Next, multiply the overhead per labor hour by the number of labor hours used to produce each unit. The common allocation bases are direct labor hours, direct labor cost, machine hours, and direct materials. The concept of predetermined overhead rate is very important because it is used most of the enterprises as it enables them to estimate the approximate total cost of each job. Larger organizations employ different allocation bases for determining the predetermined overhead rate in each production department. However, in recent years the manufacturing operations have started to use machine hours more predominantly as the allocation base.

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

Further, the company uses direct labor hours to assign manufacturing overhead costs to products. As per the budget, the company will require 150,000 direct labor hours during the forthcoming year. Based on the given information, calculate the predetermined overhead rate of TYC Ltd. Until now, you have learned to apply overhead to production based on a predetermined overhead rate typically using an activity base.

Plantwide overhead rate definition

You have to consider more than the cost of the goods or services your company sells when you set prices. A business has a variety of additional costs that must be allowed for when determining prices. A plantwide or single overhead rate is one method for allocating these indirect costs so you can set prices appropriately. The predetermined overhead rate is used to price new products and to calculate variances in overhead costs.

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. Sales of each product have been strong, and the total gross profit for each product is shown in Figure 6.7. Using the Solo product as an example, 150,000 units are sold at a price of $20 per unit resulting in sales of $3,000,000. The cost of goods sold consists of direct materials of $3.50 per unit, direct labor of $10 per unit, and manufacturing overhead of $5.00 per unit. With 150,000 units, the direct material cost is $525,000; the direct labor cost is $1,500,000; and the manufacturing overhead applied is $750,000 for a total Cost of Goods Sold of $2,775,000. To calculate the plantwide overhead rate, first divide total overhead by the number of direct labor hours used to find the overhead per labor hour.

• The company uses machine hours to assign manufacturing overhead costs to products.
• Small companies typically use activity-based costing, while large organizations will have departments that compute their own rates.
• A company’s manufacturing overhead costs are all costs other than direct material, direct labor, or selling and administrative costs.
• The predetermined overhead rate calculation shown in the example above is known as the single predetermined overhead rate or plant-wide overhead rate.

To account for these changes in technology and production, many organizations today have adopted an overhead allocation method known as activity-based costing (ABC). This chapter will explain the transition to ABC and provide a foundation in its mechanics. To calculate a predetermined overhead rate, divide the manufacturing overhead cost by the units of allocation. You also need the total number of direct labor hours and the direct labor hours required to produce each product the plant manufactures. Per unit labor hours can be calculated by dividing the total labor hours used to manufacture each product by the number of units manufactured. Typically, a plantwide overhead rate assigns a cost figure based on the labor hours needed to produce one unit.

When the $700,000 of overhead applied is divided by the estimated production of 140,000 units of the Solo product, the estimated overhead per product for the Solo product is $5.00 per unit. The computation of the overhead cost per unit for all of the products is shown in Figure 6.4. A predetermined overhead rate is defined as the ratio of manufacturing overhead costs to the total units of allocation.

Examples of Predetermined Overhead Rate Formula (With Excel Template)

Adkins holds master's degrees in history and sociology from Georgia State University. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. The articles and research target costing and selling price support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.

Which of these is most important for your financial advisor to have?

Company B wants a predetermined rate for a new product that it will be launching soon. Its production department comes up with the details of how much the overheads will be and what other costs will be incurred. Departmental overhead rates are needed because different processes are involved in production that take place in different departments. However, one major disadvantage of the method is that both the numerator and the denominator are estimates and as such, it is possible that the actual result may vary significantly from the predetermined overhead rate. Therefore, the predetermined overhead rate of GHJ Ltd for next year is expected to be $5,000 per machine hour.

The company uses machine hours to assign manufacturing overhead costs to products. Calculate the predetermined overhead rate of GHJ Ltd if the required machine hours for next year’s production is estimated to be 10,000 hours. The predetermined overhead rate is set at the beginning of the year and is calculated as the estimated (budgeted) overhead costs for the year divided by the estimated (budgeted) level of activity for the year. This activity base is often direct labor hours, direct labor costs, or machine hours. Once a company determines the overhead rate, it determines the overhead rate per unit and adds the overhead per unit cost to the direct material and direct labor costs for the product to find the total cost.

What is a Plantwide Overhead Rate?

As you’ve learned, understanding the cost needed to manufacture a product is critical to making many management decisions (Figure 6.2). Knowing the total and component costs of the product is necessary for price setting and for measuring the efficiency and effectiveness of the organization. Remember that product costs consist of direct materials, direct labor, and manufacturing overhead. A company’s manufacturing overhead costs are all costs other than direct material, direct labor, or selling and administrative costs. Once a company has determined the overhead, it must establish how to allocate the cost. This allocation can come in the form of the traditional overhead allocation method or activity-based costing..

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. 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. Enter the total manufacturing overhead cost and the estimated units of the allocation base for the period to determine the overhead rate. In these situations, a direct cost (labor) has been replaced by an overhead cost (e.g., depreciation on equipment). Because of this decrease in reliance on labor and/or changes in the types of production complexity and methods, the traditional method of overhead allocation becomes less effective in certain production environments.

The estimate is made at the beginning of an accounting period, before the commencement of any projects or specific jobs for which the rate is needed. From the above list, salaries of floor managers, factory rent, depreciation and property tax form part of manufacturing overhead. After reviewing the product cost and consulting with the marketing department, the sales prices were set. The sales price, cost of each product, and resulting gross profit are shown in Figure 6.6.

Gathering Direct and Indirect Costs

Let us take the example of ort GHJ Ltd which has prepared the budget for next year. The company estimates a gross profit of $100 million on total estimated revenue of $250 million. As per the budget, direct labor cost and raw material cost for the period is expected to be $40 million and $60 million respectively.

Overhead is the general term for costs a business pays other than the direct costs of producing a good or service. The production hasn’t taken place and is completely based on forecasts or previous accounting records, and the actual overheads incurred could turn out to be way different than the estimate. Different businesses have different ways of costing; some use the single rate, others use multiple rates, and the rest use activity-based costing. Therefore, the predetermined overhead rate of TYC Ltd for the upcoming year is expected to be $320 per hour. 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.