Question

Why is a "pre-determined overhead rate" necessary when assigning manufacturing overhead cost to products? Why don't we use similar "rates" when assigning the cost of direct materials or direct labor to products?

Answer 1

• Predetermined Overhead rate is necessary because manufacturing overheads are assigned to the cost of products.
• Manufacturing Overhead, as we know, are the INDIRECT manufacturing expenses incurred in the production of a product. Hence, the same are to be added to the cost of the product.
  BUT, since they are ‘indirect’, they cannot be directly traced to a product that ‘this amount of indirect cost’ is used in manufacture of this product’.
  For example, Factory rent is paid, and in that factory, there are various products that are produced.
  So how can that Factory Rent amount be allocated to each product without any base or ‘predetermined overhead rate’.
• That’s why the concept of predetermined overhead rate got originated, to allocate the indirect cost that cannot be traced to an individual product.
• We DON’T USE these “RATES” to assign Cost of direct materials and direct labor to product BECAUSE:
  --Direct material and direct labor are already DIRECT COSTs.
  --They can already be traced to a product and added to the cost of that individual product.
  --For example, if some amount of material is used in a product of product X, the cost of that material can be directly added to the cost of ‘X’ without any rates.