Industry Insights

In this lagging economy, many construction companies are struggling to find new work, keep their employees busy and fully use their equipment. When contractors are awarded new work, it is often at much lower profit margins. This challenges many construction companies to review their policies on equipment cost allocation and determine if their current rates used to allocate equipment costs are still appropriate.

Setting accurate equipment rates is an important part of management’s responsibilities, as equipment rates are used in determining actual contract profit, allocating overhead and setting and budgeting contract profit in construction bids. Indirect costs associated with equipment include gas and oil, storage, repairs, taxes, insurance, depreciation, etc. These indirect costs are allocated to contracts through equipment rental rates along with direct costs. Many construction companies are using the same equipment rates year after year that are based on outdated data, making this a good time for construction companies to re-examine their equipment cost allocations.

Examples of the financial impact from setting equipment costs too low or too high include the following:

Equipment Costs Set Too Low

AAA Construction has one piece of equipment with an equipment rental rate of $125 per hour. The equipment was being used daily on several contracts, being fully used at 40 hours per week. This equated to $20,000 monthly in equipment costs allocated to contract costs. This rental rate was sufficient to cover all direct and indirect equipment costs and still produced sufficient contract profits.

Due to the recession, AAA Construction now only has a few jobs, and this piece of equipment is only being used at 25 percent capacity. The result is only $5,000 monthly ($20,000 x 25 percent) in equipment costs being allocated to contract costs, which is no longer sufficient to cover all direct and indirect equipment costs, causing equipment losses on already reduced job profits.

Equipment Costs Set Too High

In an effort to compensate for increased equipment costs and/or decreased contract volume, companies are also at risk of setting equipment rates too high. Companies must be careful not to set equipment rental rates so high that they price themselves out of their market, making it harder to win bids. Setting rates too high could result in lost work and reduced profits.

Example: AAA Construction increased its equipment rental rate from $125 an hour to $200 an hour to cover additional equipment costs incurred in times where there is not a lot of construction activity. The contractor must be careful not to set this rate so high that the company will not win future contracts due to increased price competition.

Guidance on Equipment Cost Allocation

Accounting Standards CommitteeTopic 910 states the cost of a contractor’s equipment should be allocated to the particular contract on which it is used on a reasonable basis, such as time, hours of use or mileage. A rate may be arrived at that, based on the reported use of the equipment, will serve as a basis for charging the contracts on which the equipment is used. ASC Topic 910 also outlines factors that should be considered in determining your equipment rental rate, including the cost of the equipment, less estimates of its salvage value; probable life of the equipment; average idle time during the life of the equipment; and the cost of operating the equipment, such as repairs, storage, insurance and taxes.

What can you do to make sure you are using accurate equipment allocation rates?

• Make sure you are aware of all components included in determining equipment costs.
• Make sure you have management employees who monitor equipment rental rates. Companies must have a good understanding of their actual equipment costs and how they affect competitiveness and profits. Equipment rental rates should be re-evaluated during significant changes in a company’s business climate.

Equipment cost allocation is an important part of determining costs of a construction project. Setting these equipment cost allocations accurately can help attain budgeted gross profit on contracts, provide more accurate contract data for future use and accurately bid jobs for further contract opportunities.