A contractor has annual overhead costs of $240,000 and expects to generate $1,200,000 in direct costs for the year. What is the overhead percentage that should be applied to bids?
Correct Answer
B) 20%
Overhead percentage is calculated as overhead costs divided by direct costs: $240,000 ÷ $1,200,000 = 0.20 or 20%. This percentage is then applied to direct costs in bid preparation.
Why This Is the Correct Answer
The overhead percentage is calculated by dividing total overhead costs by total direct costs. In this case, $240,000 in overhead divided by $1,200,000 in direct costs equals 0.20 or 20%. This percentage represents how much overhead cost must be added to each dollar of direct cost to cover the contractor's annual overhead expenses. The 20% overhead rate ensures that all overhead costs are properly allocated across all projects throughout the year.
Why the Other Options Are Wrong
Option A: 30%
25% would recover $300,000 in overhead costs ($1,200,000 × 0.25), which is $60,000 more than the actual overhead, potentially making bids uncompetitive.
Option C: 25%
30% would recover $360,000 in overhead costs ($1,200,000 × 0.30), which is $120,000 more than actual overhead, significantly inflating bid prices and reducing competitiveness.
Option D: 15%
15% would only recover $180,000 of overhead costs ($1,200,000 × 0.15), leaving $60,000 in overhead costs unrecovered, which would result in a loss.
Memory Technique
Think 'OH/DC' - Overhead divided by Direct Costs. Remember that overhead is always 'on top of' direct costs, so it's the numerator in the fraction.
Reference Hint
Business and Finance for Contractors - Chapter on Cost Accounting and Overhead Allocation
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