What is a predetermined overhead rate?

A predetermined overhead rate is often an annual rate for assigning or allocating 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.

A predetermined annual overhead rate is likely computed shortly before the start of the accounting year in which it will be used. The computation of the rate is 1) the budgeted amount of manufacturing overhead for the upcoming year divided by 2) the budgeted or normal number of machine hours (or some other activity) for the upcoming year. Using annual amounts (and the resulting annual rate) eliminates the monthly and seasonal fluctuations which may occur.

A manufacturer producing only a few similar products might use a plant-wide overhead rate. However, if the products require different processes, it is better for each process to have its own specific overhead rate. These multiple overhead rates are also known as departmental overhead rates.