An Audit Primer
Labor burden is the cost to a company to carry their labor force aside from salary actually paid to them. Simply stated, burden is the benefits and taxes that a company must or chooses to pay on their payroll. These can include, but are not limited to, all of the following:
- Payroll Taxes – both Federal and State
- Retirement/Pension Costs
- Health Care
- Life/AD&D Insurance
- Worker’s Compensation Costs
- Long-Term Disability Insurance
- Short-Term Disability Insurance
From the standpoint of Johns Hopkins, labor burden should be the actual cost of labor and should not include any mark-up or profit to the contractor. All profit should be included in the proposed fee on the job during the bidding process. However, some contractors continue to try to profit on their labor burden to ensure they have a competitive fee and thus a better opportunity to win the job. Hopkins Internal Audit makes its policy to audit all construction management contracts over $2m. The review of labor burden tends to be a large piece of that and has produced some of our largest findings. Some examples of these findings are listed below:
- Payroll taxes charged exceed statuatory limits
- Profit sharing costs charged dependent upon the success of the company (i.e. not a customary benefit)
- Insurance costs charged at rates higher than actual cost to company (this occurs oftentimes in situations when a contractor is self-insured)
- Including costs in benefits, such as bonuses on highly compensated employees, for individuals not working on the project
- Including costs not associated with the labor (e.g. home office costs or information technology costs)
As many of the items included in burden at the time of the RFP are based on estimates, it is not surprising that the actual costs typically vary from those estimates. From our experience, typical actual labor burdens average somewhere between 30-40%.
Our audits of labor burden have taken two tracks, (1) reviewing the labor burden after the project has commenced or is complete and (2) reviewing burden before the project has begun. Attempting to review the burden after the project has commenced or is complete makes extracting cost savings very difficult as the contractor has already received payment. Holding retainage has not always been an option because general contractors will withhold retainage from the subcontractors creating the potential for liens on the project and poor contractor relations. In recent years, OHIA has moved away from this process and attempted to review the burden beforehand. Although accompanied by its own issues such as deciding how the actual costs should be determined, reviewing the burden and then agreeing with the contractor on an acceptable rate before the project begins saves a great deal of time and frustration at the end of a project. This allows the project to be closed in a much more efficient and timely manner. From an audit standpoint, once the burden rate has been agreed to, we simply need to ensure that it is being honored and that no unauthorized labor costs (e.g. home office costs) are being charged through general conditions.
Alternatively, based on our past audits, the Johns Hopkins University and Health System has begun shifting toward a fixed burden to be noted in the RFP. This burden percentage is specified by JHU regardless of the contractors actual burden cost. Contractors, with actual burden costs higher than the fixed rate, are forced to increase their fee to recover them (or maintain the same fee and take less net profit). Contractors whose burden is less than the fixed rate offered may choose to lower their fee to increase their ability to win the job. The fixed burden rate may also be subject to adjustment on a yearly basis if agreed to by JHU and the contractor.
Labor burden is a difficult topic to understand and get to the bottom of. However, it is important to stress that burden typically should not include any profit, markup or expenses unrelated to employee compensation, but should be the actual cost to carry the labor. Having hidden profit in the burden does not create a fair pricing environment when in competition with other contractors. It is Hopkins Internal Audit’s goal to ensure that contractors stay in compliance with this idea to ensure that the selection of contractors and the cost paid by Johns Hopkins is both fair and reasonable.