Predetermined overhead allocation rate

Definition

A predetermined overhead allocation rate is a method used to assign indirect costs to products based on a consistent formula. It is calculated before the period begins and involves estimating total overhead costs and selecting an allocation base.

5 Must Know Facts For Your Next Test

1. The predetermined overhead rate is calculated by dividing estimated total manufacturing overhead costs by the estimated total amount of the allocation base.
2. Common allocation bases include direct labor hours, machine hours, or direct labor costs.
3. Using a predetermined rate helps in setting product prices and budgeting more accurately throughout the year.
4. Differences between actual overhead incurred and allocated overhead are recorded as under- or over-applied overhead.
5. It simplifies accounting processes by providing a consistent method for applying overhead to production.

Review Questions

• How is the predetermined overhead rate calculated?
• Why do companies use a predetermined overhead rate instead of actual overhead rates?
• What happens when there is a difference between actual and applied overhead?

Related terms

Job Order Costing: Method of costing used when products are manufactured based on specific customer orders

Over-applied Overhead: Occurs when the allocated manufacturing overhead exceeds the actual manufacturing overhead incurred

Under-applied Overhead: Occurs when the allocated manufacturing overhead is less than the actual manufacturing overhead incurred