The determination of the manufacturing overhead rate follows the procedures discussed in the previous manufacturing overhead rate discussion. The overhead rate based on machine hours or costs assumes that overhead costs are proportional to machine hours.
Now we are going to learn some basic steps in determining the manufacturing overhead rate:
1. Costs of any service or maintenance department are estimated or budgeted according to their nature (supervision, supplies, electricity, etc.).
2. Costs are classified as fixed or variable. This classification often leads to the realization that many service departmental costs are fixed over fairly wide ranges of service volume.
3. A manufacturing overhead rate is determined by dividing total departmental cost by the number of hours the service is expected to be needed. The establishment of the use hours, i.e., for the power house, is as important here as it is in the determination of manufacturing overhead rate. The hours can be based either on past experience in a representative period or on future activity or volume as expressed in the budget. For example,
Manufacturing Overhead Rate = Estimated Expenses / Estimated Machine Hours
=$300,000/5,000=$60 per Machine Hour.
A refinement of the rate is the apportionment of fixed costs to cost centers on a readiness-to-serve basis. As some departments would require more service than others, the initial cost proration is made on that basis. The cost remaining is then divided by the budgeted hours of the recipient departments.
4. Actual service department costs incurred in the department are compared with the predetermined or budgeted costs. This comparison is made:
(1) in the service department to which the expenses are originally charged actual costs are compared with charged-out or sold-out amounts;
(2) in the benefiting (recipient) departments in which the charges for service departments’ services are linked with the predetermined budget allowances. This step is the control phase of the service department’s charging-out procedure. The foreman of the service department is responsible for the actual cost against the cost or hours charged for service.
The benefiting department foreman is responsible for the number of hours or the cost charged for service. Comparison will also lead to the calculation of variances for service and producing departments.