How to Calculate Factory Overhead Rate

Factory Overhead Rate Calculator

Sum of all indirect manufacturing costs (rent, utilities, indirect labor, maintenance).

Direct Labor Hours Machine Hours Direct Labor Cost ($) Direct Material Cost ($)

Total amount of hours or cost used as the denominator.

Calculation Result:

function calculateFactoryOverhead() { var overhead = parseFloat(document.getElementById('total_overhead_cost').value); var baseValue = parseFloat(document.getElementById('base_value').value); var type = document.getElementById('allocation_type').value; var resultBox = document.getElementById('overhead_result_box'); var rateDisplay = document.getElementById('overhead_rate_display'); var explanation = document.getElementById('overhead_explanation'); if (isNaN(overhead) || isNaN(baseValue) || baseValue <= 0 || overhead < 0) { alert("Please enter valid positive numbers for both fields."); return; } var rate = overhead / baseValue; resultBox.style.display = "block"; if (type === 'labor_cost' || type === 'material_cost') { var percentage = (rate * 100).toFixed(2); rateDisplay.innerHTML = percentage + "%"; explanation.innerHTML = "For every $1 of direct cost spent, you incur $" + rate.toFixed(2) + " in factory overhead. This is equivalent to " + percentage + "% of the base cost."; } else { var unit = type === 'hours' ? "Direct Labor Hour" : "Machine Hour"; rateDisplay.innerHTML = "$" + rate.toFixed(2) + " per " + unit; explanation.innerHTML = "For every one " + unit + " used in production, $" + rate.toFixed(2) + " of indirect factory costs are allocated to the product."; } }

Understanding your factory overhead rate is critical for accurate product costing and pricing strategies. Without a precise overhead rate, manufacturing businesses often underprice their products, leading to eroded profit margins, or overprice them, leading to lost sales.

What is Factory Overhead?

Factory overhead (also known as manufacturing overhead) includes all the costs incurred during the manufacturing process that cannot be directly traced to a specific unit of production. Unlike direct materials or direct labor, these are indirect expenses necessary to keep the facility running.

• Indirect Labor: Salaries for supervisors, janitors, and quality control inspectors.
• Facility Costs: Factory rent, property taxes, and building insurance.
• Utilities: Electricity to run machines, water, and heating for the plant.
• Depreciation: The gradual loss in value of manufacturing equipment and machinery.

The Factory Overhead Rate Formula

To calculate the factory overhead rate, you divide the total indirect costs by a specific "allocation base." The allocation base is typically a measure of activity that drives the overhead costs.

Overhead Rate = Total Indirect Costs / Total Allocation Base

Choosing the Right Allocation Base

Selecting the correct base is essential for accuracy. Common bases include:

1. Direct Labor Hours: Best for labor-intensive environments where workers manually assemble products.
2. Machine Hours: Ideal for automated plants where electricity and maintenance are driven by how long machines run.
3. Direct Labor Cost: Used when overhead is correlated to the wages paid to production staff (calculated as a percentage).

Practical Example

Let's say "Precision Plastics" has the following monthly figures:

• Total Factory Overhead: $120,000
• Total Machine Hours: 8,000 hours

Using the formula: $120,000 / 8,000 = $15.00

This means for every hour a machine runs, the company must allocate $15.00 of overhead cost to the product being made. If a specific product takes 2 hours of machine time, it carries $30.00 of overhead in addition to its direct material and labor costs.

Why Calculating This Rate is Important

By calculating the factory overhead rate, management can perform Break-even Analysis more accurately, ensure Inventory Valuation complies with accounting standards (GAAP), and identify Operational Inefficiencies. If your overhead rate per hour is rising month-over-month, it may indicate that utility costs are spiking or that equipment is becoming less efficient as it ages.