Eichleay Formula: Understanding the in Claim Quantification
Eichleay Formula is a mathematical method commonly used in construction contracts to calculate overhead costs incurred by a contractor due to delays caused by the client. It is a mechanism for determining a fair allocation of unabsorbed home office overhead costs when a construction project is delayed or suspended.
Purpose of the Eichleay Formula
When a project is delayed, the contractor may still incur general home office overhead costs (e.g., salaries, rent, utilities) even though the project isn’t progressing as planned. The formula helps quantify the amount of overhead that can be allocated to the delayed project.
The Eichleay Formula
The formula calculates the daily home office overhead allocable to a project, then multiplies it by the days of delay:
Step 1: Calculate the Overhead Allocable to the Contract
$$
\text{Allocable Overhead} = \left( \frac{\text{Total Overhead During Contract Period}}{\text{Total Billings During Contract Period}} \right) \times \text{Contract Billings}
$$
Step 2: Calculate the Daily Allocable Overhead
$$
\text{Daily Allocable Overhead} = \frac{\text{Allocable Overhead}}{\text{Contract Performance Period (in Days)}}
$$
Step 3: Calculate Total Overhead Compensation
$$
\text{Total Overhead Compensation} = \text{Daily Allocable Overhead} \times \text{Days of Delay}
$$
Key Terms
- Total Overhead During Contract Period: Total home office overhead incurred during the project’s active period.
- Total Billings During Contract Period: Revenue from all projects during the contract period.
- Contract Billings: Revenue from the specific delayed project.
- Contract Performance Period: Time from the start to the planned completion of the project.
- Days of Delay: The period of delay caused by the client or unforeseen circumstances.
Assumptions of the Eichleay Formula
- Overhead is proportionally distributed across all projects.
- The delay is caused by the client, and the contractor cannot mitigate the delay by reallocating resources.
- The contractor remains on standby and cannot take on other projects during the delay.
Example
Suppose:
- Total home office overhead = $500,000
- Total billings = $10,000,000
- Contract billings = $2,000,000
- Contract performance period = 500 days
- Days of delay = 50 days
Step 1: Calculate Allocable Overhead
$$
\text{Allocable Overhead} = \left( \frac{\text{Total Overhead}}{\text{Total Billings}} \right) \times \text{Contract Billings} = \left( \frac{500,000}{10,000,000} \right) \times 2,000,000 = 100,000
$$
Step 2: Calculate Daily Allocable Overhead
$$
\text{Daily Allocable Overhead} = \frac{\text{Allocable Overhead}}{\text{Contract Days}} = \frac{100,!000}{500} = 200
$$
Step 3: Calculate Total Overhead Compensation
$$
\text{Total Compensation} = \text{Daily Overhead} \times \text{Delay Days} = 200 \times 50 = 10,000
$$
Limitations
- The formula assumes uniform overhead distribution, which might not always align with reality.
- It is not applicable if the contractor mitigates the delay by reallocating resources.
- The contractor must prove they were on standby and unable to use their resources elsewhere.
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