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Module 10: Overhead and Indirect Cost Allocation

Writer's picture: BHADANIS Quantity Surveying and Construction Management Training Institute for Civil Engineers & Construction Professionals OnlineBHADANIS Quantity Surveying and Construction Management Training Institute for Civil Engineers & Construction Professionals Online

Overview

Overhead and indirect costs are essential components of total project costs that are often overlooked or misallocated. These costs, while not directly tied to a specific construction task, are necessary for the overall operation of the construction process. Proper allocation and management of overhead and indirect costs are crucial for ensuring that projects remain financially viable and within budget. This module will explore the types of overhead and indirect costs, methods for allocating these costs, and the importance of effective management in construction projects.

Table of Contents

Introduction to Overhead and Indirect Costs

In construction projects, costs are typically classified as either direct costs or indirect costs. Direct costs are those that can be directly attributed to a specific construction task, such as materials and labor. Indirect costs, on the other hand, are not directly linked to a specific task but are essential to the project’s operation.

Overhead costs are a subset of indirect costs that typically include general operating expenses, administrative salaries, and utilities. Properly allocating and managing these costs is essential for accurate budgeting, cost tracking, and ensuring profitability.

Types of Overhead and Indirect Costs

Overhead and indirect costs can be classified into several categories:

1. General and Administrative Costs (G&A)

These are costs associated with the general operation of the business and are not specific to any particular project. Examples include:

  • Office Rent

  • Salaries of management and administrative staff

  • Office supplies

2. Project Overhead Costs

Project overhead costs are indirect costs that are specific to a particular project but cannot be traced directly to any specific task. Examples include:

  • Site office expenses

  • Project supervision costs

  • Safety and security costs on-site

3. Financing Costs

These are the costs associated with financing the project, such as interest payments on loans or lines of credit.

Example: If a contractor borrows funds to finance a project, the interest payments on the loan would be considered financing costs.

4. Depreciation

Depreciation refers to the gradual reduction in value of equipment and assets used in the project, which is considered an indirect cost.

Example: For a construction company, the depreciation of machinery used on the site would be an indirect cost.

5. Legal and Compliance Costs

These include costs related to ensuring compliance with regulations, acquiring permits, and legal fees.

Example: Costs for legal consultations, environmental clearances, and building permits would fall under this category.

Methods of Allocating Overhead and Indirect Costs

Properly allocating overhead and indirect costs ensures that these expenses are distributed fairly across all parts of the project. Here are some common methods:

1. Proportional Allocation

In this method, overhead and indirect costs are allocated based on a proportion of direct costs. For example, the total indirect costs can be distributed based on the total labor or material costs of each task.

Example: If a project has $100,000 in direct costs and $20,000 in overhead costs, you can allocate overhead costs proportionally. If Task 1 costs $20,000, the allocation for Task 1 would be:

  • Allocation for Task 1 = ($20,000 / $100,000) * $20,000 = $4,000

Tabular Format:

Task

Direct Costs

Total Direct Costs

Overhead Allocation

Total Costs

Task 1

$20,000

$100,000

$4,000

$24,000

Task 2

$30,000

$100,000

$6,000

$36,000

Task 3

$50,000

$100,000

$10,000

$60,000

Total

$100,000

-

$20,000

$120,000

2. Rate-Based Allocation

In this method, an overhead rate is calculated, typically as a percentage of direct labor or material costs, and applied across all tasks.

Example: If the overhead rate is 15% of labor costs, and Task 1 requires $10,000 in labor, the overhead allocation would be:

  • Overhead Allocation = $10,000 * 15% = $1,500

Tabular Format:

Task

Labor Costs

Overhead Rate

Overhead Allocation

Total Costs

Task 1

$10,000

15%

$1,500

$11,500

Task 2

$15,000

15%

$2,250

$17,250

Task 3

$20,000

15%

$3,000

$23,000

Total

$45,000

-

$6,750

$51,750

3. Fixed Allocation

This method allocates a fixed amount of overhead costs based on a predetermined formula, often used for smaller or more straightforward projects.

Example: A fixed overhead cost of $10,000 is allocated to a project regardless of the size or complexity of individual tasks.

Tabular Format:

Task

Direct Costs

Fixed Overhead Allocation

Total Costs

Task 1

$30,000

$10,000

$40,000

Task 2

$40,000

$10,000

$50,000

Task 3

$50,000

$10,000

$60,000

Total

$120,000

$30,000

$150,000

Examples of Overhead and Indirect Costs Allocation

Example 1: Commercial Building Construction

  • Direct Costs: Material and labor costs for construction work.

    • Example: Concrete, labor for foundation, etc.

  • Overhead Costs: Site office, supervisory costs, security, utilities.

    • Example: Site office rent, security staff salaries.

Using the proportional allocation method, if the total direct cost is $500,000 and the overhead cost is $100,000, overhead will be allocated to each task based on its direct cost proportion.

Tabular Format:

Task

Direct Costs

Proportional Overhead Allocation

Total Cost

Foundation

$150,000

$30,000

$180,000

Structure

$200,000

$40,000

$240,000

MEP

$150,000

$30,000

$180,000

Total

$500,000

$100,000

$600,000

Example 2: Residential Home Construction

  • Direct Costs: Materials and labor for building the house.

    • Example: Bricks, plumbing, framing.

  • Overhead Costs: Project management, utility bills for the site, and administrative support.

    • Example: Office rental costs, project manager salary.

Using the rate-based allocation method, the overhead rate is set at 12% of the total labor costs. If the labor cost is $20,000, the overhead would be:

  • Overhead Allocation = $20,000 * 12% = $2,400

Tabular Format:

Task

Labor Costs

Overhead Rate

Overhead Allocation

Total Cost

Site Work

$10,000

12%

$1,200

$11,200

Framing

$8,000

12%

$960

$8,960

Plumbing

$2,000

12%

$240

$2,240

Total

$20,000

-

$2,400

$22,400

Practical Application in Construction Projects

In construction, overhead and indirect costs are typically allocated to various stages of the project. For example, during the early stages, significant overhead costs may arise due to site preparation and mobilization. These costs should be carefully tracked and allocated to ensure accurate cost reporting.

For a project with several subcontractors, the costs for project management, administrative tasks, and general office expenses are often spread across the different work activities.

By accurately allocating overhead and indirect costs, construction project managers can ensure that the full cost of the project is considered when evaluating bids, estimating future projects, and making informed financial decisions.

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