Overhead Allocation Rate Calculator
Determine how much indirect cost should be assigned to each unit of production or service.
Calculation Result
Your Overhead Allocation Rate is:
Understanding Overhead Allocation Rates
In managerial accounting, the overhead allocation rate is a critical metric used to assign indirect costs—such as rent, utilities, administrative salaries, and maintenance—to specific products, jobs, or departments. Because these costs cannot be traced directly to a single unit of output, businesses use an allocation base to distribute them fairly.
The Overhead Allocation Formula
The standard formula for calculating this rate is:
Overhead Allocation Rate = Total Indirect Costs / Total Quantity of Allocation Base
Common Allocation Bases
- Direct Labor Hours: Best for labor-intensive manufacturing environments.
- Machine Hours: Ideal for automated plants where machinery drives production.
- Direct Labor Cost: Used when overhead correlates with the wages paid to workers.
- Units Produced: A simple method when a company produces identical products.
Realistic Example
Imagine a furniture factory that incurs $120,000 in indirect costs (factory rent, insurance, and supervisor salaries) per year. The factory estimates it will use 8,000 direct labor hours during that same period.
Calculation: $120,000 / 8,000 hours = $15.00 per labor hour.
This means for every hour a carpenter spends building a table, the company adds $15 to the product cost to cover overhead.
Why Accurately Calculating Overhead Matters
Failure to calculate this rate correctly can lead to "product undercosting" or "overcosting." If you undercost, you might set prices too low and lose money. If you overcost, you might price yourself out of the market. By using a precise allocation base, managers can gain a clearer picture of true profitability.