case study - overhead costs analysis - lean project · pdf fileresource-based costing and ......

Proceedings IGLC-10, Aug. 2002, Gramado, Brazil
CASE STUDY - OVERHEAD COSTS ANALYSIS
Yong-Woo Kim1 and Glenn Ballard2
ABSTRACT
Construction projects become complicated and fragmented so that many specialtycontractors are involved. In such changed environments, a general contractors overheadcosts are increasing comparable to direct costs. In addition to an increase of volume,activities consisting of overhead costs play an important role in coordinating differentparticipants who include different specialty contractors and client.
This paper reviews traditional overhead control and critiques problems thereofthrough literature review, interviews with professionals, and data collection. It proposes anew overhead cost control method, called profit-point analysis (PPA) applying activity-based costing (ABC). It is followed by a case study presented to exemplify the newmethod.
KEY WORDS
Construction overhead costs, activity-based costing (ABC), profit point analysis (PPA),nurturing relationship
1 Ph. D. Candidate at University of California at Berkeley, [email protected] Research Director at Lean Construction Institute (LCI) and Associate Adjunct Professor at University
of California at Berkeley, [email protected]

Yong-Woo Kim and Glenn Ballard
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INTRODUCTION
Construction projects become complicated and fragmented so that many specialtycontractors are involved. In such altered environments, a general contractors overheadcosts increase comparable to direct costs. In addition to the increase of volume, activitiescontributed to overhead costs play an important role in coordinating different participantsthat include different specialty contractors and client.
However, the construction industry has not changed the method of controllingoverhead costs in construction projects. Traditionally, construction overhead usesresource-based costing and volume-based allocation (Kim and Ballard 2001, Holland andHobson 1999). Resource-based costing is the method in which costs are assigned by eachresource, and volume-based allocation is the method of cost allocation in which costs areallocated to cost objects in accordance with the volume of direct labor hours, direct laborcosts or contract amount.
This paper criticizes the traditional overhead costing in construction projects andproposes a new costing method as an application of activity-based costing. It is followeda case study to exemplify the new method. The study is confined to the perspectives of ageneral contractor, who is subcontracting most works. It is noted that numbers regardinga case study are modified because they are confidential to a company.
PROBLEMS IN TRADITIONAL OVERHEAD COSTING
The current method of overhead costing would result in the following problems:
COST DISTORTION HINDERS PROFITABILITY ANALYSIS
Construction projects have different cost codes for each resource such as project engineeror manager. They treat overhead costs separately and do not assign overhead costs towork divisions such as earthwork or to participants such as subcontractors. However, theyassign overhead costs to work divisions in proportion to direct labor hours or direct laborcosts when owners request the assignment of overhead costs (Sommer 2001). Suchvolume-based allocation results in cost distortion (Cokins 1996, Johnson and Kaplan1987, Horngren et al. 1999).
The problem of current practice regarding overhead assignment is that companies donot know real costs for each work division and those for each participants such assubcontractors because either they do not assign overhead costs or they use a uniform costdriver (i.e., direct labor costs) for assignment of overhead costs. Therefore, it is difficultto find where money is being made and lost because progress payments for each workdivision or building from clients contain overhead costs. In other words managementshave difficulty in doing a profitability analysis.
LITTLE MANAGEMENT ATTENTION TO ACTIVITIES OR PROCESSES OF EMPLOYEES
Little management attention is paid to activities or processes since every cost is assignedand reported resource by resource. In other words, little management attention is paid tosupporting activities. As a result, managements do not have information on how muchresources and what services are provided to participants such as subcontractors. It doesnot help nurture relationships with the subcontractors.

Case Study - overhead costs analysis
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PROFIT POINT ANALYSIS
This study adopts activity-based accounting (ABC) tool because activity-based costinghas been advocated as a means of overcoming the systematic distortions of traditionalcost accounting and of bringing relevance back to managerial accounting. It is necessaryto review activity-based costing because the proposed method is based on activity-basedcosting
ACTIVITY-BASED COSTING
Traditional cost accounting has been criticized for cost distortion and the lack ofrelevance during the last 20 years (Johnson and Kaplan 1987). A traditional systemreports where and by whom money is spent on, but fails to report the cost of activities andprocesses (Miller 1996). Many organizations, including petroleum and semiconductorcompanies in the manufacturing industry, have adopted the new costing method, activity-based costing (ABC).
There are two purposes of activity-based costing. The first is to prevent costdistortion. Cost distortion occurs because traditional costing combines all indirect costsinto a single cost pool. This pool is allocated on the basis of some resource common to allof the companys products, typically direct labor. Cost distortion is prevented in ABC byadopting multiple cost pools (activities) and cost drivers. The second purpose is tominimize waste or non-value-adding activities by providing a process view. Thisobjective can be achieved by activity analysis and (or) the function of monitoringactivities.
PROFIT POINT
This study assumes that contracts between a client and a general contractor, and betweena general contractor and subcontractors are fixed cost-based contracts. Suppose there is ageneral contractor who is using 100% outsourcing (specialty contracting) in performing aproject. Project management costs under the assumed condition depend largely on how tomanage different subcontractors, each of which performing one or a few work division(s).
The suggested overhead costs analysis method would determine the costs (especially,management costs) at each point (we call it profit point) where a company andsubcontractors are interfaced. This would result in revealing the flow of costs and profits.A profit point is the point where organic relations between the participants are met, ratherthan neglected. It is noted, though, that the proposed cost analysis model does not takeinto account the relationship between subcontractors.
PROFIT POINT ANALYSIS
Profitability information compiles from a companys management activities, which willbe collected at profit points in a construction site by using an activity form. Then theresult of activity analysis is applied to multiple cost objects. In our model, managementareas, work divisions / participants, and facilities are regarded as cost objects. Figure 1shows a three-dimensional cost object in our model from the perspective of a project.

Yong-Woo Kim and Glenn Ballard
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Subcontractors(W ork Divisions)
ABC Contractor
DEF Contractor
XYZ Contractor
Quali ty Control
Safety c osts
Scheduling
M anagement Area
Faci lities
Bldg #1 Bldg #2 Bldg #3 Bldg #4
Figure 1: Multiple Cost Objects
In addition to cost information for work divisions, costs for each management area willalso be known. It would give a company insight into the relationship between a companyand its subcontractors because management areas such as safety control are the core of acompanys business activities in a project. On the other hand, current accounting systemsput every cost information to cost accounts which combine profit points. It might result inpreventing a company from understanding the relationship with subcontractors.
A case study was performed to find the usefulness and limitations of this analysis,which is discussed in the following section.
CASE STUDY SUN MICROSYSTEMS PROJECT PHASE III
PURPOSES
There are three purposes of this case study, which are as follows:
The case study is to test the feasibility of PPA (profit point analysis),
The case study is performed to explore difficulties / limitations ofimplementation, and
The case study is implemented to find usefulness of PPA results.
METHODS AND PROCEDURES
The case study lets each employee use the new method and collect data from employees.For the purpose of data collection, a database is made using Microsoft Access 2000. As away to test and validate the new method, a set of information that the new method createswill be presented to several professionals. Then, professionals and researchers will beable to implement a qualitative analysis for evaluating the new method. There are sixsequential procedures to meet the purpose of this case study, which are as follows:
The first step is to identify the current practice with which overhead costs arecontrolled in the project. In this step we use document collection andinterviews with a project manager.

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The next step is to id

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