Applied Predetermined Overhead Rate - How to Compute total Production Costs using Estimated Labor & Machine Hours

Applied predetermined overhead rate is a cost accounting method that applies estimated labour or machine cost per hour to total # of actual hours in a given period, to derive the total cost of production, whether it is machine use or physical labour hours. This method is commonly used to apply factory overhead to a given job or product. The formula for applied predetermined overhead rate is:

* Budgeted annual activity hours include direct labour & machine hours.

Example

Assume a factory calculates its predetermined overhead rate based on machine use or hours. Budgeted overhead is estimated at $600,000 while budgeted machine hours are estimated at 150,000. The applied overhead rate is calculated as:

During the course of the year, actual machine hours used to output the same amount of products is 145,000 hours. Thus, what is the actual overhead?

Therefore:

The applied overhead rate method is used by cost accountants, marketing managers & management accountants to compute total production costs of a particular product. These types of costing methods, including the applied overhead rate allows management to quickly determine the costs of producing a particular product, as well as estimated contribution margin, thus allowing them to quickly make managerial decisions. Typical decisions include increasing production due to an increase in demand or higher contribution margin, or cutting back on production due to falling sales or margins.