- Cost Accounting
- Allocating Costs
- RPA Internal Indirect Costs
- University Indirect Costs (Negotiated Federal Overhead Rate)
An RPA must approach the rate calculation process carefully, so as to gain a good understanding of the business issues and monetary risks inherent in providing goods and services for a fee. This is especially important if the RPA will serve federally funded activities where most agreements are for the reimbursement of costs only, and charges are subject to audit and disallowance by both federal and state auditors.
In building rates for goods or services, departments should follow generally acceptable accounting principles and reasonable cost accounting practices. Cost accounting is generally defined as one of three types.
- Job Costing
Costs for an individual good or service (a job) are tracked, added up, and billed to the customer while work is in progress or when the job is completed.
- Example: DoIT repairs your computer on a time and material basis and charges you for the actual time and materials used in the repair (job).
- Process Costing
Time studies or other analyses are performed to determine the cost of a product that comes from a defined process. Based on the studies a price is set for the individual, saleable items that are generated by the process.
- Example: The Research Animal Resources Center routinely tests all incoming lab animals as well as regular testing of on campus animals for infectious diseases to ensure that labs stay disease free. Based on time and cost studies of each process, fees have been set for various kinds of tests. A researcher who buys a new animal is charged for each test conducted on the animal. Pricing is based on the calculated cost of conducting the test during the previous year or some recent period.
- Byproduct Costing
A saleable product or service (the byproduct) results from an activity that was not undertaken to generate the byproduct. The costs attributable to the byproduct, because they are part of the cost of a primary good or service, are generally not assigned to the byproduct.
- Example: Selling reports left over from a seminar or workshop because the reports topic has become relevant to a larger audience. The original reports may have been provided as part of a seminar/workshop fee. The selling price may be set based on the additional costs to distribute the report or on market conditions and not necessarily on the original costs.
After the specific good or service has been identified, the first step in calculating an appropriate rate is to look at exactly what it will cost to provide the good or service to be sold. In developing rates for the coming fiscal year, you should consider anticipated cost increases in prices and/or usage for the cost components used in the good or service.
Identify each cost component (both direct and indirect) that goes into the production of the good or service, then determine what portion of those costs will be recovered through user charges. The two most common cost components that make up user charges/fees are labor (salary and fringe benefits) and materials (supplies and expense).
After determining the costs to be recovered, identify a method for measuring the product or a unit of service (some common measures are time, a test result, or a deliverable item) and consistently assign costs to that unit. The staff responsible for the RPA must discuss the measure of service and the rate calculations with their Deans office, and if necessary Accounting Services. For purposes of rate documentation, a simple rate is the easiest to document.
The time an employee puts into making a product or providing a service becomes part of the cost of that good or service. How you compute the labor rate for an individual depends on what funding the individual is paid from (some funds must pay for fringe benefits while other funds do not), and whether you are attempting to recover the full cost of the labor.
If you are computing the labor costs for the coming year, include any anticipated increase in salary and fringe benefits in the calculations. If rates are being calculated for the first year of the biennial budget cycle and the salary rate increase is unknown, the Office of Auxiliary Operations Analysis (AOA) can provide an estimate for use in rate calculations. If you are calculating rates for the second year of the biennial budget cycle both the Madison Budget Office and AOA can provide the actual rate of increase.
Components to consider in calculating rates include:
- Assignable Hours
Before you establish an hourly rate for the labor component of a good or service, you must determine the hours that are to be used as the denominator in calculating the cost per hour. The cost per hour should be determined for each employee involved in providing the good or service. The number of base hours available for a full time employee is 20801; however, no one actually works that many hours on a job. To determine the hours a person is available to work (assignable hours), you must subtract hours (sick leave, vacation, and holidays) that are not assignable from the base hours available. The result is the assignable hours for an individual. The adjustment for sick leave and vacation usage should be based on the individuals historical use pattern.
Example: If Employee A is a full-time classified employee with less than five years of service his assignable hours would be calculated as follows.
|Sick Leave used||104|
|Total Assignable Hours||1796|
To ensure the accurate calculation of assignable hours an RPA should use actual leave hours used during the preceding year in computing total assignable hours. That is, use the actual sick leave and vacation hours taken, rather than hours earned. Most employees use less than the total sick leave earned in a given year and often bank vacation in a sabbatical account, thus deducting earned rather than used hours results in an understatement of assignable hours.
If an employee works less than full time, unassignable time must be prorated based on the percentage of employment for the base period.
Example: An employee who works half time would only earn one-half the number of vacation days. Ten days (two weeks) for a full-time employee*50%= five days.
Another example to take into account is an employee who only works Mondays through Thursdays. This employee will not receive credit for holidays falling on Fridays.
Current sick leave and vacation information for employees is available in the Employee Handbook.
- Billable Labor Rate
The simplest approach to determine a billable rate is to take an individuals annual rate of pay plus fringe benefits2 to arrive at the total cost of an individual. Divide that cost by the assignable hours available (as described above). This method is the most practical for incidental billing for personnel time by a small RPA that does not attempt to recover the full cost of a service.
Salary for Classified Employee A $30,000 X 41% Fringe Benefit Rate $12,300 Total $42,300 $42,300/1796 Hrs. = $23.55 per Hour
Fringe benefits are not charged to fund 101 at a department level; therefore, they may not be included in rates charged to internal users. When charging other users, use the current fringe benefit rate charged to grants and contracts. For current rates see the index of notices from Research and Sponsored Programs.
For RPAs operating from fund 128, fringe benefits should be included in the rates based on what is actually paid for each person payrolled from the operation, or an average for a group of employees with the same class3. The use of actual fringe benefits more accurately reflects costs to the RPA than the published rate, which reflects the average cost of benefits for a class of employees, campuswide. Salary and fringe benefit class codes can be found in the class code manual.
An RPA that has multiple employees of the same or similar classifications generally combines them into one group and calculates assignable hours for the group as a whole. Total salaries and fringes are then divided by total assignable hours to determine a billable labor rate for the group as a whole. This is not acceptable if the employees have a wide difference in pay scale. For example you cannot combine a $5 per hour student employee with a $45 per hour classified employee and have a $25 billing rate for the student.
If an RPA is required to recover the full cost of a service4, it must calculate billable hours before it can set a labor rate for goods or services or allocate indirect labor costs associated with a given good or service. This is a more complicated process because individuals are generally involved in other tasks that are not directly billed to customers. An RPA must first determine chargeable hours before calculating a labor rate.
- Chargeable Hours
To establish a billing rate for a full recovery RPA, you must determine the total hours billed and/or assigned as indirect costs to specific activities in a previous cycle (normally a fiscal year) for each individual or class5 of individual. The number of chargeable hours must be supported by time records that identify the cost centers/jobs for which each individual or class of individual worked. If the labor contributions of employees are assignable to specific goods or services, the full costs of their labor can be allocated to those goods or services. However, if employees are tracked or billed on an hourly basis, that same basis must be used for allocation. Estimates of chargeable hours are only acceptable in the first year of an operation.
Example: Employee A works in a shop where he spends most of his time working on specific jobs, however he must maintain shop equipment and do some paperwork. Chargeable hours are calculated as follows:
|Total Chargeable Hours:||1796|
|Less: Equipment Maintenance||396|
- Full Cost Labor Rate
To arrive at the full cost labor rate simply divide total labor cost for an individual or class of individuals by chargeable hours. The cost of any hours assigned to non-billable activities (internal overhead) is then allocated as an indirect cost (see below) of the RPA to the goods or services provided. Any labor assignable to a specific job is charged as a direct cost to that job at the calculated labor rate.
Example: Employee As Salary and Fringe equals $36,000/1200 chargeable hours = $30.00 per hour (full cost labor rate). If the employee spends two hours working on an identified project, that project is billed for the time (2 hours x $30 per hour = $60). If the same employee spends two hours on maintaining equipment used by the RPA, the value of that labor is charged to internal overhead, which will be allocated to goods and/or services.
- Indirect Labor
Indirect labor is the labor costs associated with a given good or service that are not specifically identifiable with that good or service. The cost of indirect labor is accumulated during a production period and then assigned to that good or service along with other expenses based on a predetermined allocation formula. Indirect labor may be allocated directly to a good or service or to an indirect cost function of the RPA that will be allocated to all goods and services of the RPA.
Example: Employee A spends two-thirds of his chargeable time (800 hours) working on billable projects. The other third (400 hours) are spent maintaining equipment used in the cell sorting. The value of these hours (400 hours x $30 = $12,000) becomes part of the indirect labor cost of the cell sorting process. Because the maintenance is not associated with a specific production run on the cell sorter, it is not job specific and thus becomes indirect labor. If the center charged for use of the cell sorter by the run, the allocation base for the indirect labor could be cost/number of production runs.
Example: Employee B, a senior technician, runs the department machine shop (billable labor rate of $50 per hour). She has 1,500 chargeable hours. She spends two-thirds or 1,000 hours on billable projects and one-third or 500 hours on supervising technicians working on billable projects. The 500 hours are indirect labor hours, and thus part of the internal shop overhead.
If the shop billed labor by the hour, the cost of this indirect labor would be added to the billable labor rate. Billable labor rate times the supervisory hours (500 x $50 = $25,000) equals the cost of indirect labor.
Divide the indirect labor cost for the period used to calculate rates by the total number of billed hours for all the shop employees during the same period. For example, If the shop had 5,000 total billable hours ($25,000 indirect labor cost /5,000 billable hours = $5.00 labor surcharge). An hourly rate of $55.00 ($50 billable labor + $5.00 overhead) will recover the unbillable hours of the supervisor from all projects.
1Use 2,080 hours (260 working days) per year as a standard base for rate calculation for full time hourly employees and academic staff. Although academic staff are not hourly employees and may work more than 2,080 hours per year, 2,080 hours is considered the standard.
2Fringe benefit rates are published annually by the Office of Research and Sponsored Programs for use in wriring grant proposals.
3Fringe benefits are identified by class codes associated with different classifications of employees such as classified staff, academic staff, faculty.
4Full cost means the total cost of operations including internal overhead. Typically, fund 128 RPAs fall into this category. Sales price must be set so that all costs charged to the fund 128 operation are recovered.
5Class of individual means a group of employees with similiar titles and wage rates, and performing essentially the same service. Examples include laboratory technicians or machinists.
Material is usually a part of the product you are selling and as such is either directly or indirectly assignable to the product. In most cases, the actual cost of the material will be allocated to a good or service.
If a department maintains an inventory of materials for resale, the valuation of such materials must follow standards known as generally accepted accounting principles, a body of rules codified by the Financial Accounting Standards Board (FASB) and other rule-making bodies. Acceptable valuation methods include:
- actual purchase price,
- weighted average of all the prices paid for the same item in stock,
- last in, first out (LIFO) based on the assumption you use the last item received first when filling an order, and
- first in, first out (FIFO) assuming you use the first item received when filling an order.
The price charged to the user, or allocated to a good or service for individual items must be based on one of the above valuation methods.
The cost of materials used in a product are either directly identifiable and thus easy to allocate to the product, or indirect and not clearly identifiable as a part of the product cost. As with labor, the allocation of indirect material must be on a logical and consistent basis.
- Direct Materials
When material can be directly identified as used in a product or the process by which a product is made, it is a direct cost to the product. Examples would be the photocopy charges for pages included in a class handout or a circuit board in a custom made electrical device. If the RPA is an animal care facility, feed is direct material, as would be shipping charges for delivery of goods produced.
- Indirect Materials
Often materials are used by an RPA that can not be specifically associated with the product sold. These become indirect costs of the RPA and must be allocated to the product rather than directly assigned. Examples would be paper for the FAX machine used by the RPA or the maintenance agreement for a piece of equipment owned by the RPA, but not used in production, and the cost of software used for bookkeeping purposes. General office supplies are another common indirect cost of an RPA.
Cost allocation is the process by which costs not directly identifiable with the goods are assigned to those goods in a logical and consistent manner. This allocation is necessary to accurately determine the full cost of each product. To recover the costs of operation an RPA must carefully allocate all expenses to be recovered. These costs are then recovered as the goods are sold. Where possible, the costs directly identifiable should be assigned to the individual good. Unfortunately, many costs associated with a good or service cannot be directly identified with it. This makes it necessary to allocate both direct and indirect costs. To do this an RPA must establish a logical and consistent basis for allocating costs. Following are four typical cost allocation methods.
- Units of production
If you sell a single product, divide the total cost of operating the RPA by the number of units produced (not the number of items sold).
Example: If you run a departmental photocopy center from fund 128, divide the total expenses of the center for the previous year by the total number of copies produced for sale in that year to arrive at a per copy base rate to be charged per copy in the coming year. In this example, spoiled copies and those produced and used internally are indirect costs of the RPA and excluded from the calculation of cost per copy.
|Department Total Expenses||$80,000|
|$90,000/1,800,000 copies are sold = $.05 per copy|
If you sell multiple products, some equivalent unit measure could be used to arrive at units of production.
Example: If your RPA runs an animal care facility with mice and rats, a time and materials study might find that care of four mice in a cage is the same as one rat. One rat would be the measurement unit, with four mice being the equivalent of one rat. Generally, the largest product becomes the base, with a calculation required to determine equivalency.
- Billable hours
If you bill labor directly, the allocation of costs can be based on the previous years actual billed hours. Divide the total expenses of the RPA for the previous year by the total number of billed hours for that year. This cost per billable hour becomes next years base labor rate. If you have any unbillable customers, their hours must be included in the billable hours used as a denominator so that costs are spread equally over all users.
Example: If your RPA bills on a labor hour basis you can allocate indirect costs to your good or service by dividing anticipated indirect costs by projected hours of service.
Prior Year Billed Labor Hours $5,000 Est. Additional Hrs. Due to a new Grant $1,000 Total est. Billed Hrs $6,000 Prior Year Actual Indirect Costs $15,000 Est. Addn'l indirect Costs of Added Work 3,000 Total est. Indirect Costs $18,000 $18,000 est. Indirect Costs/6,000 Hours = $3.00 per hour surcharge
Both anticipated indirect costs and projected hours must be based on actual amounts from the prior year and adjusted for expected changes for the coming year. Annual projections must also include a comparison of the prior year's projection to actuals as a benchmark of accuracy.
- Production Time
If you only bill for the end product, but labor is the major component in a good or service, you can allocate indirect costs based on the number of hours (or minutes) it normally takes to build the product or provide the service. Such an allocation must be based on periodic time studies of the production process.
Example: If your RPA does lab testing of samples, personnel directly involved in the testing should periodically keep track of the time to perform the test (a time study). Each time the test is timed, the results should be compared to the previous study, and if appropriate a new basis established for the time required. If no major variances occur in the time to test, the rounded average over the most recent periods could be used as the benchmark for the test.
The following steps show how to compute the indirect cost per test:
- Multiply the total number of tests performed in the previous year, times the number of minutes required to do the tests to arrive at total production minutes; (800 Blood screening tests performed X 20 minutes per test = 1600 production minutes).
- Divide total indirect costs for the period by total production minutes to arrive at a cost per minute; ($320 indirect cost of blood screening/1600 production minutes = .20 indirect cost per minute).
- Multiply the indirect cost per minute times the number of minutes per test to arrive at the indirect cost per test; (.20 indirect cost per minute X 20 minutes per test = $4.00 indirect cost per test).
- Total production minutes = total number of tests performed in the previous year * number of minutes per test.
- Cost per minute = Indirect costs per minute/total production minutes.
- Indirect cost per test = indirect cost per minute * minutes per test.
- Space Occupied
If the service provided involves the rental or use of space by the customer, a logical base is the number of square feet of space. It can also be refined to include the number of days used (an occupancy rate) for the year. If the RPA provides specialized lab space to users on a square foot basis, calculate the cost of providing the space as follows:
- Divide the total number of square feet available for the year by the total number of square feet rented for the same year. This yields a percentage of occupancy.
- Divide the total cost of providing the space by the total number of square feet that can be rented for the year to arrive at a gross cost per square foot for the space.
- Finally, divide the gross cost per square foot of space by the percent of occupancy to arrive at a price per square foot, based on actual occupancy.
Example: The Controlled Plant Growth Lab has 10,000 sq. feet of greenhouse space available for rent to researchers. During the year they actually rent only 8,000 sq. feet. 10,000/8,000 = 80% occupancy.
It costs $40,000 to provide the space during the year. $40,000/10,000 sq. feet = $4.00 per sq. foot (gross cost)/80 (occupancy rate) = $5.00 per sq. foot, actual cost of providing the space.
- Equipment Usage
Equipment usage is a variation of space occupancy. If you rent a piece of equipment, you can calculate the number of rental days available (usually working days) and divide that by the actual number of days rented. The result yields the percentage of days in use. Divide the annual cost of providing the piece of equipment by the gross days available, then divide the result by the percentage of use to determine the actual cost per day of rental - based on usage.
Video camera rental - 200 days rented/250 rental days available = 80 % days in use
$2500 total annual cost to offer a camera/250 days = $10 per day
$10 per day/80% = $12.50 per day actual cost based on usage.
The above examples may not fit a particular RPA because of unique characteristics of the activity. If another method is used, that method should maintain an equitable distribution of costs in a logical and consistent manner to all goods and services provided.
NOTE:You must adjust the following years rate by any new costs that are predictable or known to be forthcoming. A prime example is labor costs. The State authorizes a pay plan increase each July; therefore, labor costs should be increased to recover such an increase. Likewise, if you know a professor in your department has just received a sizeable grant and will be doubling your production, factor the change in production projections. There are always cost increases, and failing to make appropriate adjustments for such increases will lead to financial losses.
As discussed, there are indirect categories of both labor and materials in any RPA. While some can be directly attributed to a good or service, many cannot. Those that cannot are RPA indirect costs and must be accumulated and then allocated to the goods or services sold.
Many RPAs sell more than one good or service. If so, you must add a step in the cost allocation process. Find a common denominator, or denominators, for all your goods and services to use in the distribution of RPA indirect costs. This allocation base might be direct labor hours, units of product made, or paid animal care days. What you must identify is a comparable denominator by which to divide (allocate) the indirect costs between products. Then assign all indirect costs to each good or service.
Example: Billing costs could be allocated based on the number of orders billed. Support costs could be allocated based on the number of orders or calls received requiring support. Supervision could be based on the number of FTEs in each production unit.
The Media Services clerk spends 400 hours per year handling billing and collection for tapes sold. His labor rate is $24.00 per hour.
400 hrs x $24.00 per hr. = $9,600
Media Services sends 3,200 invoices per year
$9,600 cost/3,200 invoices = $3.00 per order handling charge for labor.
Do not allocate subsidized costs to a product unless the product is sold to external customers. When selling to external customers an RPA should ensure they are recovering full costs.
Example: It is standard practice to add the federal overhead rate (as a percentage of total costs) to external bills. If an RPA operates from fund 101, which does not have to pay fringe benefits on salaries, but only assesses the federal overhead rate, the UW is subsidizing the external customer. The RPA should add the appropriate fringe benefits to any salary charges before assessing the federal overhead rate. The total indirect costs can then be added to the good or service as part of the calculation of full cost and sale price for each. If an RPA has identified departmental subsidies in the rate calculation process that are not included as part of the user rate, these costs should also be added back to the costs of goods or services in arriving at the external rate.
Service Center internal billing rate is $32.00 per hour for direct labor. For an external customer:
Labor $32.00 X 10 hours = $320.00 Fringe Benefits $320X41%= $131.20 $451.20 Univ. Overhead 44% X 451.20= $198.53 Total External Charge $649.73
Depreciation is an accounting practice used to allocate the cost of a capital item over its useful life rather than expense the full cost of the item in the year of acquisition. The decision of whether or not depreciation may be included in rate calculations depends on:
- The RPA funding;
- Whether the users are internal or external; and
- Whether the equipment to be depreciated was originally purchased from federal funds.
An RPA may not include depreciation expense on any federally funded equipment in its internal user rates. Replacement cost of future equipment purchases may not be built into depreciation rates, only the actual cost may be used.
The following should clarify the policy:
- If the RPA is a fund 101 operation, depreciation expense may not be included in the rates, except when charging external users.
- If the RPA is a fund 128 operation, depreciation may, under certain circumstances, be included in the rates charged to internal users, other UW System institutions, and Wisconsin state agencies as long as the equipment was not purchased from federal funds (fund 144).
- If the equipment was not purchased from fund 128, special arrangements must be made with the Office of Research and Sponsored Programs to exclude such equipment from the equipment base used for calculating the federal indirect cost rate. These exclusions are necessary to avoid double recovery of costs through overhead charges to federal funds.
- When charging external users, depreciation may be included regardless of the funding source used to purchase the equipment.
- Equipment purchased under a lease/purchase arrangement may be depreciated as long as the lease payments are not also included in the rates.
To include equipment depreciation in user rates, the RPA must maintain a depreciation schedule documenting:
- The item's original cost (acquisition price plus shipping and installation);
- Original source(s) of funding;
- The items included in the rate calculation;
- Individual useful life6;
- Salvage value; and
- Annual depreciation expense.
In most cases, shipping, installation cost and salvage value is negligible and need not be considered. If an item is added to a depreciation schedule at a point after initial acquisition, its depreciable value must be reduced for its accumulated depreciation at the time it is added to the schedule. Charges may only be assessed for the annual depreciation for the year in which the rate is calculated. Depreciation expense may not be assessed for an asset after it is fully depreciated or has been disposed.
6Depreciation is calculated on laboratory equipment using a useful life of eight years. The useful life for computer equipment is five years. Deviation from these guidelines must be documented.
University indirect costs are compiled for recovery of costs in connection with federally funded projects. This is done in accordance with detailed federal rules and the final Modified Total Direct Cost (MTDC)7 rate is negotiated with the federal government. University wide indirect costs are assessed against research projects by the Office of Research and Sponsored Programs through the university accounting system. This overhead charge may not be assessed against internal customers. Overhead should, however, be assessed to external customers.
7MTDC consists of all salaries and wages, fringe benefits, materials and supplies, services, travel; and up to the first $25,000 of each subgrant and subcontract. Equipment, capital expenditures, charges for patient care, tuition remission, rental costs, scholarships and fellowships as well as the portion of each subgrant and subcontract in excess of $25,000 shall be excluded from the MTDC.