Overhead rates that are established for the absorption of overheads may be divided into two parts: Show
The actual overhead rate is based on the actual amount of overhead to be absorbed and the actual quantum or value of the base selected (e.g., direct wages, cost of materials, machine hours, direct labor hours, etc.). The actual overhead rate enables the recovery of the actual amount of overhead. However, its main drawback is that it is historical in nature; it can only be ascertained after the overhead costs have been incurred and measured. As such, the actual overhead rate is useless from the point of view of cost control. 2. Predetermined Overhead RateThe predetermined overhead rate is based on the anticipated amount of overhead and the anticipated quantum or value of the base. It is worked out by dividing the estimated amount of overhead by the estimated value of the base before actual production commences. It is applied for the absorption of overheads during the period for which they have been computed. Frequently Asked QuestionsWhat is the difference between the actual overhead rate and the predetermined overhead rate?The actual overhead rate is based on the actual amount of overhead to be absorbed and the actual quantum or value of the base selected (e.G., Direct wages, cost of materials, machine hours, direct labor hours, etc.). The actual overhead rate enables the recovery of the actual amount of overhead. However, its main drawback is that it is historical in nature; it can only be ascertained after the overhead costs have been incurred and measured. As such, the actual overhead rate is useless from the point of view of cost control. How are they different?The predetermined overhead rate is based on the anticipated amount of overhead and the anticipated quantum or value of the base. It is worked out by dividing the estimated amount of overhead by the estimated value of the base before actual production commences. It is applied for the absorption of overheads during the period for which they have been computed. What is the purpose of both actual and predetermined overhead rates?The actual overhead rate enables the recovery of the actual amount of overhead. However, its main drawback is that it is historical in nature; it can only be ascertained after the overhead costs have been incurred and measured. As such, the actual overhead rate is useless from the point of view of cost control. The predetermined overhead rate allows for the absorption of overheads during the period for which they have been computed and is based on the anticipated amount of overhead and the anticipated quantum or value of the base. This rate is useful from the point of view of cost control as it enables management to plan ahead and budget for the future. What is the difference between predetermining and estimating?Predetermining is a process of working out the predetermined overhead rate by dividing the estimated amount of overhead by the estimated value of the base before actual production commences. However, estimating does not involve predicting or forecasting instead it only involves quantifying for an interval of time. What is the difference between overhead costing and activity-based costing?Overhead Costing involves allocating overheads to departments, sections or production units on the basis of their use in terms of direct labour hours, machine hours etc.; While activity based costing (abc) starts with the identification of activities done by an organization to make a product or a service. Using activity based costing, it is possible to understand the value of an activity and cost it accordingly instead of using time as a basis for allocating overheads.  About the Author True Tamplin, BSc, CEPF®True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists. True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics. To learn more about True, visit his personal website, view his author profile on Amazon, his interview on CBS, or check out his speaker profile on the CFA Institute website.
What is the benefits of using a predetermined overhead rate instead of an actual overhead rate?The primary advantage of a predetermined overhead rate is to smooth out seasonal variations in overhead costs. These variations are to a large extent caused by heating and cooling costs, which, while high in the summer and winter months, are relatively low in the spring and fall.
Why is it necessary to use a predetermined overhead rate?Establishing a predetermined overhead rate for your business can give you a tool to help keep expenses in proportion with sales and production volumes. Monitoring a well-defined rate provides a quick signal that lets you know when it's time to review spending and, in doing so, will help you protect your profit margins.
Why would a business apply overhead based on a predetermined overhead rate rather than using actual costs?Below are the reasons why companies use predetermined overhead rates rather than actual manufacturing cost to apply overhead to jobs: Predetermined overhead rates are calculated based on budgeted manufacturing overhead which can be obtained in a more timely manner as compared to actual manufacturing overhead.
How predetermined overhead cost is different from actual overhead cost?As such, the actual overhead rate is useless from the point of view of cost control. The predetermined overhead rate allows for the absorption of overheads during the period for which they have been computed and is based on the anticipated amount of overhead and the anticipated quantum or value of the base.
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What are the benefits of using a predetermined overhead rate instead of an actual overhead rate?
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