Departmental Overhead Rate

What Is the Departmental Overhead Rate?

The departmental overhead rate is an expense rate calculated for each department in a factory production process. The departmental overhead rate is different at every stage of the production process when various departments perform selected steps to complete the final process.

By breaking up overhead costs for individual business sections rather than having a company-wide rate, management can assess corporate inefficiencies more accurately and take more specific action.

What Does the Departmental Overhead Rate Tell You?

An overhead rate, in managerial accounting, is an additional cost added on to the direct costs of production in order to more accurately assess the profitability of each product. To allocate these costs, an overhead rate is applied that spreads the overhead costs around depending on how much resources a product or activity used.

For example, overhead costs may be applied at a set rate based on the number of machine hours required for the product. In more complicated cases, a combination of several cost drivers may be used to approximate overhead costs.

The departmental overhead rate is specific to every segregated step in the entire process. For example, if a company makes bread, different departmental rates could be used for the actual production/manufacturing line and the bagging process.

Cost-cutting, efficiency and productivity are standard elements of a strong corporate performance methodology. Analysis and benchmarking of departmental overhead rates is an effective way to measure success. Comparisons between competitors, as well as among various internal departments help isolate efforts that are adding value, and those that are destroying enterprise value.

No two cost-cutting approaches are the same. Like all things in business, there are pros and cons to the myriad of strategies businesses can utilize. However, by following trends in departmental rates, patterns do emerge highlighting the delicate balance of short-term goals with long-term business requirements.

Determining Departmental Overhead Rates

Determining appropriate departmental rates is an area addressed by managerial accounting methods. Managerial accounting is the process of identifying, measuring, analyzing, interpreting and communicating information for the pursuit of an organization's goals.

This branch of accounting is also known as cost accounting. The key difference between managerial and financial accounting is managerial accounting information is aimed at helping managers within the organization make decisions, while financial accounting is aimed at providing information to parties outside the organization.

In managerial accounting, rather than using one overhead rate to allocate all of the overhead costs, overhead costs can be broken down by departments. Departmental overhead rates offer the flexibility to use a different activity or cost driver for each department. Often, some departments will rely heavily on manual labor while others require more machinery. Direct labor hours can be important to certain departments but machine hours might work better for others.