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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:

Applied Overhead Rate = Budgeted annual overhead / Budgeted annual activity hours*

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


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:

Applied Overhead Rate = Budgeted annual overhead / budgeted annual activity hours

Applied Overhead Rate = $600,000 / 150,000 hours

Applied Overhead Rate = $4 per machine hour

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?

Actual Overhead = Applied overhead rate x Actual machine hours

Actual Overhead = $4 x 145,000 hours

Actual Overhead = $580,000


Budgeted Overhead = $600,000

Actual Overhead = $580,000

Difference = $20,000 positive

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.

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