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Equipment Expenses & The Contractor

Today I got into a discussion regarding the various methods of accounting for equipment expenses for contracting businesses.  These are all the costs associated with an equipment fleet including registration, license fees, insurance, depreciation, maintenance, modifications and repairs.  Depending on the type of contractor these costs range from insignificant up to 30% or more of their annual costs. 

Some contractors simply choose to look at these costs as overhead.  Depending on the type of business this is usually an inaccurate allocation of the costs since they are really indirect job costs - costs that are incurred as part of constructing a project but not directly attributable to a specific project.  Assuming that the business is looking at these costs as indirect costs there are a couple of ways to allocate them. 

The simplest method is to simply allocate the costs to individual projects as a factor of labor, total revenue or using some other methodology.  There are strong arguments for this method including the fact that it takes very little time to manage throughout the year and strictly from a reporting and accounting standpoint when looking at the project portfolio for the year this method seems to be within a reasonable range of the more challenging but also most accurate method of utilizing internal billing rates for equipment as described below. 

Utilizing internal billing rates on either an hourly, weekly or monthly basis for equipment is the most accurate method of allocating indirect equipment costs to individual jobs.  The goal is to set equipment billing rates that over the course of the year will offset the total cost of the equipment fleet based on utilization on your projects.  This method requires additional paperwork, accounting data entry, management and possibly an upgrade of the accounting system to one with an equipment module.  As stated previously this is the most accurate method of recovering equipment costs but if it requires all the additional work and systems and doesn't produce substantially different accounting results then the simpler allocation methods then why go to the extra trouble? 

If you are a contractor where equipment utilized varies significantly based on the particular job and equipment makes up at least 20% of your job costs then the proper utilization of that equipment can make a huge difference in your job costs and therefore your profitability.  Running a business successfully is all about the proper utilization of resources; cash, people, material and equipment. 

I believe that people will make the right decisions if given the right information.  If you show someone how to save 10% on their job costs by changing their mix of people and equipment then they will make the right decisions every day.  If equipment costs are charged to overhead or allocated then there is no direct connection in their minds between taking an extra truck to the jobsite and additional costs.  This creates a culture of hording and feeling like the job is constantly being over-charged for the use of the equipment.  This drives poor utilization of equipment resources and that costs money every day. 

On the other hand if equipment is charged directly to the job at a rate then when estimators bid the job they have an exact number to work with and when people including project managers, superintendents and foreman take a piece of equipment to the job they know exactly what the cost will be.  When they are trained to track productivity and plan efficiently they will decide to take one truck with three people in it rather than two trucks.  Even if there are two trucks available in the yard it is still more efficient to leave one in the yard - less fuel, less risk, less wear & tear.  They will choose to work overtime to get a job done to avoid a second day of equipment utilization costs - thus making the equipment and the crew available to be utilized elsewhere. 

Again, depending on the specifics of the business but in general these little decisions made every day by every employee add up to a lot of money at the end of the year and will far outweigh the costs of implementing an equipment tracking system.  For more information regarding whether this could benefit your company look into a Rapid Construction Company Analysis (RCCA) which is potentially a free assessment. 
Posted by David on February 7, 2005 10:30 PM|Permalink

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