Today’s topic deals with how time worked (by people/labor resources) is collected and accounted for on projects charged.
Organizations that manage by project collect labor costs against projects via timecards. These organizations struggle with the rules/validations that need to be applied to this time collection process based on the following competing business requirements:
- Need for accurate time reporting for
- Paying employees what they are due
- Collecting the actual cost of doing work to allow for accurate estimating for future work
- Need for time Costing for Revenue Accrual and Invoice Generation based on project contracting rules.
Labor Resource Classification
People who charge time to projects in any organization fall into three categories:
1. Exempt resources: these are typically full-time employees of the organization who get paid a fixed salary and do not receive additional overtime compensation.
2. Hours resources: these can be full-time or contract labor that gets paid by the hour and are eligible for additional compensation (time and a half or double time) for overtime worked.
3. Contingent or Contract workers who work as employees on projects. From a time accounting perspective, these employees fall into one of the above two categories and are not considered separately for this discussion.
Time Accounting for Hourly Resources
Hourly resources need to enter all time worked with the appropriate classification (Regular/Overtime) to get paid and record accurate costs to the project, including additional charges incurred for overtime pay. The need to register all hours for the actual payment to the resource also serves a different purpose of providing accurate expended effort for future estimation. This then leaves the question of what is billable to the client. This wholly depends on the nature of the contract. The contract may demand that they be billed for all time at a standard bill rate (thereby reducing the margin to the project for overtime worked and paid) or even that no overtime be billed at all, in which case the project will need to absorb the overtime hours and their related costs.
The piece of time accounting for hourly resources that I have not addressed here is the additional complications introduced by Government and Union Regulations like prevailing wages. However, this is another topic for another day together.
Time Accounting for Exempt Resources
It is in the best interest of the project organization to enforce policies that dictate that exempt employees record all time worked on the projects on which the work was performed. This provides two significant soft benefits, one of which was discussed above: collecting accurate data for improving estimating algorithms for future work. The other benefit that can often be obscured is the visibility provided to management for the people consistently going above and beyond for their projects. Now let’s see the impact of project contracts on accounting for time of exempt resources. Contracts for project work typically come in two flavors:
1. Time and Material: Billings against these contracts typically bill for each time item is charged to the project. Billings depend on bill rate schedules for specific people or specific classes. Such contracts may further limit the number of hours that are billable per day or week basis; hence, the billability of time charged will need to be adjusted accordingly.
2. Cost Reimbursement: These contracts typically include terms for billings based on cost multipliers, cost + fixed hourly/daily/weekly fee, or even a fixed/variable fee over total project cost, which is reimbursed (as incurred) up to a specified cap. Applying multipliers or fees on cost can get complex but is relatively simple compared to figuring out how to determine the price of time charged.
The issues arise due to the need to determine the exact cost of time charged accurately, and this can get tricky in the case of exempt resources who work for a fixed salary, irrespective of the number of hours worked. For example, if an exempt resource charges more time than the standard (8 hrs/day or 40 hrs/week) hours, then the daily/weekly cost rate for the help needs to be spread over all hours worked to derive the correct cost time worked. This issue is further compounded when the same resources work on multiple projects: in this case, cost determination needs to look at all hours charged across projects.
This concept of spreading periodic cost rates for an exempt resource overall time charged by the resources is called effective costing. Some challenges in accomplishing effective costing include identifying all time charged by a person for a given period across all projects charged. Another issue deals with late time. If some time for a period is charged late, it may result in recalculating costs for all time charged to accommodate the new time charges.
One solution that some organizations use to workaround the challenges of effective costing is to limit the entry of hours to the standard hours only, i.e., 8 hours a day or 40 hours a week. This solves the problem but is not a good solution for all the reasons discussed above.
Standard v/s Actual Costing of Time
One major challenge that needs to be overcome by any organization that wants to operate on a project basis is determining which costing method they would like to use to determine cost rates for people’s resources.
1. Standard Costing: In using this method, an average cost rate is derived for all resources in a particular resource classification (Job Category) and then used for all resources in that classification
2. Actual Costing: The actual cost rates for each individual are used for costing time. This variation is referred to as Payroll costing, wherein the costs from actual payroll runs are distributed over time and charged to projects to determine project costs. However, payroll Costing has distinct disadvantages in terms of timeliness of cost collection, especially as payroll runs happen infrequently, which can delay reporting costs on the project.
The following table lists some of the advantages and disadvantages of these two approaches towards time costing.
| (Dis)Advantage |
Std. Cost |
Actual Cost |
Comments |
| 1. Accurate Cost Reporting |
X |
X |
Actual costing provides the most accurate view of the cost of time. The place where it falls short is items like variable compensation elements like Bonuses. These items are paid occasionally, and it is impossible to spread these costs over time charged in prior periods |
| 2. Labor Cost Security |
X |
Standard Costing wins on this one, as standard costing equates cost for all resources in a category. | |
| 3. Ease of Estimating |
X |
It is easier to estimate accurately with standard costing, especially when the exact resources are not known | |
| 4. Cost Variance to Plan |
X |
When std. Costing is used for planning and actuals; cost variances reflect planning deficiencies and are not based on cost rate variances. | |
| 5. Dependency on Payroll |
X |
Actual costing may depend on payroll runs to reflect the true cost of resources. |
These are some of the factors that can be used to decide which approach to use, and as is evident here, standard costing is preferred in most cases. The only time when users have no choice but to use actual costing is in very low-margin industries like Engineering and construction, where labor cost rates are known (due to prevailing and union rates), and the difference between standard and actual rates can wipe out the entire margin that a project may have planned for. Other times where actual costing may be mandated (almost) is when contracting with the government, which typically provides you with Cost Reimbursement contracts and often audit your project costs to match your payroll. That’s it for now, and remember:
There is no better way to manage a business than to Manage by Project.
PS: I welcome all comments/trackbacks/pingbacks/queries to my nascent venture here. I will try and respond to your comments, etc., in future entries.
