# Plantwide Allocation of Overhead Costs - Explained

What is Plantwide Allocation of Overhead Costs Carried Out?

# What is the Plantwide Allocation of Costs?

The plantwide allocation method uses one predetermined overhead rate to allocate overhead costs.

• Note: Direct materials and direct labor are easily traced to the product and therefore are not a part of the overhead allocation process.

Annual overhead costs are estimated and direct labor hours are used for the plantwide allocation base.

These estimates are based on the previous year’s overhead costs and direct labor hours and are adjusted for expected increases in demand the coming year.

The predetermined overhead rate is applied for each direct labor hour worked.

One cost pool accounts for all overhead costs, and therefore one predetermined overhead rate is used to apply overhead costs to products.

## How to Determine Product Costs Using the Plantwide Allocation Approach

The calculation of a product’s cost involves three components—direct materials, direct labor, and manufacturing overhead.

This information, combined with the overhead cost per unit, gives us what we need to determine the product cost per unit for each model.

Given the predetermined overhead rate per direct labor hour, and assuming it takes A hours of direct labor to build a unit product 1, and B hours to build a unit of product 2, we can calculate the manufacturing overhead cost per unit.

Manufacturing overhead cost per unit is Base Rate × A direct labor hours + Base Rate × B direct labor hours.

Combine the manufacturing overhead with direct materials and direct labor and we are able to calculate the product cost per unit.

Although the plantwide allocation method is the simplest and least expensive approach, it also tends to be the least accurate.

In spite of this weakness, why do some organizations prefer to use one plantwide overhead rate to allocate overhead to products?

Organizations that use a plantwide allocation approach typically have simple operations with a few similar products.

Management may not want more accurate product cost information or may not have the resources to implement a more complex accounting system.

As  we move on to more complex costing systems, remember that these systems are more expensive to implement.

Thus the benefits of having improved cost information must outweigh the costs of obtaining the information.

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