2). Here’s the amount of material needed and the cost:
Direct materials = 600 square feet of material needed × $5 per square foot
Direct materials = $3,000
Your other direct cost is direct labor. Your staff must cut the wood, paint it, waterproof it, and build the fence. Thinking through it further, your staff must measure and dig postholes. They then fill the area around the posts and nail the fence boards onto the posts, all while keeping everything level. Not easy! It takes real skill and planning. As a result, the owners of Reliable Fencing know it’s best to hire skilled people and pay them a reasonable hourly rate.
Your experience as Reliable’s manager allows you to estimate the labor time needed, based on several factors. You consider the square footage of material needed; the length and height of the fence; and any extra work, such as going around those tree trunks. Here’s your formula for direct labor costs:
Direct labor = hours of labor × rate paid for labor
You estimate that 2 people working 20 hours can complete the job. Using these numbers, you determine the labor cost:
Direct labor = hours of labor × hourly rate paid for labor
Direct labor = 2 workers × 20 hours × $20
Direct labor = $800
Consider one more direct cost. You saw a discussion of mileage expense earlier in the chapter. I’ll dust off that formula again and use it here:
Cost per mile = cost per gallon of gas ÷ miles per gallon for the vehicle
Mileage costs = miles needed for client × cost per mile
You calculate 15 miles (round trip) from your office to the job site. However, the work will be completed over several days. You estimate 45 total miles.
Your trucks get 20 miles to the gallon, and your fuel cost is $4 per gallon. It’s not much, but here is the direct cost for mileage:
Cost per mile = $4 gallon of gas / 20 miles per gallon
Cost per mile = 20 cents per mile
Mileage costs = 45 miles needed for client × 20 cents per mile
Mileage costs = $9.00
So you have three direct costs: materials, labor, and mileage. They are direct costs because they can be traced to the cost object: the Johnsons’ fence.
Calculating indirect costs
To allocate indirect costs, you decide on two cost pools. One pool is your vehicle and equipment costs, and includes depreciation, maintenance, repair, and insurance costs. The other pool is office cost, which includes salary, benefits, accounting costs, and legal costs for your company. The cost object for allocating these indirect costs is the customer base:
| Vehicle and equipment costs | $4,000 |
| Office cost | $7,000 |
| Customers serviced | 200 |
After you resolve how to allocate costs, try to keep it simple. You combine the indirect costs into one amount ($4,000 + $7,000 = $11,000). You then divide the indirect cost total by the number of clients for the month:
Indirect cost allocation rate = $11,000 ÷ 200 customers = $55 per customer
Indirect cost allocation rate = $55 per customer
Your office assistant asks a question: “Is that really fair? What if one client has a $3,000 job, and another’s project is only $500? Should we be charging the same amount of costs to both?” You think about the issue over lunch.
After lunch, you stop by your office assistant’s desk and say: “You know, a client should expect that if we show up for a job of any size we’re going to incur some office and vehicle costs. I don’t think a client will be surprised by those fees.”
The assistant thinks for a minute. “Yeah, that’s fair. If they showed up at my house for a job, those indirect costs seem okay. I guess I’d expect to pay for it somehow. As long as the cost charged to a small job is not huge, I think charging a rate per customer is reasonable.”
You need to weigh the cost and time needed to allocate costs with the benefit of knowing more specific information. If customers generally accept the $55 allocation rate as reasonable, great. Probably no reason to dig further into your indirect costs.
If the majority of your customers have a problem with the rate, you should consider more detailed analysis and present a more detailed indirect cost billing. If not, you may lose the opportunity to do more work with the same group of clients.
Presenting total job costs
Table 4-1 shows the total costs for the Johnsons’ fence job.
TABLE 4-1 Job Cost Sheet — Johnson Fence Job
| Type of Cost | Amount or Quantity | Price or Rate | Total |
|---|---|---|---|
| Direct material | 600 square feet | $5 per square foot | $3,000.00 |
| Direct labor | 40 hours | $20 per hour | $800.00 |
| Mileage | 45 miles | $.20 per mile | $9.00 |
| Indirect costs | 1 customer | $55 allocation | $55.00 |
