South Africa Allocation of bonus (job costing, projects)

[dhariwal57]

Hi,

How can one allocate annual bonus to all the projects/jobs (for a company which is purely job/project oriented). Annual bonus is based on annual performance and allocating it to the projects for the last month would be wrong. How can one apportion it to all year projects. Should one accrue? but then we dont know what would be the bonus amount.

Thanks
Khalid

 

[Fidget]

This largely depends on how the bonus scheme works.

If it requires all targets to be met to be payable, then don't accrue anything until it is more likely than not that it will be paid out - this is likely to be the last period of the year and paid in the first period of the next year. If it's paid in the last period of the current year (unlikely) then you don't need to accrue anything.

If it is payable on individual targets being met, then you can start accruing it from the point each target is met.

There's many ways you could apportion it, but it all depends on how the scheme works and what the performance targets are. You could apportion it on a time basis, or headcount on each project, % of value of jobs/projects etc. It's hard to say without knowing more about it.

 

[Counterofbeans]

This is simply an estimate. At the beginning of the year, if you/management believes the company will pay out bonuses at year-end, I'd start accruing bonus expense on some systematic and rational basis. Continue doing this, adjusting the YTD bonus accrual to what the best estimate of how much the company will pay, on a monthly basis. If/when it becomes believed that the Company won't pay out any bonuses, you have no choice than to reverse the previously recorded bonus expense. All of this is pursuant to the idea of a change in estimate.

In terms of how to allocate it to all the projects, I can't help you here; I'd need more information.

 

[dhariwal57]

Thanks for the reply.

The scenario is that the company is 100% IT services project based. For each project a Job Card is created where one allocates direct labour, salaries of project staff is allocated to "Project Cost of Sales" based on times spent on different projects - formula in use: Salary * %(Employee Time on Project A/Employee Time on All Projects) and in-direct costs (Office expenses are also allocated to Project Overhead). Since one does not know how much time will be spent by project, time sheets are posted every day and at the end of month cost is allocated based on total time spent on the projects for the month. For example, Employee X worked 80 hours on Project A and 20 hours on Project B then 80% of Employee X's salary is allocated to Project A and 20% of his salary is allocated to Project B. There is around 60 hours may be not related to project but then still that time is allocated in the shape of overall salary allocation. Problem comes in when there is bonus. This is direct expense but one does not know till the end of year as to one will get the bonus or not (same applies if the employee leaves before the end of the year).
Question is if one should accrue the bonus on monthly basis and allocate to the project? Or one should capture it at the end of the year and then allocate to the projects for the year (cumbersome process). If the bonus is accrued but not paid then what should one do?
At the end of the day, one wants to look at the project profitability in a true sense.

Thanks

 

[Fidget]

It seems quite similar to where I work. We have people costed to a base contract - to which their salary and other costs are charged, but over each month some will work on other contracts. At the end of each month a reallocation is done to transfer associated costs based on time spent on other contracts so that the month end accounts reflect the true costs across contracts.

There's also a similar bonus scheme whereby all targets must be met at the year end (and the employee still in post) for the bonus to be payable.

In terms of the bonus, nothing is accrued until the year end because it's at that point that we know if the bonus is payable or not. It usually is, but we don't know for sure until each year end. So nothing is accrued until the year end.

To apportion it, we use time spent on contracts - this is 100% on a single contract for some and a % split based on the monthly transfers over the year for others who've worked across contracts. The apportionment is quite straightforward as all the information is there re who worked on which contract over the year.

If you really feel the need to try and reflect an end year bonus payment in month end accounts, then you're creating work for yourself, but it can be done. You must know, or be able to calculate, the maximum bonus that would be payable assuming all targets met at the year end with amount of staff currently in position? So what you'd need to do is produce your normal (no bonus allocation) month-end accounts and show alongside that, an adjusting figure that shows the position with the partial bonus allocation. To be honest though, I can't see any value in actually doing that as it's a year end bonus rather than a monthly bonus.

 

[Counterofbeans]

In terms of the bonus, nothing is accrued until the year end because it's at that point that we know if the bonus is payable or not. It usually is, but we don't know for sure until each year end. So nothing is accrued until the year end.

This is not correct accounting. Estimates in accounting are commonplace and necessary to fairly present financial statements in accordance with GAAP, especially insofar as bonuses are concerned.

If you really feel the need to try and reflect an end year bonus payment in month end accounts, then you're creating work for yourself, but it can be done.

Replace, "can" with, "should"

To be honest though, I can't see any value in actually doing that as it's a year end bonus rather than a monthly bonus.

The value is that the matching of bonus expense is much more aligned with the corresponding revenue. To put all the expense into the last month of the year is patently incorrect. Of course, if there is significant doubt and/or management doesn't believe that the year-end bonuses will be paid, then nothing should be accrued until it's probable, but that's a different issue than (1) not recognizing the benefits and (2) not doing it because it's additional work.

 

[Fidget]

This is not correct accounting. Estimates in accounting are commonplace and necessary to fairly present financial statements in accordance with GAAP, especially insofar as bonuses are concerned.

GAAP is concerned with how end of year financial statements that will be made public are presented, GAAP is not concerned with internal month-end accounts. It is absolutely fine, and indeed correct, to show an accrual in the last period of the year for an annual bonus that only comes due to be paid when it's more likely than not that it will be paid - ie, the last period of the year, at which point a reliable estimate, if not exact amount, of the bonus due to be paid will be available and accrued, and conforms perfectly, to GAAP.

The value is that the matching of bonus expense is much more aligned with the corresponding revenue.

yep, that's another way of apportioning it.

To put all the expense into the last month of the year is patently incorrect.

It's perfectly correct. That's how the scheme works - don't know until the year end, so it's patently wrong to try and put it into each month when you've no idea if it will actually be paid or how much. Best you can do is a comparative figure per month, but as I said before, I don't really see the point of that.

Of course, if there is significant doubt and/or management doesn't believe that the year-end bonuses will be paid, then nothing should be accrued until it's probable, but that's a different issue than (1) not recognizing the benefits and (2) not doing it because it's additional work.

Management, I'm quite sure to the extent of 100% sure, will be aware that an annual bonus scheme is in place that may or may not have to pay out at the end of the year. Yet, I'm also sure to the extent of 100% sure that it is the year end overall performance of the organisation they will be thinking of. Otherwise, they'd've done a monthly bonus scheme.

 

[Counterofbeans]

GAAP is concerned with how end of year financial statements that will be made public are presented, GAAP is not concerned with internal month-end accounts. It is absolutely fine, and indeed correct, to show an accrual in the last period of the year for an annual bonus that only comes due to be paid when it's more likely than not that it will be paid - ie, the last period of the year, at which point a reliable estimate, if not exact amount, of the bonus due to be paid will be available and accrued, and conforms perfectly, to GAAP.

LOL, no.

GAAP is concerned with the measurement of economic activity, the time when such measurements are recorded into the GL, the summarization of such economic activity in the form of financial statements and the disclosures surrounding such. It has little/nothing to do with, "end of year financial statements that will be made public are presented." It has NOTHING to do with whether a company is public or private or whether financial statements are to be used internally or externally. You will never find any definition of GAAP, anywhere, that resembles that definition. As a matter of fact, I'm literally stunned that you could possibly believe that is the definition/concern of GAAP.

If someone wants to use internal financial statements that follow different rules than GAAP/externally generated financial statements (which I would refer to as the, "correct" financials), that's fine, but there is a risk in doing so and everyone who does such should be made aware of that drawback/difference. Ultimately, the cash in the bank is what it is and the financial statements, once the appropriate GAAP accruals are made, are what they are...

Insofar as a bonus accrual is concerned...

The technically correct answer is as follows:

If management, based on the information at hand, believes it is probable (& it can be reasonably estimated) that a bonus will be paid at (in reality, "shortly after") year-end, when financial results are finalized, then it IS appropriate & required to accrue the bonus expense in a systematic and rational manner on a monthly basis. Difficulty in measuring an obligation is NOT, by itself, a reason for not recording a liability if the amount can be estimated.

These current liabilities fall under the category of, "The payee is known but the amount may have to be estimated" accrual.

You continue to make reference to a, "more likely than not" threshold. That is not correct in this situation. That is a FIN 48 (codified at ASC 740) threshold, which has nothing to do with bonus payments.

It's perfectly correct. That's how the scheme works - don't know until the year end, so it's patently wrong to try and put it into each month when you've no idea if it will actually be paid or how much. Best you can do is a comparative figure per month, but as I said before, I don't really see the point of that.

No, it isn't. You are just wrong here.

When I read comments such as:

In terms of the bonus, nothing is accrued until the year end because it's at that point that we know if the bonus is payable or not. It usually is, but we don't know for sure until each year end. So nothing is accrued until the year end.

you are going to have a tough time rationalizing how not to accrue for it before year-end.

The idea that you, "don't know for sure until each year end" is patently incorrect & not appropriate. ESTIMATES are often KEY in preparing financial statements.

Clearly, a nonpublic company has much more room for negotiation than a public company, but that doesn't make it technically correct.

I go through this exact discussion each and every quarter with my auditors, Ernst & Young (& Deloitte and Touche prior to them). I have even asked this question for ~10 years while working at Deloitte and Touche myself. If you continue to insist that I'm wrong, I don't know what to tell you except that you aren't following GAAP.

 

[Counterofbeans]

Question is if one should accrue the bonus on monthly basis and allocate to the project?

The answer is yes, if management believes it is probable that such bonus will be paid out and you can reasonably estimate it.

I don't know your bonus program, but I'm willing to bet you could come up with something reasonable.

Or one should capture it at the end of the year and then allocate to the projects for the year (cumbersome process).

No, unless the threshold above isn't met.

If the bonus is accrued but not paid then what should one do?

You have no choice but to reverse the previous expense and related accrual. This would simply be a change in estimate.

At the end of the day, one wants to look at the project profitability in a true sense.

Thanks

Exactly. This is precisely why you'd want to accrue for the bonus if it is probable that a payment will be made at/near the end of the year.

 

[Fidget]

you are going to have a tough time rationalizing how not to accrue for it before year-end.

The rationale behind it is actually very straightforward. In the absence of specific guidance on the matter we have been applying the principles of FRS 12 on provisions. Hence we only accrue when it is probable/in all liklihood/more likely than not - take your pick - that the bonus will be paid out. That point does not occur until the last period of the year for us, hence we accrue in the last period of the year, and our auditors have no issue with this.

FRS 102 has now been issued, which does give specific guidance which, as it turns out, is basically the same as what we've been applying:

Recognition: Profit-sharing and bonus plans

28.8 An entity shall recognise the expected cost of profit-sharing and bonus payments only
when:

(a) the entity has a present legal or constructive obligation to make such payments
as a result of past events (this means that the entity has no realistic alternative but
to make the payments); and

(b) a reliable estimate of the obligation can be made.

So, as you can see, we've been correctly accounting for our bonus scheme all along.

 

[Counterofbeans]

Lmao...

Oh, so you're saying that an accrual is necessary when (1) a payment is probable and (2) it can be estimated?

Gee, what did I say above?

So, as you can see, you are accouting for it exactly as I stated it should be above.

 

[Fidget]

Lmao...

Oh, so you're saying that an accrual is necessary when (1) a payment is probable and (2) it can be estimated?

That's what I've been saying all along. Hallelujah! You've finally got it!

 

[Counterofbeans]

That's what I've been saying all along. Hallelujah! You've finally got it!

Unfortunately, this:

In terms of the bonus, nothing is accrued until the year end because it's at that point that we know if the bonus is payable or not. It usually is, but we don't know for sure until each year end. So nothing is accrued until the year end.

[emphasis added]

is NOT the same thing as saying, "probable." You do NOT need to know for sure if you are going to pay it or not in order to accrue to an expense in this situation. That's a different threshold. It simply needs to be probable. As such, in your situation, that must mean it isn't probable until near/at year-end that the accrual becomes probable. In the future, I'd recommend you choose your words a little more carefully.

And don't even get me started on your embarrassing definition of GAAP...

 

[Fidget]

of course it's the same thing. If you don't know something for sure until a certain time, then you don't know that it's probable until that time.

And I stand by my definition of GAAP because it is the financial statements for the whole period - generally 1 year - that are scrutinised for compliance with GAAP. Nobody is coming in on a monthly basis to audit accounts for compliance with GAAP, so things that might happen during the year - errors or omissions for example in any given month, are neither here nor there in the sense of year end accounts being deemed compliant with GAAP, providing everything is as it should be at the year end.

 

[Counterofbeans]

of course it's the same thing. If you don't know something for sure until a certain time, then you don't know that it's probable until that time.

Truly STUNNING. No they aren't the same thing.

You have issues.

And I stand by my definition of GAAP because it is the financial statements for the whole period - generally 1 year - that are scrutinised for compliance with GAAP. Nobody is coming in on a monthly basis to audit accounts for compliance with GAAP, so things that might happen during the year - errors or omissions for example in any given month, are neither here nor there in the sense of year end accounts being deemed compliant with GAAP, providing everything is as it should be at the year end.

Completely and utterly wrong. I'm embarrassed for you.