Overhead Allocation

Dear Dave
We have grown to become a multi-office civil engineering firm and are in the process of implementing a new accounting software package which will allow us for the first time in our history to generate separate profit and loss statements for each office. To do this, we need to find the best way to allocate our common corporate overhead (those costs for our central headquarters activities such as accounting, personnel, the company president’s cost, etc.) to the offices. The software vendor has offered several suggestions, but we don’t have enough knowledge about what others do to make this decision on our own.
MG TX

Dear MG
I would venture to say that by far the most common allocation method is to distribute corporate overhead to each of the offices as a percentage of the payroll of each office as a percentage of the total payroll of all offices. So, if my particular office has 23% of the payroll of all offices, my office must absorb 23% of the corporate overhead to be allocated.

As a variation of this approach, I have come across firms that allocate corporate overhead on the basis of the direct payroll (project related payroll) of each office as a percentage of the total direct payroll of all offices. I have always thought the logic of this particular approach to be flawed, as it penalizes an office (allocating it more overhead) for doing a more effective job of limiting the amount of payroll the office spends on non-project, indirect activities. This seems completely backwards to me!

Another method in use is to allocate corporate overhead among offices based on the revenue generated in each office as a percentage of the total revenue of all offices. I have a similar objection to this approach as I do to the direct payroll method because an office that generates more revenue relative to other offices, by some combination of good project management or better fees and clients, is going to get extra overhead assigned. This, too, does not seem right.

Finally, rather than a single allocation tool, a minority of firms will use multiple allocation methods to spread corporate overhead depending on the nature of each item of cost to be allocated. For example, the cost of the Human Relations manager may be allocated based on the number of employees in each office, while some corporate insurance and maintenance cost might be allocated on the square footage occupied by each office, etc. I’d recommend keeping overhead allocation as simple as possible and sticking to a single method unless there are compelling reasons to do otherwise.

Regardless of which allocation method you choose, hang on tight and be prepared to hear from those being allocated to about just how unfair the method you’ve selected is. Rather than be upset by the challenge, be pleased those responsible for office profitability are paying enough attention to figure out how one method may not be as beneficial as another given their particular offices’ circumstances. The dialog to follow is a healthy process.