Manufacturing Overhead Definition
Manufacturing overhead refers to the indirect costs incurred in the manufacturing of products and is assigned to each and every unit produced so that the cost of each product can arrive and examples include Rent of the manufacturing building or premises, Depreciation, Utilities cost incurred in manufacturing like electricity, Water, Gas, Oil, Repairs and Maintenance Costs incurred in production and Cost of Insurance etc.
Types of Manufacturing Overheads
- Variable – It depends on the no. of units produced. The cost will change if no. of units produced changes. Examples – Sales Commission, Electricity, Water
- Fixed – These are the costs that do not change even no. of units, production has changed. Examples – Rent, Depreciation, Insurance, Property Tax
Formula
The formula is represented as follows,
Examples of Manufacturing Overhead
Example #1
Below is the manufacturing overhead statement of Alfa Inc for the year 2018, where the company has estimated overhead of 9000, 10000 and 11000 units. In the below statement, the company has some variable overhead and some fixed overhead. Variable overhead will depend on no. of units, whereas fixed overhead will fix irrespective of the no. of units manufactured.
Below are the variable overhead expenses of the company
- Indirect Material cost is $ 1 per unit.
- Electricity Exp. is $ 0.50 per unit.
- Royalty expenses are $ 0.25 per unit.
- Another indirect material cost is $ 2 per unit.
Below are the fixed overhead expenses of the company
- The company has incurred a factory rent of $ 10000.
- Depreciation on plant, machinery & equipment of $ 5000;
- The insurance for manufacturing activity is $ 1500.
- The company has incurred a property tax of $ 1800.
- Other fixed overhead expenses of $ 500;
Calculation of Manufacturing Overhead for 9000 units of production
Similarly, we can calculate for 10000 and 11000 units of production.
In the above statement total variable cost of the company is $ 33,750 for 9000 units, $ 37,500 for 10000 units, and $ 41,250 for 11000 units, but the total fixed cost is $ 18,800 for all any no. of units produced.
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Example #2
Below is the example of manufacturing overhead for Mercedes-Benz Cars. In 2018 Company has manufactured 1000 units of Cars.
Below are the expenses incurred by the company.
- The company has purchased $ 500 million of material, out of which $ 100 million is indirect material.
- The total labor cost of the company was $ 350 million, out of which $ 50 million is indirect labor.
- Power, Fuel & electricity expenses incurred by the company were $ 80 million.
- The total insurance of the company was $ 20 million, out of which $ 5 million for other than manufacturing activity.
- Depreciation of Plant, Machinery, and equipment was $ 5 million.
- Research & Development expenses incurred of $ 5 million.
- Selling & Distribution expenses incurred of $ 10 million.
- Repair & Maintenance expenses of $ 15 million.
In the above examples, research & development of $ 5 million and selling & distribution expenses of $ 10 million are not related to manufacturing activity. Therefore, these expenses are not considered as manufacturing overhead of the Mercedes – Benz.
Advantages
- Considering overhead as a part of the cost of each product helps the pricing of the product effectively.
- Its costs are tax-deductible. A company should identify all these costs as part of his manufacturing expenses because this will allow them to reduce the taxable income and lower the tax burden.
- It helps to control the cost in the inflationary market by controlling the manufacturing cost, failing to control overhead costs could increase the product cost.
- Assigning the overhead with products allow management to better planning, budgeting, and pricing of the product.
Disadvantages
- It requires manpower for assigning the manufacturing unit to each and every unit of production.
- Fixed manufacturing costs will continue even if there is no production. This means the company has to expend without any manufacturing activity which will affect company cash flow and profitability.
Conclusion
Manufacturing overhead costs are those costs which are directly not traceable means all indirect cost related to manufacturing activity. It does not expense out in the period in which they have incurred, but it has to be added to the cost of the product.
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