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Unabsorbed overhead and the unabsorbed overhead methodologies are among the most misunderstood concepts and procedures in the cost engineering field. Unabsorbed overhead is also one of the more significant cost factors in delay claims.
Project managers, contract administrators, lawyers, and accountants use the term unabsorbed overhead during contract claim negotiations, but many do not understand the meaning of the term, the calculation methods, and the effects of various methodologies.
This article defines the terms, demonstrates some of the calculation methodologies, and discusses the effect methodology has on the claim quantum.
When a contractor claims compensation for unabsorbed home-office overhead (also referred to as extended overhead or unabsorbed overhead), the contractor is attempting to recover the general and administrative (G&A) costs associated with an unanticipated owner-caused delay to a contract. The G&A costs are the home-office overhead expenses associated with managing the operation as a whole and are not directly associated with any one particular contract. In other words, it is the home-office staff and expenses involved in managing the entire company. This cost continues to be incurred at the home office despite the suspension or delay of any particular contract. The G&A cost incurred during the delay period, which relates to a suspended or delayed contract, is referred to as unabsorbed home-office overhead.
Unabsorbed home-office overhead is understood differently when dealing with a fixed-price contract as opposed to a cost contract; however, either way, the term unabsorbed home-office overhead is really a misnomer. On fixed-price contracts, the G&A cost is included in the contractor's bid estimate and therefore in the bid price. Should the project be delayed, however, and the completion date extended, the contractor would not be able to recover costs associated with the contract extension, since the price is fixed. Consequently, in a fixed-price contract, the contractor's claim is for extended overhead.
In cost contracts, all overhead costs are allocated to ongoing projects based on the "direct contractual costs generated during the period" (cost base). However, during a delay, due to the lack of cost base, G&A costs cannot be allocated to the delayed contract, but can be allocated to other ongoing projects. Therefore, a cost contract claim is for the costs that were charged to other contracts, due to a lack in...