Advantages of Using the Plantwide Overhead Rate Method
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- Explanation
- Plantwide Overhead Rate Formula
- How to Calculate?
- Why it’s Important?
- Recommended Articles
- What is the advantage of using multiple overhead rates vs a single plantwide overhead rate?
- What is a single plantwide overhead rate?
- What is one advantage of using a departmental rate for allocating overhead?
- Why is it better to use separate overhead rates?
This type of overhead allocation is used in small entities with simple cost structures. This method takes into account the complexity of a company’s cost structure and the batch size of different products. It is more accurate than other methods of overhead allocation because it accounts for the costs of multiple departments with different levels of complexity. The plantwide overhead rate is more complex than other types of overhead allocation because it accounts for the batch size and amount of labor. A plantwide overhead rate is faster because it uses a single allocation base for all the costs.
It is easier to apply a plantwide overhead rate to a small number of departments. This method is more precise than the other types of overhead allocations because it uses valid identifiers to allocate costs across different departments. A plantwide overhead rate is not suitable for companies that operate many different types of services. Using cost pools allows a company to determine its total manufacturing expenses and then allocate costs to individual departments based on these identifiers.
A plantwide overhead rate can be calculated using a single cost-per-machine hour calculation. This method is more accurate than a departmental overhead rate. For example, if a manufacturing operation produces several similar products, it can calculate a plantwide overhead rate of $40 per machine hour for all production units. In this way, a company can budget $800,000 for its total manufacturing overhead costs and expect 20,000 machine hours of good output.
A plantwide overhead rate is more precise than the single cost allocation method. The plantwide cost allocation allows a company to allocate a plant’s overhead costs across multiple departments without having to assign cost drivers to individual products. In addition to accuracy, the single method can also be more flexible. It can be more efficient than the other methods. And it’s better for financial statements if the cost pools are well-defined and have a common basis.
For plants with multiple products, the overhead rate is calculated based on each department’s main activity. Each department’s overhead budget is divided by the cost drivers of its different departments. The shipping department may be responsible for several products, while the machining department is responsible for just one. So, when calculating an overall overhead rate, choose the most accurate method based on production volume.
o A plantwide overhead rate is more accurate than the traditional volume-based methods. The traditional method is less accurate and easier to implement. Compared to the other two methods, the plantwide overhead rate method is the preferred method for large manufacturing companies. The reason for this is that it allows for more effective cost control and has fewer cost objects. The latter has a lower level of accuracy.
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Related
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.
Explanation
Plantwide 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:
- The total sum of the overhead costOverhead cost are those cost that is not related directly on the production activity and are therefore considered as indirect costs that have to be paid even if there is no production. Examples include rent payable, utilities payable, insurance payable, salaries payable to office staff, office supplies, etc.read more to be allocated is not worldly enough. Using multiple allocation rates to drive a higher level of allocation is not needed.
- The various departments present in the company are providing a similar type of service.
- The management accepts using a single allocation base to allocate the entire overhead cost.
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
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For eg:
Source: Plantwide Overhead Rate [wallstreetmojo.com]
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.
- The first and foremost information is required in the total operational cost apart from the direct cost of production. Usually, direct costs are raw materials and direct labor hours. The indirect costIndirect cost is the cost that cannot be directly attributed to the production. These are the necessary expenditures and can be fixed or variable in nature like the office expenses, administration, sales promotion expense, etc.read more is what we call the overheads.
- We will also require the total number of direct labor hours to produce each product in the company. The per-unit labor costCost of labor is the remuneration paid in the form of wages and salaries to the employees. The allowances are sub-divided broadly into two categories- direct labor involved in the manufacturing process and indirect labor pertaining to all other processes.read more is calculated by taking the total labor hours and dividing the sum by the number of units manufactured by the company.
- Now coming to the final step of calculation for arriving at our calculation, we need to first divide the business’s total overhead by the sum of the additive labor hours put in, which have been consumed to estimate the overhead consumed per hour of labor. After this, the resultant is multiplied by the total labor hours consumed to manufacture per output. Thus, this way, we can arrive at the plantwide overhead rate.
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.
Example
Let 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?
- It is best for firms that are small in size and have a uniform cost structureCost Structure refers to those costs or expenses [fixed as well as variable costs] which businesses will incur or will have to incur to produce the desired objective of the business; such costs include the cost of purchasing the raw material to the cost of packaging the finished products.read more.
- It is easier for firms with a single product offering or for firms where all departments produce similar products or have uniform cost objects.
- It makes the calculation easy as only one rate gets allocated to the product or cost objects.
- 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.
- Plantwide overhead rate simplifies overhead allocation as only a single overhead rate is used for calculation.
Recommended Articles
This 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 –
- Scenario Planning
- Applied Overhead
- Administrative Overhead
- Absorbed Overhead
- Factory Overhead
What is the advantage of using multiple overhead rates vs 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.
What is a single 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 one advantage of using a departmental rate for allocating overhead?
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.
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.