A single rate for the absorption of manufacturing overhead of all production centers

What is Factory Overhead?

Factory overhead is the costs incurred during the manufacturing process, not including the costs of direct labor and direct materials. Factory overhead is normally aggregated into cost pools and allocated to units produced during the period. It is charged to expense when the produced units are later sold as finished goods or written off. The allocation of factory overhead to units produced is avoided under the direct costing methodology, but is mandated under absorption costing. The allocation of factory overhead is required when producing financial statements under the dictates of the major accounting frameworks.

Examples of Factory Overhead

Examples of factory overhead costs are noted below:

Production supervisor salaries
Quality assurance salaries
Materials management salaries
Factory rent
Factory utilities
Factory building insurance
Fringe benefits
Depreciation
Equipment setup costs
Equipment maintenance
Factory supplies
Factory small tools charged to expense
Insurance on production facilities and equipment
Property taxes on production facilities

The range of possible factory overhead costs can be quite extensive, depending upon the size and complexity of a factory operation and the level of detail at which costs are recorded.

Factory Overhead Variances

After factory overhead is allocated to inventory, the amount actually allocated will vary from the standard amount that had been budgeted to be allocated. This difference is caused by either a spending variance or an efficiency variance. The spending variance occurs because the actual amount of factory overhead expenditure incurred in the period was different from the standard amount that had been budgeted at some point in the past. The efficiency variance occurs because the the amount of units to which the factory overhead was allocated varied from the standard amount of production that had been expected when the allocation rate was set up.

Factory Overhead Best Practices

The use of factory overhead is mandated by accounting standards, but does not bring real value to the understanding of overhead costs, so a best practice is to minimize the complexity of the factory overhead allocation methodology. Ideally, there should be a small number of highly aggregated factory overhead accounts that are pooled into a single cost pool, and then allocated using a simple methodology. Also, the amount of factory overhead analysis and recordation work can be mitigated by charging all immaterial factory costs to expense as incurred.

Terms Similar to Factory Overhead

Factory overhead is also known as manufacturing overhead or manufacturing burden.

Producing things isn’t cheap. There are so many costs that occur during production that it can be hard to track them all. These costs are what is called manufacturing overhead.

Let’s define manufacturing overhead, look at the manufacturing overhead formula and how to calculate manufacturing overhead.

What Is Manufacturing Overhead?

Manufacturing overhead is part of a company’s manufacturing operations, specifically, the costs incurred outside of those related to the cost of direct materials and labor. This is why manufacturing overhead is also called an indirect cost.

However, costs that are outside of the manufacturing facilities are not product costs and are not inventoriable. These costs, which include selling, general and administrative expenses, such as corporate salaries, audit and legal fees, are simply recorded as expenses and are added to the income statement for the accounting period in which they occur.

Manufacturing overhead is added to the units produced within a reporting period and is the sum of all indirect costs when creating a financial statement. It is added to the cost of the final product, along with direct material and direct labor costs. According to generally accepted accounting principles (GAAP), the manufacturing overhead appears on the balance sheet as the cost of a finished product in and inventory and work-in-progress inventory as well as the cost of the goods income statement.

Being able to track those costs is important and project management software can help. ProjectManager is online work and project management software that delivers real-time data to monitor costs as they happen. Our live dashboard requires no setup and lets you see how much you’re spending during production and make sure that you’re staying within your budget. Get started with ProjectManager for free today.

ProjectManager’s live dashboard tracks costs in real time. Learn more.

What Is Included in Manufacturing Overhead?

The reason why manufacturing overhead is referred to by indirect costs is that it’s hard to trace them to the product. A final product’s cost is based on a pre-determined overhead absorption rate. That overhead absorption rate is the manufacturing overhead costs per unit, called the cost driver, which is labor costs, labor hours and machine hours.

There are five basic types of costs that are included in manufacturing overhead, which is as follows:

Indirect Labor

These are costs that the business takes on for employees not directly involved in the production of the product. This can include security guards, janitors, those who repair machinery, plant managers, supervisors and quality inspectors. All their salaries are considered indirect labor costs. Companies discover these indirect labor costs by identifying and assigning costs to overhead activities and assigning those costs to the product. That means tracking the time spent on those employees working, but not directly involved in the manufacturing process.

Indirect Materials

These are costs that are incurred for materials that are used in manufacturing but are not assigned to a specific product. Those costs are almost exclusively related to consumables, such as lubricants for machinery, light bulbs and other janitorial supplies. These costs are spread over the entire inventory since it is too difficult to track the use of these indirect materials.

Utilities

Costs associated with utilities can be hard to calculate as they fluctuate with the number of materials being produced. Therefore, natural gas, electricity and water are overhead costs, but they aren’t constant. You might need more or less, for example, depending on the demand for your product in the market. This makes them variable overhead costs. They are calculated for the whole facility, then allocated over the entire product inventory.

Related: 10 Free Manufacturing Excel Templates

Physical Costs

These physical costs are calculated either by the declining balance method or a straight-line method. The declining balance method involves using a constant rate of depreciation applied to the asset’s book value each year. The straight-line depreciation method distributes the carrying amount of a fixed asset evenly across its useful life. The latter is used when there is no pattern to the asset’s loss of value.

Financial Costs

As the name implies, these are financial overhead costs that are unavoidable or able to be canceled. Among these costs, you’ll find things such as property taxes that the government might be charging on your manufacturing facility. But they can also include audit and legal fees as well as any insurance policies you have. These financial costs are mostly constant and don’t change so they’re allocated across the entire product inventory.

Examples of Manufacturing Overhead Costs

Some other examples can include the rent you pay on your factory building, supplies that are not directly associated with products and wages of people who work in the plant but are not directly creating products.

Manufacturing Overhead Formula

First, you have to identify the manufacturing expenses in your business. Once you do, add them all up or multiply the overhead cost per unit by the number of units you manufacture. To get a percentage, divide by your monthly sales and multiply that number by 100. Here’s the manufacturing overhead equation:

Manufacturing Overhead Costs / Number of Sales x 100 = Percentage.

How to Calculate Manufacturing Overhead

The first thing you have to do is identify the manufacturing overhead costs. These are the indirect costs that help run the manufacturing facility. All these indirect costs are added together. Now that you have an estimate for your manufacturing overhead costs, the next step is to determine the manufacturing overhead rate using the equation above.

When you do this calculation and find that the manufacturing overhead rate is low, that means you’re running your business efficiently. The higher the percentage, the more likely you’re dealing with a lagging production process.

This not only helps you run your business more effectively but is instrumental in making a budget. Knowing how much money you need to set aside for manufacturing overhead will help you create a more accurate budget.

Manufacturing Overhead Calculation Example

Consider Tillery Manufacturing, a business that makes shoes. In a good month, Tillery produces 100 shoes with indirect costs for each shoe at $10 apiece. The manufacturing overhead cost for this would be 100 multiplied by 10, which equals 1,000 or $1,000.

Now, what is the percentage of that? You need to first figure out what your monthly sales are. Let’s say you sell 50 shoes each month. Therefore, the percentage is 1,000 divided by your monthly sales of 50 multiplied by 100 equals 5000. That gives you a percentage of two percent, which is very good. Your fantasy manufacturing business is very efficient!

How ProjectManager Helps with Manufacturing Costs

ProjectManager is cloud-based software that keeps everyone connected in your business. Salespeople on the road are getting the same real-time data that managers and workers are the floors are using to run production. ProjectManager has the tools you need to keep monitor and control all your costs, including your manufacturing overhead.

Manage Planned and Actual Costs on Interactive Gantt Charts

Once you set a baseline to capture your schedule, planned costs and actual costs can be compared to make sure you’re keeping to your budget. You add the hourly rate of your work and then assign their hours, which will then populate the Gantt and the sheet view (like the Gantt but without a graphic timeline). You can also track non-human resources, such as equipment, suppliers and more.

Track Costs With One-Click Reports

As we mentioned above you can track costs on the real-time dashboard and real-time portfolio dashboard, but you can also pull cost and budget data in downloadable reports with a keystroke. Get reports on project or portfolio status, project plan, tasks, timesheets and more. All reports can be filtered to show only the cost data and then easily shared by PDF or printed out to use update stakeholders.

Streamline Payroll With Secure Timesheets

Our timesheet feature is a secure way to track the cost and the time your team is putting into completing their tasks. Teams can log hours or managers can set their hours. Once the timesheet is submitted, it’s locked for security. You can even set reminders for timesheets to make sure that everything runs smoothly.

There are other notifications you can receive by email or in the tool to alert you about activity and task reminders. Our collaborative platform lets you share files and comment with everyone no matter where or when. There’s also workflow automation and task authorization to free up your workers to focus on what matters without jeopardizing quality. You get it all with ProjectManager.

ProjectManager is award-winning work and project management software that connects hybrid teams with collaborative to the core tools and a single source of truth. With features for task and resource management, workload and timesheets, our flexible software is able to meet the needs of myriad industries. Join the teams at Seimens, Nestle and and NASA that have already succeeded with our tool. Get started with ProjectManager today for free.

What is absorption overhead rate?

In accounting, absorption rate (or the rate of absorption) is the rate at which companies calculate and allocate their overhead expenses. 2 These are the costs associated with providing goods and services to their customers, though these expenses aren't directly traceable to end products.

What is absorption rate in manufacturing?

The rate of absorption is the predetermined rate at which overhead costs are charged to cost objects (such as products, services, or customers). The rate of absorption drives the amount of overhead costs that are capitalized into the balance sheet of a business.

How do you calculate manufacturing overhead rate?

To compute the overhead rate, divide your monthly overhead costs by your total monthly sales and multiply it by 100. For example, if your company has $80,000 in monthly manufacturing overhead and $500,000 in monthly sales, the overhead percentage would be about 16%.

What is labor absorption rate?

It is calculated as (overhead cost/ Labour hours required for production) if the labour hour required is 1000 and the overhead to be absorbed is 250 then the rate is . 25 per labour hour. if 20 labour hours are required to complete a job then the overhead will be 5.