Because some of the production departments used more of some service departments' efforts/costs than others, accountants responded by first allocating the service department costs to the production departments, and then developing manufacturing overhead rates for each of the production departments. These rates were computed by dividing each production department's costs (its own direct costs plus the service departments' costs allocated to it) by its machine hours.
Basing the manufacturing overhead rates on a company's production departments was an improvement over using just one rate for the entire plant—particularly when companies began manufacturing a greater variety of products. Some products being manufactured may have required many machine hours in one department but very few hours in another department, while other products may have used a much different combination of machine hours.
Let's illustrate this method by assuming just two products (X and Y) are being manufactured in a factory that has one service department (Factory Administration, S1) and two production departments (Machining, P1; Finishing, P2).