Question

Why are predetermined overhead rates calculated and used to estimate manufacturing overhead instead of using actual overhead amounts?

Answer 1

There are three main portion of cost of finished goods that is material , labor and overhead.

How much material will be used over a unit and how much labor hours will be incurred on a unit is known at the time of production so we can directly calculate cost but we don't know how much overhead will be incurred because it's kind of a cost which will be known to us at the end of period. For example repair and maintenance of machines.

But we can not wait for the end of period because we have to sell finished goods so we have to assign overhead to goods so we use a predetermined rate which will be based on estimates , previous years budgets or market analysis. For example we can set that almost overhead is 160% of labor so this will be used as rate.

I hope you understood.

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