Direct Expense VS. Direct Labor?

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    Michael Ermann

    To address your questions. . .

    1. Does direct expense include direct labor? I’m sorry to say that your friend was right. Direct expenses do include direct labor.
    2. this "direct salary" is the $$$ architects charge clients, or the actual $ the firm pays the architects? The direct salary is the money the firm pays the architects who work at the firm (though, to your question, when the client is paying by the hour for the architects’ time, the direct salary is multiplied by some factor, usually between 3.0 and 4.0, to come up with the fee the architect charges the client).
    3. Definition of Direct Expense: Why it specifically mentions to "plus project-related expenses included in all lump sum fee contracts?” . . . . This means that even if the client is not paying by the hour, and instead is paying a lump sum for services, the work that the architects do on behalf of the client still counts, if only internally to the architect’s accounting, as akin to “billable hours.”

     

    It helps to put the stream of money going out of an architecture firm into three baskets.

    The first is direct expenses, which are those related the work the architect performs for the client. This is how architects pay for indirect expenses and make a profit, because a well-run firm will charge the client much more for the work than the firm will pay to do the work. Payment, by the firm, to the draftsman, for red-lining an RCP is a direct expense.

    The second basket is indirect expenses, which are those not related to the work the architect performs for the client. When you charge your firm for boxing up the items on your desk in preparation for your firm’s move to a new office, that falls as an indirect expense to the firm.

    The third basket, reimbursable expenses, sits on a continuum between the first two. These are generally charged to the client, but at a small mark-up—for instance, enough to recoup the cost of plotting the CD set, including maintenance to the plotters, but not enough to help pay for the office move, and not so much that the firm is turning a profit by plotting drawings.

    So, in summary, the firm has revenues collected from the client for design fees (at a big mark-up) and reimbursables (at a small mark-up). . .  and whatever money is left over after paying direct expenses (for the RCPs) and indirect expenses (for the office move) and reimbursables (for the plotting) becomes the firm’s profit. Michael Ermann, Amber Book

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    Hongxi Yang (Edited )

    Michael,

    Thank you very much for your time and effort. This is SUPER HELPFUL!

    Just to make sure that I fully understand the answers: 

    According to AHPP page 1124, Direct Expense includes Direct Personnel Expense (DPE), and DPE includes Direct Salary Expense (DSE). In other words, Direct Labor = Direct Salary = Direct Salary Expense, these 3 terms in AHPP are basically the same concept, correct? I quickly drew 2 diagrams to illustrate the idea Thanks again!

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    Michael Ermann

    I like your diagrams. You got it correct. . . except payroll tax, health insurance, etc. is an indirect cost, not a direct cost (can't charge the client for staff healthcare, firm retirement contributions, payroll taxes) . So you'll want to remove that small bubble in the second image. --Michael Ermann, Amber Book

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    Hongxi Yang

    Thanks for pointing it out! Whether “payroll tax and health insurance etc.” should be counted as Direct Expense -as I looked into this matter, I found 2 different arguments:

    1. I drew the 2nd diagram according to

    A. AHPP Page 1124: “Direct personnel expense (DPE): Direct salaries of all the architect’s personnel engaged on the project and the portion of the cost of their employee benefits related thereto.”

    B. ARE 5.0 Review Manual Page 2-2: “Direct Personnel Expense: the expense of employee salaries plus the cost of mandatory and discretionary expenses and benefits such as payroll taxes and health insurance.”

    C. When I googled “payroll tax, health insurance, Direct personnel expense”, multiple resources claimed that payroll tax/health insurance is fringe benefit, and it belongs to Direct personnel expense/Direct expense/Direct cost.

    2. On the other hand, many tables on AHPP, page 424 for instance, count Total Expense = Direct Labor Salary Expense (only Direct Labor, not even “Direct Expense”) + Indirect Expense. And the “payroll benefits/discretionary benefits” sits in the category of Indirect Expense.

    So I guess… ridiculously Direct Personnel Expense is half in “Direct Expense” and half in “Indirect Expense”...?

    Much appreciated.

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