A predetermined overhead rate is an allocation rate that is used to apply an estimated cost of manufacturing overhead to either products or job orders. Show
This rate is usually calculated at the start of an accounting period by dividing the cost of manufacturing overhead by the activity driver, which is also sometimes referred to as the activity base or allocation base. Common examples of activity drivers are machine hours, direct materials, or direct labor hours.  Formula for Predetermined Overhead RateThe predetermined overhead rate can be calculated by using the following formula: Predetermined Overhead Rate = Estimated Cost of Manufacturing Overhead / Estimated Activity Driver Now, let’s take a look at this formula in action with some examples. Examples of Predetermined Overhead RateExample 1Ralph’s Machine Tools Company assigns manufacturing overhead costs based on direct labor and applies this rate to job orders. Ralph’s Machine Tools Company had an estimated manufacturing overhead cost of $15,000 for the upcoming year. The direct labor hours it expects for the upcoming year are 2,000. This information can be used to calculate the predetermined overhead rate. Estimated manufacturing overhead cost/Estimated total units in the allocation base = Predetermined overhead rate The predetermined overhead rate for Ralph’s Machine Tools Company is: $15,000/2,000 hours = $7.50 per direct labor hour. The formula used to compute the predetermined overhead rate uses estimates. This means that the overhead that is applied to jobs or products is different than the actual overhead from the product or job. The adjustment made to eliminate this difference at the end of the period is called the disposition of over or underapplied overhead. Example 2Dorothy’s Hat Company computed a predetermined overhead rate based on annual machine hours. At the start of 2021, Dorothy’s Hat Company estimated that the total manufacturing overhead cost for the year would be $320,000, and the total machine hours would be 50,000 hours. The company actually had $300,000 in total manufacturing overhead costs for the year, and the actual machine hours used were 53,000. Now, compute the predetermined overhead rate for 2021. Determine the manufacturing overhead costs that Dorothy should have applied to her hats. AnswerPredetermined overhead rate: Estimated manufacturing overhead cost/Estimated machine hours $320,000/50,000 hours = $6.40 per machine hour Manufacturing overhead applied to products: Actual machine hours used x Predetermined overhead rate 53,000 * $6.40 = $339,200 Example 3The operating and cost data are given next for three separate companies. The companies use different allocation bases when calculating their predetermined overhead rates.
Company 1: Machine hours Company 2: Direct materials cost Company 3: Direct labor hours Next, calculate the predetermined overhead rate for the three companies above. AnswerCompany 1 Estimated manufacturing overhead cost/Estimated machine hours $1,000,000/140,000 hours = $7.14 Company 2 Estimated manufacturing overhead cost/Estimated direct materials cost $860,000/$600,000 = $1.43 Company 3 Estimated manufacturing overhead cost/Estimated direct labor hours $1,110,000/150,000 = $7.40 Multiple Predetermined Overhead RatesThe predetermined overhead rate as calculated above is a plant-wide overhead rate or a single predetermined overhead rate. This rate is generally only used by small companies. Large companies will typically have a predetermined overhead rate for each production department. Using multiple predetermined overhead rates is more complicated and takes more time, but it is generally thought to be more accurate than using a single predetermined overhead rate for the entire plant. Example 4The Holiday Candy Company uses a job-order costing system and calculates different predetermined overhead rates for its molding and packaging departments. These are the estimates the company computed at the start of 2021. Molding DepartmentDirect labor hours: 5,000 Machine hours: 25,000 Manufacturing overhead cost: $150,000 Direct labor cost: $50,000 Packaging DepartmentDirect labor hours: 24,000 Machine hours: 7,000 Manufacturing overhead cost: $528,000 Direct labor cost: $240,000 The molding department bases its overhead rate on its machine hours. Whereas the packaging department bases its overhead rate on labor hours. Now, calculate the predetermined overhead rate for the departments listed above. AnswerMolding Department The overhead rate for the molding department is computed by taking the estimated manufacturing overhead cost and dividing it by the estimated machine hours. Overhead rate for the molding department = estimated manufacturing overhead cost/ estimated machine hours $150,000/25,000 hours = $6 per machine hour The overhead rate for the molding department is $6 per machine hour. Packaging Department The overhead rate for the packaging department is calculated by taking the estimated manufacturing overhead cost and dividing it by the estimated direct labor cost. Estimated overhead for the finishing department = estimated manufacturing overhead cost/ estimated direct labor cost $528,000/$240,000 = $2.20 per dollar of direct labor The overhead rate for the packaging department is $2.20 per dollar of direct labor. This means the manufacturing overhead cost would be applied at 220% of the company’s direct labor cost. Article Sources & Citations FundsNet requires Contributors, Writers and Authors to use Primary Sources to source and cite their work. These Sources include White Papers, Government Information & Data, Original Reporting and Interviews from Industry Experts. Reputable Publishers are also sourced and cited where appropriate. Learn more about the standards we follow in producing Accurate, Unbiased and Researched Content in our editorial policy.
When a company uses a predetermined overhead rate?What is Predetermined Overhead Rate? A predetermined overhead rate is an allocation rate that is used to apply an estimated cost of manufacturing overhead to either products or job orders.
How do I calculate predetermined overhead rate?Predetermined Overhead Rate = Estimated Manufacturing O/H Cost / Estimated total Base Units. O/H is overhead.. Total base units could be the number of units or labor hours etc.. Why must a company use predetermined overhead rates when using job order costing?However, predetermined overhead rates allow production managers to allocate overhead expenses as soon as production begins. Having this information when production begins allows managers to make better cost-based business decisions. These include cost-control assessments as well as pricing and budgeting decisions.
At what stage is the predetermined manufacturing overhead rate calculated quizlet?The calculation of the predetermined overhead rate is made at the beginning of the period under a normal costing system. Which of the following statements is correct? The Work in Process inventory account is increased when manufacturing overhead is applied to production.
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