Overhead rates that are established for the absorption of overheads may be divided into two parts:

  1. Actual Overhead Rate
  2. Pre-Determined Overhead Rate

1. Actual Overhead Rate

The actual overhead rate is based on the actual amount of overhead to be absorbed and the actual quantum or value of the base selected (e.g., direct wages, cost of materials, machine hours, direct labor hours, etc.).

The actual overhead rate enables the recovery of the actual amount of overhead. However, its main drawback is that it is historical in nature; it can only be ascertained after the overhead costs have been incurred and measured.

As such, the actual overhead rate is useless from the point of view of cost control.

2. Predetermined Overhead Rate

The predetermined overhead rate is based on the anticipated amount of overhead and the anticipated quantum or value of the base.

It is worked out by dividing the estimated amount of overhead by the estimated value of the base before actual production commences. It is applied for the absorption of overheads during the period for which they have been computed.

Frequently Asked Questions

What is the difference between the actual overhead rate and the predetermined overhead rate?

The actual overhead rate is based on the actual amount of overhead to be absorbed and the actual quantum or value of the base selected (e.G., Direct wages, cost of materials, machine hours, direct labor hours, etc.). The actual overhead rate enables the recovery of the actual amount of overhead. However, its main drawback is that it is historical in nature; it can only be ascertained after the overhead costs have been incurred and measured. As such, the actual overhead rate is useless from the point of view of cost control.

How are they different?

The predetermined overhead rate is based on the anticipated amount of overhead and the anticipated quantum or value of the base. It is worked out by dividing the estimated amount of overhead by the estimated value of the base before actual production commences. It is applied for the absorption of overheads during the period for which they have been computed.

What is the purpose of both actual and predetermined overhead rates?

The actual overhead rate enables the recovery of the actual amount of overhead. However, its main drawback is that it is historical in nature; it can only be ascertained after the overhead costs have been incurred and measured. As such, the actual overhead rate is useless from the point of view of cost control. The predetermined overhead rate allows for the absorption of overheads during the period for which they have been computed and is based on the anticipated amount of overhead and the anticipated quantum or value of the base. This rate is useful from the point of view of cost control as it enables management to plan ahead and budget for the future.

What is the difference between predetermining and estimating?

Predetermining is a process of working out the predetermined overhead rate by dividing the estimated amount of overhead by the estimated value of the base before actual production commences. However, estimating does not involve predicting or forecasting instead it only involves quantifying for an interval of time.

What is the difference between overhead costing and activity-based costing?

Overhead Costing involves allocating overheads to departments, sections or production units on the basis of their use in terms of direct labour hours, machine hours etc.; While activity based costing (abc) starts with the identification of activities done by an organization to make a product or a service. Using activity based costing, it is possible to understand the value of an activity and cost it accordingly instead of using time as a basis for allocating overheads.

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