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Guide · Pricing & Margin

Allocating Overhead to Products: Choose a Driver

Compare unit-based and machine-hour overhead allocations, then separate assigned cost from costs that a decision actually changes.

By PriceAndProfit Editorial Updated 3 min read

On this page
  1. Worked calculation
  2. Decision checks and limits
  3. Apply the calculation

Overhead allocation assigns shared costs to products using a chosen activity base. It can help estimate full product cost, but the allocation is not a bill triggered by each unit. The choice of driver matters: a product using twice as much machine time may consume a different share of factory support than a product that merely ships in twice as many units.

Worked calculation

Planned overhead rate = budgeted overhead ÷ budgeted driver activity; allocated product overhead = rate × product driver usage

Suppose a workshop budgets $12,000 of production overhead and 600 machine hours for a month. The planned overhead rate is $20 per machine hour. Product A requires half an hour per unit, so it receives $10 of overhead per unit. Product B requires two hours, so it receives $40. If the shop makes 400 units of A and 200 units of B, total machine time is 600 hours and the allocations reconcile to $4,000 plus $8,000.

An allocation based simply on the 600 total units would assign $20 to every unit. Product A would receive $8,000 and product B $4,000, reversing their cost shares. Neither arithmetic calculation is inherently broken; they answer the allocation question using different drivers. Choose the driver based on how the costs are incurred and the management purpose, then document limitations rather than presenting the rate as an objective physical property of the product.

Hypothetical worked example
ProductUnitsMachine hours per unitMachine-hour allocation per unitUnit-based allocation per unit
A 400 0.5 $10 $20
B 200 2.0 $40 $20

Decision checks and limits

Actual activity can differ from the budget. If the shop uses only 500 machine hours, applying the planned $20 rate assigns $10,000. With actual overhead still $12,000, the $2,000 difference remains visible as unassigned or underapplied cost in the management reconciliation. Dividing the same fixed total by fewer hours after the fact raises the apparent unit cost, but it does not mean making one additional unit now causes all of that allocated cost.

For a special order or make-versus-buy decision, identify the overhead that changes between alternatives. A continuing lease may remain even if a product is outsourced; an additional equipment rental may be avoidable. Keep that relevant-cost analysis alongside the full-cost view. Avoid loading the same overhead into unit cost and then subtracting it again as a fixed monthly expense. A documented driver and reconciliation make allocations useful without mistaking an accounting assignment for an incremental cash consequence.

Apply the calculation

  1. Group costs by behavior

    Separate cost pools that plausibly follow different activities instead of forcing all shared spending through one driver.

  2. Set the rate transparently

    Record the budgeted cost, capacity assumptions, and activity base. Keep the planned rate distinct from an actual-period recalculation.

  3. Reconcile and interpret

    Explain under- or overassignment and use avoidable costs, not arbitrary allocations, when comparing a specific operational choice.

Method references: OpenStax: Cost behavior patterns. Accessed October 22, 2026. All dollar figures are hypothetical worked examples.

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