Definition
The Plantwide Overhead Rate, in finance, refers to the total allocation of a manufacturing plant’s overhead costs over its entire production volume. This singular rate is used throughout an entire plant, regardless of the diversity of products or functions within it. It’s calculated by dividing total overhead costs by total production volume.
Key Takeaways
- The Plantwide Overhead Rate is a single overhead rate that is used across an entire manufacturing plant. It combines all departments and overheads into one bulk amount for more simplicity.
- It’s calculated by dividing total overhead costs by total direct labor hours or machine hours. This rate is applied to overhead allocation for each product based on their usage of labor or machine hours.
- Although it simplifies cost calculation, the Plantwide Overhead Rate may lead to inaccurate product costing if different departments or products use resources at different rates as it assumes uniform distribution of overheads.
Importance
The Plantwide Overhead Rate is a crucial finance term as it pertains to the allocation of overhead costs throughout an entire manufacturing operation. By using a single overhead rate to distribute costs, companies can simplify their cost accounting procedure, making it less complex and more manageable.
This rate is calculated by dividing total overhead costs by the total amount of the chosen allocation base, commonly direct labor hours or machine hours. It provides a consistent way to assign overhead cost to every individual product; thus, helping businesses understand the overall cost of producing each of their products.
Ultimately, it’s important for pricing decisions, profitability analysis, and management planning. However, it may not be very accurate if the company manufactures diverse products requiring unequal overhead resources.
Explanation
The Plantwide Overhead Rate is an extensively used mechanism in cost accounting, serving a substantial purpose in the distribution of manufacturing overhead costs across various product lines. This method assumes that all overhead costs incurred within a manufacturing plant are driven by the same factor – usually direct labor hours or machine hours.
It is designed to allocate costs to products based on a singular, plant-wide base, thus evenly distributing overhead costs amongst products. The Plantwide Overhead Rate is majorly employed as a tool to determine the true cost of product manufacturing.
It helps management make informed financial decisions regarding product pricing, profitability analyses and cost control measures. Additionally, it aids in setting a selling price for products and enable companies to manage their budget effectively.
Moreover, by applying a plant-wide overhead rate, companies can simplify their costing process, which may be particularly beneficial for smaller companies or those with less complex operations.
Examples of Plantwide Overhead Rate
Manufacturing Companies: Many manufacturing companies, like those in the automotive or electronics industries, use a plantwide overhead rate to allocate their overhead costs. This is done by dividing the total overhead costs of the entire plant by the total machine hours or labor hours. For example, if a car manufacturing company incurs $2 million in overhead costs in a year and the total machine hours were 1 million, then the plantwide overhead rate would be $2 per machine hour.
Restaurant and Hospitality Industry: Restaurants often split their costs into direct and indirect (overhead) costs. If a large restaurant chain, for instance, chooses to allocate its overhead costs based on the total meal preparation hours across all its branches, it is an example of using a plantwide overhead rate. The plantwide rate will be calculated by dividing total overhead by the total preparation hours.
Health Care Institutions: Large hospitals may apply plantwide overhead rates to distribute among various departments like pharmacy, radiology, and surgery. For decentralizing expenses, they calculate the plantwide overhead rate by dividing total overhead costs by total patient care hours or other suitable base. For example, if a hospital has a total overhead of $10M and 200,000 patient care hours, the plantwide overhead rate would be $50 per patient care hour.
Frequently Asked Questions: Plantwide Overhead Rate
What is a plantwide overhead rate?
A plantwide overhead rate is an accounting method used in cost accounting, where the entire overhead of a manufacturing plant is allocated to each unit of production. This overhead includes costs that are not directly tied to a specific product, such as maintenance, utilities, and indirect labor costs.
How is a plantwide overhead rate calculated?
The plantwide overhead rate is calculated by taking the total overhead costs of the plant and dividing it by the total amount of cost drivers. Cost drivers are any factors that cause a change in the cost of an activity. The resulting figure is then used to assign overhead costs to products.
What are the advantages of using a plantwide overhead rate?
The advantage of using a plantwide overhead rate is that it simplifies the cost allocation process. It is easier to implement because it requires less data collection and less intricate cost calculations than other methods of overhead allocation, like departmental or activity-based costing.
What are the limitations of the plantwide overhead rate?
The main limitation of the plantwide overhead rate is that it may not provide an accurate cost per unit for each product. This is because this method uses a single, average figure to assign costs, without taking into account the specific cost drivers for each product.
Related Entrepreneurship Terms
- Absorption Costing
- Cost Pooling
- Activity-Based Costing (ABC)
- Fixed Overheads
- Variable Overheads
Sources for More Information
- Investopedia: This platform offers easy-to-understand and detailed explanations about various finance related topics including the Plantwide Overhead Rate.
- Accounting Tools: This website is a comprehensive resource for professionals in the accounting field and offers deep insights into specific concepts like the Plantwide Overhead Rate.
- Corporate Finance Institute: CFI is a professional certifications provider in the field of finance and offers courses as well as free resources, which include information about the Plantwide Overhead Rate.
- Accounting Coach: This website provides free online education on accounting and finance topics and contains information about the Plantwide Overhead Rate.
