Shop Burden on Change Order

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We typically bill change orders as either fabricated material, delivery, installation or shop hours , material, delivery and installation.

We are doing a project that we have 5 months of change orders and the owner is questioning the burden on our shop rate. I explained to the contractor that my shop rate included manufacturing overhead and if they wanted to pay based on actual labor cost plus direct hard costs they would have to pay to use the machines by the hour (We submit a labor rates with machine rates with our bid)

This has been going round and round so today I wrote this long wined email which I thought others could use in the future if they need to as reference point.
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Contractor,

Historically change orders have been custom fabricated materials or for other subs material costs + markup plus field labor and it is the field labor where burdens have been monitored.

I doubt the paint manufacturer or drywall manufacturer is providing a cost to make their product.

Part of the premise for this methodology is the sub is onsite, using the space and owner provided utilities to perform the work so the markup is limited because the costs for the sub in the field are limited to labor.

We are making custom goods. As a manufacturer who contracts the installation portion of a contract (field labor) the manufacturing process has different burdens than a sub that only performs field labor.

We have 35,000 square feet of plant, office and manufacturing space. We have about 3 Million dollars in equipment that we utilize to produce the products.

We consume about $3500 a month in electricity.

The $85 shop rate includes normal burdens plus a percentage of indirect and direct costs.
Some of these costs are

Electricity for lights and the machines to operate.

Air and dust collection for the machines that require them

Local air quality district fees for waste (sheet goods) and dust.

Trash created by the waste from material utilized in your project.

Insurance costs for the plant.

Machinery payments and repairs on machines you aren’t being charged to utilize.

Tooling for machines you aren’t being charged to utilize

Use of a forklift to unload materials from trucks you aren’t being charged to utilize.

Use of our ware house to store materials you aren’t being charged to utilize.

Use of our CNC saw to automatically cut parts you aren’t being charged to utilize

Use of our network to transmit computerized programs to the saw you
aren’t being charged to utilize

Use of our Laser tech edgebander to apply edgebanding to parts you aren’t being charged to utilize.

Use of a conveyor part movement system to move parts from one machine to the next you aren’t being charged to utilize

Use of a 5 axis CNC machine to drill shelf holes, dowel holes, back grooves, lock holes, you aren’t being charged to utilize

Use of CNC drill and insertion machine to drill horizontal holes, shoot glue, insert dowel for construction you aren’t being charged to utilize.

Use of pneumatic clamping machines to compress parts at the correct pressure and hold cabinets square while gluing you aren’t being charged to utilize.

The IRS requires us to pay taxes on about 33% of materials and labor as overhead on WIP

https://www.irs.gov/businesses/small-businesses-self-employed/capitalizatio
n-period-of-direct-and-indirect-costs.

https://www.irs.gov/businesses/small-bu
sinesses-self-employed/inventory-manufacturing-tax-tips#wip

Work in Process
The three elements of work-in-process consist of:
• Direct Materials - Materials that become an integral part of the finished product, are consumed in the manufacturing process and are identified with specific units or processes
• Direct Labor - Labor which can be associated with particular units. Labor includes basic compensation, overtime pay, vacation and holiday pay, sick leave pay, and payroll taxes
• Indirect Costs - Costs necessary for production other than direct production costs. Indirect costs include variable and fixed overhead. They may be classified as to type for identification with various activities and to facilitate groupings for determining unit costs. Under prior law, manufacturers were required to comply with the full absorption rules under Section 1.471-11 of the Regulations. The full absorption rules provided three categories of indirect costs associated with production activities

So if this were 12-31-2016 and we had the large amount of unbilled activity I would be recognizing income and paying tax based on the cost of labor, materials and 33% OH.
Manufacturers fall under different tax regulations than most sub-contractors.

I cannot allow the customer to use my 3 Million dollar investment in equipment for free. Just like a crane or excavating machine has a cost separate from the operator so should the use of our machines have an hourly rate on that model.

That will increase your change order costs or they can pay a higher markup on material a lower labor cost and a higher markup on labor based on the IRS regulations (33% cost recovery+12% markup on each). And 12% markups on things like fasteners and glue used in the field.

The most accurate cost method would be for me to document
a) Cost to receive and store materials
b) Cost to move materials to equipment
c) Cost to use each piece of equipment based on the published rates.
d) Cost to move parts between each piece of equipment.
e) Cost to store completed goods because the site was not ready
f) Cost to deliver each delivery
G) Charge for each field visit related to a change order.

So they have a few choices we bill labor at direct cost plus direct burden and they pay to utilize all the equipment they aren’t paying for.

Let me know how you want us to proceed.

Thanks
Alan

Click the link below to download the file included with this post.

Standard_Labor_Rates.pdf

Sea444

Or, you could just quote a price for the change,and get approved in writing beforehand. Giving a customer too much information is always a mistake.

james mcgrew

Member

I am with Sea on this, I refused a bank job last week as it was obvious (And i mean real Obvious) that the young new to the trade GC was going to use me as a professor to teach him his job,

that said most times i simply tell them

"Look please do not compare my rate to a sub who can go to lowes buy pvc pipe or conduit , install it and hand you a bill in 7 days. other wise i will show you where to get the material and once delivered to your site then you can figure out the manufacturing part."

said that to one GC and he fedex'd me a check the next day

Alan F.

Sea, James,
This format for change orders is not voluntary, its incorporated into most commercial bids and contracts we do.

The GC.s ask you to confirm you agree to markup rates, labor rates at time of bid that are part of the contract with owner.

The issue for us isn't providing the information, the issue is only the burden on shop labor, which is what I address.

The owner in this case is one of the largest Universities and they have their own procedures and contracts.

It is a fair process to insure the subs don't overcharge the owner by setting the ground rules at time of bid and incorporating them into the contract.

Some contracts ask for adds and deducts per foot for specific items.

For us its pretty common to break out every change order into shop hours materials and labor.

cabinetmaker

After playing games with a few large universities for approval for payment of change orders after the work was done, I turn in my invoices and proof of delivery and hit them with costs of doing business properly, open 55 gal drum of glue - inspect viscosity and relative weight per oz, inspect shipment for damage, catalog=e and inventory items, office check invoice to packing slips, prep materials for processing through automated machines, inspect parts for qc as they come off, seems tedious and absolutely ridiculous, but the transparency they demand with the money is there and no one can refute the the line items as valid. Haven' held up a payment since.

Yes, we spell out all manufactured work in our proposals as "customized work made to fit the customers facility, that is verified in field to fit the unique space."

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