Overhead is the term given to indirect production costs for goods being manufactured as opposed to direct or variable costs. Specifically, the overhead recovery rate helps managers determine which fixed costs are not driven by volume or the number of goods sold. In order to better measure the costs associated with overhead, managers can look at the overhead recovery rate as a basis for comparison.
- Skill level:
Figure out the total overhead costs for the organisation. Overhead costs are defined as those costs which are not directly associated with labour, such as salaried employees, utilities and rent. For instance, if the amount paid for salaried labour, utilities, and rent for the month is £32,500, £650 and £2,600, respectively, the total amount paid to overhead is £35,750.
Figure out the total costs associated directly with the costs of producing the good or service. These are costs that can be directly linked to the production of a product or service. For example, if hourly labour and inventory costs are £39,000 and £6,500, respectively, then the total direct costs are £45,500.
Calculate the overhead recovery rate. Divide the indirect costs of production by the direct costs of production. For example, £35,750 divided by £45,500 is .7857 or 78.6 per cent. This means that for every 60p of direct costs, the company will have $.78 of indirect overhead costs.
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