Total job costs
Deciding on costing for IT consulting projects
If you manufacture lawn mowers or provide landscaping services, job costing is pretty straightforward. With the help of this book (a shameless plug), you’ll understand the types of costs incurred, and be able to assign costs as either fixed or variable.
Cost accounting gets more complicated when you work in a consulting role — someone who gets paid for what they know. Doctors, attorneys, and architects are good examples. Sure, you can measure the hours worked by the consultant, but what about other costs? The costing process may get confusing, and you may not determine the total costs accurately. You know what that means: Without the correct total cost, you can’t price your product to reach a specific profit level.
As technology advances continue, business owners need more IT consulting help. In fact, you may be writing checks for IT services right now (and maybe I should have picked IT as a career). Since everyone needs IT help eventually, let’s use IT to understand how consultants use job costing to manage their businesses.
In this example, assume that Everest Investment Management is a money manager, and the owners need a better system to provide their clients with monthly investment statements. Customers benefit from statements that are clearly labeled, use colors, and present financial data using charts and graphs. Investors need to know where they stand financially, and a well-designed statement is a huge added value for customers, particularly for clients who are not financially savvy. I hope you’re buying what I’m selling here.
Determining project needs
Prestige IT is asked to bid on Everest’s project, and Julie the owner starts to document the steps required to complete the project. So, what needs to happen to get a better investment statement to customers? Mull over these steps:
Discussing the project with staff. Julie must understand how statements are currently created, and what customer feedback reveals about the current format. After a long discussion and follow-up communication, the Prestige team and the Everest staff must agree on a list of needed changes.
Building a prototype. Next, Julie uses what she learned to create a new version of the statement. Everest supplies a fictitious list of customer securities and the customer’s buy and sell transactions for stocks and bonds. Prestige’s software program produces a statement, based on the trading activity.
Implementing the new software. When the Everest staff agrees that the software can produce accurate statements, Prestige must take all the existing client data and use the new software to generate customer statements. This is the hard part — just ask anyone who works in IT about converting to a new system. The process requires careful data management and testing, and each statement must be reviewed for accuracy. Everest needs accurate statements to comply with industry regulations, and to serve the needs for customers.
Whew! That sounds like a ton of work. How much is this going to cost?
Plugging in job costing
Use job costing when each product you make or service you provide has a unique set of costs. I think you’ll agree that job costing is needed for the Everest project.
At this point, step back, take a deep breath, and think about four types of costs originally discussed in Chapter 2: fixed costs, variable costs, direct costs, and indirect costs. Ready to do this? Let’s tackle them in two chunks: fixed and variable, then direct and indirect.
MULLING OVER FIXED COSTS AND VARIABLE COSTS
Prestige IT has a big variable cost, which is the hours that Julie and her IT staff spend on the project. To compute costs, Julie simply multiplies a billable hourly rate for each staffer, multiplied by the expected hours worked. However, it’s not possible to forecast the exact number of hours of labor required.
If you work in a consultant role, provide a range of hours required for the job, based on your best estimate. In this example, Julie forecasts 800 to 1,000 total hours, and hours greater than 1,000 require prior approval from Everest. This approach prevents any client surprises, if more hours are needed to complete the work. As long as you document how the hours were used and what work remains, you can justify the extra hours needed to complete the project.
Prestige will have other variable costs, including travel, office supplies, and possible subscription fees for specialized software used for the project.
There may also be a small amount of fixed costs related to the project. For example, Prestige may purchase a commercial liability insurance policy, to protect the firm against a client lawsuit. While many firms have these policies in place, Prestige may need to pay an additional premium for the Everest project risk exposure.
SEPARATING DIRECT COSTS AND INDIRECT COSTS
To this point, Prestige has analyzed direct costs, meaning costs that can be traced to the project (both fixed and variable). To determine total costs, Julie must allocate indirect cost. You’ll find a fascinating discussion of direct costs and indirect costs in Chapter 2.
Here are Prestige’s largest indirect costs:
Home office costs: Salary and benefits paid to office support staff, and the lease payment on the office building.
Asset depreciation expense: Prestige purchases hardware and software for use on many customer projects, and buys office furniture. Each of these assets incurs depreciation expense.
Prestige also incurs marketing and advertising costs, which are indirect costs. These costs are allocated, based on a level of activity (labor hours, number of customer projects, and so on.) You can allocate indirect costs more precisely using activity-based costing, which is explained in Chapter 5.
Taking a Closer Look at Indirect Costs using Normal Costing
In this section, you apply indirect costs to your product or service. You also plan direct and indirect costs using a normal costing system. Actual costs represent what comes out of your checkbook. You determine actual costs after the work is completed. Normal costing instead uses budgeted data, which is generated before the work is completed. Normal costing uses a budgeted price or rate and multiplies that rate by the actual quantity used.
It’s difficult to plan your work without some budgeted rates of cost. That’s the purpose of normal costing. The process creates budgeted rates that you can use to plan your work. You don’t have to wait until the end of the job
