Predetermined Overhead Rate (POHR) represents the allocation of estimated manufacturing overhead costs to products or services. It is computed by dividing total estimated overhead costs by the total estimated activity base. The activity base, typically, is direct labor hours, direct labor cost, or machine hours. For example, if a company estimates overhead costs to be $500,000 and anticipates 25,000 direct labor hours, the POHR would be $20 per direct labor hour ($500,000 / 25,000). This rate is then applied to each product or service based on the actual amount of the activity base used.
The calculation of this rate is important for several reasons. It provides a consistent and systematic way to assign indirect costs to products, facilitating accurate product costing. This accuracy is crucial for pricing decisions, profitability analysis, and inventory valuation. Historically, predetermined rates were developed to address the fluctuating nature of actual overhead costs and production volumes, providing a more stable cost allocation method throughout the accounting period. The use of POHR is essential in applying overhead costs to work-in-process inventory and the finished goods inventory to ensure that financial reports follow generally accepted accounting principles (GAAP) where applicable.
