Payroll Charged to Projects

Dear Dave
Perhaps you could settle a discussion we have been having at our office about assigning payroll to individual projects. Our engineering firm has three principals, two of which spend more than half of their time working on projects. The principals’ salaries are higher than what we pay non-principal engineers of similar capability and experience because the principal salaries also include a large premium for their management duties.

The issue becomes that each time a principal charges time to a project it is at their full salary rate (which includes the management premium) which makes its difficult for some projects, with significant principal involvement, to show a "profit". Our project managers get frustrated because they are held accountable for project profit and because profit is a key component of their personal yearend bonus plan.
JB MN

Dear JB
This is not an uncommon issue. Short of client contractual constraints or agreements to the contrary, there are two basic approaches.

As a way to cope, some firms will develop both a "Job Cost Rate" and a "Payroll Rate" for each staff member. For the majority of employees in most firms, the two rates are the same. But in situations as you described, the job cost rate (the hourly dollar amount that gets charged to a project) might be a rate lower than the payroll rate based on a determination by that firm of what a particular staff member contributes to the project as an engineer. The excess of the payroll rate over the job cost rate becomes part of the firm’s general overhead and is spread across all projects along with other common costs such as heat, light, rent, etc. Today’s engineering firm accounting software packages each have provisions to accommodate this practice.

Some firms purposefully choose to do nothing and charge the full payroll rate to each project. They want each project to reflect the exact actual payroll incurred on each project and not increase the firm’s across-the-board cost of doing business by adding back the excess of payroll over job cost to general overhead. The thinking being that if particular clients, or project types, routinely require disproportionate high-priced staff time, they want to spot that and adjust the fees charged for those projects to include this cost and avoid having to increase the firm’s overhead cost of doing business to all other projects or clients who do not.