How to Allocate Overhead Costs to Other Classes
How to Allocate Overhead Costs to Other Classes in Quickbooks
By Peggy Seville, Certified QuickBooks ProAdvisor
November 10, 2017
You’ve been using Class tracking in Quickbooks to separate out income and expenses into different profit centers. This field is used for monitoring the performance of different segments of your business such as Departments, Divisions, Product Lines, Programs, Projects, Events, and more. Not sure what the Class field is? Click here to read more about Classes.
It’s great that you are using Class tracking in Quickbooks so you can see a Profit & Loss by Class. You are already getting some excellent information about your business, but are you allocating overhead costs in QuickBooks to those different profit centres?
Why is Overhead Cost Allocation so Important?
This is an important step that often gets missed. You may think you’re making money in a certain area of your business until you apply your overhead costs and get a big surprise. You might find out that some cost centres are supporting other cost centers. Maybe your company would be better off if you dropped that segment of your business!
When do I Make a QuickBooks Overhead Cost Allocation?
At the end of your reporting period, think about how your overhead or common administrative costs should be applied to the other Classes. This could happen monthly, quarterly or annually. I recommend starting with at least quarterly first. If you choose annually, by the time you get this information it may be too late to make adjustments.
How to Calculate Overhead Costs in Quickbooks?
Pick a method that is most appropriate for your business to determine the ratio. Here are some ways that overhead can be allocated to your classes in Quickbooks. Calculate for each class the:
• Percent of Gross Sales (less meaningful)
• Percent of Gross Profit (Income less Cost of Sales)
• Net Profit (Income less Cost of Sales less Expenses)
• Hours spent
• Payroll costs
For example, there is a department in your company which is consuming more of your staff’s time than others, so you use the Percent of Hours method to allocate overhead. Your Gross Profit ratio of this department is 20%. When you compile the hours spent (from your time tracking software), you realize that the percent of hours spent was 35%. Now, 35% of payroll costs should be applied instead of 20%. The profit picture of this Class is suddenly changed and might no longer be profitable.
Imagine if you had just continued along in your business without figuring this out. It would be a continued drain right off the bottom line. Not taking the time to apply administrative or overhead costs to your other Classes in Quickbooks can be a costly oversight.
How do I Allocate Administrative Costs to my other Classes?
You can make a journal entry to remove the income or expense from the Admin class and apply it to the same accounts with the appropriate classes. The journal entry would appear like this:
Job Supplies Dr 20,000 Commercial
Job Supplies Dr 20,000 Residential
Job Supplies Cr 40,000 Overhead
Alternatively, you could export your Profit & Loss by Class into Excel and make the changes in a spreadsheet instead of your accounting system. If you are handy with Excel, you can apply a formula to make the allocations.
There are pros and cons of each method.
Of course, you could start in Excel and when you have picked a method and obtained your results, then you could enter the journal entry into Quickbooks.
Example of Overhead Allocation
For example, Joe runs growing a plumbing business and he has a small crew of 5 plumbers. He does some residential and commercial work. Recently, he has bid on some new construction jobs too and that has been going very well. His Classes in Quickbooks are:
• New Construction
When he runs his Income Statement broken down by each division, he can see that each one is making a profit. He is making a positive overall net profit which he would like to increase but finds satisfactory. He’s never allocated his overhead costs to the other divisions before, but thought he would like to do it for this quarter to see how his New Construction segment is really performing. Here is Joe’s Profit & Loss by Class before the allocation of overhead costs.
Joe has determined that the Percentage of Gross Profit for each Class is the best method. He decides to export his Profit & Loss by Class into Excel to make the allocations. After he applies the overhead to each division, his report now looks like this:
The new division has only made $15,383 in its first year. It’s not that much but it’s only the first year and at least it’s making a profit. Then he realizes that he really had to bid low on those new jobs to get them since there were a lot of other companies bidding. Maybe he should use the % of Payroll Costs instead to allocate his overhead. Joe recalculates his overhead and now his Profit & Loss report by division looks like this:
This method may be more telling of the true performance of Joe’s recently added division. It is now no longer making a profit. The New Construction division has taken 14.9% of the total payroll costs but only produced 4.1% of his Gross Profit. The Gross Profit for this division is too low to be truly profitable. Now Joe has the information he needs to make some decisions about bidding on future jobs. He can set a minimum profitability objective on future new construction bids. If he has to bid lower than that to get the job, it’s better to just walk away.
Now we understand the importance of taking the extra step to allocate administrative costs in QuickBooks. You might be overlooking some critical information about your business and miss maximizing your profit. Making the right choice of allocation methods to use and playing around with different scenarios can highlight some important differences and change the profitability picture.
Want some assistance analyzing your Class tracking in Quickbooks and allocating overhead? We are here to help! Click here for more information.