Plantwide vs Departmental Overhead Rates
Plantwide rate = one cost pool for the whole factory. Multiple rates = separate cost pools for different departments.
| Term | Definition |
|---|---|
| Plantwide overhead rate | A single POHR used throughout a plant |
| Multiple predetermined overhead rates | Separate overhead cost pools with their own rates, often by department |
| Cost pool | A bucket where indirect costs accumulate before allocation |
The granularity spectrum
| Level | Cost Pools | Allocation Bases | Accuracy | Complexity |
|---|---|---|---|---|
| Plantwide | 1 (all MOH) | 1 | Lowest | Lowest |
| Departmental | 1 per department | 1 per department | Medium | Medium |
| ABC (Chapter 7) | Multiple per activity | 1 per activity | Highest | Highest |
How does the choice affect job costs?
Cook Company: Plantwide vs Departmental
Department A Department B Total Overhead cost $84,000 $252,000 $336,000 Direct labour-hours 21,000 7,000 28,000 DLH Machine-hours 7,000 21,000 28,000 MH Cost driver DLH (labour-intensive) MH (machine-intensive) — Calculating the rates:
- Plantwide: 12/DLH**
- Dept A: 4/DLH**
- Dept B: 12/MH**
Impact on job costs:
Job Work Done Plantwide Departmental Distortion Job X 700 DLH in A, 1 MH in B $8,400 $2,812 +$5,588 overcharged Job Y 0 DLH in A, 700 MH in B $12 $8,400 −$8,388 undercharged
The plantwide rate massively overcharges labour-intensive jobs and undercharges machine-intensive jobs.
The cross-subsidization problem
Cross-subsidization = one product type subsidizes another without anyone realizing it
If you use DLH but overhead is driven by multiple factors:
| Job Type | DLH | Machine Hours | Setups |
|---|---|---|---|
| Simple high-volume | 100 | 10 | 1 |
| Complex low-volume | 20 | 200 | 15 |
Allocating on DLH alone undercharges complex jobs. Result: you bid low on complex work (thinking it’s profitable) and high on simple work (driving customers away).
When the textbook says to choose
The textbook frames this as cost-benefit:
“The decision comes down to costs versus benefits. It is cheaper to use a plantwide rate, but separate rates are more informative when activities that drive overhead differ among departments.”
And provides this test:
“Would my decisions change if I had the more detailed information?”
The problem with that test
Beyond the Textbook
The circular reasoning: You can’t answer “would decisions change?” without actually having the information.
This is WYSIATI (What You See Is All There Is):
What You See (Plantwide) What You Don’t See One rate, simple application How much each product is over/under-charged Job costs that seem reasonable That Job X subsidizes Job Y Bids that feel competitive That you’re winning unprofitable work The distortion is invisible until you run the alternative calculation.
Connection to Simplicity Moves Cost, It Doesn’t Reduce It:
Choosing plantwide doesn’t eliminate complexity—it moves it to:
- Lost bids on machine-intensive jobs
- Won unprofitable labour-intensive jobs
- Invisible margin erosion
When is a single base “close enough”?
| Situation | Why One Base Works |
|---|---|
| Overhead is small | 5% of cost × 30% error = 1.5% total cost error |
| Products are homogeneous | Everything consumes resources similarly |
| One factor dominates | 80% of overhead correlates with one driver |
The middle ground: Departmental rates
Most companies don’t go full ABC but also don’t use plantwide. They use departmental rates:
| Department | Rate | Base |
|---|---|---|
| Machining | $45/MH | Machine hours |
| Assembly | $22/DLH | Direct labour-hours |
| Finishing | $8/unit | Units processed |
A job passing through all three gets charged from each department’s pool.
Defining your own allocation base
The textbook examples (DLH, machine hours, materials cost) are common, not exhaustive. Any measurable activity that correlates with overhead can work.
Four criteria for a valid allocation base:
| Criterion | Question |
|---|---|
| Causal relationship | Does this activity actually drive overhead? |
| Measurable | Can you quantify it objectively? |
| Practical to track | Is tracking cost < accuracy benefit? |
| Estimable in advance | Can you forecast it for POHR calculation? |
Industry-specific examples:
| Base | Industry/Context |
|---|---|
| Number of setups | Batch manufacturing |
| Number of purchase orders | Procurement-heavy operations |
| Square footage | Warehouse operations |
| Flight hours | Aviation |
| Patient days | Healthcare |
An allocation base is a theory about what causes overhead. You're making a causal claim that should be defensible.
A better decision framework
Instead of “Would my decisions change?” (which you can’t answer), ask:
“What’s the cost if the distortion exists and I don’t see it?”
If the answer is mispriced jobs, won unprofitable work, lost profitable work—that’s a high cost. Running a sample calculation to find out may be worth it.
Preview: Activity-Based Costing (Chapter 7)
| Chapter 5 Approach | Chapter 7 Approach (ABC) |
|---|---|
| Pool all overhead together | Separate pools by activity |
| One allocation base | Each pool has its own driver |
| Accept averaging | Match costs to what causes them |
ABC asks: “What activities consume resources, and what drives those activities?” More accurate—but more complex.