In an uncertain economy, accurate and actionable job cost
accounting is more important than ever. If you haven't already, consider using
activity-based costing (ABC) to obtain more precise and useful information.
Done right, ABC helps you use your resources more efficiently by
allocating expenditures — especially overhead and indirect costs — more
realistically than traditional job costing. As a result, you can better
determine the actual cost of each project.
ABC 101
Traditional job costing typically allocates overhead and
indirect costs based on labor hours or a similar volume-based measure. This can
result in over- or undercosting.
In contrast, ABC generally allocates overhead costs based on the
performance of specific activities that generate costs. Each activity is
clearly defined to prevent overlap. Examples include:
- Sourcing and
ordering materials and supplies,
- Preparing
equipment for use, and
- Doing cleanup.
ABC allows you to capture all the costs associated with each
activity in a project with overhead incorporated into each as appropriate.
These include labor, equipment, materials, subcontractors and depreciation. It
eliminates overly broad cost classifications, such as "overhead" or "operating
expenses."
Essentially, you calculate the costs associated with each
activity and assign them to jobs based on the extent to which each project uses
the respective activities. The allocation is determined by applying so-called
cost drivers — basically anything that incurs a variable indirect cost or uses
a resource. Examples of cost drivers include equipment usage (for equipment
maintenance costs) and the number of purchase orders (for procurement costs).
Overhead and indirect costs are assigned to specific activities
and, in turn, allocated to jobs based on their utilization of the activities.
So, a project that requires a high number of purchase orders, for example, will
be assigned a larger portion of the procurement activity's costs.
This type of cost accounting is an ongoing process. Activities
and the supply of various resources are adjusted throughout each project phase
based on variances between budgeted and actual costs. ABC doesn't replace a
traditional cost accounting system, but it provides valuable additional data
for evaluating how efficiently your construction business is operating.
Pros and cons
Unlike businesses that manufacture or sell goods, construction
companies can't simply divide up their expenses equally among a set number of
units. Because jobs consume different resources in varying amounts over various
time periods, the traditional approach to allocating overhead and indirect
costs can present a distorted financial picture of your individual projects.
With ABC, you can more easily identify why some jobs take more
time or money than expected, as well as which activities consume the most
resources. You can also uncover where waste might be occurring and pinpoint
spending overruns.
On a more positive note, ABC also helps you determine the kinds
of jobs and activities that are most profitable. It can lead to improved
strategic planning, decision making, budgeting and pricing. It enhances
estimators' accuracy and allows for simpler revisions if a project's scope
expands.
That said, establishing ABC can be challenging, partly because
of the comprehensive employee training required. Project managers and others
may need to provide more detailed, granular information than they have in the
past. The greater the number of people adding data, the higher the likelihood
of inaccurate inputs that skew the numbers and undermine their value.
Additionally, some employees may grumble about the hassle or
take a lackadaisical approach to recording and reporting data. While it's easy
for them to understand how clocking in and out benefits them directly, the
rewards of this additional layer of tracking may not be so apparent.
Trial project
Implementing ABC can be a daunting process. However, bear in mind that you don't have to do it all at once. Consider using it on a trial project and assessing the results. If satisfied, you can expand ABC to more jobs from there.