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.
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. 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. 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:
- The total sum of the overhead costOverhead CostOverhead cost are those cost that is not related directly on the production activity and are therefore considered as indirect costs that have to be paid even if there is no production. Examples include rent payable, utilities payable, insurance payable, salaries payable to office staff, office supplies, etc. to be allocated is not materialistic enough. The usage of multiple allocation rates to drive a higher level of allocation is not needed.
- The various departments which are present in the company are providing a similar type of service.
- The management accepts to use a single allocation base for allocation of the entire overhead cost.
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., 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 = 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.
- The first and foremost information is required in the total operational cost apart from the direct cost of production. Usually, direct costs are raw materials and direct labor hours. The indirect costIndirect CostIndirect cost is the cost that cannot be directly attributed to the production. These are the necessary expenditures and can be fixed or variable in nature like the office expenses, administration, sales promotion expense, etc. is what we call the overheads.
- We will also require the total number of direct labor hours to produce each product in the company. The per-unit labor costLabor CostCost of labor is the remuneration paid in the form of wages and salaries to the employees. The allowances are sub-divided broadly into two categories- direct labor involved in the manufacturing process and indirect labor pertaining to all other processes. is calculated by taking the total labor hours and dividing the sum by the number of units manufactured by the company at a specific point of time.
- Now coming to the final step of calculation for arriving at our calculation, we need to first divide the business’s total overhead with the sum of the additive labor hours put in, which has been consumed to estimate the overhead consumed per hour of labor. After this, the resultant is multiplied by the total of labor hours consumed to manufacture per output. Thus, this way, we can arrive at the plantwide overhead rate.
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. 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.
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?
- It is best for firms that are small in size and have a uniform cost structureCost StructureCost Structure refers to those costs or expenses (fixed as well as variable costs) which businesses will incur or will have to incur to produce the desired objective of the business; such costs include the cost of purchasing the raw material to the cost of packaging the finished products..
- It is easier to calculate for firms with a single product offering or for firms where all departments produce similar products or have uniform cost objects.
- It makes the calculation easy as only one rate gets allocated to the product or cost objects.
- It produces more accurate results for firms producing single products than the cost pool method, which makes the calculation more complicated.
- It is a time-saving process when compared to the multiple allocation process or multiple overhead rates.
- Plantwide overhead rate simplifies overhead allocation as only a single overhead rate is used for calculation.
This has been a guide to What is Plantwide Overhead Rate & its Definition. Here we discuss the formula to calculate the plantwide overhead rate and why its important along with examples. You can learn more about from the following articles –