Reasonable Overhead Costs

Reasonable overhead costs are indirect costs that a supplier properly incurs or allocates in performing a contract, where the nature and amount of the cost do not exceed what a prudent person would incur in a competitive business. The test comes from Canada's federal contracting policy, which treats a cost as reasonable when it is normal and necessary and not excessive. See the Treasury Board contracting policy.

The term joins two cost-accounting ideas. Overhead is a cost that supports several activities and is not traced to one specific contract or deliverable. Reasonableness is the judgment about whether that cost is appropriate in kind and in size. Together they set the standard a supplier must meet when a contract allows recovery of indirect costs.

How federal policy defines a reasonable cost

The Treasury Board policy says the cost of work, products or services includes the applicable direct and indirect costs reasonably and properly incurred or allocated in performing the work, less applicable credits. Overhead therefore sits inside the contract cost, but only to the extent it is reasonable and properly allocated. The policy is published on the Treasury Board of Canada Secretariat site.

Related federal guidance adds that a cost is considered against whether it is normal and necessary for the supplier's business or for performing the contract. That guidance is available in the Treasury Board policy instrument. Public Services and Procurement Canada applies the same prudent-person standard in its Practitioner's Guide for Pricing, which defines a reasonable cost as one that does not exceed what an ordinary prudent person would incur in conducting a competitive business.

What counts as overhead

Overhead is also called indirect cost. It is a cost incurred for the business generally and cannot be identified and measured as directly applicable to the performance of one contract or project. Administration, facilities, equipment and other shared resources are typical examples.

Innovation, Science and Economic Development Canada uses this definition in its Technology Demonstration Program. Its cost principles annex describes indirect costs as overhead and requires that eligible project costs be reasonably and properly incurred or allocated.

Where the term appears in CanadaBuys guidance

The federal buyer's guide on elements to consider at award uses the phrase in the context of contracts with former public servants. It states that reasonable overhead costs, such as travel expenses, must be excluded from a prescribed limit. It adds that those costs should still be strictly controlled because of the sensitivity of such contracts.

The exclusion does not remove scrutiny. Buyers are expected to keep overhead and similar expenses under tight control even when they fall outside the limit.

A comparable test in UK defence contracting

The UK government applies a similar test to overhead. Under qualifying defence contracts, a cost must be appropriate, attributable to the contract and reasonable in the circumstances, and this applies equally to overhead costs, according to the UK pricing queries guidance. The UK allowable costs guidance defines overhead as a cost used by multiple activities that cannot be traced, or that the parties agree not to trace, to a discrete package of goods, works or services under a particular contract.

What it means for a supplier bidding on Canadian public contracts

• Check whether the solicitation or contract allows recovery of indirect or overhead costs. Where it does, the clause sets the terms.
• Identify the cost basis for each overhead item and be ready to show how it is allocated to the contract or project.
• Be able to show that each cost is normal and necessary for the business or the work and is not excessive by the prudent-person standard.
• Expect the documentation required to vary with the applicable solicitation or contract clause.