 In this discussion, we will discuss the discussion question of discuss what a predetermined overhead rate is and how it is calculated and used. If we see a discussion question like this or an essay question like this, even if we don't know exactly what a predetermined overhead rate is, support accounting instruction by clicking the link below, giving you a free month membership to all of the content on our website broken out by category further broken out by course, each course then organized in a logical reasonable fashion, making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files, and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it. We could start by thinking, well, it has something to do with overhead overhead typically has something to do with production. So we might want to start there, we could say, well, how does overhead fit into production? How might we use a rate? What is overhead? And by starting there, even if we don't know exactly where we're going, that might give us some points if we're talking about an essay question. So if we're thinking about overhead, we're typically thinking about some type of manufacturing process. So we can think there, we can at least say, well, overhead is typically going to be used not in a company that doesn't have inventory, but one that creates the inventory. So it's going to be in a manufacturing company. And it's not just going to be in a company that purchases and sells inventory. So that's the first thing we can get to we can typically say, well, overhead is going to be related to us producing inventory in a manufacturing type of company. Now there's going to be three types of things when we produce inventory, we always whenever we think of inventory, we want to think of three things, there's going to be direct labor, direct materials and overhead. That's what inventory consists of the things the labor put into it and everything else that we had to put into to basically convert it from raw materials to whatever the end product is when we make it. Now, of course, here, we're focusing in on the overhead. So the overhead is the everything else. So we can say, well, overhead itself is going to be everything else. Our goal is to try to track everything else that's within the production process that we cannot apply like to a specific job, or we cannot apply to a specific process. And therefore, we need to put it into this bucket of overhead. And that's the problem with overhead, we don't know, we don't know where it should go, we can apply it to the job directly. It's not direct labor, it's not direct cost, it's some, it's some, we don't know which, if we think of a job cost system, we don't know which job to apply it to, that's the problem. That's why we can't put it directly in the working process. And then, of course, we're going to have to apply it to work in process, but not using a direct process because we don't know exactly what it is, but some type of estimate. And of course, that's what this calculation is going to help us do. The predetermined overhead rate is going to help us to estimate how much of this overhead should go into each job. Now, when you consider that problem, if we have, if we have a set amount of overhead, if you imagine, well, we got this much overhead, that we need to apply it to this many jobs, if we have five jobs, and we've got a thousand in overhead, then if you, if you consider that problem, you might say, well, and that's an easy problem to solve. I'll just take the overhead and divide it by five jobs and then apply it out to the five jobs evenly, and that'll be it. But of course, we cannot do that for a few different reasons. One, the jobs aren't the same. If we're using a job cost system, the jobs may differ. So we don't know, some jobs will be larger, some will be smaller, doesn't seem proper to apply the same amount of overhead to them. And two, we're going to be finishing jobs as we go. And we want to apply the overhead to it, even though we may not know what the actual overhead is, until the end of the time period, meaning things like paying the utility bill, things like recording depreciation, those types of things we don't usually do until the end of the month. But we want to apply overhead as we go. So even though we're using the utilities on the factory, we don't really know exactly what the utilities bill is until the end of the month, that's going to go into overhead, and then we're going to apply it out. So we don't even know what the end month overhead is to apply out to the jobs that we're making in this month. So for those two reasons, we're going to have to come up with some type of estimate that will one, it'll be allocated more to the bigger jobs, less to the smaller jobs and two, it'll allow us to allocate during the month, even though we don't know what total overhead is that we're actually using on the current jobs that we're working on. So the way to do that is we're going to have to use this estimate, we'll use this predetermined overhead rate. And the predetermined overhead rate is going to be us using the estimated overhead and dividing it by some type of estimate of a cost driver. So we're going to take the estimated total overhead for the for the month and divide it by some type of allocation factor, some type of cost driver. So an estimated cost. So let's think about how that would that would work. Again, we don't we don't know exactly what the total overhead cost will be. We can estimate that how would we estimate it probably look at last month, we probably look at last month and then make projections into the future. So we would say this is what we think overhead costs will be all the stuff will add together. And then we're going to divide it by some kind of cost driver some some kind of allocation basis. And this is where we're going to try to figure out which jobs are going to be larger or smaller based on this this allocation. So common usages would be direct labor, either cost or direct labor hours or direct materials. And the idea being that if we take the total cost that we think it's going to happen throughout the time period divided by this allocation driver, such as direct labor, then we can use that ratio to allocate out the cost. So we're basically just using direct labor as an allocation ratio so that we can see larger jobs, then we would expect to have more labor smaller jobs have lesser labor. And then we would we would divide this out and that would give us our predetermined overhead rate. Once we have the predetermined overhead rate, then we can just have our jobs and as we create our jobs, we'll have direct material for each job, we'll have direct labor for each job. And then we'll multiply our predetermined overhead rate times the cost driver, the activity based driver that we're using if we use direct labor, we can multiply that rate times the direct labor in order to get the amount of overhead we're going to allocate to the job. So remember that that the overhead doesn't have anything to do with direct labor specifically. But direct labor is used on a ratio basis to see how big one job is in proportion to another job, and therefore apply more of the estimated overhead that will happen throughout the time period to the larger jobs and less to the smaller jobs.