A contractor has an annual payroll of $500,000 and wants to allocate overhead at 15% of direct labor costs. If direct labor represents 60% of total payroll, what is the overhead allocation amount?
Correct Answer
A) $45,000
Direct labor = $500,000 × 60% = $300,000. Overhead allocation = $300,000 × 15% = $45,000. The overhead rate is applied only to the direct labor portion, not the total payroll.
Why This Is the Correct Answer
The correct answer is A because overhead allocation must be calculated based on direct labor costs only, not total payroll. First, we calculate direct labor as 60% of the $500,000 total payroll, which equals $300,000. Then we apply the 15% overhead rate to this direct labor amount: $300,000 × 15% = $45,000. This two-step process ensures we're allocating overhead based on the appropriate cost base.
Why the Other Options Are Wrong
Option B: $105,000
$105,000 seems to result from applying an incorrect percentage to either the total payroll or direct labor amount, possibly confusing the overhead rate with another percentage in the problem.
Option C: $75,000
$75,000 would result from incorrectly applying 15% to the total payroll ($500,000 × 15% = $75,000) instead of first calculating the direct labor portion. This ignores the fact that only 60% of payroll represents direct labor costs.
Option D: $90,000
$90,000 appears to be calculated by taking 60% of the total payroll and then applying an incorrect percentage, or by some other mathematical error in the overhead calculation process.
Memory Technique
Remember 'DOH' - Direct labor first, Overhead rate second, not the other way around. Always calculate your base (direct labor) before applying any allocation percentages.
Reference Hint
Look up cost accounting and overhead allocation methods in the business management section, typically found in chapters covering project cost control and estimating.
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