Pre-determined Overhead Rate

by Obaidullah Jan, ACA, CFA

Pre-determined overhead rate is the rate at which the manufacturing overhead is charged to work-in-process inventory.

Pre-determined overhead rate is calculated at the start of a managerial accounting cycle based on total budgeted overhead cost and some relevant cost driver (such as total budgeted labor hours, total budgeted labor cost, etc.). Manufacturing overheads is applied to a product as the product of the units of the cost driver and pre-determined overhead rate. Since actual results are compiled at the period end only, the overhead application based on pre-determined overhead rate is useful in costing products.


$$ Pre\text{-}determined\ Overhead\ Rate \\= \frac{Total\ Budgeted\ Manufacturing\ Overheads}{Total\ Units\ of\ Cost\ Driver} $$


Chinar Pharmaceuticals is commencing its next accounting year. It expects to incur total manufacturing overheads of $10 million. During the year total labor costs are expected to be $3 million for a 5,000 total labor hours. Total processing hours are 100,000. Find the pre-determined overhead rate. The company has a product named X1 which consumed 25,000 processing hours, find the manufacturing overheads to be charged to the product.

Chinar Pharmaceuticals can calculate pre-determined overheads based either on total labor cost, total labor hours or total processing hours. Selection of a cost driver is a matter of judgment. Since the company is not very labor intensive, use of processing hours as a cost driver would seem appropriate.

Pre-determined overhead rate based on processing hours equals total budgeted manufacturing overheads (of $1,000,000) divided by total budgeted processing hours (which are 100,000). It gives us a pre-determined overhead rate of $10 per processing hour.

Manufacturing overheads charged to X1 = pre-determined overhead rate × processing hours incurred on X1 = $10 per processing hour × 25,000 processing hours = $250,000