(Updated Feb. 8, 2016) If you assign overhead costs without using activity based costing, your construction overhead is probably greater than you know.
Anyone who spends time managing the actual work that goes on at a construction site knows it would get pretty murky if they tried to allocate overhead costs to each little activity.
Too Many Cost Codes
One minute they’re explaining plan details to a subcontractor and the next they’re meeting with an inspector, or banker’s representative. Things get even foggier when they find themselves stepping in to clarify a work procedure for the employees of an absent subcontractor. While “technically” they shouldn’t be doing that, “realistically” they decide their intervention to be of minimal risk, and they respond to keep things on schedule.
What about the support people who back-up those front line managers? It gets even tougher at that level to keep track of the numbers of copies or FAXes the admin person handled for each job. Or, the number of phone calls those same team members fielded and then charged them to the right job. This extends to everyone’s job back at the office, and for that matter, the office itself. Consequently these items and many others get assigned to “overhead.” And while they have lived there nicely for a long time there are those who suggest it may be time to reassess how to allocate overhead costs.
Assign Overhead with Accurate Costs
In their “ Case Study-Overhead Costs Analysis,” Yong-Woo Kim and Glenn Ballard reveal that using profit-point analysis and applying activity-based costing would be a more effective and accurate way to allocate overhead. They point out that traditional cost accounting has been criticized for decades because it fails to “report the cost of activities and processes,” and that other industries have abandoned it for activity-based costing (ABC). Instead of putting all overhead costs under a resource that is common to all of the company’s products, like labor, the overhead items are directly applied to the activity that benefited from that overhead.
The Proof is in the Record
The authors go on to present a case study that demonstrates how this methodology was used on an actual project for Sun Microsystems. The conclusion was that the process was “feasible on actual construction projects and has many positives, with some limitations.” The profit-point analysis that this method allows will yield:
- data that can help with future subcontractor selection
- provide some insight regarding the performance of subcontractors
- help when negotiating fees for additional work
- add some efficiency to employee tasks since they are required to fill out activity forms.
A big plus is that data compiled can be used in the future in creating more accurate bids and in convincing clients to use particular specialty subcontractors.
There is much more about construction efficiency at the Lean Construction site.