How to Calculate Manufacturing Overhead Costs?

How to Calculate Manufacturing Overhead Costs?

Manufacturing Overhead costs are the indirect factory-related costs utilizes at the time of manufacturing a product.

For calculating manufacturing overhead costs, you need to add all the indirect industrial costs brought about while manufacturing an item. 

It includes the expenses of :

  •  Indirect materials
  •  Indirect labor 
  •  Machine repairment
  •  Depreciation
  •  Manufacturing plant supplies
  •  Power supplies
  •  Insurance 

 The list goes on.

Manufacturing overhead also refers to the factory overheads or Manufacturing support costs. Manufacturing overhead costs do not include administration and advertisement expenses. 

This article covers: 

What To Include in Manufacturing Overhead? 

For manufacturing items, you need extra resources and labor. It also requires a continuous supply of electricity and factory resources to carry on its processes smoothly.

Examples are:

  • Wages of maintenance faculty 
  • Wages of industrial supervisors 
  • Wages of the material handlers 
  • Wages of the quality control staff 
  • Lease of the production building 
  • Taxes and insurance charges on manufacturing facilities and equipment
  • Computer and communication system for manufacturing facility
  • Devaluation of manufacturing equipment
  • Supplies not associated with products 
  • Utilities for factory
  • Wages for Caretaker staff

These expenses do not include variable costs that need to manufacture products, such as,

  •  Direct materials 
  •  Direct labor 

How to Calculate Manufacturing Overhead Rate? 

CALCULATING THE TOTAL MANUFACTURING OVERHEAD :

Identify all the manufacturing process’s indirect costs, then add all the indirect expenses to calculate the manufacturing overhead. 

The Overhead Rate: 

For determining the overhead manufacturing rate, you need first to calculate manufacturing overhead costs. It is the percentage that you should pay for overheads consistently every month. 

Let’s take an example:

If your organization has $100,000 in monthly manufacturing overhead and

 $600,000 in monthly sales, the overhead rate will be:

Manufacturing Overhead Rate = Overhead Costs/Sales x 100 

Manufacturing Overhead Rate = 100,000/600,000 x 100 

Manufacturing Overhead Rate = 17%

It implies 17% of your monthly income will be your organization’s overhead expenses. If the manufacturing overhead rate is low, it shows that the business is utilizing its assets productively. In another case, a higher ratio indicates a slow production process. 

  • You can set up a budget by determining the manufacturing overhead costs. Then you can keep the money with you to cover all the overhead costs. 

How to Account for Manufacturing Overhead? 

As per the Generally Accepted Accounting Principles (GAAP), you need to add the manufacturing overhead to direct labor and direct materials costs for determining the cost of goods sold and the value of inventory. 

You should add these costs in the stock valuation of finished goods and work in progress. 

The income statement and balance sheet must have COGS and inventory value. 

How Do You Calculate Allocated Manufacturing Overhead? 

You need to allocate the manufacturing overhead to each product to keep each manufacturer’s financial statement in compliance with GAAP.

Steps to Calculate Allocated Manufacturing Overhead:

The calculation of Allocated Manufacturing Overhead follows the following steps:

  1. Calculate the manufacturing overhead costs. Some of them are permanent, while others may vary with an increase and decrease in production.
  1. Selection of allocation base includes direct machine hours and direct labor hours. A business assigns overhead costs to products on the basis of an allocation base. 
  1. The next step is to divide the manufacturing overhead costs by the allocation base to calculate the manufacturing overhead. 
  1. You need to determine the allocation base through the factory’s maintenance and payroll records in the current period. 
  1. For calculating the manufacturing overhead, you need to divide the allocation base value by the number of units produced.  

For Example,

If a manufacturing plant has $3,000 in overhead costs and

600 direct work hours,

The overhead cost = $3,000/600) = $5 connected to each work hour. 

Manufacturing overhead is important for running a manufacturing unit. By keeping a record of these costs help you to determine the efficiency and performance of your business. It also helps you to control your overhead costs as per requirement.