Question

Why do companies use predetermined overhead rates rather than actual manufacturing overhead costs to apply overhead to jobs? What factors should be considered in selecting an allocation base to be used in computing a predetermined overhead rate?

Answer 1

Most of the companies prefer to use predetermined overhead rates instead of the actual manufacturing overhead costs to apply overhead to jobs due to the following reasons:

-- The predetermined rate remains unchanged from month to month. When the volume of goods produced varies from month to month, there would be variation in the actual rate from month to month, even though the total cost remains unchanged from month to month.

-- Predetermined overhead rates helps in the simplification of the record keeping, thus make it possible for the organisations to estimate job costs sooner

-- The predetermined overhead rates take into consideration all the abnormal factors related to a specific job while the actual overhead rate does not take into consideration all the abnormal factors

Predetermined overhead rates are used for applying the overhead to jobs. For creating the rate, the cost drivers are used to assign overhead to jobs. Typically in computing a predetermined overhead rate use a measure of activity which is mostly based on; which means the labor hours vs. machine hours