Benefits Of Job Costing For Contractors

Creating a competitive advantage is exceedingly difficult in the construction industry. Competition for good contracts is vigorous and is made tougher by this down-turn in the economic cycle. A competitive advantage can be created by implementing and maintaining a good accounting and job costing system. Having an efficient and accurate job costing system is imperative for both meaningful interim reporting and for useful historical data that is subsequently used in future estimates.

Construction contractors typically code their expenses into three main categories: direct job costs, indirect job costs, and general and administrative expenses. The accounting pronouncements of Statement of Position 81-1 (Accounting for Performance of Construction-Type Contracts) indicate that indirect costs related to contracts need to be included as part of the costs associated with jobs. In order to properly expense indirect costs to jobs, the contractor must use a systematic and rational method of allocation.

The first thing to determine when creating or modifying a job costing system is what indirect costs should be allocated to jobs. Each company has its own unique costs and it is important that the controls in place support the tracking of costs accurately and efficiently. The job costing system should be designed not only to track costs for accounting purposes, but also to provide management with timely and accurate interim data that can be used for future job bids. The two most identifiable indirect costs that should be allocated are those associated with labor and owned equipment.

Among the largest indirect costs that can be job costed are indirect labor costs. There are several indirect costs of labor that might not be charged to the jobs when incurred. Costs such as unemployment insurance, health insurance, and vacation frequently are not charged to jobs as they accumulate. A job costing system should charge these costs to each job based on a standard allocation method such as direct labor hours, or another appropriate allocation method for unique projects. An accrual and a corresponding expense should be booked to each job, accurately stating the costs of that job, no matter when those benefits are actually paid-out. This method forces the job costing system to recognize the real costs and burdens associated with each employee.

Another important indirect cost which impacts job profitability is “owned” equipment costs. Often, costs associated with equipment, such as depreciation and maintenance, are accumulated and allocated to jobs at year end on an “ability to bear” method. While this smoothes the profits of individual jobs for presentation, it may not be the most accurate method for allocating overhead. Although some jobs have a large margin before overhead allocation, job profitability is skewed if equipment costs are not allocated based on a systematic method. As a result, costs of individual jobs may be misstated depending on how much owned equipment was utilized. This method potentially lends itself to overbidding jobs with light equipment use and underbidding jobs with heavy equipment use. In order to determine the true costs associated with “owned” equipment, a good practice is to set up rental allocation rates for equipment based on fair market values for all equipment being used, and charge those costs to jobs on an hourly or weekly rate. The goal is to avoid a large unallocated equipment pool capable of diminishing profits at year end. By developing a systematic approach to allocating these costs, accurate results can be measured in a timely manner.

A well designed and maintained system for job costing will not only provide an accurate reporting of company earnings and job cost reporting, but also supply management with useful information. This includes knowing your actual costs for bidding purposes and providing the most accurate figures for other third-party users. If you would like assistance with your job costing or want additional information, please contact Chris Newman, BP's leader of the Construction & Real Estate Group, at (425) 454-7990.

Rhett Ennis, MAcc
Construction & Real Estate Group