Learn the ABCs of activity-based costing

by Dave Wolfenden, CPA, CVA, MS, Managing Director

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Your latest project might be running on budget, but how can you determine whether your work in progress is really boosting profits or hurting the bottom line? Or, if a job is exceeding forecasted costs, how do you break it down to identify the problem?

Many construction companies have addressed such issues by measuring the cost and effectiveness of individual jobsite activities. This is done through an accounting process called activity-based costing (ABC).

Challenge and solution
As you well know, construction sites contain many “parts” — people, machinery, materials. These parts work together to complete a great many tasks, or activities, over the course of the project.

Because of the varied resources used to complete each activity, it can be challenging to calculate and track costs, efficiency and sources and uses of cash. Yet, as a contractor, you need this information to ensure you’re not wasting time, money or resources — and to bid on future projects more effectively.

In a construction context, ABC assigns cost codes (think of them as price tags) to each activity completed onsite based on the resources consumed. These cost codes define the activity; the equipment, materials and labor used to complete it; and how long it takes to finish the task.

Calculating a cost code
Here are four basic steps used to create a cost code in activity-based costing:

  1. Identify activities. Create a list of tasks your company performs to complete a job. Define each activity in such a way that there’s no overlap between them.
  2. Allocate resources. For each activity, list resources used. These include material, equipment, labor hours and subcontracting costs.
  3. Calculate the per-unit cost of each resource.Determine costs using purchase receipts. (You may have to calculate an average cost based on purchase receipts for a specific period.) Choose a standard, measurable unit of each resource and calculate the cost per unit. For example, if a box of screw anchors holds 100 and costs $30, the per-unit cost of screw anchors would be 30 cents if you consider one “unit” to be a single screw anchor. For labor hours, the measurable unit would be the wage paid per hour.
  4. Determine how much of each resource is used for each activity.Multiply the per-unit cost of each resource by the number of units consumed. Add indirect costs to determine the total cost; these may include rents, machinery payments, salaries and other expenses that don’t directly contribute to completing an activity.

Powerful benefits
Construction companies can use ABC to more accurately estimate the cost of each activity and evaluate the process involved, as well as apply those cost estimates to future bids. The process could benefit your construction company in several powerful ways:

Gain insight into what’s working and what can be improved. If a job is costing more than it should, or is taking too long to complete, ABC prices out and quantifies for each task:

  • The materials consumed,
  • Which pieces of equipment were deployed, and
  • How many labor hours were spent to complete.

You then examine that analysis to identify wastefulness and adjust as necessary. When used correctly — that is, with ongoing reporting by project managers — ABC can track the progress of jobs in real time, so you can correct mistakes and inefficiencies before losing money to them. You also may be able to uncover excessive spending trends, so you can better control purchasing.

Identify what’s profitable and what isn’t. The combination of direct costs (resources consumed, such as materials) and indirect costs (expenses not solely related to one project) can make it difficult to pinpoint which jobsite activities are effective and which either aren’t adding value to a project or are causing wastage.

ABC provides the means to collect the necessary data on specific tasks, employees and equipment so you can determine what’s helping the project and what isn’t. Thus, for strategic planning purposes, the process can provide a clearer picture of what types of activities and jobs will likely boost the bottom line and enable you to grow your construction business.

More accurate estimates. Because ABC gives you a more detailed look at the elements driving the cost of each jobsite activity, you can naturally devise more precise estimates. With price tags attached to everything, estimators can “cut up” a prospective job into well-defined activities and then calculate estimates for each of those tasks, resulting in a more accurate overall project estimate.

If the scope changes, thereby increasing or decreasing the number of activities, it’s much easier to recalculate the estimate. Activities essentially become line items that can be added or deleted.

An intriguing challenge
Please note: We’ve provided here a basic overview of ABC, but don’t construe this article as comprehensive or complete coverage of the topic. Also, bear in mind that implementing ABC is neither easy nor instantaneous. Software is available that can help shorten the learning curve, but you should still expect to face an arduous training process to get everyone onboard.

Discuss the idea with your CPA to get a better idea of precisely how ABC could be applied to your construction company’s projects and whether it’s right for you.

We welcome the opportunity to put our construction industry expertise to work for you. To learn more about how our firm can help advance your success, please contact Dave Wolfenden at (302) 254-8240.

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