FOH Applied Rate and Cost Drivers

One of the tools used for controlling FOH costs is the use of an FOH applied rate. Now how do we calculate this applied rate and what is its purpose? I'll start with the purpose. This is a budgeted rate based on the expected working conditions of the company, which is used to budget for the coming period.

The formula of FOH rate is = Total Budgeted Indirect Expenses/Expected capacity

The expected capacity could be expected hours of labour for the company's budgeted target of production, hours of machine running for the production of units expected, etc. Whatever it may be it is up to the management but it is better that the denominator chosen be the cost driver of that product.

Cost Driver is any activity in the production process that is primarily and largely responsible for the costs incurred. The higher the quality of the cost driver chosen the better the calculated applied rate.

Factory Overhead (FOH)

While ascertaining the overall cost of the finished goods manufactured by a company, we first identify the three basic elements which constitute the product. These, as you may remember, are Materials, Labours, and Factory Overhead (FOH).

Right now, I am going to venture into some details relating to FOH; which are the indirect expenses incurred by the company during the production process, and which become part of the product. Indirect here means that the costs of these expenses cannot be easily identified with a single unit of product produced. For example, when a supervisor looks over the work being done on several units of products the salary of the supervisor which should have otherwise been classified as Labour cost, would be treated as an indirect cost and all indirect costs would fall under the head FOH.

The business continues to spend money on all sorts of expenses like electricity, water charges, watchman's pay, rent, etc., but all of these expenses will only be included in the cost of product if these relate to the factory. For control purposes, the management of a company doesn't just spend money haphazardly without any control tool. Luckily some tools are available to the management which include preparing budgets, using an FOH applied rate, calculating FOH variances, etc. These will be discussed later.