Allocate Manufacturing Overhead After Automation: Labor or Machine Hours?

A direct-labor-hour base costs the line that keeps its operators a larger share of one factory overhead pool than the line whose labor hours automation has cut. Calculate that same pool again on machine hours, and leave every dollar and hour blank until the plant’s own records fill them.

The predetermined overhead rate is estimated manufacturing overhead divided by one estimated activity base, then multiplied by each line’s actual activity in that same base. OpenStax states that rule in section 4.4 of Principles of Accounting, Volume 2: Managerial Accounting (published February 14, 2019). In that section’s fixed-rent illustration, $1,000 of monthly rent is $2 per unit when the month makes 500 units and $0.50 per unit when the next month makes 2,000 units. Those figures are the textbook’s illustration of a fixed monthly rent, not a plant overhead rate and not a recommended base. This page is the two-column sheet for one pool. It does not fill a rate, a dollar amount, or a choice between labor hours and machine hours.

Use one period and one pool in both columns. The machine-hour column repeats that same pool. It is not a second bill.

What goes into the manufacturing overhead pool?

Manufacturing overhead is every manufacturing cost except direct materials and direct labor. OpenStax section 4.4 lists indirect materials, indirect labor, manufacturing utilities, and depreciation of manufacturing equipment. Factory property insurance and factory equipment rental are in the same family: the cost is real, and it is not traced to one job, so it is assigned by a systematic rule.

Electricity and heat show why the tracing fails. The section’s point is that you do not know the electricity and heat of one job, and a January job is not a fair “more expensive” product than the same job in March merely because the building used more heat. Selling costs, general administration, and research and development sit outside the pool. The section treats research and development as an expense recognized when incurred, not as a cost of the job.

Write the accounts you included next to the pool cell. If an account is missing from the books you have open, leave the pool cell blank. Do not borrow a rate from another plant to finish the row.

Takeaway: One pool, named accounts, and no direct materials or direct labor inside it.

Why calculate the rate before the year starts?

The rate is set before the fiscal year and, in the OpenStax treatment, typically stays in place for that year. Actual overhead is still recorded as it arrives. Applied overhead uses the rate. The two totals rarely match exactly, because the rate was an estimate.

The section gives three reasons for estimating:

• Overhead is uneven through the year. Electricity is the example, and it moves with weather and time of day.
• Some overhead is fixed, so the cost per unit moves when output moves. The rent illustration above is that case: the month’s $1,000 does not change, and the per-unit figure does.
• The plant often knows how many units a contract requires before it knows next year’s utility bills.

The fixed, variable, and total cost formulas keep a period total separate from a per-unit average. Use them before you read a lower unit overhead as a smaller monthly bill.

OpenStax names a later section for disposing of underapplied or overapplied overhead. This page stops at the difference. It does not choose a write-off or a proration.

What can the allocation base be?

The base is the activity that drives the pool. OpenStax lists direct labor hours, direct labor dollars, materials used, units produced, and any other activity with a cause-and-effect tie to the overhead. Direct labor hours, direct labor dollars, and machine hours are the ones it says are often chosen, because those measures are already on the product and, as they rise, so do utilities, supervisor time, equipment use, and depreciation.

The same section says direct labor hours were the traditional base, and that machine hours or units produced have become more common as technology reduces direct labor. Management still selects the activity that drives the overhead. The sentence is not an instruction to switch every automated plant to machine hours.

A labor-hour rate and a machine-hour rate answer different questions. The first spreads the pool in proportion to operator time. The second spreads it in proportion to machine time. After automation, those two clocks diverge: one line can log fewer operator hours while its machines run longer. Neither column on this sheet is the correct product cost until the plant shows which clock moves with the pool.

Fewer operator hours are not, by themselves, a smaller overhead pool. Depreciation, factory rent, and supervisor pay can remain after the operators move. Labor savings versus redeployment separates freed hours from wages the company still pays. Keep that test off this sheet: this sheet assigns a pool you have already defined. It does not decide whether payroll fell.

How do you fill the two-base sheet?

Copy the blank table. Then follow the row order. Stop on any row you cannot fill from a record.

1. Write the period. A rate for the year and activity for one week do not belong on the same sheet.
2. Enter the estimated pool once. Repeat that same figure in the machine-hour column. If you do not have the estimate, leave both pool cells blank.
3. Enter estimated direct labor hours under the labor-hour base, and estimated machine hours under the machine-hour base. Include every product or department that will absorb this pool, not only line A and line B.
4. Divide the pool by that column’s estimated activity. If the estimated activity is zero, the rate is undefined. Leave the rate cell blank rather than dividing by an activity you do not have.
5. Enter each line’s activity in the unit of that column: labor hours in the labor-hour column, machine hours in the machine-hour column. Multiply the rate only by that same activity. A rate per labor hour times a machine hour, or a rate per unit times an hour, is a different calculation from the one OpenStax applies.
6. Add applied overhead for line A and line B. That sum is the conservation check in the next section.
7. Divide each line’s applied overhead by that line’s good units. If good units are zero, the unit overhead is undefined. State whether “good” means completed or accepted. Do not add the two unit-overhead cells and expect the pool.

Cost per good pack divides a period’s cash operating cost by accepted packs and keeps the equipment purchase on its own line. Depreciation of manufacturing equipment is inside the overhead pool under the OpenStax definition used here. Do not paste this sheet’s unit overhead into that cash-per-pack figure unless you list which accounts moved.

Common mistake: Dividing the pool by sales, or multiplying a per-hour rate by units. The denominator of the rate and the activity you multiply have to be the same measure.

When do the line shares add back to the pool?

Applied overhead on a line equals the rate times that line’s activity. The sum of applied overhead equals the estimated pool only when the activities you multiplied are the same activities that formed the denominator, and those activities are the whole base.

On a planning sheet, that means line A plus line B plus every other user of the base equals the estimated activity. Leave out a third product, a support department, or idle capacity that still sits in the denominator, and the two lines will fail the add-back even though each multiplication is right.

On an actual sheet, the sum equals the rate times actual activity. It equals the estimated pool only when actual activity equals the estimate. It equals actual overhead only by chance. OpenStax records actual overhead in the manufacturing overhead account and applies overhead from that account at the predetermined rate. The section says the applied amount and the actual amount are rarely equal. Record the difference. Do not force the two line cells to add to the actual bills by changing one line’s hours.

The labor-hour column and the machine-hour column will not give line A the same applied overhead once the hours diverge. That split is the comparison. It is not a verdict. The base that tracks the pool is the one to keep, and this page does not have the plant’s cost behavior, so the choice cell stays blank.

Takeaway: Add applied dollars across every user of the base. Do not add the per-unit overhead figures, and do not edit hours so the columns match.

Which records fill the blank cells?

If a log does not exist, the cell stays blank. A blank machine-hour column means you cannot run the machine-hour base yet. It does not mean the labor-hour base wins.

The production economics reading guide is the index for the neighboring calculations, including cost per good pack and the fixed and variable formulas.

When this sheet does not apply

Use a separate copy of the sheet for each overhead pool. This page does not build a rate from several activities at once.

The sheet is a product-costing worksheet in the sense of the OpenStax section. It is not a tax filing, an audit position, or a machine quotation.

OpenStax’s observation that machine hours have become more common is not a rule that this plant’s base must change. Change the base only when you can show which activity drives the pool you named. Until then, keep both columns and leave the choice blank.

The $1,000 rent, the 500 units, the 2,000 units, the $2, and the $0.50 are the textbook illustration cited above. They are not inputs to the blank cells.

Method and sources

The method, the pool boundary, the rate formula, the list of bases, the practice of setting the rate before the year, and the rent illustration are from OpenStax, Principles of Accounting, Volume 2: Managerial Accounting, section 4.4, “Compute a Predetermined Overhead Rate and Apply Overhead to Production.” Authors: Mitchell Franklin, Patty Graybeal, and Dixon Cooper. Publisher: OpenStax, Houston. Publication date: February 14, 2019. The copy read for this page is the cached text of that section (HTTP 200), and that copy carries a copyright line dated April 23, 2026. Section URL: 4.4 Compute a Predetermined Overhead Rate and Apply Overhead to Production.

The blank cells are intentional. No plant ledger was used. Public how-to pages and a locked homework item were read while scoping the search task. Their rates, currencies, and worked answers are not inputs here, and they are not a recommended base.

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