Budgeted Overhead Rate Calculator
Calculation Result
The Budgeted Overhead Rate is:
How to Calculate Budgeted Overhead Rate
The Budgeted Overhead Rate (often called the Predetermined Overhead Rate) is a crucial metric in managerial accounting used to apply manufacturing overhead costs to products or job orders. Unlike direct materials and direct labor, overhead costs (like factory rent, electricity, and supervisor salaries) cannot be easily traced to specific units. Therefore, companies must estimate a rate at the beginning of the period to allocate these costs effectively.
Understanding the Components
- Estimated Total Manufacturing Overhead Costs: This is the sum of all indirect manufacturing costs expected for the upcoming period. It includes indirect materials, indirect labor, depreciation on factory equipment, property taxes on the factory, and utilities.
- Allocation Base: This is the driver used to assign overhead costs to products. It should be the factor that causes the overhead costs to increase. Common bases include Direct Labor Hours, Machine Hours, Direct Labor Cost, or Units Produced.
Step-by-Step Calculation Guide
- Estimate Overhead Costs: At the start of the year, budget all fixed and variable manufacturing overhead costs. Example: Rent ($100,000) + Utilities ($50,000) + Indirect Labor ($150,000) = $300,000.
- Select an Allocation Base: Determine what drives your costs. If your factory is automated, "Machine Hours" is likely the best driver. If it is labor-intensive, "Direct Labor Hours" is preferred.
- Estimate the Total Base Quantity: Project the total volume of the chosen base for the period. Example: You expect to run machines for 15,000 hours.
- Divide: Perform the division to get the rate.
$300,000 / 15,000 hours = $20 per Machine Hour.
Why Not Use Actual Overhead Rates?
Using an actual overhead rate requires waiting until the end of the accounting period when all costs are known. However, managers need cost information immediately to price products, bid on jobs, and monitor profitability. The budgeted rate allows for Normal Costing, where overhead is applied throughout the year based on the predetermined rate, smoothing out seasonal fluctuations in costs or production volume.
Example Scenario
Imagine a furniture manufacturer, "WoodCraft Inc." They estimate the following for the next year:
- Total Overhead Costs: $1,200,000
- Total Direct Labor Hours: 40,000 hours
- Total Machine Hours: 10,000 hours
If they choose Direct Labor Hours as their base:
Rate = $1,200,000 / 40,000 = $30 per Direct Labor Hour.
If a specific table takes 5 labor hours to build, the applied overhead would be 5 × $30 = $150.
Interpreting the Results
If your actual overhead costs at the end of the year differ from the applied amount (calculated using this rate), you will have either under-applied or over-applied overhead. This variance is usually adjusted in the Cost of Goods Sold (COGS) account at period end.