Manufacturing costs are made up of three elements:
- Direct materials (such as the aluminium used in automotive manufacturing)
- Direct labor (such as a machinist)
- Manufacturing overhead
Manufacturing overhead, therefore, does not include direct materials or direct labor costs. It is “the total cost involved in operating all production facilities of a manufacturing business that cannot be traced directly to a product”.
What Costs Does Manufacturing Overhead Include?
Also known as production overhead, factory overhead, or factory burden, manufacturing overhead refers to all of the indirect costs required to operate your factory. These might include:
- Indirect labor, such as maintenance and cleaning personnel
- Factory equipment, such as forklifts
- Rent, insurance, property tax, and depreciation on facilities
- Depreciation on machinery (manufacturing equipment)
- Maintenance/repairs on manufacturing facilities and equipment
- Indirect materials, such as lubricants
- Safety and quality costs, including salaries of quality control staff
Other business expenses that take place outside factory operations such as administrative costs, sales, and marketing, are not included in manufacturing overhead.
Accounting and Allocating for Manufacturing Overhead
Manufacturing overhead must be considered when determining the costs of goods sold and the value of inventory. Overhead should be included in the valuation of both finished goods and works in progress.
Allocating overhead costs to each unit produced can be challenging, as there is often no direct relationship between an overhead cost (such as property tax) and the product manufactured. Depending on the circumstances, businesses might allocate manufacturing overhead in proportion to labor hours per unit produced or the square footage used by production equipment.
How Can Calculating Your Manufacturing Overhead Reduce Costs?
Calculating the indirect costs involved in each unit produced in your factory is an essential step to understanding and then reducing those costs by removing unnecessary expenses.
This could involve:
- Changing utility suppliers to save on electricity or gas
- Sourcing multiple quotes for indirect labor, such as cleaners or repair workers
- Waste reduction (and subsequent reduction in waste disposal costs)