Question

Please discuss (including use of quantitative data) the purpose of using a predetermined overhead rate?

Answer 1

Predetermined overhead rate is used to apply manufacturing overhead to job orders or products and is usually computed at the beginning of each period by dividing the estimated manufacturing overhead cost by an allocation Base. The allocation Base is also known as activity driver or activity Base. Examples of activity drivers are labor hours, machine hours etc.

Predetermined overhead rate = estimated manufacturing overhead cost / estimated total units in the activity Base.

For example, ABC is a company which usually uses direct labor hours to assign manufacturing overhead to job orders.

The estimated manufacturing overhead cost = $ 10,000.

Direct labor hours = 1,000 hours.

Predetermined overhead rate = 10,000/1,000

Predetermined overhead rate = $ 10 per direct labor hours.

Predetermined overhead rate is very useful as it is a easy way to assign cost based on the activity drivers. It helps to estimate cost at beginning of period and helps to know the estimated profit.

SUMMARY:

It is the simplest way to calculate. Also helps to know the estimated cost per unit.