To determine whether its business operations will be successful, a firm calculates its manufacturing overhead rate, which it uses to set a price on the product they produce. The manufacturing overhead cost covers all indirect aspects of production (Warren, Reeve & Duchac, (2009). However, firms use a predetermined overhead rate rather than the actual overhead costs to apply overhead to jobs, because actual rate is calculated seasonally and it can result in fluctuations in the rate of overhead. This means that the firm needs to wait until the end of the period, a situation that necessitates the use of predetermined overhead rate.

Under-applied overhead are less than the actual overhead and they increase the cost of goods sold, while over-applied overhead are higher than the actual overhead and they reduce the cost of goods sold (Warren, Reeve & Duchac, 2009).). At the end of the period, the presence of a debit balance on the manufacturing overhead account shows under-applied overhead, while a credit balance shows over-applied overhead.

Plantwide overhead rate is the sole rate utilized to assign all firm’s manufacturing overhead costs to the production of output; it is the amount per machine hour; percentage of direct costs of products and amount of per labor hour (Warren, Reeve & Duchac, 2009). Some firms use multiple overhead rates when they have large amount of overhead to assign; as such services offered by the diverse departments are differentiated and this necessitates the use of multiple overhead rates. Use of multiple overhead rates enhances the accuracy of the overhead assignment.

When automated equipment replaces direct labor, overhead rates increase and the direct labor decreases. However, in case the predetermined overhead rate was based on the direct labor, there is an increase in the predetermined overhead rate.