How to Calculate the Predetermined Overhead Rate

Predetermined Overhead Rate Calculator

Understanding and Calculating the Predetermined Overhead Rate

In cost accounting, businesses need to allocate manufacturing overhead costs to products. These overhead costs include indirect expenses like factory rent, utilities, depreciation on machinery, and salaries of factory supervisors. Since it's often impractical to allocate these costs as they occur, companies use a predetermined overhead rate. This rate is an estimate calculated before a period begins and is used to apply overhead costs to jobs or products throughout that period.

The predetermined overhead rate helps in several ways:

• Product Costing: It allows for timely and consistent costing of products, enabling better pricing decisions.
• Budgeting and Control: It provides a benchmark for comparing actual overhead costs incurred, aiding in variance analysis and cost control.
• Decision Making: Consistent product costing supports informed decisions regarding production levels, product mix, and outsourcing.

How to Calculate the Predetermined Overhead Rate

The most common method for calculating the predetermined overhead rate involves using a cost driver. A cost driver is an activity that causes overhead costs to be incurred. For manufacturing environments, direct labor hours or direct labor cost are frequently used as the allocation base (cost driver).

The formula for the predetermined overhead rate is:

Predetermined Overhead Rate = Estimated Total Manufacturing Overhead Cost / Estimated Total Amount of the Allocation Base

This calculator uses Direct Labor Hours as the allocation base, which is a very common practice.

Here's a breakdown of the inputs:

• Estimated Total Manufacturing Overhead Cost: This is the total anticipated indirect factory costs for the period (e.g., a year). This includes all factory-related expenses that are not direct materials or direct labor.
• Estimated Total Direct Labor Hours: This is the total number of direct labor hours expected to be worked during the period.
• Estimated Direct Labor Rate per Hour: This is the average wage rate expected to be paid to direct laborers per hour.

Example Calculation:

Let's say a manufacturing company estimates the following for the upcoming year:

• Estimated Total Manufacturing Overhead Cost: $500,000
• Estimated Total Direct Labor Hours: 10,000 hours
• Estimated Direct Labor Rate per Hour: $25 per hour

Using the calculator:

• Estimated Total Manufacturing Overhead Cost: 500000
• Estimated Total Direct Labor Hours: 10000
• Estimated Direct Labor Rate per Hour: 25

The calculator will determine:

• Predetermined Overhead Rate (per direct labor hour): $500,000 / 10,000 hours = $50 per direct labor hour.
• Predetermined Overhead Rate (per direct labor dollar): $500,000 / ($10,000 hours * $25/hour) = $500,000 / $250,000 = 2.00 or 200% of direct labor cost.

This means that for every direct labor hour worked, $50 of manufacturing overhead will be applied to the product. Alternatively, for every dollar of direct labor cost incurred, $2.00 (or 200%) of manufacturing overhead will be applied.