Predetermined Overhead Rate Calculator
Your Predetermined Overhead Rate is: — per direct labor hour.
Understanding the Predetermined Overhead Rate
The predetermined overhead rate is a crucial concept in cost accounting, used by businesses to allocate manufacturing overhead costs to products or services. It allows for more accurate product costing and pricing before the period's actual costs are known.
What is Manufacturing Overhead?
Manufacturing overhead encompasses all indirect costs associated with the production process that cannot be directly traced to specific units of product. This includes items such as:
- Factory rent or depreciation
- Utilities (electricity, gas, water) for the factory
- Indirect labor (supervisors, maintenance staff, quality control)
- Factory supplies
- Depreciation of factory equipment
- Indirect materials
Why Use a Predetermined Rate?
Businesses need to cost their products for inventory valuation, pricing decisions, and profitability analysis. However, actual overhead costs are often not known until the end of an accounting period (e.g., month or year). If a company waited until then to allocate overhead, it would be difficult to make timely pricing decisions or assess product profitability during the period.
By using a predetermined rate, companies can apply overhead to production as it occurs, leading to more consistent and timely product costing.
How to Calculate the Predetermined Overhead Rate
The formula for calculating the predetermined overhead rate is straightforward:
Predetermined Overhead Rate = Total Estimated Overhead Costs / Total Estimated Allocation Base
In this calculator, we are using Direct Labor Hours as the allocation base. This is a common practice, especially in labor-intensive industries, where overhead costs are assumed to be driven by the amount of labor involved in production.
Key Components:
- Total Estimated Overhead Costs: This is your best estimate of all indirect manufacturing costs for the upcoming period. This estimate is typically based on historical data, budgets, and forecasts.
- Total Estimated Allocation Base: This is your best estimate of the total amount of the chosen allocation base for the upcoming period. If using direct labor hours, this would be the total number of direct labor hours expected to be worked. Other common allocation bases include machine hours or direct labor cost.
Example Calculation
Let's say a manufacturing company estimates its total overhead costs for the next year to be $50,000. They also estimate that they will incur a total of 2,500 direct labor hours during that year.
Using the formula:
Predetermined Overhead Rate = $50,000 / 2,500 Direct Labor Hours = $20 per Direct Labor Hour.
This means the company will allocate $20 of overhead cost to each direct labor hour worked on production.
Using the Calculator
To use this calculator, simply input your best estimates for the total overhead costs and the total expected direct labor hours for the period. Click "Calculate Rate" to see your predetermined overhead rate per direct labor hour.