Why Is Budgeted Manufacturing Overhead Rate Necessary?

Budgeted Manufacturing Overhead Rate or a predetermined factory overhead rate or a predetermined overhead rate all sounds the same : A predetermined manufacturing overhead rate provides the only feasible method of computing product overhead costs promptly enough to serve management needs, identify inefficiencies, and smooth out uncontrollable and somewhat illogical month-to-month fluctuations in unit costs.

For example, the various overhead expenses must be charged to all work done during any period of production. How can such a charge be made? It is possible to allocate actual overhead to all work completed during the month, using a base actual direct labor dollars, direct labor hours, machine hours, or some other base. As long as the volume of work completed each month the same, and costs are within control limits, this method might be accurate. As variations occur, work completed during different months would receive a greater or a smaller charge -an inequitable situation. Budgeted Manufacturing Overhead Rate should be almost near to actual.

For example, costing problems would result if actual costs incurred for repairs and maintenance were charged directly to a job or product. What work should be charged with the expense of these repairs? Should work processed during the month when repairs are made be charged therewith?

This procedure is again unreasonable. Ordinarily, repairs are necessary because of wear and tear over a much longer period than one month and are made to permit continuous operations in any month. Furthermore,  manufacturing overhead costs need to be assigned to production promptly, and inefficiencies need to be identified. Therefore, manufacturing overhead is usually charged to work done on an estimated basis. However, the use of estimates can cause certain difficulties because underlying data are the result of opinions and judgments. Consequently, estimates must be the outcome of careful studies. A Budgeted Manufacturing Overhead Rate helps a manufacturing cost accounting department by giving acceleration in performing monthly closing.

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