Overhead costs are indirect costs of production. The overhead application rate, also called the predetermined overhead rate, is often used in cost and managerial accounting for calculating variances. The basic formula to calculate the overhead application rate is to divide the budgeted overhead at a particular rate of output by the budgeted activity for the rate of output.
Determine the amount of overhead costs for a period. Overhead costs include rent, indirect materials, labour and any other costs not directly associated with production. For example, a firm finds that the overhead cost payments for one month total £9,750.
Determine the amount of hours normally worked during production. For example, the firm's direct labour usually works 6,000 hours a month.
Divide overhead costs by the amount of hours works to calculate overhead application rate. In this example, £9,750 divided by 6,000 direct labour hours equals an overhead application rate of £1.60 per direct labour hour.