Pre-determined overhead rate
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A pre-determined overhead rate is the rate used to apply manufacturing overhead to work-in-process inventory. It is calculated as estimated manufacturing overhead cost divided by estimated amount of cost driver or activity base. Common activity bases used in the calculation include direct labor costs, direct labor hours, or machine hours.
The use of such a rate enables an enterprise to determine the approximate total cost of each job when completed. In recent years increased automation in manufacturing operations has resulted in a trend towards machine hours as the activity base in the calculation.
This is related to an activity rate which is a similar calculation used in Activity-Based Costing. A pre-determined overhead rate is normally the term when using a single, plant-wide base to calculate and apply overhead. Overhead is then applied by multiplying the pre-determined overhead rate by the actual driver units. Any difference between applied overhead and the amount of overhead actually incurred is called over- or under-applied overhead.
