How to Compute Overhead Rate for Standard Costing & Utilize Variances
Many businesses have failed due to inappropriate accounting for overhead costs in their pricing strategies. Don’t let that happen to your business. In a manufacturing environment, appropriately accounting for overhead costs begins with identifying overhead pools and establishing a reasonable monthly expense budget. An overhead pool may consist of one cost center or a consolidation of many cost centers. However, the overhead pool needs to be segregated from Operating Expenses, which include Sales, Marketing, R&D, Distribution, Administration, which all belong below gross profit on a P&L.
The overhead pool should encompass all the costs associated with producing and delivering products that can’t be identified with a specific product or cost objective. This includes things such as utilities, supplies, rent, depreciation, shop floor supervisors, packaging, etc. Once you have the overhead pool identified and its costs determined, you just need to use the earned hour plan for the work center and divide the total overhead pool expense by the total earned hours to derive the overhead rate. The article also delves into how to segment monthly variances into spending and absorption components to generate insights into the factors causing production variances.