Far Overhead Rate Calculation

Understanding and Calculating the Factory Overhead Rate

Factory overhead, also known as manufacturing overhead or burden, refers to all the indirect costs incurred in the production process that are not directly attributable to specific products. These costs are essential for running a manufacturing facility but don't directly tie into the creation of a single unit. Examples include rent for the factory building, utilities, depreciation of machinery, salaries of supervisors and maintenance staff, and indirect materials.

To accurately determine product costs and make informed pricing decisions, businesses need to allocate these overhead costs to the products manufactured. The factory overhead rate is a crucial tool for this allocation. It's an estimated rate used to apply overhead costs to cost objects (like products or services) based on a predetermined allocation base. This rate is typically calculated at the beginning of an accounting period and is used throughout that period.

How to Calculate the Factory Overhead Rate

The basic formula for calculating the factory overhead rate is:

Factory Overhead Rate = Estimated Total Factory Overhead Costs / Estimated Total Allocation Base

Let's break down the components:

• Estimated Total Factory Overhead Costs: This is the sum of all indirect manufacturing costs expected to be incurred during a specific period (e.g., a year or a quarter). This includes items like factory rent, utilities (electricity, water, gas), depreciation of factory equipment and buildings, salaries of factory supervisors, quality control personnel, janitorial staff, and indirect materials and supplies.
• Estimated Total Allocation Base: This is a measure of production activity that is expected to drive overhead costs. Common allocation bases include:
  • Direct Labor Hours: If overhead is thought to be driven by the amount of time labor spends on production.
  • Direct Labor Costs: If overhead is related to the cost of labor.
  • Machine Hours: If production is highly automated and overhead is driven by machine usage.
  • Units Produced: If overhead is relatively fixed and each unit incurs a similar overhead cost.
  The choice of allocation base is critical and should be the one that best correlates with the incurrence of overhead costs for the specific business.

Using the Factory Overhead Rate

Once the rate is calculated, it's applied to the actual activity level of the allocation base for each product or job. The formula for applying overhead is:

Applied Factory Overhead = Factory Overhead Rate × Actual Amount of Allocation Base Used

For example, if your overhead rate is $15 per direct labor hour and a specific job uses 10 direct labor hours, you would apply $150 in overhead to that job.

This calculator helps you quickly determine your factory overhead rate based on your estimated costs and chosen allocation base.

Factory Overhead Rate Calculator