Predetermined Overhead Rate - Overheads, Cost Accounting Video Lecture | Cost Accounting - B Com

in this video we're going to discuss how
to calculate a predetermined overhead
rate but first we should probably
understand why we need to have a
predetermined overhead rate for example
why don't we just wait till the end of
the period and see what overhead is then
so that we have a more accurate a figure
well the thing is we have to remember
that cost accounting information is
intended to be timely and relevant and
if even if we have to sacrifice some
accuracy by not waiting to the end of
the period it's more timely if we can
get the data get the numbers right now
even if we have to use an estimate right
which is ultimately what we're doing to
the predetermined overhead rate we're
coming up with a budgeted idea an
estimate of what the overhead is going
to be and then we're applying that so
the reason that is more timely or more
relevant information is that let's say a
customer comes to us let's say that we
we manufacture furniture right so we we
have a small place that we build custom
furniture for people and someone comes
in and says ok I want to know how much
it would be if you could give me a quote
for a bookshelf so if we're going to
give this person a quote do we say ok
well come back at the end of the period
and then we'll know what the overhead
was and we'll be able to give you an
accurate quote of what you owe is so of
course not right they're going to want
to quote now or tomorrow or sometime in
the near future and you can't just wait
to the end to see or the accurate totals
of what the overhead were so you need
some kind of way to estimate right now
additionally overhead costs and I'll
just abbreviate oho overhead costs tend
to fluctuate over time some of them and
this isn't all I mean remember overhead
cause or we're talking about a really
big pool of different kinds of costs
here but let's take one type in
particular utilities so we think about
for example do you think that it might
cost more to heat our factory or our
building in the winter ok now so if it's
December and we're trying to calculate
the overhead right now for this month
and we say okay this'll this will be
more accurate
well now the jobs that were giving
quotes on are going to look like they're
costing us more it's more expense
to do a job in winter as opposed to
February or excuse me as opposed to July
or some month other than December so
we're we're really why not wanting to
catch capture any kind of these
fluctuations or anything like that we
really just want to wait a give kind of
a standard quote and say okay here's
what it's going to cost to build this
bookshelf we're going to have some
direct materials we're gonna have some
direct labor and we're going to have
some overhead here's the total cost
based on those figures so now that we
kind of have a rationale for why we
would be calculating a predetermined
overhead rate and so just waiting to the
end of the period and seeing what actual
overhead is let's go and actually
calculate a predetermined overhead rate
and see how it actually works out in
practice so for our example let's say
that we have a manufacturing plant a
factory that makes two two things that
makes cars and it makes trucks so we've
got these two different divisions at our
factory and so someone comes I know this
is in common but let's just say someone
actually wanted a quote for one car from
this Factory a quote for one car and the
factory says you know what we're not
going to give it to dealership but we'll
just directly deal with you we'll give
you a quote for this this one car and
you're saying okay this does great let's
let's see the quote so on that quote
they break it down and you've got raw
materials right this is a steel and
everything to build the car that's
$5,000 and then the direct labor I'll
just abbreviate DL that's $3,000 and
then the manufacturing overhead I'll
just MOH and and that's what we're
trying to figure out so we say how much
how much do we charge to overhead how
will we go about calculating a
predetermined overhead rate how will we
go about applying it and we're not
taking the consideration profits or
anything like that this is just simply
they're just giving you an estimate of
the cost right so the cost for one car
so the overhead in terms of getting this
predetermined rate first thing we need
to have is something called a cost
driver a cost driver it's a very
important concept
driver could be a lot of things some
common things that you'll see be
something like machine hours the number
hours a machine is running labor hours
but but it could it could be a number of
things in a hospital could be the number
of beds occupied in our case let's use
labor hours now the idea behind this
should be that whatever we're choosing
as our driver should be something that
has some kind of relationship to the
actual overhead for in the idea being
that more labor hours implies more
overhead now certain things as we just
talked about utility expense it's going
to be difficult to find that relation
but remember there are a lot of things
in overhead it's a big pool so there's
something that's driving overhead costs
right if we run the Machine more than it
costs more for overhead we know the
relation is not going to be perfect
right these things are an overhead
because they're not directly traceable
to begin with but we want some kind of
relation and so what we're going to use
at our firm we think ok labor hours is
the best cost driver so what we do now
is we say ok well regarding these labor
hours what is the budgeted amount for
the year and then what's our budgeted
overhead so let me just let me just
write out the little equation we'll have
here this will give us our rate is
budgeted overhead and then divide that
by our budgeted cost driver which in
this case is going to be labor hours and
by budgeted I mean these are estimates
now this is going to yield this is are
going to give us our rate I'll just say
our pre let me let me just abbreviate
that there ok so let's say that we
estimate that during the year we look
forward and say during the year we're
going to have four million dollars in
overhead we know that's not necessarily
going to be spot on that's our estimate
and then in terms of the labor hours we
think that we'll have about a hundred
labor-hours okay now we just we just do
a little little division here that gives
us $40 and what is this $40 that's $40
of manufacturing overhead applied per
labor hour right so this is this is our
rate this is our predetermined rate so
for every labor hour that we incur every
time someone works an hour of labor on a
job we're going to apply $40 of overhead
to that job so let's say that this these
$3,000 a direct labor let's just say
that that was based on 100 labor hours
hundred labor hours so people worked for
a hundred hours to build this car with
no idea if that's a good estimate or not
but that's what we're going to use so
now we just say okay well this
manufacturing overhead now we have to
use our rate which is that $40.00 that
we just calculated multiply it by the
actual number of labor hours right
that's a poor looking dollar sign I
apologize so we take this $40 and we say
okay that's the rate and now we just
apply it multiply it by the 100 labor
hours that gives us $4,000 now again
this is not the actual manufacturing
overhead this is the amount of applied
manufacturing overhead this is how much
we have applied to this job okay so we
just say we use our estimated overhead
or estimated labor hours to give us a
rate per hour right and that's that $40
then multiply as we incur actual labor
hours we say that they are driving the
overhead and so we apply it hundred
hours at $40 an hour 4,000 manufacturing
overhead now if we look now
we want to do this quote just for
completeness sake now we'd have five
thousand plus three thousand plus four
thousand twelve thousand dollars we
would quote as the cost to build this
car