Overhead Rate Calculator
Calculate the overhead allocation rate — the indirect cost applied per direct labor hour. Manufacturers and project managers use it to price products and allocate overhead costs accurately.
About this calculator
The overhead rate (also called the predetermined overhead rate) allocates indirect manufacturing costs — such as rent, utilities, and supervision — to individual products or jobs based on a measurable activity driver. The most common formula is: Overhead Rate = Total Overhead Costs / Direct Labor Hours. This gives you a dollar amount of overhead to assign for every hour of direct labor worked. For example, if a factory incurs $200,000 in overhead and workers log 5,000 direct labor hours, each hour carries $40 of overhead. This rate is added to direct material and direct labor costs to determine the full cost of production. Accurate overhead rates are essential for setting selling prices, preparing bids, and evaluating product profitability. Companies typically calculate the rate at the beginning of the year using budgeted figures, then apply it throughout the year.
How to use
A small furniture manufacturer estimates its annual overhead costs — rent, utilities, equipment depreciation, and supervisory salaries — at $180,000. Production employees are expected to work 9,000 direct labor hours during the year. Enter Total Overhead Costs = $180,000 and Direct Labor Hours = 9,000. The calculator computes: Overhead Rate = 180,000 / 9,000 = $20 per direct labor hour. If a custom table takes 8 hours of direct labor to build, it is allocated 8 × $20 = $160 in overhead costs on top of direct materials and labor wages.
Frequently asked questions
What costs are typically included in total overhead costs for manufacturing?
Total overhead costs include all indirect manufacturing expenses that cannot be traced directly to a specific product. Common examples are factory rent, building insurance, equipment depreciation, utilities (electricity, heating), maintenance and repairs, quality control salaries, and factory supervision wages. They do not include direct materials (raw inputs) or direct labor (wages of workers directly building the product). Properly identifying and capturing all overhead costs before calculating the rate is critical — omitting costs leads to underpricing and eroded margins.
Why do companies use direct labor hours as the overhead allocation base?
Direct labor hours are a popular allocation base because overhead costs like supervision and utilities tend to increase as more labor hours are worked, creating a logical cause-and-effect relationship. In labor-intensive industries, this driver reflects how much factory capacity and support resources a product consumes. However, companies may choose other drivers — such as machine hours for automated factories or units produced for simple single-product operations — if those better reflect the actual consumption of overhead. The goal is to choose a base that most closely mirrors how overhead costs are actually incurred.
How does an inaccurate overhead rate affect product pricing and profitability?
If the overhead rate is too high, products will be overcosted, leading to prices that are uncompetitive and potentially lost sales. If the rate is too low, products are undercosted, meaning the company unknowingly sells below true cost and loses money on every unit. At year-end, the difference between applied overhead and actual overhead (called over- or under-applied overhead) must be reconciled — usually by adjusting cost of goods sold. Using accurate, up-to-date estimates and reviewing the rate annually helps minimize this distortion and ensures pricing decisions are based on realistic cost data.