How do you determine predetermined overhead rate?

A predetermined overhead rate (POHR) is a rate used to apply manufacturing overhead (MOH) to work in progress inventory. To compute the POHR some preliminary work is needed. First, a measure of activity, called the cost driver, has to be selected as the basis for assigning MOH cost. Examples of cost driver may be machine hours, labour hours, raw material use, etc. Second, two estimations are required before calculations can be made: (1) the amount of MOH cost that will be incurred during the period and (2) the amount of cost driver that will be used during the same period. With these two estimations, a POHR is found as followed:

POHR = Estimated MOH cost (1) / Estimated Amount of Cost Driver (2)

With this you have the POHR! Be wary however that POHR is not the best way to apply overhead because it is a single cost driver method of applying cost. That is, the cost driver chosen may not be reflective of all situations. For example with the growing automation in production, labour hours may not be the most reflective cost drivers for items that are machine made. Secondly, the POHR is flawed when it comes to volume of production. Because the single rate is applied to all products, a low volume production that uses less cost driver than a higher volume production is applied the same amount of cost per unit as the higher volume production.

A better application of overhead is the Activity Based Costing system, which you may want to look up.