Question

Why would a manufacturing firm use departmental rates rather than one

factory overhead (OH) rate? Describe an advantage and a disadvantage of using

departmental rates.

Answer 1

Departmental overhead rates are used by many manufacturers instead of using a single, plant-wide overhead rate. The reason for departmental overhead rates is that a manufacturer is likely to produce many diverse products which use different processes (each of which has different costs).

To illustrate, let's assume that a manufacturer has three operations with each occurring in a separate department:

Dept #1 uses a large, sophisticated machine having a cost of $900,000
Dept #2 uses a small $40,000 machine to refine the products coming out of Dept #1
Dept #3 is an additional, optional process that uses a $10,000 machine
When the manufacturer divided its total manufacturing overhead for the upcoming year by the total machine hours for the upcoming year, the result was a plant-wide overhead rate of $30. If Product A requires 7 hours in Dept #1 and 1 hour in Dept #2, it will be assigned overhead of $240 [(7+1)X$30]. If Product B requires 2 hours in Dept #1, 2 hours in Dept #2, and 4 hours in Dept #3, it will also be assigned overhead of $240 [(2+2+4)X$30].
When departmental overhead rates were computed, the manufacturing overhead rate for Dept #1 was $50 per machine hour (resulting from high amounts of depreciation, electricity, maintenance, etc.). The overhead rate per machine hour for Dept #2 was $20, and $15 for Dept #3. Using the more accurate departmental overhead rates Product A will be assigned overhead of $370 [(7X$50)+(1X$20)]. Product B will be assigned overhead of $200 [(2X$50)+(2X$20)+(4X$15)].

Single overhead rates apply cost allocations for expenses incurred across the entire plant. Common overhead rates include cost allocations for such expenses as indirect materials, indirect labor, utilities expenses, insurance and property taxes, as well as depreciation of buildings, furnishings and equipment. Single overhead rates are figured by dividing the total cost of overhead by cost drivers common throughout each department or section of the business. Cost drivers can be defined as the primary reasons for indirect costs.

Advantage :- Companies put machinery to use in processing, refining and converting raw materials. Workers also supply labor and talent in making manufactured products. These inputs used in manufacturing are known as overhead, and they are instrumental in determining the value of finished products. Since large companies have vast amounts of overhead to calculate, there are a number of methods for estimating the overall costs of production. The departmental overhead rate method is an estimate where labor and machine hour rates are calculated by department

Disadvantage :- The departmental overhead rate will skew when each department is responsible for multiple products varying in labor and machine hours. This is likely to occur when departments are large. This also creates redundancy since each department must measure and calculate its respective rate. Departmental overhead rates assume that costs can easily be separated from one department to another.

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