The following system is presented to focus on How to Calculate Overhead Rate or calculate Factory Overhead per Machine Hour or labor hour. The basic to calculate Overhead Rate involves the following procedures:
Estimating the Activity Level and Expenses.
The first step to calculate the overhead rate is to determine the activity-level to be used for the base selected and then estimate or budget each individual expense at the estimated activity level in order to arrive at the total estimated overhead.
For example take the estimated factory overhead for Proctor Products, Inc. for a normal capacity activity level estimated at 200,000 direct labor hours or 5000 machine hours.
Classifying Expenses as Fixed or Variable.
The classification of expenses according to changes in volume attempts to establish a variability pattern for each expense item. This classification must, in turn, consider certain specific assumptions regarding plant facilities, prices, managerial policy, and the state of technology. Once the classification has been decided, the expense may remain in this category for a limited period of time. Should underlying conditions change, the original classification must be reviewed and expenses reclassified as necessary. Variable expenses change with production volume are considered a function of volume ; that is, the amount of variable expense per unit is constant. Fixed expenses, on the other hand, are just the opposite. The total amount is fixed, but the expense per unit is different for each production level. Increased production causes a decrease in fixed expense per unit.
Knowledge of the effect of fixed and variable expenses on the product unit cost is highly important in any study of factory overhead. A knowledge of the behavior of all costs is fundamental to the planning and analytical processes for decision-making purposes. An examination of fixed and variable expenses indicates the difficulty of segregating all expenses as either fixed or variable. Some expenses are partly fixed and partly variable; some are fixed to a certain production level and then increase as production increases. Furthermore, costs may change in step like fashion at various production levels. Such expenses are classified as semi-variable expenses. Because expenses are to be classified as either fixed or variable, the fixed portion of any semi-variable expense and the degree of change in the variable part must be determined.
Several methods are available to aid in finding the constant portion and the degree of variability in the variable portion. These procedures determine the relationship between increases in production and increases in total and individual expenses. For example, when production is expected to increase 10 percent, it is possible to determine the corresponding increase in total expense as well as the increase in individual expenses such as supplies, power, indirect labor, etc.Total expenses as expressed earlier amount to $300,000; in the illustration above, they are classified as either fixed or variable.
Establishing the Factory Overhead Rate.
After the activity level for the selected base and the factory overhead have been estimated, the overhead rates can be computed. Assuming the direct labor hours base is used and direct labor hours for the coming year are estimated to be 200,000 (normal capacity level), the factory overhead rate at this selected activity level would be;
Factory Overhead Rate = Estimated Expenses/Estimated Direct Labor Hours
= $300,000/200,000=$1.50 per DLH
Factory Overhead Rate = Estimated Expenses / Estimated Machine Hours
=$300,000/5,000=$60 per Machine Hour.
This rate is used to charge overhead to jobs or products. Amounts applied are first entered in subsidiary ledgers such as job order cost sheets and cost of production reports. Direct labor hours, direct labor cost, or other similar data already recorded determine the amount of overhead chargeable to each job or product.