Question

2. What are the three methods that can be used to allocate overhead cost?

3. Explain the Direct cost of overhead allocation?

Answer 1

Ans.2). Overhead costs are indirect costs. The three ways to allocate overhead costs are direct method, step-down method and reciprocal method.

Ans.3). Overhed costs are allocated to each division based on one metric. Let us take an example which allocates overhead costs based on the number of labour hours.

Supposing a company manufactures two products, product A and product B.

It has overhead costs of $400

	Product A	Product B	Total
Direct labour hours	120	40	160
Cost to be allocated	0.75	0.25	1
Overhead costs	300	100	400

Thus, overhead cost allocation = overhead cost* direct labour hours for one product/total direct labour hours.