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

NEW WORK REQUIRED BY THE CHANGE Contractor Air Force 140 hrs@ $30.00 95 hrs@ $27.50 Mr. Foster was of the opinion that 95 hours is a liberal amount for this part of the estimate as the terminal block locations and wiring schematic of leads in the respective consoles were changed only slightly due to the change order and the balance of the assembly time was directly applicable to attaching subcontracted harnesses following almost the same routine as the original system. The contractor stated that Mr. Foster was not considering all of the costs of the change since he had included in the 140 hours for new work the labor costs associated with the three days during which his assemblers had to sit around with nothing to do while waiting for new wiring diagrams to be prepared and the materials required by the change secured. Mr. Foster replied that the contractor should have been able to use the personnel on other work. The contractor replied that the production of this item had been shut down for a total of 11 days and that he had been able to economically use the personnel affected on other work for 8 days, but could find nothing for them to do for the remaining 3 days. The contractor further stated that Mr. Foster ignored the affect of the change on the learning of his employees. That, in calculating the cost of the new work, he had applied an appropriate learning curve and that he had also calculated the affect of the change on the rate of improvement on the 60 units on which none of the work affected by the change had been performed, plus an allowance for the affect of the change on the improvement rate of the unchanged portion of the work.

3. CREDIT FOR OLD WORK ON THOSE UNITS ON WHICH NONE OF THE WORK

AFFECTED BY THE CHANGE HAD BEEN PERFORMED

Contractor's Estimate Air Force

40 hrs 70 hrs

In attempting to determine what credit should be given for the old work on those units on which it had not been performed, Mr. Foster ran into considerable difficulty. He reviewed a copy of the contractor's original estimate but the cost of the work affected by the change had not been separated from the overall estimate.

Relating the ratio of the changed work to the total number of hours in the original estimate, Mr. Foster determined that a credit of 70 hours should be used.

To this the contractor replied that while Mr. Foster's estimate of 70 hours for the changed work in the original estimate was reasonable, he had again failed to take into account the improvement curve. The contractor contended that the 70 hours was the average for the entire quantity of 175 required by the contract while the credit should be based on the average for the last 60 units which would be considerably below the average for the entire 175 units.

Questions:

11. Is the contractors approach a reasonable one?

12. Assuming the buyer accepts the contractor's contention, should he require that the contractor furnish an improvement curve to substantiate his claim?