5 hours to make? Then we would use our $5 per direct labor hour, ×. If a widget takes 2 hours to make, we would then allocate 2 × $5 or $10 to the costs involved in making the widget as our overhead costs. Our predetermined overhead rate would be $5 per direct labor hour. Let’s assume we calculated our estimated total manufacturing overhead cost at $50,000 for the coming period and our estimated total amount of the allocation base in direct labor hours at 10,000 hours. Predetermined overhead rate × Amount of the allocation base incurred by the job Finally compute the predetermined overhead rate.Use the cost formula** to estimate the total manufacturing overhead cost for the next period.Estimate the total fixed manufacturing overhead costs for the coming period and the variable manufacturing overhead cost per unit of the allocation base.Estimate the allocation base that will be required for next period’s estimated production level.There are four steps to determine this rate, and it is done prior to the start of the period. Predetermined overhead rate = Estimated total manufacturing overhead costĮstimated total amount of the allocation base: Once the total overhead cost has been calculated, it is then divided between the production based on whichever allocation base the company has determined most effective.
The most commonly used allocation bases are direct-labor hours, direct labor cost, units of product (if there is only one product made) or machine hours.
An allocation base is defined as the measure used to assign overhead costs to products and services. We can use historical data to calculate a predetermined overhead rate which can be applied based on an allocation base. (An enterprise budget results from looking at a point on a production function.) The base unit for enterprise budgets is typically one acre for crops and one. Divide your result by the number of products you manufactured during the period to determine your product cost per unit. Rent, utilities, mortgage interest, production supervisors and maintenance staff all are costs that will need to be allocated by calculating an overhead rate. Add together your total direct materials costs, your total direct labor costs and your total manufacturing overhead costs that you incurred during the period to determine your total product costs. Remember our discussion about indirect costs-these costs fall into our overhead. Overhead costs are all of those costs that a business incurs that cannot be directly related to a particular product.
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