A plant-wide overhead rate is often a single rate per hour or a percentage of some cost that is used to allocate or assign a company's manufacturing overhead costs to the goods produced.
A plant-wide rate could be adequate in the following situations:
- There is one root cause of the indirect manufacturing costs
- The company manufactures similar products
- The company has relatively small, consistent amounts of inventory
However, if the company manufactures diverse products, some of which use expensive equipment while some use only inexpensive equipment, or the company wants precise costs for pricing decisions, a plant-wide rate is not appropriate. In response to this situation, manufacturers will use departmental overhead rates and perhaps activity based costing.
Example of Plant-wide Overhead Rate
Let's assume that a company's manufacturing overhead costs [equipment depreciation, electricity, maintenance, supervisors, etc.] is budgeted to be $800,000 for the new year. The company produces similar products and it expects to use 20,000 machine hours. Based on this information, the company's plant-wide overhead rate will be $40 per machine hour. If each product requires 15 minutes of machine time, each product's cost will include $10 of manufacturing overhead [15 minutes = 1/4 hour X $40 per machine hour].
Overhead expenses are the costs incurred by a business in the course of its day-to-day operations. They are found in the selling, general and administrative [SG&A] section of the income statement, the three items combined make up the operating expenses of a business.
Rent, utilities, postage, supplies and computer equipment are all part of overhead.
“Overhead” costs are directly related to the day-to-day operation of the business. Examples include rent, insurance, utilities and office supplies.
Why departmental overhead rates might be used instead of a single plantwide overhead rate?
Using departmental overhead rates will better reflect the costs of manufacturing Product A and Product B compared to using a single, plant-wide overhead rate.
Why is departmental overhead rate better?
Departmental overhead rates offer the flexibility to use a different activity or cost driver for each department. Often, some departments will rely heavily on manual labor while others require more machinery. Direct labor hours can be important to certain departments but machine hours might work better for others.
What is one advantage of using a departmental rate for allocating overhead?
Easier to Manage
This allows for quicker decision-making with regards to keeping costs in line. It also makes it easier to identify trends leading to higher costs when compared to a method involving company-wide overhead rates. This flexibility can allow departments to allocate costs more accurately.
What is the typical level of overhead for a business?
Generally speaking, SG&A should be between 15% and 25% of revenues.
However, some companies may have AGCs ranging from 20% to 30% of sales. “It depends on the industry or type of business you’re in,” he adds.
On a percentage basis, labor-intensive businesses, such as restaurants and hotels, may have higher SG&A than businesses in capital-intensive industries, such as manufacturing, which produces goods.
For example, a restaurant may have a 50% cost of goods sold or cost of sales, leaving a 50% gross profit. In this case, the restaurant’s SG&A may be 30%, leaving an operating profit of 20%.
In manufacturing, cost of goods sold can be 65% to 70% of revenue, leaving 30% to 35% for AGI and operating income.
If your CPV is 70%, you have 30% left. If you have 30% left, your AGI must not exceed 20%. That leaves 10% for operating income before taxes.
Why multiple overhead rates should be used in this company rather than a single rate?
If your product mix is more complex and customized, you may use multiple overhead rates to allocate costs more accurately. If one department is machine-intensive and another is labor-intensive, for example, multiple rates may be appropriate.
When should you use a plantwide overhead rate?
Plantwide Overhead Rate Method The plantwide overhead rate method is practical when [1] overhead costs are closely related to production volume, or [2] a company produces only one product.
Which of the following is a disadvantage to using a single plantwide factory overhead rate?
Which of the following is a disadvantage to using a single plantwide factory overhead rate? The rate assumes that factory overhead costs are consumed in the same way by all products.
What are the advantages of using a single plantwide overhead rate?
Advantages: More accurate overhead cost allocation. More effective overhead cost control. Focus on relevant factors.
Why do you consider departmentalization of overheads necessary?
The departmentalization overhead costs is important because bit allows for better planning and control if the head of each department is held accountable for costs and productivity of his department.
What will the use of departmental overhead rates generally result in?
The use of departmental overhead rates will generally result in: The use of a separate cost allocation base for each department in the shop.
What are the advantages of departmentalization of factory overhead?
What are the advantages of departmentalizing manufacturing overhead costs? The departmentalizing of manufacturing overhead costs allows for better planning and control if the head of each department is held responsible for the costs and productivity of his or her department.
What is the rationale for the use of departmental rates rather than blanket rates?
What are the benefits of using a departmental overhead rate? Using a departmental overhead rate is beneficial because it ensures that all jobs and Units of Production are charged with their fair share of overheads. This is suitable when jobs and units do not spend a similar amount of time in each department.
Why may departmental overhead rates not correctly assign overhead costs?
Departmental overhead rates will not correctly assign overhead costs in situations where a company has a range of products and complex overhead costs. This is because the departmental approach relies exclusively on volume-related allocation bases.
What is single plantwide rate?
The plantwide overhead rate is a single overhead rate that a company uses to allocate all of its manufacturing overhead costs to products or cost objects. It is most commonly used in smaller entities with simple cost structures.
Which of the following is a disadvantage of the department overhead rate method?
Which of the following is a disadvantage of the departmental overhead rate method? It may fail to accurately assign many overhead costs that are not driven by production volumn.
Which of the following is considered the most accurate method in allocating overhead costs to products?
An activity-based costing system is considered more complex than using a single plantwide rate to allocate overhead, but an ABC system is also considered a more accurate way to allocate overhead costs.
How do cost flows using activity-based costing differ from cost flows using one plantwide rate?
Chapter 3 Item #5 How do cost flows using activity-based costing differ from cost flows using one plantwide rate? Activity-Based Costing differs to plantwide because ABC uses more than cost pool, allowing the cost to allocated to each products based on activities needed to complete the product.
What are the advantages of departmentalization?
The main advantages of departmentalization can be highlighted as follows:
- Specialization And Work Division. …
- Improved Productivity. …
- Fixed Authority And Responsibility. …
- Measurement Of Performance. …
- Resource Utilization. …
- Better Administrative Control.
What is departmentalization overhead?
Departmentalization of overheads refers to the process of determining the overhead costs of each department involved in production.
What is known as departmentalization of overhead?
Departmentalization of overhead is known as primary distribution. Primary distribution involves apportionment or allocation of overhead to all departments in a factory on logical and rational basis. This process of apportionment is also known as departmentalisation of overhead.
What will the use of departmental overhead rates generally result in?
The use of departmental overhead rates will generally result in: The use of a separate cost allocation base for each department in the shop.
Which allocation method is best?
The best method for allocating overhead in construction is a way that’s fair. After all, the idea is to allocate [or, distribute] costs that each job shares responsibility for — meaning the job either caused or benefited from the cost. But, the costs should also be proportional to that responsibility.
Why are departmental overhead rates sometimes not accurate in assigning overhead costs to products?
Departmental overhead rates may not correctly assign overhead costs due to: a. the use of direct labor hours in allocating overhead costs to products rather than machine time or quantity of materials used.
Which is the most scientific practical and accurate method of recovery of overhead?
Answer: Machine Hour Rate: Machinery hour rate means the expenses incurred while running a machine for one hour. No doubt, it is quite logical and- scientific method for absorption of factory overheads used in production.
Which overhead absorption rate is generally used where we use more machines in the production process?
Machine hour rate method is suitable when machines are extensively used in production. Merits: [1] It is a scientific method of absorption, since time factor is taken into account.