Construction contractors, professional service firms, specialty manufacturers, and other companies that work on large projects often struggle with job costing. Full cost allocations are essential to gauging whether you are making money on each job. But some companies simply lump indirect job costs into overhead or fail to use meaningful cost drivers, thereby skewing their profit reports. Here is what you should know to avoid this pitfall and get a clearer picture of your company’s profitability.
Indirect job costs vs. overhead costs
The Financial Accounting Standards Board defines job costs as “the sum of the applicable expenditures and charges directly or indirectly incurred in bringing [a job] to its existing condition and location.” These may include direct costs, such as labor and materials, and indirect costs. The latter can be divided into two groups:
Costs identified with more than one job. These typically consist of benefits for frontline workers, workers’ compensation insurance, and insurance to reduce the company’s liability risks. This category also may include company vehicle costs, such as gasoline, maintenance, and repair expenses, and equipment depreciation.
Costs that are only indirectly related to jobs. Common examples of these indirect costs include project manager salaries and benefits, cell phone bills, payroll service fees, and vehicle tracking and monitoring systems.
Indirect costs and overhead are often confused. The term ‘overhead’ refers to costs related to running your company that you cannot attribute directly or indirectly to a project. They tend to be consistent over time. It is important to not include overhead costs, such as office rent, when identifying indirect costs.
Using a cost driver
You can systematically allocate indirect job costs using a ‘cost driver.’ Two common cost drivers are labor hours and dollars.
For example, suppose liability insurance for an engineering firm costs $100,000 annually. That amount divided by 12 months is $8,333 a month. To follow the allocation process through to completion, you would tabulate the billable hours for each job on a monthly schedule. Then, perhaps with your accountant’s help, you could divvy up that $8,333 each month to put those dollars onto that month’s active jobs pro rata. Now that $100,000 is no longer overhead — those dollars are indirect job costs.
Once indirect costs are allocated and included in the reports given to managers tracking the progress of cash outflows to their jobs, your company’s management team can discuss how to avert upcoming cash flow problems. This can buy you some time to make corrections.
Monitoring the bottom line
We can find meaningful methods of allocating job costs to help evaluate your company’s profitability. Contact us for more information.