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Two Ways to do Labor Cost Allocation


Labor Cost Allocation

There are 2 methods of doing labor cost allocation: standard cost and actual cost. Each has its own benefits and limitations; choosing which option is better, is a unique decision for your business. In the end, it all starts with following one or the other.

By understanding which solution best suits your business, you’ll be able to implement accurate job costing; this results in reduced expenses, better budgeting, increased profits, and accurate price setting of future jobs. Those are big benefits.

Download eBook 28 Ways to Improve Your Business's Cash FlowWe’re going to walk you through each method and how they can apply to your business–but first, we’re going to provide some additional information on terms you’ll need to know for the rest of the article.

Important Terms...

  • COGS (Cost of Goods Sold) are the costs attributed to producing goods sold by a company–this includes labor and material costs
  • Job costing is putting costs to deliver your product or services into the COGS section on the income statement. It’s moving those costs above the line and into COGS accounts (which for service businesses and nonprofits typically consists of 70-80% direct labor, in addition to direct materials, vendors, and third parties)
  • Direct labor costs are payroll (gross wages), payroll taxes and benefits (health insurance, 401k, deferred compensation, Aflac, parking, uniforms, fringe benefits, PTO, and training)
  • Indirect labor costs include travel, employee engagement expenses (such as prizes, bonuses, and team building)
Many business owners fall into the trap of not calculating ALL costs involved in project work. Don’t underestimate labor costs, as this can affect your overhead and bottom line!

Now let’s go into the two methods of appropriating these costs, and how they affect your business model.

Standard Costing

Standard costing means you assign a predetermined estimated cost to your labor, materials, and overhead. For QuickBooks users, it’s very easy to do job costing when you pay your bills because the accounts payable function has job costing built-in for the materials. It’s the time and overhead that can make things tricky.

You can complete this costing model by coming up with an average dollar value of cost for a standard hour of work. This can be achieved by either person or position.

Although this option is simplified, it’s not preferred (though, it is better than not doing any kind of labor cost allocation at all). The advantage of standard costing is that it’s inexpensive to establish and easy to implement. You set it up once and there’s no upkeep or money required to maintain it.

However it does come with a price, the price of inaccuracy–especially over time. Since it’s no one’s job to manually go in after payroll is run and update the standard cost rate (with variable compensation such as raises, bonuses and job changes) over time, standard costing becomes meaningless.

Suddenly, the lines become blurred and it’s difficult to know which of your clients or projects are most profitable. You undercount what the cost rate should be, which affects your profitability.

The reality of a standard cost rate is that you need to review it on a quarterly basis, or preferably, a monthly basis (depending on how often things change with payroll) to reconcile it with your actual cost. You must reconcile; too many businesses don’t do this when using standard costing–what they call to “true up the costs”–and don’t adjust the cost to make them true again.

Sure, costs may have been true back in December when you last viewed them, but if you gave out a quarterly bonus or any raises in Quarter 1, then, at the end of the quarter, you need to “true it up” again. That means you need to reconcile it to the general ledger or the accounting system.

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Actual Costing

Your other option is automating the process, which is a preferred method and simple to do in QuickBooks; the entire process of reconciling, that is. You don’t need to reconcile with the actual job cost method–which we’ll go into shortly–because standard cost involves reconciling to your actual expenses, your actual salary, benefits and taxes.

When you use the Actual method, there’s no need to reconcile. By using this method, you save time because you’re already “trued up.” Every time you change someone’s salary or their health insurance changes, for instance, those are the actual costs that you charge to customers in jobs.

This second method, the actual method, is accomplished through a combination of timesheets inside QuickBooks and Intuit payroll or Insperity workforce optimization. These services are the only 2 that offer fully automated, time-driven and activity-based job costing in a QuickBooks system environment.

(As you may realize from this, you don’t need to reconcile because any changes in payroll or benefits are what actually gets charged in that time-driven, activity-based costing.)

With this method, the mistake you don’t want to make is focusing solely on salary, salary + taxes, or, at most, salary + taxes + labor costs.

You’re missing salary + taxes + health insurance as your total labor cost.

As a result, you’re dramatically understating total labor costs. As we mentioned with standard costing, business owners don’t really see their profits correctly because profits are a guessing game, whereas, with actual costing, you can see exactly what costs are by person. You can also add an allocation of overhead on top of that, on a per-hour basis (the indirect labor cost).

From here, you take the direct salary, taxes, health insurance, 401(k), and whatever else you want, and allocate it using the appropriate optimization job costing.

You need two things in order to do this. Number one is TSheets and number two is Intuit or Insperity’s Workforce Optimization.

Using Intuit

Intuit pays the payroll and the taxes. If you run your 401(k) through a paycheck, they will record it. But they don’t handle health insurance.

For health insurance, you must work with a separate company. You go to Allstate or State Farm–whomever–and you pay a separate bill for health insurance. When Intuit payroll does the actual job costing, it only allocates what Intuit paid–which doesn’t include health insurance.

Using Insperity

InsperityUnlike Intuit, Insperity Workforce Optimization pays for everything. It pays salary, taxes, health insurance, and 401(k). If you provide someone a bonus, it pays the bonus. If you pay for uniforms, they’re added to the job cost. Insperity allocates the whole direct labor costs. Everything is allocated with Insperity for 100% true labor cost allocation.

Either solution, though, is fantastic and better than using an indirect method.

QuickBooks Best Practices for Optimal Job Costing

For accurate and holistic job costing, timesheets needs to be integrated with QuickBooks. We recommend Tsheets, because it is the #1 time tracking app that integrates with Quickbooks and we love using it.

Manually entering timesheets into QuickBooks is just too expensive and time-consuming. Manual entry typically involves paying someone–usually in the $45/hour range with fully loaded labor costs–to actually key in data.

You’re wasting cash having them chase down people who manually enter data into a spreadsheet (or some other form like an email) and retyping them into QuickBooks. That’s, unfortunately, what most businesses do.

This isn’t a best practice because there’s a high risk for error, not to mention it’s labor-intensive. There will always be the looming “somebody has to do this when they have time,” and it’s a pain for the business. No one wants to do it.

With Tsheets, you can make a simple Start or Stop button accessible through your employees’ iPhone, or use their GPS system to automatically fill out a timesheet or call it in. Once the timesheet is transferred to QuickBooks, it utilizes a built-in feature that allows you to use timesheets to generate payroll.

When you run payroll, payroll is automatically posted inside QuickBooks, pulling in allocated information from what’s on the timesheet. By having time at the economic unit, the customer or job level, you can generate true profitability by tagging each job.

You can then:

  • Add custom fields to a job form
  • Track the sales rep. who sold a job
  • See profitability by industry, team, sales rep, and marketing campaign

Once you’re able to accomplish this you will be able to track profitability at the smallest kernel–the smallest unit of measure. It’s all part of the magic of job costing. You want to job cost at your smallest relevant unit of measure, so you can measure performance against that metric.

This will help you answer some key strategic questions: Are you pricing your jobs right? Who should you hire? Who should you fire? Where should you spend your money?

With proper job costing and management reporting in place, you can build reports that show you profitability any way you want so you can make better decisions. Doing so helps you run better, grow faster, and make more money.



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