Because the actual cost of factory overhead incurred differs each month and is not perfectly variable with respect to production activity, a predetermined factory overhead rate is often used to smooth factory overhead costs in proportion to production activity throughout the year. Factory overhead is charged to the producing departments at the end of each month to determine the cost of units manufactured during the month. If predetermined rates are used to apply overhead, the rates are multiplied by the actual amount of the activity base used in each producing department. For American Chair Company , factory overhead is charged to the producing departments using predetermined rates of $ 7.60 per machine hour in the Cutting Department and $ 12 per direct labor hour in the Assembly Department. During January, 1040 machine hours were used in Cutting and 921 direct labor hours were worked in Assembly. Overhead charged to production for the month is $ 7,904 in Cutting (1,040 machine hours x $7.60) and $11,052 in Assembly (921 direct labor hours x $ 12).
The following entry illustrates the charge for factory overhead to the two producing departments of American Chair Company in January, assuming that a separate account is used for the applied overhead.