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What is a Manufacturing Overhead Rate?

Manufacturing Overhead Rate

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Manufacturing Overhead Rate

The manufacturing overhead rate is a calculation used in cost accounting to determine how much overhead costs will be assigned to each unit of production. The rate is calculated by dividing total overhead expenses by the total number of units expected to be produced, or in some cases, by total direct labor hours or machine hours, depending on the allocation base used. This results in a per-unit or per-hour cost figure.

For example, let’s consider the company from our previous example, Widgets Inc. If Widgets Inc. expects to produce 10,000 widgets in the upcoming quarter and the total manufacturing overhead budget is $65,000, the overhead rate would be calculated as follows:

Manufacturing Overhead Rate = Total Manufacturing Overhead / Total Expected Units Manufacturing Overhead Rate = $65,000 / 10,000 units Manufacturing Overhead Rate = $6.5 per unit

This means that Widgets Inc. would apply $6.5 in overhead costs to each widget it manufactures. This information would be vital for the company when determining the total cost of producing each widget and in turn, in setting an appropriate selling price.

It’s important to note that manufacturing overhead rates can be calculated using different allocation bases. The choice of allocation base (units produced, direct labor hours, machine hours etc.) would depend on the cost drivers or activities that cause the overhead costs. The key is to choose the allocation base that most accurately links the overhead cost to the activity causing it.

Example of a Manufacturing Overhead Rate

Let’s continue with our Widgets Inc. example and use a different overhead allocation base, say machine hours.

Suppose Widgets Inc. expects to use 5,000 machine hours in the upcoming quarter. The total manufacturing overhead budget remains $65,000. The manufacturing overhead rate is then calculated as follows:

Manufacturing Overhead Rate = Total Manufacturing Overhead / Total Machine Hours Manufacturing Overhead Rate = $65,000 / 5,000 machine hours Manufacturing Overhead Rate = $13 per machine hour

This indicates that for every hour a machine runs, Widgets Inc. would apply $13 in overhead costs. This would help Widgets Inc. allocate the right portion of overhead costs to each product depending on the machine hours spent on its production.

Later, if a specific widget model, Widget-A, required 2 machine hours to produce, the overhead cost allocated to one unit of Widget-A would be:

Overhead cost for Widget-A = Manufacturing Overhead Rate * Machine hours for Widget-A Overhead cost for Widget-A = $13 * 2 = $26

So, the overhead cost applied to each unit of Widget-A would be $26. This calculation would be crucial in determining the total production cost for Widget-A and hence its selling price.

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