Proration Method of Overhead Allocation
The proration method bases overhead allocation on your enterprise’s actual total overhead. With this method, the sum of all amounts is charged to overhead projects. A project, phase, or task assumes its proportionate share of the overhead pool.
Calculation
- Its share of enterprise-wide direct labor
- Its share of enterprise-wide revenue
DPS uses the following formula to calculate the overhead for each project:
Prorated Overhead Allocation % Rate = Year-to-Date Indirect Expenses / Year-to-Date Direct Labor or Revenue
The prorated year-to-date overhead amount is then distributed to all regular-type projects using the following formula:
% Rate * Year-to-Date Project Direct Labor or Revenue = Overhead Allocated to Project
Pros and Cons
With proration, the sum of all amounts allocated in the current period is equal to your enterprise’s actual overhead amount for the period. The benefit of this approach is that overhead allocation is based on real numbers. The problem is that your actual overhead amount may vary quite a bit from period to period and season to season, making it difficult to forecast project performance. To keep seasonal fluctuations to a minimum, you should consider accruing large expenses, such as professional liability insurance or depreciation, over the course of the year.
Example
For example, assume that you choose to prorate overhead based on enterprise-wide revenue. You have $100,000 in indirect expenses and $500,000 in revenue. The City Hall project has revenue for the year that totals $50,000.
Overhead Allocation Rate:
YTD Indirect Expenses (100,000) / YTD Revenue (500,000) = .20 (20%)
The overhead allocation rate is 20%.
Overhead Allocated to the City Hall Project:
% Rate (20%) * YTD Project Direct Revenue (50,000) = 10,000
The City Hall project is allocated $10,000 of overhead from the total overhead expense.