Ken believes his company's overhead costs are driven (affected) by the number of direct labor hours because the production process is very labor intensive. During the period, the company produced 5,000 units of Product A requiring a total of 800 labor hours and 2,500 units of Product B requiring a total of 200 labor hours. What allocation rate should be used if the company incurs overhead costs of $20,000?

The Absorption Overhead rate must be used which can be computed using the following formula:

Absorption Overhead Rate (OAR) = Total overhead / Absorption Basis

Here as we know that the absorption basis is labor hours because the overhead costs are driven by the direct labor hours and also that the total overhead is $20,000.

Putting values in the formula:

Absorption Overhead Rate (OAR) = $20,000 / (200 + 800) Hrs = $20 per Hr

Total Overheads share for Product A = $20 per hour * 800 Labor hrs worked on product A = $16,000

For unit Product A = $16000 / 5000 units of A = $3.2 per unit of product A

Similarly for Product B:

Total Overheads share for Product B = $20 per hour * 200 Labor hrs worked on product B = $4000

For unit Product B = $4000 / 2500 units of A = $1.6 per unit of prduct B