Burning the Candle at Both Ends – Indirect Costs and Time-Rate Hierarchies

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In this four-part series, we have been discussing the special challenges that manufacturers face when addressing both government and commercial markets. Cincom’s Craig Phillips, Product Manager for Manufacturing, has addressed the concept of pooling and tracking both allowable and unallowable costs in the project-based manufacturing environment.

Today we talked with Craig about rate hierarchies and indirect costs; how they are affected by change over time and how they are treated as they move through the hierarchy of cost pools within the organization.

Complex organizations are always challenging from an accounting perspective because costs and indirect costs must be carefully allocated across multiple categories and levels within the organization. The more complex the organization and the more variable its day-to-day structure and composition, the more difficult it is to correctly and accurately identify specific dollar amounts that are allocable to specific categories within specific projects.

Additionally, there is the component of time to consider. The computational formulas used to compute specific costs will change for many reasons over time. Perhaps the resources are devoted to a particular project change. This might manifest itself as larger or smaller amounts of floor space, utilization of services not previously required or different consumption levels of electricity or water.

The formulaic rates used to calculate these expense types are subject to periodic adjustment. These variations do not need to occur within the individual project to change the percentages used for that project.

If headcount for the company doubles in a particular department and the new headcount has nothing to do with a given project, the percentage used in calculating the project share of headcount utilized will change. This is because while the project’s impact or use of headcount is unchanged, the actual percentage of total hours is less. Over the course of a year or the life of a given project, many different rates may apply for a given cost-allocation computation.

Multi-level Indirect Rate Hierarchies

Previously we talked about pools for gathering various types of expenses as they are incurred. The pools are arranged in specific hierarchies that allow the accumulated expenses to be allocated into other pools downstream for further allocation. The allocation formulas must be applied in a specific order and at specific times against expenses incurred and allocated to a given pool.

This provides an easy-to-track, easy-to-explain logic for justifying why a given dollar amount is allocated against a given project. It is simply not practical for companies to lump all expenses into a single pool and then charge specific percentages against specific projects.

As an example, let’s look at overhead. As overhead expenses are incurred, they are allocated into one of two pools. First we have G&A (General and Administrative) overhead, which covers the day-to-day costs of running the business. These might include salaries, wages, rent, utilities and depreciation expenses. A second pool for overhead represents those overhead expenses such as selling costs, advertising and commissions. This type of split is important to GovCon manufacturers because sales expenses and advertising costs are not accepted as expenses against projects.

Splitting overhead into these two pools makes it easier to isolate those overhead dollars that can be allocated as indirect costs of the individual project.

Once this split is made, the intermediate pools can be further split into final pools as the individual portions of the operating expenses are further segregated into allocable expenses. In the case above, a direct project expense pool is created at the same hierarchical level as the G&A and operating overhead expenses. But the operations pool would feed into final allocation pools identifying those expenses that are directly allocable to projects and those that are not.

Finally, at the project level, the allocated expenses are further segregated into specific pools that are tied to specific projects. Once the expenses are pooled into specific project pools, further allocation pools would be associated with specific activities and subsequent cost categories.

Software supporting the GovCon manufacturer should be able to help automate this process. The pools, expenses, indirect costs and rates must be defined by the manufacturer, but the software should readily support this activity.

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