Calculating Overhead, Salaried Employees & Direct Labor

[jjg1ttes]

Unless I'm provided with compelling evidence to the contrary, I believe that a portion of the management salaries of my Plant Manger and my Quality Inspector should be included as direct labor for the purposes of calculating realistic overhead.

Does this make sense?

The real question is where to draw the line? How much of a salaried employee's contribution towards customer activity is direct labor, and how much is regular administrative?

We're a job shop, so there's new jobs going on all the time. So, in addition to spending time on new set-ups (directly associated to customer orders), the manager also spends a great deal of time on administrative, job specific activities.

For example, once a customer places an order, the manager might spend an hour drafting a new cad drawing for use on the shop floor to replace a less clear drawing provided by the customer. Also, for every new job, a new, detailed traveller needs to be written up by the manager for the shop labor employees. Depending on the job, there could be multiple travellers, and preparing them could add up to a few hours or more.

Similar issues arise with QC. QC inspects all the imcoming and in process material, as well as final customer product before shipment. Is that direct labor?

thx.
-r

 

[dcasto]

Wide open on how to handle. You are correct that the time sheets for everyone in the company should be allocated to each piece manufactured to get the true picture of the costs and profit margins.

The question comes on how much time and resources need to be expended just to get the exact measurement. Do you want the President filling out time cards? Should there be overtime allocated for salaried exempt people. Basic accounting principles allow for estimates that do not significantly change the accounting accuracy.

Finally, in business it isn't costs that drive profit margin as much as what the market will bare. Some products have huge margins and others skinny. You may spread some costs from your skinny to your high profit, which looks bad, but that skinny product maybe your base load and keeps the bills paid when no other products are on the shop floor.

On the oppisite side, I've seen incremental marginal costs used that put the company in a spril. This is where you state the new product should be hit with no overhead because it was there before the product was added. Soon, deals were being made like this and all the products produced could not carry the company overhead.

You need to find a balance between the two, good luck.

 

[jjg1ttes]

dcasto -

thanks for the input. Your feedback is related to the issued swimming around in my head, but a little to the outside of what I'm concerned with presently.

Allow me to clarify.

Let's assume that the average hourly direct labor wage of the 6 employees in my shop is $15.82/hr.

Now, consider that I have a production engineer earning $900/wk who estimates that he spends, on average, 70% of his time engaged in activities directly related to customer orders.

What I'm thinking here for the purpose of calculating overhead is that I should:
(1) treat that $900/wk as $22.50/hr,
and
(2) that I should then take 70% of that $22.50 ($15.75) and treat that value as the hourly wage of a 7th direct labor employee.

If this is actually a sensible approach, then another question presents itself.
When accounting for the expense of the production engineer's salary (indirect labor) is it appropriate to factor in just the remaining 30% of his salary since 70% of it was applied to direct labor?

what say ye?
-r

 

[IRstuff]

Your example is somewhat unclear, but the 70% needs to be allocated across all the employees that he manages; if that's 6, then it should be divided by 6. That accounts for the "direct" labor.

Indirect and General and Adminstrative would be the remaining 30%, plus bennies, plant/utilities, profit, etc., aggregated across the plant and allocated to each direct employee.

A more comprehensive system might have different I/G&A's allocated differently for line vs. engineering as an example.

TTFN

FAQ731-376

 

[jjg1ttes]

IRstuff -

i'd be glad to clarify if you'd like to comment on what is unclear.

I think I get the idea of what you're saying - spread the DL cost of the managerial staff across the cost of the 6 employees in direct labor staff.

now consider this - what if there are 2 or 3 or more salaried employees who contribute some portion of their efforts to direct labor? Should I just total up the $ value of their contribution and divide that by 6 and add it in?

 

[IRstuff]

That would be the general approach.

TTFN

FAQ731-376

 

[dcasto]

Thanks IR stuff, of course you will need full costs including taxes, insurance and so on.
As Ir pointed out, at some point you may just assume that some engineers and managers just get added back indirectly to the line workers, in any case you end up with a good accounting.
I like to take engineers total costs and apply 50% of it as overhead spread amongst all projects, then have them do an allocation that spreads the other 50% directly to projects. It takes the pressure of making them account for "billable" hours and is explainable to management (customers too).

 

[IRstuff]

Every company has its own financial structure. Most aerospace companies work with a "wrap rate," which is a multiplier against the direct hourly rate. I recall wrap rates on the order of 3x to 3.5x a long while back.

TTFN

FAQ731-376

 

[IRstuff]

Oh, and companies tend to flip-flop on managers; one year they're direct charging, another, they're indirect. Either way, the customer ALWAYS questions why the overhead is so high, or why there are direct charges for supervision. It's annoying.

TTFN

FAQ731-376

 

[griffengm]

jjg1ttes,
Your idea has some academic backing though it may be old enough that things have changed. See what you think.
Some time past, Purdue Ag Econ department broke down time distribution for Managers and salespeople at fertilizer plants(distribution centers). They found that a company could "legitimately" charge about 30% of the salary of these two positions to direct labor justified by the tasks performed. During the seasonal rush, these two people tended to make deliveries, custom mix material and repair equipment.
I've observed that in some shops this dynamic holds true regardless of the product although some go far out of their way to have any hint of it.

Griffy

 

[jjg1ttes]

griffengm -

I think it's interesting that you find my idea to be:

old enought that things have changed.

Since I'm a fairly new manager in the dawn (early morning?) of his career, I'd like to think my ideas are freshly contemporary... perhaps I'm just an old soul when it comes to matters of the shop floor.

Old idea or new, I think I've decided to abandon this quandry for the time being as it's almost too complicated to warrant the extra effort in my calculations...

In any case, I'm making an effort to examine our financials any way I can to develop a better understanding our our overhead and how it affects our pricing strategy for build-to-order work so I can reason with the sales department to stop taking on jobs that seems to be such mega mega losers... i.e. jobs that are easy to get, but end up costing rather than earning us $$

everyone's input so far has been valuable.
-r

 

[MedicineEng]

See it helps:
In my company my department is considered a "services department",that is, ir porvides engineering services to the rest of the company. We charge the "clients" in the following way:
Imagine the following:
Total staff: 20
Mechanical: 12
Mech engineer:1
electricians:5
Elect engineer:1
Secretary:1
Then we only charge mechanical rate and electrician rate To find the hour rate to charge we use:
Mech rate: (Mech cost of salaries and benefits+cost of mech engineer+Cost of department head*12/20+cost of secretary*12/20)/12
Elect rate: (elect costs+elect engineer cost+department head*5/20+secretary cost*5/20)/5

It's not perfect, but it has been working.
This means that if for instance someone asks a job, then the engineer assesses and concludes that is not feasible/needed, there will be no costs to clients.