Overhead Disputes (Suggested by Howard Wright) The Azure Ship Company works on U.S. Navy vessels and commercial vessels. General yard overhead (for example, the cost of the purchasing department) is allocated to the jobs on the basis of direct-labor costs.

In 19-3 Azure’s total $150 million of direct-labor cost consisted of $50 million Navy and $100 million commercial. The general yard overhead was

$30 million.

Navy auditors periodically examine the records of defense contractors.

The auditors investigated a nuclear submarine contract, which was based on cost-plus-fixed-fee pricing. The auditors later claimed that the Navy was entitled to a refund because of double-counting of overhead in 19_3.

The government contract included the following provision:

Par. 15-202. Direct Costs.

(a) A direct cost is any cost which can be identified specifically with a particular cost objective. Direct costs are not limited to items which are incorporated in the end product as material or labor. Costs identified specifically with the contract are direct costs of the contract and are to be charged directly thereto. Costs identified specifically with other work of the contractor are direct costs of that work and are not to be charged to the contract directly or indirectly. When items ordinarily chargeable as indirect costs are charged to the contract as direct costs, the cost of like items applicable to other work must be eliminated from indirect costs allocated to the contract.

A special expediting purchasing group, the SE group, had been formed to do work (in addition to that rendered by the central purchasing group) on obtaining materials for the nuclear submarine only. Their direct costs, $5 million, had been included as direct labor of the nuclear work. Accordingly, overhead was applied to the contracts in the usual manner. The SE costs of

$5 million were not included in the yard overhead costs. The auditors claimed that no overhead should have been applied to these SE costs.

Compute the amount of the refund that the Navy would claim.

Suppose that later the Navy also discovered that $4 million of general yard overhead was devoted exclusively to commercial engine-room purchasing activities. Compute the additional refund that the Navy would probably claim. lop2