What is a plantwide overhead rate Why are multiple overhead rates rather than a plant wide overhead rate used in some companies?

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Ahmed Elhadad
A plant-wide overhead rate is a single rate used to assign or allocate all of a company's manufacturing overhead costs to its production output. (Manufacturing overhead costs are the indirect costs of production such as repairs, maintenance, depreciation, electricity, supervision, etc.) Often the plant-wide rate is an amount per machine hour, an amount per labor hour, or a percentage of a product's direct costs.
Using a plant-wide rate is logical when there is one root cause of the indirect production costs and the company manufactures similar products. For example, a company with a simple manufacturing operation that produces similar products could have a plant-wide overhead rate of $40 per machine hour if it has budgeted $800,000 of total manufacturing overhead costs and it expects to produce 20,000 machine hours of good output.
On the other hand, if the company manufactures diverse products, some of which use expensive equipment while some use only inexpensive equipment, a plant-wide rate is not appropriate. In response to this situation, manufacturers have developed departmental overhead rates. Thus, only the products that use the expensive equipment in a specific department will be assigned a higher overhead rate of perhaps $70 per departmental machine hour. The products requiring a simpler operation such as assembling may be assigned overhead at a rate of perhaps $20 per direct labor hour.
Some companies have moved beyond both the plant-wide rate and the departmental rates because they want to consider all of the activities that are driving up manufacturing overhead costs. These companies are attempting to find the root causes of the indirect manufacturing costs so they can assign the costs to products in a more logical manner (instead of merely spreading the costs arbitrarily via plant-wide or departmental production hours). This effort is known as activity based costing.
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Indirect vs. Direct Costs
Total Number Of Units
Factor in Shipping
Quality Control
Plantwide Overhead Rate Method
Why are multiple overhead rates used rather than a plantwide overhead rate in some companies?
What is a plantwide overhead rate?
What is the rationale for the use of departmental rate's rather than plant wide rate s?
Why is plantwide overhead rate important?

Ahmed Elhadad

Accountant , IFRS

Published Oct 13, 2015

A plant-wide overhead rate is a single rate used to assign or allocate all of a company's manufacturing overhead costs to its production output. (Manufacturing overhead costs are the indirect costs of production such as repairs, maintenance, depreciation, electricity, supervision, etc.) Often the plant-wide rate is an amount per machine hour, an amount per labor hour, or a percentage of a product's direct costs.

Using a plant-wide rate is logical when there is one root cause of the indirect production costs and the company manufactures similar products. For example, a company with a simple manufacturing operation that produces similar products could have a plant-wide overhead rate of $40 per machine hour if it has budgeted $800,000 of total manufacturing overhead costs and it expects to produce 20,000 machine hours of good output.

On the other hand, if the company manufactures diverse products, some of which use expensive equipment while some use only inexpensive equipment, a plant-wide rate is not appropriate. In response to this situation, manufacturers have developed departmental overhead rates. Thus, only the products that use the expensive equipment in a specific department will be assigned a higher overhead rate of perhaps $70 per departmental machine hour. The products requiring a simpler operation such as assembling may be assigned overhead at a rate of perhaps $20 per direct labor hour.

Some companies have moved beyond both the plant-wide rate and the departmental rates because they want to consider all of the activities that are driving up manufacturing overhead costs. These companies are attempting to find the root causes of the indirect manufacturing costs so they can assign the costs to products in a more logical manner (instead of merely spreading the costs arbitrarily via plant-wide or departmental production hours). This effort is known as activity based costing.

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If your company manufactures several products at different locations in your plant, each product has its own overhead expenses. Instead of figuring overhead costs for each product, you can calculate plant-wide expenses. This averages the costs for all products, and gives you an overview of expenses for your entire manufacturing operation. Sometimes called the "predetermined overhead rate," your plant-wide figure helps you understand your company profitability.

Indirect vs. Direct Costs

Your indirect costs are those that continue no matter how much or how little you manufacture. These include things like rent or mortgage payments, insurance, equipment leases, and plant maintenance. Look at such bills for your manufacturing plant and total them up. This figure is your plant-wide indirect cost that you must pay just to be in business. All of your manufacturing activities depend on the services you are paying for throughout your plant.

Direct costs, by contrast, vary with each product you make. These include energy usage, wages for production and shipping personnel, and materials. Each product will use a different amount of these resources, but you can use a grand total for each direct cost as your plant-wide figure. This is the average direct cost for manufacturing all of your products.

Total Number Of Units

You probably produce different numbers of units for each product. Some small products may require large quantities, while complex projects may take longer to produce and therefore result in fewer units during any given period. Add up the total number of units you produce in a month regardless of which product it is.

Factor in Shipping

Some products are cheaper to ship than others, but total your shipping costs on a plant-wide basis. Include packing materials, postage and vehicle expenses. Do not include wages for shipping personnel because you already included these in your direct costs for the entire plant.

Quality Control

Some of your products will need more quality checking than others. You have to pay for personnel to do this checking, and in some cases you have to pay production personnel to fix the problem. In other cases, you may have to throw out defective products and write off the cost of making them. Add up all your quality control expenses into one grand total, even if most of the quality problems are with one or two products.

Plantwide Overhead Rate Method

You are now in a position to calculate the plantwide overhead rate which, as Accounting Tools describes, will allow you to specify the overhead across your entire plant. Accounting for Management gives the following formula:

Predetermined overhead rate = (estimated manufacturing overhead cost) / (estimated total units in the allocation base)

To find your overhead cost, add up all your subtotals of expenses, direct and indirect. Divide your total expenses for the plant by the total number of units you produce. This will give you a per-unit rate. Using the plantwide overhead rate formula, if expenses come to $10,000 for instance and you produce 2,500 units, $10,000 divided by 2,500 equals four. You are paying, on average, $4 per unit in overhead on a plant-wide basis.

Why are multiple overhead rates used rather than a plantwide overhead rate in some companies?

Some companies used multiple overhead rates because plantwide overhead rate is not always accurate which can lead to overapplication on one product and under application on the other. Multiple overhead rates are used by big companies that have a wide variety of cost pools and cost drivers.

What is a plantwide overhead rate?

What is a Plantwide Overhead 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.

What is the rationale for the use of departmental rate's rather than plant wide rate s?

The reason for departmental overhead rates is that manufacturers are likely to produce many diverse products which use different processes in different departments and each has different costs.

Why is plantwide overhead rate important?

It produces more accurate results for firms producing single products than the cost pool method, making the calculation more complicated. It is a time-saving process compared to the multiple allocation process or multiple overhead rates.