overhead rate

https://www.bookstime.com/ing the percentage conversion, we see Bob’s total overhead costs with regard to sales are 25%. Following are some of the disadvantages of using a predetermined overhead rate. Following are some of the advantages of using a predetermined overhead rate. The drawbacks linked with a predetermined overhead rate are stated below. The overhead rate for the packaging department is $2.20 per dollar of direct labor. One such metric that you may have heard of is predetermined overhead rate.

manufacturing cost

Since the amount of actual overhead is more than the forecasted overhead, the manufacturer has over-absorbed its overhead costs. Had the manufacturer’s overhead costs totaled less than the estimated costs, the manufacturer would have under-absorbed its overhead costs. Therefore, the predetermined overhead rate is $2 per direct labor hour.

Overview Of Predetermined Overhead Rate

Again, that means this business will incur $8 of overhead costs for every hour of activity. That means this business will incur $10 of overhead costs for every hour of activity. The predetermined overhead rate calculation shown in the example above is known as the single predetermined overhead rate or plant-wide overhead rate. This example helps to illustrate the predetermined overhead rate calculation.


A pre-predetermined overhead rated overhead rate is the rate used to apply manufacturing overhead to work-in-process inventory. The pre-determined overhead rate is calculated before the period begins. The first step is to estimate the amount of the activity base that will be required to support operations in the upcoming period. The second step is to estimate the total manufacturing cost at that level of activity. The third step is to compute the predetermined overhead rate by dividing the estimated total manufacturing overhead costs by the estimated total amount of cost driver or activity base. Common activity bases used in the calculation include direct labor costs, direct labor hours, or machine hours.

Direct Labor Hours

Since we need to calculate the predetermined rate, direct costs are ignored. This means that for every hour of machine work, the company can expect to incur $5.60 in overhead costs. Hence, this predetermined overhead rate of 66.47 shall be applied to the pricing of the new product VXM.

How do you apply overhead cost per job using a predetermined overhead rate?

  1. Total Job Cost = Direct Materials + Direct Labor + Applied Overhead.
  2. Predetermined Overhead Rate = Estimated Overhead / Estimated Activity.
  3. Total Job Cost = Direct Materials + Direct Labor + Applied Overhead.

Those advantages come at a cost, both in resources and time, since additional information needs to be collected and analyzed. In order to accurately calculate the predetermined overhead rate, the historical cost should be handy. The more historical data a company has, the greater accuracy it would have in ascertaining the pre-determined overhead cost. It is often overly simplistic and incorrect to assume that direct labor-hours is a company’s only manufacturing overhead cost driver.

As Good as Historical Data

He has a Bachelor’s degree in Business Management from Stevenson University, Maryland and a Master’s degree in Curriculum and Instructional Design from Western Governors University, Utah. He has developed curriculum for both residential and online courses for over five years and holds a position in both academic and business management as a college-level education manager for the past twelve years. Our mission is to empower readers with the most factual and reliable financial information possible to help them make informed decisions for their individual needs. Finance Strategists is a leading financial literacy non-profit organization priding itself on providing accurate and reliable financial information to millions of readers each year. The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.

Predetermined overhead rates are essential to understand for eCommerce businesses as they can be used to price products or services more accurately. They can also be used to track the financial performance of a business over time. According to a survey 34% of the manufacturing businesses use a single plant wide overhead rate, 44% use multiple overhead rates and rest of the companies use activity based costing system.

Pre-determined overhead rate

Managers may then be tempted to increase prices at the worst possible time–just as demand is falling. As stated above, it involves calculating the total manufacturing overhead cost and dividing it by an activity base. Based on this definition, the formula for the predetermined overhead rate is below.

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