What is the advantage of using multiple overhead rates vs a single plantwide overhead rate?
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The departmental overhead rate is an expense rate calculated for each department in a factory production process. The departmental overhead rate is different at every stage of the production process when various departments perform selected steps to complete the final process. Show
By breaking up overhead costs for individual business sections rather than having a company-wide rate, management can assess corporate inefficiencies more accurately and take more specific action. What Does the Departmental Overhead Rate Tell You?An overhead rate, in managerial accounting, is an additional cost added on to the direct costs of production in order to more accurately assess the profitability of each product. To allocate these costs, an overhead rate is applied that spreads the overhead costs around depending on how much resources a product or activity used. For example, overhead costs may be applied at a set rate based on the number of machine hours required for the product. In more complicated cases, a combination of several cost drivers may be used to approximate overhead costs. The departmental overhead rate is specific to every segregated step in the entire process. For example, if a company makes bread, different departmental rates could be used for the actual production/manufacturing line and the bagging process. Cost-cutting, efficiency and productivity are standard elements of a strong corporate performance methodology. Analysis and benchmarking of departmental overhead rates is an effective way to measure success. Comparisons between competitors, as well as among various internal departments help isolate efforts that are adding value, and those that are destroying enterprise value. No two cost-cutting approaches are the same. Like all things in business, there are pros and cons to the myriad of strategies businesses can utilize. However, by following trends in departmental rates, patterns do emerge highlighting the delicate balance of short-term goals with long-term business requirements. Determining Departmental Overhead RatesDetermining appropriate departmental rates is an area addressed by managerial accounting methods. Managerial accounting is the process of identifying, measuring, analyzing, interpreting and communicating information for the pursuit of an organization's goals. This branch of accounting is also known as cost accounting. The key difference between managerial and financial accounting is managerial accounting information is aimed at helping managers within the organization make decisions, while financial accounting is aimed at providing information to parties outside the organization. In managerial accounting, rather than using one overhead rate to allocate all of the overhead costs, overhead costs can be broken down by departments. 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.
ExplanationPlantwide overhead rate is a method of allocating manufacturing 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 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 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 You are free to use this image on your website, templates, etc, Please provide us with an
attribution linkArticle Link to be Hyperlinked 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 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. ExampleLet 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 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. Why it’s Important?
Recommended ArticlesThis has been a guide to What is Plantwide Overhead Rate & its Definition. Here we discuss the formula for calculating the plantwide overhead rate and its importance and examples. You can learn more about it from the following articles –
What are the advantages of using a plantwide overhead rate?More accurate overhead cost allocation. More effective overhead cost control. Focus on relevant factors. Better management of activities.
Why is it better to use separate overhead rates rather than plantwide rates?This approach typically provides more accurate cost information than simply using one plantwide rate but still relies on the assumption that overhead costs are driven by direct labor hours, direct labor costs, or machine hours.
Why is it better to use separate overhead rates?Within a large manufacturing business with departments ranging from sales to assembly to administration, separating overhead rates gives management a clearer picture of the price of production.
How do multiple production department and the single plantwide factory overhead rate method differ?The single plantwide factory overhead rate method indicates that both products have the same factory overhead per unit. Each product uses the direct labor hours differently. Thus, the multiple department rate method avoids the cost distortions by accounting for the overhead in each production department separately.
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