Overhead Rate

Definition of 'Overhead Rate'

In managerial accounting, a cost added on to the direct costs of production in order to more accurately assess the profitability of each product. Overhead costs are all costs that are not directly related to the production of the good to be sold. These include administrative salaries, the costs of the building or machinery, commissions to salespeople, and many other items.

To allocate these costs, an overhead rate is applied that spreads the overhead costs around depending on how much resources a product or activity used. For example, overhead costs may be applied at a set rate based on the number of machine hours required for the product. In more complicated cases, a combination of several cost drivers may be used to approximate overhead costs.

Investopedia explains 'Overhead Rate'

It is often difficult to assess precisely the amount of overhead costs that should be attributed to each production process. Therefore, costs must be estimated based on an overhead rate for each cost driver or activity.