Lessons · Accounting · the predetermined overhead rate
The predetermined overhead rate
Overhead cannot be traced, so it is spread using a rate worked out in advance: estimated overhead for the period divided by the estimated amount of whatever drives it -- machine hours, labour hours, units.
Hone is a place to practise a career, one idea a day. This is one of its lessons, written out in full and free to read without an account.
In beta. This lesson was written for Hone and has not yet been checked by a qualified accountant. Practice material, not professional advice. What that means.
What it is for
It is set in advance because a quote given in March cannot wait for December's actual overhead. That is also its weakness: the rate is an estimate divided by an estimate, and both can be wrong, which is exactly what the next lesson is about.
How to think about it
Take estimated total overhead for the period. Choose the activity that best explains why overhead is incurred. Divide. Keep the rate and use it all year.
Worked example
Estimated overhead for the year: 180,000An estimate, made before the year starts.
Estimated machine hours: 30,000The driver, and also an estimate.
Rate = 180,000 / 30,000 = 6.00 a machine hourFixed for the year, so a quote can be given in March.
A job taking 12 machine hours absorbs 72.00 of overheadApplied by the rate, not by what actually happened.
Your turn
Estimated overhead 180,000 over 30,000 machine hours. Write the line that gives the rate.
Rate = 180,000 / = 6.00 a machine hour
Solve one, graded on the server
The trap
Choosing the driver because the figure is easy to get rather than because it explains the overhead. A rate per labour hour in a factory where the cost is driven by machines will quietly overcharge the hand-finished work and undercharge the automated work, for years.