Definition: Budgeted indirect-cost rate is an estimated method to allocate expenses to units in a production batch or cost pool. In other words, it’s way for management to assign costs to units that are produced in pools on a budgetary basis. Let’s take a look at how this method is derived and used.
What Does Budgeted Indirect Cost Rate Mean?
The budgeted indirect cost rate formula is calculated by dividing the budgeted annual indirect costs by the budgeted annual quantity of the cost allocation base. This is a mouthful, but it’s pretty simple. Basically, it’s dividing the indirect costs of producing the pool by the number of units in the allocation base, so we can assign a cost to each unit.
For example, if the company spent $300 on indirect costs for a pool of 300, $1 of indirect costs would be allocated to each unit. This formula works for any type of indirect expense like overhead or labor.
During the budgeting process, management can estimate the amount of overhead, labor hours, and other indirect expenses that will be incurred to manufacture the products during the period. These budgeted numbers are then allocated to the number of units to be produced during the period with the cost rate. This way management can predict what their manufactured cost of goods will be at different levels of production and make a finalized plan for the upcoming period.
This concept carries over to the normal costing system that traces direct costs to a cost object by using the actual direct cost rates.