overhead progress. As a result, the Criteria only requires a minimum level of monthly overhead analysis: that of comparing overhead budgets to overhead actuals (with the stipulation that any resultant variance be explained as to its cause).