How to Calculate Predetermined Overhead Allocation Rate
In managerial accounting and cost accounting, accuracy is key to pricing products correctly. The Predetermined Overhead Allocation Rate (POHR) is a crucial metric used to assign manufacturing overhead costs to products or job orders. Since actual overhead costs are not known until the end of the period, businesses must estimate a rate at the beginning of the year to apply costs as production occurs.
This guide explains the concept in detail and provides a specialized calculator to help you compute your allocation rate instantly.
Overhead Rate Calculator
Total indirect costs expected for the upcoming period.
Labor Hours or Machine Hours
Direct Labor Cost ($)
Select whether you are allocating based on time (hours) or cost (dollars).
The total volume of activity expected (hours or dollars).
Estimated Overhead:–
Estimated Base:–
Predetermined Rate:–
function updateBaseLabel() {
var type = document.getElementById('baseType').value;
var label = document.getElementById('baseLabel');
var input = document.getElementById('estAllocationBase');
if (type === 'dollars') {
label.textContent = "Estimated Direct Labor Cost ($)";
input.placeholder = "e.g. 150000";
} else {
label.textContent = "Estimated Total Allocation Base (Hours)";
input.placeholder = "e.g. 20000";
}
}
function calculatePOHR() {
// Get input values
var overheadInput = document.getElementById('estOverheadCost');
var baseInput = document.getElementById('estAllocationBase');
var typeInput = document.getElementById('baseType');
var resultBox = document.getElementById('resultBox');
var overhead = parseFloat(overheadInput.value);
var base = parseFloat(baseInput.value);
var type = typeInput.value;
// Validation
if (isNaN(overhead) || overhead < 0) {
alert("Please enter a valid positive number for Estimated Overhead.");
return;
}
if (isNaN(base) || base <= 0) {
alert("Please enter a valid positive number for the Allocation Base.");
return;
}
// Calculation
var rate = overhead / base;
var formattedRate = "";
var interpretationText = "";
// Formatting based on type
if (type === 'dollars') {
// Usually expressed as a percentage of direct labor cost
var percentage = rate * 100;
formattedRate = percentage.toFixed(2) + "% of Direct Labor Cost";
// Format numbers for display
document.getElementById('dispOverhead').textContent = "$" + overhead.toLocaleString(undefined, {minimumFractionDigits: 2, maximumFractionDigits: 2});
document.getElementById('dispBase').textContent = "$" + base.toLocaleString(undefined, {minimumFractionDigits: 2, maximumFractionDigits: 2});
interpretationText = "For every $1.00 spent on Direct Labor, apply $" + rate.toFixed(2) + " of overhead.";
} else {
// Expressed as currency per unit (hour)
formattedRate = "$" + rate.toFixed(2) + " per Hour";
// Format numbers for display
document.getElementById('dispOverhead').textContent = "$" + overhead.toLocaleString(undefined, {minimumFractionDigits: 2, maximumFractionDigits: 2});
document.getElementById('dispBase').textContent = base.toLocaleString() + " Hours";
interpretationText = "For every hour of activity, apply $" + rate.toFixed(2) + " of overhead.";
}
// Display results
document.getElementById('dispRate').textContent = formattedRate;
document.getElementById('interpretation').textContent = interpretationText;
resultBox.className = "result-box visible";
}
What is a Predetermined Overhead Rate?
The Predetermined Overhead Rate is a ratio calculated before the start of an accounting period. It helps manufacturers apply indirect costs (overhead) to products based on a specific driver of activity, known as an allocation base.
Unlike direct costs (like raw materials), overhead costs (like factory rent, electricity, and supervisor salaries) cannot be directly traced to a single unit of product. The POHR bridges this gap by estimating a standard cost per unit of activity.
The Formula
The calculation is straightforward but relies on accurate estimation. The formula is:
Predetermined Overhead Rate = Estimated Total Manufacturing Overhead / Estimated Total Allocation Base
Breakdown of Components:
Estimated Manufacturing Overhead: The sum of all forecasted indirect costs for the year (rent, utilities, depreciation, indirect labor).
Allocation Base: The activity that drives the overhead costs. Common bases include:
Direct Labor Hours (DLH)
Machine Hours (MH)
Direct Labor Cost ($)
Why "Predetermined"?
You might wonder why companies don't just use the actual overhead costs. The problem is timing. Actual costs (like utility bills) often arrive weeks after production is finished. If a company waited for actual bills, they couldn't calculate the cost of goods sold (COGS) or set prices in real-time.
By using a predetermined rate, known as Normal Costing, accountants can apply overhead to jobs as soon as they are completed, smoothing out seasonal fluctuations in costs.
Example Scenarios
Scenario 1: Machine Intensive
A car parts manufacturer relies heavily on robotics.
Estimated Overhead: $1,000,000
Estimated Base: 50,000 Machine Hours
Calculation: $1,000,000 / 50,000 = $20.00 per Machine Hour.
If a specific batch of gears takes 100 machine hours to produce, the applied overhead is $2,000.
Scenario 2: Labor Intensive
A custom furniture shop relies on skilled carpentry.
Estimated Overhead: $200,000
Estimated Base: $400,000 Direct Labor Cost
Calculation: $200,000 / $400,000 = 0.50 or 50% of Direct Labor Cost.
If a carpenter is paid $1,000 to build a table, the shop allocates an additional $500 for overhead.
Common Mistakes to Avoid
Mixing Units: Ensure you are not dividing dollars by hours without noting the unit differences.
Using Actual Figures: Remember, POHR is calculated using estimates at the beginning of the year, not actuals at the end.
Wrong Base: Choosing an allocation base that doesn't actually drive costs (e.g., using direct labor hours when the factory is fully automated) leads to distorted product costs.