Overhead Budget Meaning
Overhead Budget is prepared to forecast and present all the expected costs concerning the manufacturing of the goods which the company expects to incur in the next year. It excludes the direct material and the direct labor cost and the information of which becomes part of the cost of the goods sold in the master budgetMaster BudgetMaster Budget is an all-inclusive financial planning document that covers all the smaller budgets of the Company to present a detailed view of its financial standing. It includes cash flow forecast, capital investments, expected future sales, & production levels etc. read more.
Components of Manufacturing Overhead Budget
The following are the components of the overhead budget
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For eg:
Source: Overhead Budget (wallstreetmojo.com)
#1 – Employee Costs
Employee cost refers to the amount paid to the employee for the work done by them. Overhead budget considers the cost which the company expects that it will incur on its employees in the next year like salary etc.
#2 – Insurance Expense
Insurance expense is the expense incurred by the company for insuring the various things and has to make the payment of its premium regularly. So, these costs which the company expects that it will incur on insurance premium in the next year are considered as overhead and will be shown in the overhead budget.
#3 – Rent Expenses
Property which is used for production is generally taken on the rent by the company so for this rent has to be paid, which becomes part of the overhead of the company. So, these costs which the company expects that it will incur for paying rent in the next year are considered as overhead and will be shown in the overhead budget.
#4 – Depreciation
Depreciation refers to the reduction in the value of fixed assetsFixed AssetsFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples.read more due to the normal wear tear, technological changes, etc., which are charged as an expense in the income statement of the company. So, depreciation costs which the company expects that it will incur in the next year are considered as overhead and will be shown in the overhead budget.
#5 – Freight
Freight refers to the charge paid by the companies to transport the goods using any means of transport. It is one of the essential expenses which many of the companies have to incur, and such freight cost, which the company expects that it will incur in the next year are considered overhead and will be shown in the overhead budget.
#6 – Utility Expenses
Utility Expenses refers to the cost that is incurredCost That Is IncurredIncurred Cost refers to an expense that a Company needs to pay in exchange for the usage of a service, product, or asset. This might include direct, indirect, production, operating, & distribution charges incurred for business operations. read more by the company for availing the services or facilities provided by public utility companies and includes facilities like telephone facility, water, sewer, electricity, gas, etc. These costs are essential for the operation of the business and all these costs which the company expects that it will incur in the next year are considered as overhead and will be shown in the overhead budget.
#7 – Maintenance Cost
Maintenance Costs refers to those costs which the company incurs to keeps the items in good working condition. These costs are essential for the operation of the business and all these costs which the company expects that it will incur in the next year are considered as overhead and will be shown in the overhead budget.
#8 – Taxes
Taxes refer to the compulsory financial charge imposed by the government of the country on the individual and organizations working there. The company has to pay these expenses compulsorily and is thus considered as the overhead expenses of the company. All these costs which the company expects that it will incur in the next year are considered as overhead and will be shown in the overhead budget.
Apart from these costs, all the expected costs with respect to the manufacturing of the goods which the company expects to incur in the next year except the cost of direct materialThe Cost Of Direct MaterialDirect Material Cost is the total cost incurred by the company in purchasing the raw material along with the cost of other components including packaging, freight and storage costs, taxes, etc. that are related directly to the manufacturing and production of various products of the company.read more and the direct labor cost will be considered while preparing the overhead budget.
Example of Manufacturing Overhead Budget
XYZ ltd manufactures different products and makes the forecast related to the overhead expensesOverhead ExpensesOverhead cost are those cost that is not related directly on the production activity and are therefore considered as indirect costs that have to be paid even if there is no production. Examples include rent payable, utilities payable, insurance payable, salaries payable to office staff, office supplies, etc.read more for the upcoming year, which ends in December 2020. It forecasted that the employee costs in the next year would be $ 10,000 in quarter 1, $ 12,000 in quarter 2, $ 12,000 in quarter 3, and $ 14,000 in quarter 4. Insurance expenseInsurance ExpenseInsurance Expense, also called Insurance Premium, is the amount a Company pays to obtain an insurance contract for covering their risk from any unexpected catastrophe. You can calculate it as a fixed percentage of the sum insured & it is paid at a daily pre-specified period. read more, rent expenses, and the depreciation expenses are expected to remain fixed for all the four quarters of $ 6,000, $ 9,000, and $ 10,000 per quarter, respectively.
Utility expenses forecasted for the next year would be $ 5,000 in quarter 1, $ 7,000 in quarter 2, $ 6,000 in quarter 3 and $ 7,000 in quarter 4 and the income tax expenses forecasted for the next year would be $ 3,000 in quarter 1, $ 3,000 in quarter 2, $ 4,000 in quarter 3 and $ 4,000 in quarter 4
Prepare the necessary Overhead Budget of the company XYZ ltd for the coming year ending in December 2020.
Solution
Following is the Overhead budget of XYZ ltd for the year ended on December 31, 2020.
Advantages
Thus in the above example, the Overhead budget prepared shows calculation regarding the various expenses forecasted by the company.
The different advantages related to the Overhead Budget are as follows:
- With the budget, employees know the limit of expenditure that they could incur on specific activities in a pre-determined period, thereby keeping the control on the business expenses and getting the desired results set by the management for the business.
- It helps allocate the business resources into different goods and services efficiently and effectively.
Disadvantages
The disadvantages related to the Overhead Budget are as follows:
- Preparation of Overhead budget is the time-consuming process that needs management time and the efforts
- It is based on management judgment and the estimations, so the effective and accurate forecast of the overhead and expense is generally not possible in today’s scenario and this competitive and sometimes unpredictable market.
Important Points
The different important points related to the Overhead Budget are as follows:
- The business which is working since many years can be prepared Overhead budget effectively and accurately then new as a new business can only prepare a budget using the Overhead forecasting strategies and not by following the past trend.
- The preparation of the Overhead budget in the small business is more cumbersome.
Conclusion
Thus, the Overhead budget forecasts the Overhead expenses of the business, giving necessary targets to employees related to expenses. With the budget, employees know the limit of expenditure that they could incur on specific activities in a pre-determined period, thereby keeping the control on the business expenses and getting the desired results set by the management for the business.
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