The predetermined overhead rate is the estimated management overhead cost divided by the allocation base, which is also referred to as "activity base" or "activity driver."Continue Reading
The predetermined overhead rate is used to apply manufacturing overhead to products or job orders and is usually calculated before a period begins. It is used in order to limit the fluctuations caused by seasonal factors in the overhead costs or allocation base. Overhead costs are the business costs other than raw materials that keep the business in existence, such as rent, electricity and personal wages. In this case, the cost of management is estimated, then the number of units in the allocation base is estimated.
Examples of allocation bases that are commonly used are direct labor hours or dollars, machine hours and direct materials. Machine hours are the most common due to increased automation in manufacturing processes. The predetermined overhead rate can be a single or plant-wide rate, but a more accurate and complex formula is used for what is called a multiple predetermined overhead rate, which is more time consuming. At the end of the period, an actual overhead rate is calculated, and the elimination of differences between this and the initial estimate is known as disposition of over or under applied overhead.Learn more about Managing a Business