Overhead Rates

The ability to control program costs involves more than tracking labor dollars and labor hours. Overh dollars can be one of the biggest headaches in controlling program costs and must be tracked along w labor hours and dollars. Although most programs have an assistant program manager for cost whose responsibilities include monthly overhead rate analysis, the program manager can drastically increase success of his program by insisting that each program team member understand overhead rates. For example, if overhead rates apply only to the first forty hours of work, then, depending on the overhea rate, program dollars can be saved by performing work on overtime where the increased salary is at a lower burden. This can be seen in Example 14-2 below.

Example 14-2. Assume that ApexManufacturing must write an interim report for task 1 of project 1 during regular shift or on overtime. The project will require 500 man-hours at $15.00 per hour. The overhead burden is 75 percent on regular shift but only 5 percent on overtime. Overtime, however, is paid at a rate of time and a half. Assuming that the report can be written on either time, which is cost-effective—regular time or overtime?

• On regular time the total cost is:

(500 hours) x ($15.00/hour) x (100% + 75% burden) = $13,125

(500 hours) x ($15.00/hour x1.5 overtime) x (100% + 5% burden) = $11,812.50

Therefore, the company can save $1,312.50 by performing the work on overtime. Scheduling overtime can produce increased profits if the overtime overhead rate burden is much less than the regular time burden. This difference can be very large in manufacturing divisions, where overhead rates between 300 and 450 percent are common.

Regardless of whether one analyzes a project or a system, all costs must have associated overhead rates. Unfortunately, many program managers and systems managers consider overhead rates as a magic number pulled out of the air. The preparation and assignment of overheads to each of the functional divisions is a science. Although the total dollar pool for overhead rates is relatively constant, management retains the option of deciding how to distribute the overhead among the functional divisions. A company that supports its R&D staff through competitive bidding projects may wish to keep the R&D overhead rate as low as possible. Care must be taken, however, that other divisions do not absorb additional costs so that the company no longer remains competitive on those manufactured products that may be its bread and butter.

The development of the overhead rates is a function of three separate elements: direct labor rates, direct business base projections, and projection of overhead expenses. Direct labor rates have already been discussed. The direct business base projection involves the determination of the anticipated direct labor hours and dollars along with the necessary direct materials and other direct costs required to perform and complete the program efforts included in the business base. Those items utilized in the business base projection include all contracted programs as well as the proposed or anticipated efforts. The foundation for determination of the business base required for each program can be one or more of the following:

• Actual costs to date and estimates to completion

• Proposal data

• Marketing intelligence

• Management goals

• Past performance and trends

The projection of the overhead expenses is made by an analysis of each of the elements the constitute the overhead expense. A partial listing of those items that constitute overhead expenses is shown in Table 14-7. Projection of expenses within the individual elements is then made based on one or more of the following:

• Historical direct/indirect labor ratios

• Regression and correlation analysis

• Manpower requirements and turnover rates

• Changes in public laws

• Anticipated changes in company benefits

• Fixed costs in relation to capital asset requirements

• Changes in business base

• Bid and proposal (B&P) tri-service agreements

• IR&D tri-service agreements

For many industries, such as aerospace and defense, the federal government funds a large percentage of the B&P and IR&D activities. This federal funding is a necessity since many companies could not otherwise be competitive within the industry. The federal government employs this technique to stimulate research and competition. Therefore, B&P and IR&D are included in the above list.

The prime factor in the control of overhead costs is the annual budget. This budget, which is the result of goals and objectives established by the chief executive officer, is reviewed and approved at all levels of management. It is established at department level, and the department manager has direct responsibility for identifying and controlling costs against the approved plan.

The departmental budgets are summarized, in detail, for higher levels of management. This summarization permits management, at these higher organizational levels, to be aware of the authorized indirect budget in their area of responsibility.


Building maintenance Building rent Cafeteria Clerical

Clubs/associations Consulting services Corporate auditing expenses Corporate salaries Depreciation of equipment Executive salaries Fringe benefits


New business directors Office supplies Payroll taxes Personnel recruitment Postage

Professional meetings Reproduction facilities Retirement plans Sick leave Supplies/hand tools Supervision

General ledger expenses

Telephone/telegraph facilities

Group insurance Transportation

Holiday Utilities

Moving/storage expenses Vacation

Reports are published monthly indicating current month and year-to-date budget, actuals, and variances. These reports are published for each level of management, and an analysis is made by the budget department through coordination and review with management. Each directorate's total organization is then reviewed with the budget analyst who is assigned the overhead cost responsibility. A joint meeting is held with the directors and the vice president and general manager, at which time overhead performance is reviewed.

Project Management Made Easy

Project Management Made Easy

What you need to know about… Project Management Made Easy! Project management consists of more than just a large building project and can encompass small projects as well. No matter what the size of your project, you need to have some sort of project management. How you manage your project has everything to do with its outcome.

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