Predetermined Overhead Rate

Predetermined Overhead Rate is the overhead rate used to calculate the Total Fixed Production Overhead. It is part of the Absorption Costing calculation.

The Predetermined Rate is usually calculated annually and at the beginning of each year. This rate will be recalculated if the predetermined is materially incorrect or different from the actual.

If there are no significant changes, the Predetermined Overhead Rate will be kept for use in the following year. The rate is calculated based on the assumption, and mostly there is small material that we could not avoid.

The concept of calculating Predetermined Overhead Rate is using the expected total overhead that is hoping to incur for the whole period.

And then, allocate those expenses to the expected total number of units of products that the entity expected to produce for the same period.

The formula for Predetermined Overhead Rate

Here is the formula

predetermined-overhead-rate

or

Estimate Annual Manufacturing Overhead / Estimate Annual Total Production in Unit

So, base on this formula, you need to know expected annual manufacturing overhead expenses. These expenses could estimate base on the previous year’s expenses. And taking account of all of the related factors. For example, an increase or decrease in the productions.

Another important thing you need to know is the annual production budget. This budget is normally prepared annually based on the related factors. For example, the company’s expected sales, demand in the market, or else. This data normally obtain from the sales department.

Importance: You can use other Drivers rather than Estimate Annual Total Production in Unit if those cost drivers are more suitable.

Example of Predetermined Overhead Rate

Now, to help you get a better understanding, let move to the example.

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In this example, we will provide you with the step by step on how to calculate Predetermined Overhead Rate.

Example:

ACB is a company operating in car manufacturing. The company’s cars will be sold locally and export to a foreign country. Sales this year are expected to increase. And the total estimated sales for the whole year would be 500,000 Units.

CFO needs you as the cost accounting to calculate the overhead rate for this coming year. Base on the expectation from the budgeting department, the total overhead expenses would be $6,00,000.

Now, let calculate the overhead rate together. The overhead rate is calculated by:

Estimate Annual Manufacturing Overhead / Estimate Annual Total Production in Unit.

Base in information in the scenario,

  • The Estimate Annual Manufacturing Overhead / Estimate Annual Total Production in Unit is $6,000,000.
  • And the Estimate Annual Total Production in Unit is 500,000 Unit.

Therefore, the Predetermined Overhead Rate that use to apply to car unit cost is 6,000,000 / 500,000

Hope this help!

Written by Sinra