Departmental overhead rates are used by many manufacturers instead of using a single, plant-wide overhead rate. The reason for departmental overhead rates is that a manufacturer is likely to produce many diverse products which use different processes (each of which has different costs).
To illustrate, let's assume that a manufacturer has three operations with each occurring in a separate department:
- Dept #1 uses a large, sophisticated machine having a cost of $900,000
- Dept #2 uses a small $40,000 machine to refine the products coming out of Dept #1
- Dept #3 is an additional, optional process that uses a $10,000 machine
When departmental overhead rates were computed, the manufacturing overhead rate for Dept #1 was $50 per machine hour (resulting from high amounts of depreciation, electricity, maintenance, etc.). The overhead rate per machine hour for Dept #2 was $20, and $15 for Dept #3. Using the more accurate departmental overhead rates Product A will be assigned overhead of $370 [(7X$50)+(1X$20)]. Product B will be assigned overhead of $200 [(2X$50)+(2X$20)+(4X$15)].
Having multiple, departmental overhead rates will better reflect the costs of manufacturing Product A and Product B compared to using a single, plant-wide overhead rate.