Plantwide Overhead Rate

Updated on April 11, 2024
Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Plantwide Overhead Rate?

The Plantwide overhead rate is the overhead rate that companies use to allocate their entire manufacturing overhead costs to their line of products and other cost objects. This overhead allocation method finds its place in very small entities with a minimized or simple cost structure.

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As the name implies, these overhead rates take into account the entire plant and not a particular segment or department. It is one of the simplest forms of resource or cost allocation. The plantwide overhead rate might not help obtain exact figures, but the estimates are efficient enough for better planning.

Plantwide Overhead Rate Explained

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 small firms and has a simple cost structure. However, 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 types of services, and lastly, when it is evident that the company must use different types of the allocation base. Therefore, 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.

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Formula

The formula that helps us calculate plantwide overhead rate is given below:

Plantwide-Overhead-Rate-Formula-1

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Plantwide Overhead Rate = Total Overhead / Direct Labor Hours

It means the total number of direct labor hours is taken as the denominator, which 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.

One more approach is to calculate the plantwide overhead rate using an alternative approach or direct costDirect CostDirect cost refers to the cost of operating core business activity—production costs, raw material cost, and wages paid to factory staff. Such costs can be determined by identifying the expenditure on cost objects.read more method. 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 period. Thus, this total overhead is divided by the total direct cost to ascertain the single plantwide overhead rate.

Example

Let us consider the following example to understand the concept better:

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 500 labor hours. So, the total overall labor hours stand 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. We find the resultant number as 100,000/1500 = $67 as overhead per labor hour. Therefore, product A will need 1000/500 or 2 hours per production unit. Therefore, the overhead rate for product A is $67*2 = $134/unit. Similarly, product B needs 500/1000 or 0.5 hours per production unit. Therefore, the overhead rate for product B is $67*0.5 = $33.5/unit.

Importance

When plantwide overhead rate is calculated and is known to the entities, they can can plan and allocate overhead costs per the estimates. There are many other aspects that make these rates important for business firms:

Plantwide Overhead Rate vs Departmental Rate

Both plantwide rate and departmental rate are means of estimating the overhead cost allocation to products and services. However, there are a few points of differences that make each preferable by firms as per their requirements and suitability.

Let us have a quick look at the following differences between these two overhead rates:

  • As the names imply, the plantwide overhead rate is an estimate obtained on plant-wise basis, while the departmental overhead cost estimate suggests the allocation of costs based on particular departments.
  • In plantwide means, a single overhead cost estimate is obtained. On the contrary, departmental overhead costs provides cost allocation estimates, which is different for different departments.
  • Plantwide overhead rate works well for firms with few products and not-very-widely spread businesses. The departmental overhead costs are recommended for firms with multiple products and widely spread reach.

Recommended Articles

This has been a guide to what is Plantwide Overhead Rate. Here, we explain its formula, see how to calculate it along with an example, vs departmental rate. You can learn more about it from the following articles –