Which is the correct formula for computing the overhead rate?

Question

BlackTom AI · Accepted Answer

Predetermined overhead rate equals estimated overhead divided by the estimated use of the cost driver for the activity.

1. Relevant knowledge points and concepts
- Overhead rate (predetermined) is used to allocate indirect costs to products or activities before actual results are known.
- The cost driver is the activity measure that best correlates with overhead (e.g., machine hours, labor hours, units).
- The numerator is the estimated total overhead for the period (budgeted indirect costs). The denominator is the estimated total quantity of the chosen cost driver for the period.

2. Step-by-step reasoning process
- Decide the period and identify all overhead costs to be allocated (rent, utilities, indirect labor, depreciation).
- Select the appropriate cost driver (e.g., machine hours).
- Estimate total overhead for the period and estimate total cost-driver activity for the same period.
- Divide the estimated overhead by the estimated cost-driver quantity to obtain the overhead rate per unit of driver.

3. Calculations with intermediate steps (example)
- Estimated overhead for period = $120,000.
- Estimated machine hours (cost driver) = 20,000 hours.
- Overhead rate = estimated overhead / estimated driver = $120,000 / 20,000 hours = $6.00 per machine hour.
- To apply: if a job uses 50 machine hours, allocated overhead = 50 × $6.00 = $300.

4. Why the correct answer is correct
- Using estimated values produces a predetermined rate that allows consistent product costing throughout the period and avoids fluctuations from timing of actual expenses. The formula explicitly matches the provided answer: estimated overhead for the activity / estimated use of the cost driver for the activity.

5. Why other plausible options are incorrect
- Actual overhead / actual driver: this yields a retrospective allocation and cannot be used for interim costing or pricing decisions during the period.
- Estimated overhead / actual driver: mismatches budgeting with actual activity, producing variable per-unit rates that defeat the purpose of a stable predetermined rate.
- Using non-driver denominators (e.g., number of units when units don’t drive overhead) misallocates costs.

6. Conclusion
The correct formula is estimated overhead for the activity divided by estimated use of the cost driver for the activity, which matches the provided answer.

Which is the correct formula for computing the overhead rate?Single choice

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