Plantwide Overhead Rate

What is Plantwide Overhead Rate?

Plantwide overhead rate is the overhead rate which is used by companies for the purpose of allocating its entire manufacturing overhead costs to its line of products and other cost objects respectively and this method of overhead allocation finds its place in very small entities with minimized or simple cost structure.

Explanation

Plantwide overhead rate is a method of allocating manufacturing overheadManufacturing OverheadManufacturing Overhead is the total of all the indirect costs involved in manufacturing a product like Property Tax on the production premise, Remunerations of maintenance personnel, Rent of the manufacturing building, etc. read more costs to the products and cost objectsCost ObjectsA cost object is a method that measures product, segment, and customer cost separately to determine the exact cost and selling price. read more associated with the business. It is generally suited for firms that are small and have a simple cost structure. There are a few scenarios where its usage is suitable:

On the contrary, a single plantwide overhead rate is not suited for firms where the overhead to be allocated is a mammoth sum, various departments associated with the company are providing different levels and type of services, and lastly when it is evident that the company must use different types of the allocation base. In practical scenarios, it is generally seen companies will avoid its use and instead use a small number of cost poolsCost PoolsA cost pool is a strategy to identify the company's individual departments or service sector costs incurred. It determines the total expenses incurred in manufacturing goods and allocates them to different departments or service sectors based on valid identifiers known as cost drivers.read more, which are again separately allocated with different overhead rates.  Although it is a time-consuming process, it increases the accuracy of the overall overhead allocation process. Thus, a trade-off between time and accuracy comes in the way of using a single plantwide overhead rate or usage of cost pools.

Plantwide Overhead Rate Formula

Plantwide Overhead Rate

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Source: Plantwide Overhead Rate (wallstreetmojo.com)

Plantwide Overhead Rate = Total Overhead / Direct Labor Hours

It means the total number of direct labor hours is taken as the denominator, and this is divided by the numerator as the total overhead cost of the company.

How to Calculate?

The calculation of the plantwide overhead rate first requires gathering the following information.

There is one more approach to calculate the plantwide overhead rate using an alternative approach or direct costDirect CostDirect costs are costs incurred by an organization while performing its core business activity and can be attributed directly in the production cost, such as raw material costs, wages paid to factory staff, power & fuel expenses in a factory, and so on, but do not include indirect costs such as advertisement costs, administrative costs, etc.read more method. Here instead of direct labor hours, we use the direct cost for our calculation. To calculate this, we first need to identify the total direct cost of production and the total overhead cost for the specific time period. Thus, this total overhead is divided by the total direct cost to ascertain the single plantwide overhead rate.

Example

Let us consider a scenario where a company’s total overhead cost for a specific month is $100,000. The manufacturing plant requires 1000 labor hours to manufacture 500 units of a specific product, which we assume as product X. The same manufacturing plant also produces 1000 units of another product, which we call product Y, using another 500 labor hours. So, the total of overall labor hours stands at 1500.

To arrive at the calculation, we need to divide the total overhead of $100,000 by the total labor hours, which is 1500.  This way, we find the resultant number as 100,000/1500 = $67 as overhead per labor hour. Product A will need 1000/500 or 2 hours per unit of production. Therefore, the overhead rate for product A is $67*2 = $134/unit. Similarly, product B needs 500/1000 or 0.5 hours per unit production. Therefore, the overhead rate for product B is $67*0.5 = $33.5/unit.

Why it’s Important?

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