Assume that Vickers Manufacturing estimates it will spend $1 million on overhead expenses. Vickers is a highly automated manufacturing plant; therefore, the majority of its overhead expenses relate to machinery (depreciation, repairs and maintenance, electricity used). Machine hours used would be a reasonable way to allocate overhead costs to products because use of machinery causes (or drives) overhead expenses. Vickers estimates that it will run its machines for 40,000 hours during the year.

(1) Please provide the formula that would be used to calculate Vickers predetermined overhead rate and perform the calculation. Why is it necessary to calculate a predetermined overhead rate?

(2) The calculation you used in the formula above should have included an activity base. Considering the different activity bases that could potentially be used, is it relevant that Vickers is described as a highly automated manufacturing plant? What might be the result if direct labor hours were used as the activity base (instead of machine hours) in a situation like this?

(3) Using the pre-determined overhead rate calculated above, calculate the overhead that would be allocated to a product that uses 3.5 hours of machine time. What will happen if actual overhead costs turn out to be higher or lower than this calculation?