What is a predetermined overhead rate?

Definition of Predetermined Overhead Rate

A predetermined overhead rate is often an annual rate used to assign or allocate indirect manufacturing costs to the goods it produces. Manufacturing overhead is allocated to products for various reasons including compliance with U.S. accounting principles and income tax regulations.

Traditionally, the predetermined manufacturing overhead rate was calculated prior to a new year by dividing the budgeted amount of manufacturing overhead for the upcoming year by the normal or expected number of production machine hours for the upcoming year. Using the planned annual amounts for the upcoming year reduces the fluctuations that would occur if monthly rates were used.

A manufacturer producing a variety of products that require different processes will have multiple overhead rates known as departmental overhead rates instead of just one plant-wide overhead rate.

Example of Predetermined Overhead Rate

Prior to the start of the accounting year, JKL Corp calculates the predetermined annual overhead rate to be used in the new year. JKL's profit plan for the new year includes $1,200,000 as the budgeted amount of manufacturing overhead. JKL allocates the manufacturing overhead based on the normal and expected number of production machine hours which are 20,000 for the new year. Therefore, the JKL's predetermined manufacturing overhead rate for the new year will be $60 ($1,200,000/20,000) per production machine hour.