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Overhead--Total Revenues.

Between July 1992 and March 1995, Jay Automotive Industries (Jay) had gross revenues of $38.2 million, including revenues from its "COPAR" store from a contract with Fort Polk, Louisiana, of $6.2 million. COPAR was a store set up by Jay, and the contract required Jay to sell and the government to have agencies buy listed automotive parts through the store at listed prices.

During the last seven months of the contract, the using agencies bought parts from other sources using issued credit cards. Average monthly revenues at the COPAR store prior to the use of the credit cards were $225,000. During the seven months of credit card use, revenues averaged $46,000. Jay incurred fixed overhead at both its home office and at the COPAR store during the contract period. Jay believed that the diversion of sales from the contract reduced its overhead recovery and, in July 1996, made claim to the contracting officer (CO) for $121,000. The decision of the Armed Services Board of Contract Appeals (ASBCA) from the "deemed denial" of Jay's claim is reported as Jay Automotive Specialties, Inc., ASBCA 50036, 99-1 BCA 30,186 (December 1998).

The board noted that there was no direct evidence of the quantity or value of the diversions. Using the Freedom of Information Act and discovery procedures, Jay tried to acquire those details. The credit card receipts did not disclose what was purchased. The board noted that the only way to determine what should have been purchased from Jay would have been to interview each user of the credit cards. Since there were over 100 such users, that process was impractical. The board held that the average monthly difference between revenues at the COPAR store before and after the credit card diversion ($178,000) for the period of seven months ($1.25 million) was a "reasonable and sufficiently accurate estimate for use in the computation of an equitable adjustment."

The government argued that there should be a downward equitable price adjustment because of "improper sales" (those of unlisted items) during the first 26 months. The CO had personally examined 4,000 of the more than 8,000 requisitions and concluded that 10 percent, or about 400, "appeared to involve orders for unauthorized parts." He selected 69 such purchases as representative. The board decided that the 69 selections were not representative and the evidentiary record did not establish credentials for the CO in the field of statistical sampling. It rejected the CO's theory that sales during the first 26 months "were inflated due to 'so called' unauthorized sales."

To establish the amount of its claim, Jay first calculated the portion of its overhead pool allocable to the COPAR store by multiplying its actual overhead rate by the actual revenue to establish an allocable overhead amount. It then added the amount of the diverted revenue and established a new, lower overhead rate. The difference in rate multiplied by the actual overhead resulted in the claimed amount.

The Defense Contract Audit Agency (DCAA) used the same figures for revenue and overhead pools and assumed the validity of the amount of the diversions, but questioned Jay's methodology. DCAA established an overhead rate by adding the diversions to the actual revenue and dividing the total into the overhead pool to come up with a percentage overhead rate. With diverted revenue included, the percentage of overhead allocable to COPAR was higher than the actual experience. DCAA then multiplied the overhead pool by its calculated percentage, resulting in an amount of overhead allocable to Jay's contract, had there been no diversions. When the actual allocable overhead amount was subtracted from the DCAA higher allocable overhead amount, the difference was $85,700, which represented the appropriate and lower equitable adjustment.

The government lawyer offered a different methodology based on his thinking on a precedent case. He divided the actual overhead pool by the actual revenue and obtained an overhead rate. Then he divided the overhead pool by the total revenues, including the diversions, and developed a different rate. He then subtracted the lower rate from the higher and applied the difference in rate to the total revenues to come up with $22,000, a much lower equitable adjustment.

The board's methodology was different from the others and was the one that counted as the decision. It accepted Jay's calculations for actual allocable overhead and the actual overhead rate. It calculated a new overhead rate with the diversions added. Then it calculated the overhead costs using the new rate. Those costs represented a percentage of the total revenues with the diversions added. There was a small percentage difference between the actual overhead rate and the percentage that the theoretical revenues bore to the theoretical allocable overhead. Multiplying that small difference by the actual revenues in the COPAR store resulted in the equitable adjustment granted by the board of $49,497.

Several thoughts are produced by this decision. Actual average revenues before and after the diversions established the board's satisfaction as to the amount of the diversions. This could be called the "total revenue method," applied in the absence of specific evidence of the amount of the diversions. (The total cost method of proving additional costs--comparing actual to estimated costs--has always been suspect.) The absence of detail on the diverted orders was the rationale.

Could the case have been determined in some other manner? Could the sellers of the diverted products have been identified? Doubtless there would have been fewer of them! Could they have been solicited to provide the details of the orders placed with them? That should have established the quantity of "unauthorized sales" also. The idea seems to have occurred to no one involved in the case.

Four different methods of calculating the equitable adjustment were offered in the case. Each had its own logic and was persuasive. The board did not discuss the basis it used for rejecting the proposals by Jay, DCAA, or the government lawyer. Nor did it discuss the basis upon which it selected its own preferred method. It merely presented each method in detailed, clear calculations, which left no doubt as to how the calculations were made. It might be useful to read the details of the calculations in the case text to fully absorb their implications. Meaning no disrespect to any of the participants in this case, there is an old expression, "figures lie and liars figure." One must wonder how to apply this decision and its calculations in the next case of underabsorbed overhead where the government is responsible for lost revenue.


ROBERT D. WITTE is senior partner in the firm of Witte & Lestz, P.C., White Plains, New York. One of the original members of NCMA, he is an Honorary Life Member, a Fellow, winner of the Charles J. Delaney Memorial Award for articles appearing in Case Commentary, and a member of NCMA's Central Connecticut Chapter. The Blanche Witte Memorial Award is in memory of his mother.
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Publication:Contract Management
Geographic Code:1USA
Date:Oct 1, 2000
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