How Should I Allocate Overhead Costs?

Q:
At our growing construction company, we do a pretty good job of tracking costs-labor, material and equipment-down to the cost code level. I was thinking maybe we should begin tracking labor burden costs, but our CPA told me that we should take it a step further and allocate all overhead costs. I just don’t know where to start or if it’s even worth the effort. What’s your opinion?

Sam

A:
Your CPA is absolutely correct. Tracking labor burden costs by job is better than nothing, but without allocating all overhead costs, you simply won’t have a complete picture of each job’s profitability. As we all know, successful contracting is the result of job cost accuracy and control-including those elusive overhead costs.

Is it worth the effort? That really depends on what kind of accounting system you have in place. Since generic small business accounting software doesn’t have the ability to track costs by job (either direct costs or indirect costs), overhead costs are another calculation that must be performed outside the system. Sophisticated construction accounting software has the power to simplify this important task, but you must first choose a method of allocation that works best for you. Your CPA is probably the most knowledgeable resource to help with that decision.

The good news is that once a distribution method has been chosen, technology can automate the entire overhead allocation process. Using a good job costing system, you can easily capture overhead costs, calculate a ratio against actual expenses and report these costs in a way that’s accurate and understandable. Most good accounting software should have the ability to offer both “before” and “after” reports to help you see the effect that overhead has on the bottom line. When all is said and done, you’ll have a crystal clear picture of each job’s profitability as well as for the company as a whole.

Fred

Construction Business Owner, October 2009