Is There a Proper Accounting for Indirect Costs? Presented By: Bob Biehl, CPA, CCIFP Director of Construction Industry Services GBQ Partners LLC

Director of Construction Industry Services Bob Biehl, CPA & CCIFP is the Director of Construction Industry Services at GBQ Partners LLC in Columbus, Ohio, where he began his career 28 years ago after receiving a Bachelor’s Degree from Ohio University. Bob serves over 50 construction clients and is active in over 9 construction trade associations including CFMA and CICPAC. Bob has served on the following CFMA National Committees: The Executive Committee; Leadership Committee; Chapter Resource Committee; Bob is Chairman of the ICCIFP and has served on the ICCIFP Question Writing Committee. In addition, Bob is Past President of CICPAC. Bob Biehl, CPA, CCIFP Director of Construction Industry Services GBQ Partners LLC 230 West Street, Suite 700 Columbus, OH 43215 (614) 947-5211 Bbiehl@gbq.com

Goals Understand: How accurate job costing fits into the whole construction process The importance of knowing all your costs: The difference between direct costs, indirect costs and general and administrative costs. How to properly account for each of the above types of costs. How to properly account for under/over allocated indirect and equipment costs.

Goals Understand: The impact of NOT allocating all indirect and equipment costs to contracts on the percentage-of-completion and to loss contracts. The importance of not reconciling open and closed job schedules to the financial statements.

How Job Costs are Related to the Entire Construction Process Estimating Construction Accounting Analysis (monitoring) and wrap-up

Construction Accounting Estimating Analysis / Wrap-up The Circle

Why is Knowing Your Costs the Most Important Aspect of Construction Accounting ? It helps you: In the bidding process. Determine problem jobs and people. Price change orders. In the claims process. Reconcile job cost reports to the financial statements. Make better business decisions.

Direct Costs Direct costs include all costs which can be directly identified with an individual job. Direct job costs allow you to measure your actual performance against your estimate. Best in Class contractors identify and charge as many costs directly, along with pooled direct and indirect costs.

Typical Direct Costs Labor and Burden (allocated from indirect pools) Materials Subcontracts Equipment Owned (directly charged – hourly, daily, etc.) Rented (directly charged, but has allocations to it – fuel, insurance, etc.) Bond Costs Insurance (can have both direct and indirect components) General Conditions Labor burden is a hybrid, because much of the burden is not incurred unless there is direct labor charged to the job.

Labor Burden Calculation Workpaper Field Labor 1. Company Share—F.I.C.A. 7.65% 2. Workers’ Compensation 4.44% 3. Federal Unemployment 0.80% 4. State Unemployment 1.20% 5. Liability Insurance 6. Vacation (a) 5.35% 7. Health Insurance (b) 10.99% 8. Other: 401(k) (c) 2.08% Total 32.52% (a) Vacation & Holiday Calculation Total vacation & holiday weeks 64 divided by total work force weeks in a year $1,196 = 5.35% (b) Health Insurance Calculation Total health benefits payment for a month $2,638 divided by the total payroll for a month $24,000 = 10.99% (c) 401(k) Calculation Total 401(k) benefits paid for a month $500 divided by the total payroll for a month $24,000 = 2.08% Input: # of field employees Work weeks Vacation weeks Monthly field payroll Monthly health benefits paid Monthly 401(k) benefits paid 23 52 64 $24,000 $ 2,638 $ 500

Indirect Costs Indirect costs typically cannot be “directly” identified to a specific project, but primarily relate to the completion of multiple direct activities occurring on different projects. Common indirect costs (four major pools): Overhead (project-related) Safety (non-project specific) Small Tools and Supplies Training Indirect costs are allocated to projects using logical costs aggregation (pools) and applying those costs, based on a direct cost component.

Indirect Pools – Allocation Bases “Consistency is Critical” Labor Indirect (vacations, holidays) Burden (FICA, unemployment) Project Overhead Supervision (if not charged direct) Overhead (rent, related costs) Purchasing Department Equipment Fixed and Operating Costs Allocation calculation: Indirect Cost Pool ----------------------- = Direct Cost Base Allocation Basis Direct payroll dollars/hours Direct payrolls Direct payroll hours Total project costs Direct materials and subcontractors Equipment run hours Equipment run and idle hours Indirect Cost Rate

Development of Indirect Cost Allocation Development of Pools and Bases. The company builds an annual plan. A critical focus is the market. The plan builds budgets – Revenue and Costs. Budgets identify direct and indirect costs: Pools (numerator) – Buckets of costs to be allocated Bases (denominator) – Method to spread cost Budgets establish estimating rates for the direct and indirect costs. Budgets establish job cost, equipment and plant charges, etc. Rates are consistent between estimating and job cost. Rate variances are reviewed, as well as the plan, throughout the year.

Examples of Overhead Allocation Methods – Direct Labor Allocation based on direct labor costs of $59,000 Burden rate: $17,500 ÷ $59,000 = 29.66% Direct x Burden = Allocated Labor Rate Overhead Contract A 23,000 $ 29.66 % 6,822 Contract B 4,000 1,186 Contract C 32,000 9,492 59,000 17,500

Examples of Overhead Allocation Methods – Materials Allocation based on direct labor costs of $63,700 Burden rate: $17,500 ÷ $63,700 = 27.47% Direct x Burden = Allocated Material Rate Overhead Contract A 21,000 $ 27.47 % 5,769 Contract B 13,200 3,626 Contract C 29,500 8,105 63,700 17,500

Discussion Question Do you reallocate under or over applied indirect costs (excluding equipment) to contracts?

Break Even Analysis Definition: Example 1 – Fixed Overhead 1 2 3 General Administrative Expenses/Gross Profit = Breakeven Sales Example 1 – Fixed Overhead 1 2 3 Overhead 5,000,000 5,000,000 5,000,000 Gross Profit % 13% 18% 25% Breakeven Sales 38.5 Mil 27.8 Mil 20.0 Mil

Break Even Analysis Example 2 – Fixed Gross Profit 1 2 3 1 2 3 Overhead 5,000,000 6,000,000 7,000,000 Gross Profit % 18% 18% 18% Breakeven Sales 27.8 Mil 33.3 Mil 38.9 Mil

General and Administrative Costs General and administrative costs are NOT direct or indirect costs. These costs should include the cost of running the office, accounting, human resources, information technology and marketing the business.

Overhead Recovery Single Percentage – Overhead costs at $200,000 divided by total costs at $1,000,000 = 20% to be recovered Duel Percentage - Overhead costs at $200,000 with material at $100,000 and labor at $400,000 than you would add 20% to material and 80% to labor to recover the $200,000.

Levels – Using Factoring Multiple Overhead Recovery (Material, labor, equipment and subs) General standards Material 5% Equipment 15% Subcontractors 5% Labor remaining amount not covered by others

Equipment Costs Many contractors believe that the equipment is FREE once it is acquired! They never charge equipment to a job. They consider equipment an overhead cost. Remember: EQUIPMENT is a CHOICE NOT to use LABOR! (It is cheaper in some third-world countries to use labor rather than equipment.)

Creating an Equipment Cost Center Costs to include: Acquisition and Financing Costs Depreciation Interest

Creating an Equipment Cost Center Costs to include: Operating Costs Maintenance Repairs Insurance Taxes Fuels and Oils Labor

How Do You Allocate Equipment Costs to Jobs? Hourly? Daily? Weekly? Customer Billing Rate? Internal Cost Rate? Third-Party Rate Book? Idle Rate? Operating Rate?

Calculating and Equipment Rental Rate (Example) Acquisition Cost: $45,000 Interest/Internal Capital Cost (8.5%): 10,394 Subtotal $55,394 Estimated Years in Service 7 Annual Acquisition Cost and Internal Cost Recovery $ 7,913

Calculating and Equipment Rental Rate (Example) Operating Costs: Repairs $ 6,000 Taxes 450 Insurance 450 Fuel and oil 5,100 Equipment management 1,350 Annual Operating Costs $ 13,350

Calculating and Equipment Rental Rate (Example) Annual Acquisition and Interest Cost Recovery $ 7,913 Annual Operating Costs 13,350 Total Annual Costs $ 21,263 Annual Service Hours 1,100 Average Equipment Rate per Hour $ 19

Other Rate Considerations Salvage Value? Interest Rate? Inflation rate for replacement cost? Inflation rate for fuels and oils? Don’t forget the cost of add-on pieces of equipment: GPS Buckets Etc.

Do you reallocate under or over applied equipment costs to contracts? Discussion Question Do you reallocate under or over applied equipment costs to contracts?

Reconciling Job Schedules to Income Statement Revenue – potential issues Costs – potential issues Credibility

QUESTIONS ??