The Predetermined Overhead Rate is Calculated by Taking

Predetermined Overhead Rate Calculator

Direct Labor Hours Machine Hours Direct Labor Cost ($)

function updateBaseLabel() { var type = document.getElementById("allocationBaseType").value; var label = document.getElementById("baseAmountLabel"); if (type === "hours") { label.innerText = "Estimated Total Direct Labor Hours"; } else if (type === "machine") { label.innerText = "Estimated Total Machine Hours"; } else if (type === "cost") { label.innerText = "Estimated Total Direct Labor Cost ($)"; } } function calculatePOR() { var overhead = parseFloat(document.getElementById("estOverheadCost").value); var base = parseFloat(document.getElementById("estBaseAmount").value); var type = document.getElementById("allocationBaseType").value; var resultBox = document.getElementById("porResult"); var resultValue = document.getElementById("rateValue"); var resultDesc = document.getElementById("rateDescription"); if (isNaN(overhead) || isNaN(base)) { alert("Please enter valid numbers for both Overhead Costs and Allocation Base."); return; } if (base === 0) { alert("The Allocation Base amount cannot be zero."); return; } var rate = overhead / base; resultBox.style.display = "block"; if (type === "cost") { // When base is a cost (dollars), the rate is typically expressed as a percentage var percentage = rate * 100; resultValue.innerText = percentage.toFixed(2) + "%"; resultDesc.innerText = "of Direct Labor Cost"; } else { // When base is hours, the rate is dollars per hour resultValue.innerText = "$" + rate.toFixed(2); if (type === "hours") { resultDesc.innerText = "per Direct Labor Hour"; } else { resultDesc.innerText = "per Machine Hour"; } } }

How the Predetermined Overhead Rate is Calculated

In Managerial Accounting, the predetermined overhead rate is calculated by taking the estimated total manufacturing overhead costs and dividing them by the estimated total amount of the allocation base. This calculation is performed before the beginning of an accounting period (typically a year) to facilitate job costing and pricing decisions.

Predetermined Overhead Rate = Estimated Overhead Costs / Estimated Allocation Base

Understanding the Components

To use this formula correctly, you need two specific estimates derived from the company's annual budget:

• Numerator (Top): Estimated Total Manufacturing Overhead Costs. This includes all indirect costs associated with production, such as factory rent, utilities, depreciation on factory equipment, and indirect labor/materials. It does not include selling or administrative expenses.
• Denominator (Bottom): Estimated Total Allocation Base. This is the driver that causes overhead costs to be incurred. Common bases include Direct Labor Hours, Machine Hours, or Direct Labor Costs. Ideally, there should be a strong correlation between the base and the overhead costs.

Why Calculate "Predetermined" Rates?

Companies calculate this rate in advance because actual overhead costs are usually not known until the end of the month or year. However, managers need to know the cost of a product immediately upon completion to determine pricing and profitability. By using a predetermined rate, companies can apply overhead to jobs using "Normal Costing" as they are completed.

Calculation Example

Imagine a furniture manufacturing company with the following budgeted data for the upcoming year:

• Estimated Total Manufacturing Overhead: $600,000
• Estimated Allocation Base (Direct Labor Hours): 20,000 hours

The predetermined overhead rate is calculated by taking:

$600,000 / 20,000 Hours = $30.00 per Direct Labor Hour

This means for every hour a direct laborer works on a piece of furniture, the company will add $30 to the cost of that product to cover indirect factory expenses.

Application of the Rate

Once the rate is established, it is used throughout the period to apply overhead. If a specific custom table takes 10 hours of direct labor to build, the applied overhead would be:

10 Hours × $30/Hour = $300 Applied Overhead

At the end of the period, accountants will compare the Applied Overhead to the Actual Overhead to determine if overhead was over-applied or under-applied, requiring an adjustment to the Cost of Goods Sold.