Question

Why do companies use predetermined overhead rates rather than actual manufacturing overhead costs to apply overhead to jobs?

Please provide a thorough response!

Answer 1

Overhead cannot be traced directly to jobs. Many companies use a predetermined overhead rate instead of actual overhead because of the following reasons:

1. Overhead costs are generally not incurred uniformly by the companies throughout the year. For example, heating costs are lesser during summer months. However, allocating less overhead costs to a job produced in the summer compared to one produced in the winter may not be useful.
2. Some overhead costs, like factory building rent, are fixed costs. As, generally the volume of goods produced in each month is different, the actual rate would vary from month to month, even though the total cost is constant. The predetermined rate, does not change from one month to another.
3. Job costs can be estimated easily and promptly by using pre-determined overhead rates as the actual amount of expenditure may be found at a later date.

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