In January 2011, The ABC Company received a contract form the Army for 175 electronic devices. The contract was a firm fixed price contract at a unit price of $115,000, and a total price of $20,125,000. The price included a 12% profit. The delivery schedule called for 25 a month commencing in May 2011, with delivery completed by December 2011.

In July, a change order was made by the Army in several of the components. At the time of the change the contractor had completed 75 but had no shipped any of the items. Another 50 units were partially completed. The components affected by the change were completed on 40 of the 50 items. Ten of the work-in progress items were not affected by the change. The contractor submitted the following cost proposal:

COMPLETED UNITS AFFECTED BY THE CHANGE:

Labor

Removing changed work 90 hrs

New work 140hrs

230hrs @$30 (Labor estimated in the original contract @27.50/hr)

$ 6,900.00

overhead @180%(overhead original contract @110%) $12,420.00

MATERIAL

manufacturing cost $22,570.00

G&A @15% (original contract G&A 6%) $3,385.50

Total $25,955.50

Profit @12% $3,114.60

Total cost of change per unit $29,070.10

Number of units affected by the changes (75+40) x115

$3,343,061.50

UNITS ON WHICH CHAGNED WORK HAD NOT BEEN PERFORMED

Labor

new work 140hrs

less estimated cost of old work 40 hrs (this portion originally estimated 70hrs)

100 hrs @$30 $3,000.00

overhead @180% $3,250.00 $5,400.00

Material $3,250.00

Less old material $2,650.00 $600.00

Manufacturing cost $9,000.00

G&A 15% $1,350.00

total cost $10,350.00

profit @12% 1,242.00

unit cost of change $11,592.00

x 60 units on which none of the work affected by the change had been performed (x60) $695,520.00

Total cost of change ($3,343,061.50 +$695,520.) $4,038,581.50

Mr. Stinson, who was assigned the responsibility of negotiating the change, requested that an analysis be made of the proposal. Mr. Foster who was the analyst disclosed the following points of difference.

REMOVING CHANGED WORK

Contractor's Proposal 90 hrs @$30/hr Army 60 hrs @$27.50/hr

Mr. Stinson was of the opinion that the company had overestimated the amount of time required to remove the work affected by the change which had already been performed. His opinion was strengthened by the fact that the contractor estimated the time required to install the work at only 40 hrs elsewhere in his proposal. The contractor informed him that there was no relation between the time required to install new work and the cost of removing the old work; that in this case a considerable amount of the changed work involved terminal block locations and wiring which was inaccessible without removing other work already installed.

Q1. Is the contractor's argument a reasonable one?

Q2. What should the buyer do?

Mr. Foster also suggested that since the contractor had estimated labor at $27.50/hr in the original contact, the same figure should be applied to the labor for removing the changed work.

Q3. Do you agree with Mr. Foster's approach, viz; using the labor rate used in the original proposal to price out the work associated with the change ($27.50 vs $30.00)?

Q4. Would you advocate using eh same approach if the work required by the change was to be performed by a lower paid class of workers than originally estimated ($27.50 vs $22.50)?

Q5. if a composite labor rate, developed on the basis of the overall mix of work on the entire contract, was used in the original estimate, should the same composited rate be used in pricing the work associated with the change?