GAAP (generally accepted accounting principles) dictates that the total cost of finished goods and works in progress that manufacturers include on their balance sheet and cost of goods income statement must include manufacturing overhead cost.
What are Overhead Costs?
Manufacturing overhead includes the total amount of indirect costs involved in production, and usually includes line items such as salaries of factory management and other non-production employees, equipment depreciation, and electricity and other utilities.
Manufacturing overhead costs include a mix of fixed, variable, and semi-variable overheads. Fixed costs are the same each month (or other time period) regardless of the amount of units that were produced. Variable costs fluctuate based on production levels, and semi-variable overhead costs are partially fixed and partially variable.
All of the different types of manufacturing overheads must be taken into account when calculating the total manufacturing overhead cost.
Total Manufacturing Overhead Cost Formula
The formula used to calculate manufacturing overhead cost is simply the adding up of all overhead expenses:
Total manufacturing overhead cost = indirect labor + indirect materials + utilities + insurance + depreciation + any other overhead costs
A factory overhead example using the formula above may look like this:
Company X produced 20,000 widgets in Q1 and following is a breakdown of overhead costs:
|Indirect Labor (i.e. plant manager, security guards, etc.)||$9,000|
|Indirect Materials (any material used that cannot be assigned to a specific product)||$8,000|
|Electricity, Gas, and Coal (utilities)||$8,500|
|Total Manufacturing Overhead Costs||$44,000|
From this table, we know that the total manufacturing overhead cost of producing 20,000 widgets is $44,000. Simple division reveals that the total manufacturing overhead cost per unit is 44,000/20,000 = $2.20.
This number can then be used to project future manufacturing overhead costs based on the number of widgets the company plans to produce. For example, if they plan to increase production to 30,000 widgets, it will cost them 30,000 * 2.20 = $66,000 in manufacturing overhead costs.