By means of the cost allocation method in table form – one of many cost accounting instruments – it is possible to spread overhead costs across all cost centres. This practice also requires a highly cost-reflective breakdown of overhead types. In the following example, overheads such as salary, rent, and insurance were broken down in the following manner:
- Employee salaries according to their respective cost centres
- Rental costs according to the surface used (sq. m.) of respective cost centres
- Employee insurance costs according to their respective cost centre
Example: calculating the overhead rate by means of the cost allocation method
For a good understanding of the entries from the cost allocation method of calculation, let’s stick to one cost centre only: the material overheads costs. There are a total of 8 employees – those from the purchase department, the incoming goods warehouse, and those who inspect the incoming goods. Employees receive a monthly salary of £2,500, which amounts to the total overhead cost of £20,000. The monthly insurance cost of each employee amounts to £500, resulting in the total insurance cost of £4,000. Warehouse rental is £6,000.
Overhead cost type | Total | Material overheads costs | Production overheads costs | Administration overheads costs | Sales overheads costs |
Wages | 90,000 | 20,000 | 30,000 | 20,000 | 20,000 |
Rental | 36,000 | 6,000 | 20,000 | 6,000 | 4,000 |
Insurance | 14,000 | 4,000 | 2,000 | 4,000 | 4,000 |
Total overhead cost | 140,000 | 30,000 | 52,000 | 30,000 | 28,000 |
Calculation base | | 100,000 | 200,000 | 150,000 | 200,000 |
Overhead rate | | 30% | 26% | 20% | 14% |