Overhead Rates

The ability to control program costs involves more than tracking labor dollars and labor hours; overhead dollars, one of the biggest headaches, must also be tracked. Although most programs have an assistant program manager for cost whose responsibilities include monthly overhead rate analysis, the program manager can drastically increase the success of his program by insisting that each program team member understand overhead rates. For example, if overhead rates apply only to the first forty hours of work, then, depending on the overhead rate, program dollars can be saved by performing work on overtime where the increased salary is at a lower burden. This can be seen in Example 14-2 below.

Example 14-2. Assume that ApexManufacturing must write an interim report for task 1 of project 1 during regular shift or on overtime. The project will require 500 man-hours at $15.00 per hour. The overhead burden is 75 percent on regular shift but only 5 percent on overtime. Overtime, however, is paid at a rate of time and a half. Assuming that the report can be written on either time, which is cost-effective—regular time or overtime?

• On regular time the total cost is:

(500 hours) X ($15.00/hour) X (100% + 75% burden) = $13,125.00

(500 hours) X ($15.00/hour X 1.5 overtime) X (100% + 5% burden)

Therefore, the company can save $1,312.50 by performing the work on overtime. Scheduling overtime can produce increased profits if the overtime overhead rate burden is much less than the regular time burden. This difference can be very large in manufacturing divisions, where overhead rates between 300 and 450 percent are common.

Regardless of whether one analyzes a project or a system, all costs must have associated overhead rates. Unfortunately, many program managers and systems managers consider overhead rates as a magic number pulled out of the air. The preparation and assignment of overheads to each of the functional divisions is a science. Although the total dollar pool for overhead rates is relatively constant, management retains the option of deciding how to distribute the overhead among the functional divisions. A company that supports its R&D staff through competitive bidding projects may wish to keep the R&D overhead rate as low as possible. Care must be taken, however, that other divisions do not absorb additional costs so that the company no longer remains competitive on those manufactured products that may be its bread and butter.

The development of the overhead rates is a function of three separate elements: direct labor rates, direct business base projections, and projection of overhead expenses. Direct labor rates have already been discussed. The direct business base projection involves the determination of the anticipated direct labor hours and dollars along with the necessary direct materials and other direct costs required to perform and complete the program efforts included in the business base. Those items utilized in the business base projection include all contracted programs as well as the proposed or anticipated efforts. The foundation for determination of the business base required for each program can be one or more of the following:

• Actual costs to date and estimates to completion

• Proposal data

• Marketing intelligence

• Management goals

• Past performance and trends

The projection of the overhead expenses is made by an analysis of each of the elements that constitute the overhead expense. A partial listing of those items is shown in Table 14-7. Projection of expenses within the individual elements is then made based on one or more of the following:

• Historical direct/indirect labor ratios

• Regression and correlation analysis

• Manpower requirements and turnover rates

• Changes in public laws

• Anticipated changes in company benefits

• Fixed costs in relation to capital asset requirements

• Changes in business base

• Bid and proposal (B&P) tri-service agreements

• Internal research and development (IR&D) tri-service agreements

For many industries, such as aerospace and defense, the federal government funds a large percentage of the B&P and IR&D activities. This federal funding is a necessity since

Project Management Made Easy

Project Management Made Easy

What you need to know about… Project Management Made Easy! Project management consists of more than just a large building project and can encompass small projects as well. No matter what the size of your project, you need to have some sort of project management. How you manage your project has everything to do with its outcome.

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