How to Calculate Overhead Rate (With Examples)

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To accurately assess profitability and price their products appropriately, businesses look at the overhead rate — the cost added on to the direct costs of production. The overhead rate spreads indirect costs across direct costs based on the allocation measure, which can be a dollar amount for direct costs, total labour hours, or even machine hours.

Overhead rate example: Anna’s ice cream factory

Example 1: Overhead rate per employee

Anna has an ice cream factory that had overhead expenses totalling $900,000 in June. In that same month, she had 400 employees working on the production line.

Overhead rate = Indirect cost / Number of employees = $900,000 / 400 staff = $2,250

The factory’s overhead rate per employee is $2,250. This means that it cost the company $2,250 in overhead costs for every employee.

Example 2: Overhead rate per hour worked

In July, Anna’s factory had overhead expenses totalling $900,000 and her staff worked a total of 504,000 hours making ice cream.

Overhead rate = Indirect cost / Hours worked = $900,000 / 504,000 hours = $1.79

The factory’s overhead rate per hour is $1.79. This means that it cost the company $1.79 in overhead costs for every hour of labour.

Example 3: Overhead rate per direct cost

In August, Anna’s factory had overhead expenses totalling $1,000,000 and direct costs totalling $250,000

Overhead rate = Indirect cost / Direct costs = $1,000,000 / $250,000 = $4

The factory’s overhead rate per direct cost is $4. This means that it cost the company $4 in overhead costs for every dollar spent on direct expenses.

Anna now knows how to accurately price her ice cream in order to maintain a healthy profit margin that compensates for her indirect costs.

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Greg Roughan - Unleashed Software
Greg Roughan

Article by Greg Roughan in collaboration with our team of inventory management and business specialists. Greg has been writing, publishing and working with content for more than 20 years. His writing motto is 'don't be boring'. His outdoors motto is ''I wish I hadn't brought my headtorch', said nobody, ever'. He lives in Auckland, New Zealand, with his family.

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