Evolution of the Hourly Rate

A recent question on the CSMFO website was from a finance director that wondered what to do when the fiscal year had twenty-seven pay periods. This question is only relevant for cities that pay biweekly and was actually addressed in the 1960’s by the old MFOA. The solution involved accruing the partial pay period for the years that had only twenty-six pay periods so that the money was available for the twenty-seventh payroll. The calculations were cumbersome in the pre-Lotus/Excel days and involved calculating when the twenty-seventh payroll would occur. It is calculated to occur every twenty-one years (remember the leap years if you are calculating). The result shows that an employee with a nominal $100,000 salary only gets paid about $99,661 and change in a non-leap year.

The effect on the hourly rate by recognizing the impact of the twenty-seventh pay period was negligible, but it was the beginning of the movement away from the 2,080-hour year for payroll. It meant that cities should consider the year to be 2,088 hours (365 days). Yet it was common practice until the 1980’s to figure and employee’s hourly rate as their annual salary divided by 2,080. It was also common, up to that point, to bill an employee for services at that rate. This would mean that our $100,000 employee would be billed at $48.08 for an hour’s work.

To be fair to our predecessors, until the passage of California’s Proposition 13 in 1978, there was no incentive to charge the full cost of anything as the property tax covered the difference. As a finance director, my attempts to institute elementary cost accounting for my city were met with indifference until Prop. 13 and its successor, Proposition 4 – the “Spirit of 13” initiative – were adopted.

Around that time, I joined with two former city managers to provide consulting services to local government. The company was known as Management Services Institute until the 1990’s when we renamed ourselves Revenue & Cost Specialists, LLC.

Our unique, at the time, product was a restatement of financial information from the expenditure basis to the expense basis of accounting and the use of cost accounting to better quantify the costs of city services. Based on my education (MBA - University of Chicago) and experience (CPA, audited cities and finance director for three cities), I was asked by the League of California Cities to co-author a study of cost accounting and reporting concepts with William Holder (currently Dean of the USC Leventhal School of Accounting). The study, Cost Accounting for California Cities, was published by the League in June, 1981.

The “hourly rate’ of the study included the following components:

1. Hourly salary cost equal to the total annual salary divided by the available work-hours.

2. Calculation of the available work-hours which excluded holidays, vacations, a portion of sick leave, an estimate of start-up/down time, training time, tail-gate time and any other time that would be unproductive.

3. Calculation of a fringe benefit rate that would include retirement, medical, Medicare and insurances (unemployment, workers’ comp., disability). Recently, benefits for retirees have been allocated to current employees for calculating the hourly rate.

4. A proportionate share of general operating costs, building operational costs and asset replacement costs.

5. General and departmental (all levels) overhead based on staff that were responsible for directing the service providers.

The simple hourly rate that we started with ($48.08) easily grows to $150 or more depending on the data and the assumptions.

The “hourly rate” of the study evolved to the “Fully-Burdened Hourly Rate” (FBHR) which we use today. After coining the term, FBHR, it is very satisfying to hear professionals in the field now refer to hourly rates as being “fully-burdened.”