What is a Predetermined Overhead Rate?
A predetermined overhead rate is an allocation rate that is used to apply the estimated cost of manufacturing overhead to cost objects for a specific reporting period. This rate is frequently used to assist in closing the books more quickly, since it avoids the compilation of actual manufacturing overhead costs as part of the period-end closing process. However, the difference between the actual and estimated amounts of overhead must be reconciled at least at the end of each fiscal year.
Larger organizations may employ a different predetermined overhead rate in each production department, which tends to improve the accuracy of overhead application by employing a higher level of precision. However, the use of multiple predetermined overhead rates also increases the amount of required accounting labor.
How to Calculate a Predetermined Overhead Rate
The predetermined rate is derived using the following calculation:
Estimated amount of manufacturing overhead to be incurred in the period ÷ Estimated allocation base for the period
A number of possible allocation bases are available for the denominator, such as direct labor hours, direct labor dollars, and machine hours.
Example of a Predetermined Overhead Rate
The controller of the Gertrude Radio Company wants to develop a predetermined overhead rate, which she can use to apply overhead more quickly in each reporting period, thereby allowing for a faster closing process. For this calculation, she uses the average manufacturing overhead cost for the past three months, and divides by the estimated amount of machine hours to be used in the current month, based on the most recent production schedule for the period. This results in $50,000 being allocated to inventory in the period. A later analysis reveals that the actual amount that should have been assigned to inventory is $48,000, so the $2,000 difference is charged to the cost of goods sold.
Problems with Predetermined Overhead Rates
There are several concerns with using a predetermined overhead rate, which include are noted below.
Overhead Rate is Not Realistic
Since both the numerator and denominator of the calculation are comprised of estimates, it is possible that the result will not bear much resemblance to the actual overhead rate.
Sales and Production Decisions are Faulty
If sales and production decisions are being made based in part on the predetermined overhead rate, and the rate is inaccurate, then so too will be the decisions.
Variance Recognition Problems
The difference between the actual and predetermined amounts of overhead could be charged to expense in the current period, which may create a material change in the amount of profit and inventory asset reported.
Weak Link to Historical Costs
The use of historical information to derive the amount of manufacturing overhead may not apply if there is a sudden spike or decline in these costs.
Enabling Assessment 2 - BCOST221: COST ACCOUNTING (BSA22) 2nd Sem SY 2021-2022 - Enabling Assessment 2 - DLSU-D Coll…
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BCOST221: COST ACCOUNTING (BSA22) 2nd Sem SY 2021-2022
Enabling Assessment 2
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Question 1
What is the definition of a variable cost?
Response:
A cost that changes in total in response to changes in one or more cost drivers.
Question 2
Maple Mount Fishery is a canning company in Astoria. The company uses a normal costing system in which factory overhead is applied on the basis of direct labor
costs. Budgeted factory overhead for the year was 324,000 of direct labor costs. During the year, the company incurred the
following actual costs.
Direct materials used$ 384,000
Direct labor306,000
Factory overhead658,000
The January 1 balances of inventory accounts are shown below.
Materials-all direct$ 70,000
Work-in-process41,000
Finished goods26,000
The December 31 balances of these inventory accounts were ten percent lower than the balances at the beginning of the year.
The total manufacturing costs for the year are:
Response:
$1,332,600.
Question 3
The time ticket shows which amount for an employee?
Response:
Total hours worked each day.
Question 4
Which of the following is not one of the four steps to obtain the predetermined overhead rate?
Response:
Select the most appropriate cost driver(s) for applying the factory overhead costs.
Question 5
Under full costing, fixed manufacturing overhead costs would be classified as:
Response:
Product costs.
Question 6