If your business has more than one contract, contracts of differing types, contracts in both the government and the commercial market place, if you operate part of your business as a for-profit entity and another parts as not-for-profit entity, if some of your products and services utilize significantly more purchased materials than others, or if you subcontract a sizable share of your contractual efforts, you should be understanding and utilizing allocations.
Good allocation practices can provide a better understanding of the “true” cost of your products and services, allowing you to become more competitive, better utilize your available assets and facilitate your management decision making process. Allocations that should be understood and considered for utilization include:
Fringe Benefits – These are the costs incurred by your company for the benefit of your employees. They include:
- Employer paid federal, state and local payroll taxes (FUTA, SUTA, FICA and etc.),
- Workers compensation,
- Paid time-off (holidays, vacations, sick-time, jury duty, bereavement, etc.) referred to as PTO,
- Medical, dental and vision plans,
- pension costs,
- Company contributions to 401(k) and 403(b) plans, ESOP,
- Severance payments and
- Life insurance where the employee, not the company, is the beneficiary.
These costs are traditionally pro-rated over the costs of associated direct labor. Where there are classifications of employees receiving significantly varying levels of benefits (i.e., part time, retired), this category of costs might be segregated and result in multiple fringe benefit rates applicable to the direct labor generated by that group of employees.
Overhead – This category of cost includes those incurred specifically to support your direct labor employees in the performance of their tasks. If your operations are mono-functional, these costs may be included in your general and administrative expense pool eliminating the need for an overhead rate. If your operations are multi-functional (assembly, machining, testing, quality control, etc.), you may want to create separate rates allocable to the direct labor generated by each function. Creating an overhead rate has the benefit of better allocating these support costs to your products and services and, at the same time, competitively lowering your general and administrative expense rate. Performing efforts both at your facilities, as well as, at you customers’ facilities may allow you to gain a competitive advantage by creating a customer/client-site rate and a company-site rate to reflect the lack of expenses and facility costs provided by your customer.
General and Administrative Expenses – Referred to as G&A or SG&A (when it includes marketing and selling expenses) are those costs incurred for the benefit of the entire operation. Examples of costs included here include: executive salaries, finance and accounting, legal, sales and marketing, business licenses and fees, Board of Directors, general business insurance, etc. Bid and proposal (B&P) and independent research and development (IR&D) costs are to be accumulated as a direct project cost with all applicable fringe and overhead loadings and included here by regulation in the G&A expense pool.
G&A (SG&A) expenses are allocated under two basic methods – Total Cost and Value-Added. G&A expenses allocated under the Total Cost method are allocated over all costs incurred by your organization that are not included in the G&A expense pool. G&A expenses allocated under the Value-Added method are only allocated to costs incurred within your organization. They are not allocated to purchased materials or efforts performed by subcontractors.
Material Handling – If your products or services include a significant amount of materials, you may find it beneficial to establish a material handling expense allocation rate. Included in this expense pool, allocated over the value of the purchased material, would be expenses such as purchasing, receiving inspection, stocking and stockroom maintenance expenses, facilities costs, material movement, etc.
Major Subcontracts – When subcontract major portions of your contractual obligations, it might be beneficial to establish a major subcontract allocation rate. This is different from the material handling rate since it pertains to the subcontracting of portions of contract performance that you either do not have the capacity to perform on schedule or the expertise in-house that is needed. It differs from the costs associated with the purchase of materials in that it is more of a contractual relationship with other organizations that you are working with to provide the product or service required. Your organization has minimal administrative expense (i.e. monitoring performance, billing, etc.) associated with these subcontracted efforts and the support they require is primarily the subcontractor’s initial responsibility. If you choose to establish a major subcontract rate, you must use the value-added basis for allocating your G&A expenses so as to not apply your G&A on top of that of the subcontractor.
Service Centers – The use of service centers is an internal process for the allocation of homogeneous grouping of costs to the benefiting multiple indirect cost pools. Examples would include facility/occupancy costs (i.e. rent, depreciation, maintenance, security, etc.) which would be allocated to all operational indirect cost pools based on their usage of facility square footage (cost per square foot) and communications/information technology which can be accumulated and allocated to users in all expense pools based on usage or headcount. Creation of service centers facilitates the budgeting and monitoring process of the costs included in the service center on a total basis versus trying to budget and monitor individual users. It is important to recognize that the costs accumulated in each service center should be completely allocated out at the end of each fiscal period.
Finally, KISS, a play on Keep It Simple Stupid, applicable to your cost allocation processes would be Keep It Simple and Supportable. Be sure to use allocation metrics that are documented in some auditable, easily obtained and supported records that minimize or eliminate the ability to manipulate the resulting allocations.