Predetermined overhead rate

Definition

The predetermined overhead rate is a calculation used to allocate estimated manufacturing overhead costs to products or job orders, based on a specific activity base, such as direct labor hours or machine hours. It is determined before the period begins and helps in budgeting and costing processes.

5 Must Know Facts For Your Next Test

1. The formula to calculate the predetermined overhead rate is Estimated Overhead Costs divided by Estimated Activity Base.
2. It is used in both traditional allocation methods and some modern costing systems.
3. Helps in applying overhead consistently throughout the accounting period.
4. Can lead to under-applied or over-applied overhead if estimates are inaccurate.
5. Essential for determining product costs under traditional absorption costing.

Review Questions

• What is the formula for calculating the predetermined overhead rate?
• Why is a predetermined overhead rate important in managerial accounting?
• How can inaccuracies in the predetermined overhead rate affect financial statements?

Related terms

Absorption Costing:

A method where all manufacturing costs, including fixed and variable overhead, are allocated to products.

Activity-Based Costing (ABC): A more precise method of allocating overhead costs based on activities that drive costs.

Variable Costing:

A costing method where only variable manufacturing costs are included in product cost; fixed manufacturing overhead is treated as a period expense.