Overhead Allocation Calculator
Allocate your overhead costs
Enter total overhead and direct cost drivers to calculate overhead allocation rates using labour cost, material cost, unit, and prime cost methods.
How overhead allocation works in cost accounting
Overhead allocation is the process of assigning indirect costs to products, services, or departments so that each can bear a fair share of the business's total cost. Indirect costs, also called overhead, include rent, utilities, depreciation, administrative salaries, and other costs that cannot be directly traced to a specific product or job. Without proper allocation, you cannot know the true cost of producing each product or delivering each service.
Accurate cost allocation is critical for pricing decisions. If overhead is not correctly reflected in product or service costs, you may be pricing some products below their true cost and others above, creating cross-subsidies that hide the real profitability of each line. Over time, this can lead to poor strategic decisions about which products to grow, which to discontinue, and how to price competitively.
There are several common allocation methods, each using a different cost driver as the basis for allocation. The right method depends on what best explains how overhead is consumed. This calculator shows the allocation rate for all common methods so you can choose the one that makes the most sense for your business.
Direct labour cost method
This method allocates overhead in proportion to the direct labour cost of each product or job. If overhead is $60,000 and direct labour is $120,000, the overhead rate is 50 percent of direct labour cost. For a job that uses $10,000 of direct labour, you would allocate $5,000 of overhead. This method works well when labour is the primary driver of overhead consumption, such as in service businesses and labour-intensive manufacturing.
Direct material cost method
This method allocates overhead in proportion to material costs. It is appropriate when material usage drives significant overhead costs such as storage, handling, and quality inspection. If overhead is 75 percent of direct materials and a product uses $8,000 in materials, the overhead allocated to that product would be $6,000.
Units produced method
This method divides total overhead by total units produced to get a fixed overhead cost per unit. It is the simplest method and works well when all products are similar in complexity and resource consumption. It breaks down when products vary significantly in size, complexity, or production time.
Prime cost method
Prime cost is the total of direct labour and direct materials. This method allocates overhead as a percentage of prime cost, combining both drivers into a single allocation base. It is a compromise that works reasonably well for diverse product mixes where neither labour nor materials alone is the dominant cost driver. Activity-based costing (ABC) is a more sophisticated alternative that traces overhead to specific activities, but it requires significantly more tracking infrastructure.
