Wrap Rate Technique Chapter 14

Introduction The Wrap Rate technique is a method used to allocate profit and other overhead costs to actual labor costs. Total Cost equals – Direct Labor Cost – plus Overhead Cost – plus Other Costs

Direct Labor Many of our cost estimating relationships use labor hours as a parameter, or predict cost in terms of labor hours. There are two major categories of direct labor: – Engineering » Activities associated with research, design, and development or preparation of products and procedures. – Manufacturing » This is the “hands-on” effort to produce a product.

Wrap Rates Once we have determined the labor hours required to produce an item, either by performing an engineering buildup or by applying a cost estimating relationship, we need a means of converting those hours to dollars. A fully-burdened labor rate is a rate which includes all the contractor costs necessary to convert an estimate of contractor hours to contractor dollars. The wrap rate will typically include the direct labor wage rate, overhead costs, and other costs.

Wage Rates Four general factors impact the labor wage rate: – Variations in Geographical Locations » Supply and Demand of Work Available – Contractor Labor Force Variations » Supply and Demand of Workers – Variations in Skills » High skills vs. low skills – Variations with Time » Inflation » COLAs

Overhead Rates Also known as Indirect Cost or Burden. These costs are not directly identifiable with a specific cost objective. There are two distinct types of overhead costs: – Those that are so general in nature they cannot be assigned to a specific cost objective » Plant and equipment maintenance – Those that are so inconsequential that the cost of accounting for them exceed the benefits derived from doing so. » Consumables such as washers, sandpaper, lubricants.

Overhead Rates Most firms collect indirect costs in aggregate cost accounts called overhead pools such as – Manufacturing and Engineering Indirect Pools – General and Administrative Pools – Service Center Pools

Overhead Rates Most common Indirect Cost Pools: – Material Overhead: Costs related to transportation, acquisition, inspection and handling of materials. – Manufacturing Overhead: Indirect labor costs including supervision, inspection and maintenance. – Engineering Overhead: Costs of directing and supporting the activities of the Engineering Department. – General and Administrative: The costs of the company’s general and executive offices.

Overhead Recovery Bases In order to recover overhead costs it is necessary to allocate the indirect costs to the cost objective. This allocation results in charging the cost objective a share of the total indirect costs. Bases often include: – Direct Labor Hours – Direct Labor Dollars – Number of Production Units – Machine Hours

Other Costs The last piece needed to build a fully burdened wrap rate is “Other Costs.” “Other Costs” typically include – Profit (or fee) – Cost of Money – General and Administrative

Calculating a Wrap Rate Ship Hull Manufacturing Engineering Quality Control Tooling Manufacturing Direct Labor Overhead Mfg. Materials Other Costs Profit Cost of Money General & Admin Wrap Rate Components Wage Rate Overhead Other Costs

Calculating a Wrap Rate Example: Estimate the fully burdened contractor support cost given the following information: Given: – Expected contractor support is 120 man-months – Contractor support wage rate is $52.50 per man-hour – 160 man-hours per man-month – Overhead rate is 150% of Direct Labor dollars – Other Cost rate is 15% of (Direct Labor dollars + Overhead dollars)

Calculating a Wrap Rate Wage Rate = $52.50 per labor hour (CY98$) Overhead Rate = (150%)(Wage Rate) = (150%)($52.50) = $78.75 per labor hour Other Cost Rate = (15%)(Wage Rate + Overhead Rate) = (15%)($ $78.75) = $19.69 per labor hour Wrap Rate = Wage Rate + Overhead Rate + Other Cost Rate = $ $ $19.69 = $ per labor hour

Calculating a Wrap Rate Total Labor Hours = 120 man-months X 160 man-hours per man-month = 19,200 man-hours Fully burdened contractor support cost is $ X 19,200 man-hours = $2,898,048 (CY98$)