This section is from the book "The Law Of Contracts", by William Herbert Page. Also available from Amazon: Commercial Contracts: A Practical Guide to Deals, Contracts, Agreements and Promises.
Memorandum on Definition of Actual Costs and on Method of Collating Cost
Data - Definitions.
Definition of Actual Cost. - The actual cost of production of the articles hereby contracted for is hereby defined as consisting of and including the following elements:
(1) The cost of all direct labor definitely ascertainable as used in the production of the articles herein contracted for.
(2) The cost of all direct materials and supplies definitely ascertainable as entering into or expended in the production of the articles herein contracted for.
(3) A fair amount to cover the depreciation accruing during the period of production of the articles under this contract on that portion of the plant, equipment and facilities owned by the contractor and used in or necessarily rendered idle on account of the production of the articles herein contracted for and properly chargeable thereto.
(4) A fair proportion of overhead expenses other than that included in item (3). By the term "overhead expenses" is meant the indirect labor and other manufacturing expenses, and the general and administrative expenses applicable to and necessary in connection with the production of the articles contracted for herein, provided that nothing herein shall be deemed to include interest, rent, advertising, collection expense, credit losses, discounts, and such taxes as income and excess profit taxes imposed by the Government of the United States.
Indirect Material. - Indirect material consists of such material as factory supplies, which, while used in the process of manufacture, either do not enter into the product, or else enter in such a way as not to be chargeable conveniently to any particular article.
Indirect Labor. -' Labor used in repairing, handling, trucking, sweeping, supervising, etc.; in short, labor not expended directly upon the product may be classed in the overhead as part of the indirect labor.
Freight, Cartage and Express (Inward). - These items should be included and charged as part of the direct material costs. When such treatment is impracticable, they may be treated as part of the overhead costs.
Experimental Work. - Experimental work directly necessary in connection with this contract, not expressly provided for, may be included as part of the overhead cost.
No portion of experimental work on other products of the contractors shall be included in the Actual Cost, except relatively small residual expense which it is impracticable to allocate distinctly.
Defective Work. - It is recognized that work under this contract will be done under abnormal conditions, and, therefore, wastage, scrap and corrective-labor thereon, which could not be avoided by the exercise of good faith, shall be allowed as an element of actual cost.
Liability Insurance. - Accrued liability insurance in so far as it covers employees working on Government contracts may be included as part of the overhead. Such accruals may cover premiums payable to insurance companies, state compensation boards, or sums paid under independent insurance plans not materially exceeding in cost those of insurance companies or state compensation boards.
Packing and Packing Supplies. - These items may include boxes, lumber, nails, containers, strapping, and miscellaneous packing supplies, and also the packing labor which is incurred, and these items may be included as part of the overhead.
Repairs. - The costs of repairs allowed in current expenses are those for repairs and alterations which are made currently to provide for the ordinary and regular upkeep of the plant, the cost of which is a usual and fairly consistent annual charge. Repairs and alterations of a general nature which are necessary only at intervals of more than a year, or replacements and unusual repairs which would involve a significant increase in the overhead expense shall not be considered as expense, but shall apply against the reserve established to provide for depreciation.
Scrap and Waste. - Whenever the scrap and waste and containers on Government work have a salvage value, this value should either be deducted from the material cost or from the overhead.
Administrative Expenses. - Tn the majority of cases the time of the administrative force is spent in supervising the selling organization, in solving problems of production, and in looking after the finance of the business; therefore administrative expense is partly a production cost, and partly a selling cost
Only that portion of the administrative expense which is applicable to Government work may be included as part of the overhead costs.
Salaries. - Excessive salaries or other excessive compensation shall not be allowed. In order to form a basis for passing on this matter, an amount of salary or other compensation paid to any individual for the three years prior to the war shall be considered as one of the factors in determining the amount to be allowed.
Royalties. -Any royalties or payments which the contractor may be obliged to assume or pay for the use of any patent rights in connection with the production of the articles may be included in actual cost.
Rent. -' Rent proper is not chargeable to actual cost but payments for rent shall be analyzed between (a) repairs and depreciation, and (b) return on investment, including interest on investment. For the purpose of this contract, that portion of rent payments estimated to represent cost of repairs and depreciation, shall be allowed in actual cost.
Employes' Welfare. - All of the following items may be included as overhead expense:
(1) Wages paid employes while absent on account of sickness.
(2) Expenses of operation and maintenance of plant hospitals, also medicine and supplies for first aid to the injured, expenditures for Hospitals and other organizations to cover definite benefits to employes.