What is Manufacturing Overhead?
The total costs involved in product manufacturing is called manufacturing overhead. We can also consider it as the cost incurred during a firm’s manufacturing operations. Manufacturing overhead is also known as factory burden, factory overhead, and production overhead. It is different from direct labor and direct material costs. Businesses can consider it as an indirect cost.
In simple words, we can say that the manufacturing overhead cost cannot be traced directly during the manufacturing of goods.
Significant factors in manufacturing overhead
Manufacturing overhead costs apply to finished products or goods. These are based on pre-established overheads and calculated based on the absorption rate. Major factors that are included in manufacturing overhead include:
- Utilities: All utility costs such as electricity, water, and gas are included. These costs change according to the quantity of the produced materials. If the demand for a product is high in the market, it will increase. If the request for products is low in the market, it will decrease.
- Indirect Labor: These include the salaries for the labor not directly linked with production. Salaries of janitors, security guards, plant managers, machine maintenance specialists, quality inspectors, plant supervisors, etc. are included. This cost is assigned to each manufacturing product as a total cost.
- Physical Cost: The physical goods used for production are included in these costs. These usually involve expenses incurred by the production facilities, their depreciation, the cost of buying new equipment, repairing new machines, and other related expenses. The accountants calculate this cost either with the straight-line method or with the decline balance method.
- Indirect Material: This cost is charged for products used in the manufacturing processes but cannot be linked to a specific product. It generally includes equipment lubricants, light bulbs, and janitorial materials.
- Financial Cost: It is the financial cost that cannot be canceled or avoided in any case. It includes audit, property tax by the government, and legal fees. The insurance fee is also a part of this cost. This cost does not change frequently.
Some businesses also include the legal expenses into manufacturing overhead costs. However, these are not your indirect cost. If you own a law firm, these expenses are directly linked with production costs. It is your direct cost.
Minor factors included in manufacturing overhead
Related factors necessary to run the production unit or factory include:
- Rent
- Insurance
- Depreciation
- Tax
- Safety and quality cost
- Maintenance
- Indirect labor salaries
- Factory equipment
- Repairing cost
Overhead costs can include fixed monthly and annual costs like leases, wages, and insurance. It also provides marketing costs like ads which fluctuate monthly depending on market activity.
How to calculate manufacturing overhead
Manufacturing overhead can be calculated as an individual expense per unit, or as a total for the entire production. A company must categorize all overhead costs for a specific time frame. If you want to figure out manufacturing overhead quickly, break the time frame into months.
After categorization, add all the costs to get the total overhead price for a specific accounting period. Now you can calculate the percentage of sales on the overhead percentage. An overhead percentage indicates how much money the company pays on overhead and how much money it spends producing a product or service.
OVERHEAD RATE CALCULATIONS
To measure the overhead rate, divide the business’s gross monthly overhead costs by its monthly sales and multiply it by 100. For instance, a company has $20,000 monthly overhead cost and the monthly sales are $100,000.
Overhead Rate = (Monthly Overhead Costs / Monthly Sales)*100
The overhead rate would be:
= (20,000/100,000) * 100
= 0.2*100
= 20%
How to Control Manufacturing Overhead
To reduce manufacturing overhead, reuse supplies and equipment from other production units. Communicate with additional production facilities. If there is some non-useable equipment, avail them. Factories can redeploy free equipment into their production unit. The company will save time and money from it.
Another way to reduce overhead production costs is by upgrading the equipment. Instead of purchasing new equipment, upgrade the older ones. It will save money.
Companies also need to keep track of their operating expenses as they can waste funds prematurely if not appropriately managed. These can become a more considerable expense in the total cost as they are not linked with direct income. They can be like a burden on the business.
