What is the formula for the predetermined overhead rate?

What is the formula for the predetermined overhead rate?

• A. Actual overhead / actual activity.
• B. Estimated overhead / estimated allocation base.
• C. Applied overhead equals rate × actual activity.
• D. Overhead is allocated to jobs using direct labor cost.

Answer: (A)

The main concept here is setting an overhead rate before the period starts so you can assign overhead to products as work is done. The formula used to determine this rate is the estimated total overhead for the period divided by the estimated total amount of the allocation base you’ll use to drive overhead costs (such as direct labor hours, direct labor cost, or machine hours). This rate is then applied to actual activity to cost jobs: applied overhead = predetermined rate × actual activity. Using estimates keeps cost assignment predictable and helps prevent large swings in overhead costs from month to month. It also means you’re applying overhead based on a measure that correlates with how overhead is actually incurred (the chosen allocation base). If you used actual overhead divided by actual activity to set the rate, you’d be calculating the rate after the fact, which defeats the purpose of a predetermined rate. The concept you apply during the period is rate times actual activity, which then becomes the overhead applied to each job. Direct-labor cost is not the universal base for all situations; the base is chosen to best reflect how overhead is consumed (common choices include direct labor hours or machine hours).

The main concept here is setting an overhead rate before the period starts so you can assign overhead to products as work is done. The formula used to determine this rate is the estimated total overhead for the period divided by the estimated total amount of the allocation base you’ll use to drive overhead costs (such as direct labor hours, direct labor cost, or machine hours). This rate is then applied to actual activity to cost jobs: applied overhead = predetermined rate × actual activity.

Using estimates keeps cost assignment predictable and helps prevent large swings in overhead costs from month to month. It also means you’re applying overhead based on a measure that correlates with how overhead is actually incurred (the chosen allocation base). If you used actual overhead divided by actual activity to set the rate, you’d be calculating the rate after the fact, which defeats the purpose of a predetermined rate. The concept you apply during the period is rate times actual activity, which then becomes the overhead applied to each job. Direct-labor cost is not the universal base for all situations; the base is chosen to best reflect how overhead is consumed (common choices include direct labor hours or machine hours).