A departmental rate, in the context of cost accounting, is a way to allocate overhead costs to different departments within an organization. The aim is to distribute indirect costs, such as rent, utilities, and management salaries, that can’t be easily traced to a particular product or service.
The departmental rate is calculated by dividing the total overhead cost of a department by a chosen allocation base. This base is often a measure of the volume of activity in the department, such as direct labor hours, machine hours, or direct labor costs.
Once the departmental rate is calculated, it can be used to apply overhead costs to the products or services produced in that department. By doing so, the company can gain a more accurate understanding of the total cost of producing each product or service, which can assist in pricing decisions, profitability analysis, and budgeting.
It’s worth noting that this method assumes that all products or services in a department use overhead resources in the same way. If different products use overhead resources at different rates, a more complex cost allocation system, such as activity-based costing, might be needed.
Example of a Departmental Rate
Let’s take an example of a manufacturing company that makes two types of products: Tables and Chairs. The manufacturing process takes place in two main departments – the Assembly Department and the Finishing Department.
- Assembly Department: The total overhead costs for this department, including costs for electricity, rent, and supervisory salaries, amount to $600,000 for the year. The total direct labor hours worked in this department for the year are 30,000 hours. So, the departmental rate for the Assembly Department would be calculated as $600,000 / 30,000 hours = $20 per direct labor hour.
- Finishing Department: The total overhead costs for this department amount to $400,000 for the year. The total direct labor hours worked in this department for the year are 20,000 hours. Thus, the departmental rate for the Finishing Department would be $400,000 / 20,000 hours = $20 per direct labor hour.
Now, let’s say a particular table requires 3 hours of labor in the Assembly Department and 2 hours in the Finishing Department. The overhead cost allocated to the table from each department would be:
- Assembly Department: 3 hours x $20/hour = $60
- Finishing Department: 2 hours x $20/hour = $40
So, the total overhead cost allocated to the table would be $60 + $40 = $100. This would be added to the direct costs of making the table (like the cost of wood and the wages of the workers) to find out the total cost of producing that table.
This method of calculating departmental rates and applying overhead helps the company better understand the true cost of its products, which is essential for pricing and profitability analysis.