Factory Overhead

Factory overhead, also called "manufacturing overhead" or "factory burden,"

comprises the indirect expenses associated with the operations of a
manufacturing plant; these costs cannot be directly charged to a specific
product or project. All expenses that fall under under factory overhead are
divided into three different subcategories: indirect material, indirect labor and
other indirect costs.
Components of factory overhead
Indirect material + Indirect labor + other
indirect costs = factory overhead

Indirect Material
Indirect materials are those not directly used
as raw materials for the production of goods
and services. The use of indirect material
makes the production process possible, more
efficient and safer. Indirect materials include
lubricants, fuels, cleaning chemicals and
protective gear.
Direct vs. Indirect Expenses

every factory or production plant requires

employees to undertake the production. As
these employees are associated directly with
the production process, the wages paid to
them are considered direct expenses.
Indirect expenses, on the other hand, are
incurred indirectly during the production
process and do not result in actual
production. Such expenses often facilitate
production and make it more efficient.
Indirect labor

Indirect labor refers to the cost of those

employees who are associated with the
production process, but not on specific units
or products; they indirectly produce goods
and services by supporting the production
facility. Indirect labor costs include the cost of
factory supervision, inspection teams,
superintendents, factory managers and
clerks.
Other Indirect Costs
Other indirect costs include rent, property tax
on the factory premises, fire insurance,
depreciation of the plant and machinery,
repairs and maintenance of machinery,
utilities, and taxes. These costs are further
classified as either fixed or variable factory
overhead.
Fixed & Variable Factory
Overhead

Expenses that do not change with changes

in production are called fixed expenses, or
fixed factory overhead, and include
property insurance, depreciation, property
taxes and salaries for non-production
employees.
Variable expenses change in direct
proportion to the production of goods and
services; these include heating, electricity,
water, indirect labor and indirect materials
Examples
overhead expenses include:
Indirect material - Welding rods, glues, and product wrappers.
Indirect labor Salary for the maintenance staff, technical support
staff, etc.
Machine depreciation This includes the depreciation cost of
manufacturing equipment.
Rent This would include rent that is paid for the manufacturing or
assembly facilities.
Property taxes This is the tax that is paid for the land on which
the factory sits, or the proportion of which is directly attributable to
the manufacturing process.
Factory maintenance supplies Any supplies or expenses that
are incurred to keep the factory running. This may include items
such as grease for the machines and replacement parts.
Heating and lighting Heating, lighting, and other utility charges.
How to Calculate factory overhead
It is a number that represents the overhead costs of
producing the product in your factory.
List every business expense that youve incurred
during the period
Separate the listed expenses into two smaller lists --
one covering direct costs and the other indirect costs.
Add together the list of indirect costs and list of direct
costs to calculate the overhead costs and the total
direct costs for your factory and for your factory.
Divide the overhead costs for the factory by the direct
costs to calculate the overall overhead rate for the
factory
How to Calculate Applied Overhead
Costs

applied overhead costs = budgeted annual

rate x budgeted annual hours.
Determine the budgeted annual rate
Determine the budgeted annual activity
hours which are also a management
estimate
Multiply the budgeted overhead rate by the
budgeted annual activity hours.
How to Calculate Actual
Overhead
Determine payroll costs. Average the past 12
payroll cycles to determine your average
monthly costs.
Gather your business credit cards from the past
year in which money is still owed. Calculate the
total you have paid each month for all cards.
Divide by 12 to get your company's average
credit card expense.
Calculate all indirect monthly expenses, such as
rent payments, company car expenses, mileage,
vendor bills, utility costs, entertainment costs,
business lunches and supply purchases.
Calculate all your direct monthly expenses
for labor or manufacturing that goes
towards producing services or products for
your company
Add together your average monthly payroll
cost, your monthly credit card expense and
your indirect and direct monthly expenses.
The total is your company's actual
overhead. This total needs to be accounted
for in the budget for your business each
month
Control
Among the 3 elements of cost it requires
most extensive study because it represents
the most difficult problem (consider the
size of the company and its products)
CHARGING MFG. OVERHEAD TO
PRODUCTION
Actual Costing using arbitrary application
rate at the end of the period (could cause
delay)
Normal Costing pre-determined overhead
rate to allocate manufacturing overhead
costs to jobs.
PURPOSE OF OVERHEAD
RATES
Job costs is essential for managerial
decisions. While Materials and Labor can
easily be computed, it is important to have
a basis for computing or assigning cost to
overhead. Predetermined overhead rate are
used to ESTIMATE manufacturing overhead
costs.
DETERMINATION OF OVERHEAD COSTS:
Direct labor costs
Direct labor hours
Direct material costs
Machine Hours
 Example

Manufacturing overhead costs 96,000

Number of units of production 24,000
Direct Material costs 480,000
Machine Hours 12,000
Direct Labor Hours 40,000
Direct Labor Costs 200,000
DLC Basis
Estimated Mfg. Overhead Costs/Estimated DL
Costs = %age of DL Costs

96,000/200,000 = 48% of DL Cost

Hence, if actual labor costs incurred in

particular job totalled 6,000, the applied
overhead would be 2,880 (6,000 x .48)
DL Hour Basis
Estimated Manufacturing Overhead
Costs/Estimated DL Hours= Rate per Direct
Labor Hour

96,000/40,000 = 2.40 per direct labor hour

If job required 2,250 DL hours, overhead

cost would be 5,400 (2,250 x 2.40)
Direct Material Cost Basis
Estimated Manufacturing Overhead
Costs/Estimated Direct Material Costs =
%age of Material Costs

96,000/480,000 = 20% of materials costs

If actual material costs is 22,000, the

overhead costs is 4,400 (22,000 x .20)
Machine Hours
Estimated Manufacturing Overhead
Costs/Estimated Machine Hours = Rate per
Machine Hour

96,000/12,000 = 8 per machine hour

So, if 400 machine hours, overhead costs to

be applied is 3,200 (400 x 8)
Unit of Production Basis
Estimated Manufacturing Overhead
Costs/Estimated Unit of Production =
Overhead Cost per Unit of Production

96,000/24,000 = 4 per unit

1,200 units, the overhead costs to be applied

is 4,800 (1,200 x 4)
Recording Applied MO costs
Assume applied MO costs during the month
is 540,00

WIP 540,000
Manufacturing Overhead Control
540,000
To record applied manufacturing overhead
for the month

Assuming actual manufacturing overhead in

640,000
Over/under applied OH
Over (a credit balance in the MOC) when
product costs are overstated bec. Actual
overhead costs are lower than applied.
Under (a debit balance in MOC) when
overhead costs are higher than applied.
Underapplied MOH 100,00
MOH Control 100,000
To close mfg. overhead control account at
the end of the month
Over-applied or Under-applied
Overhead Rate
Overhead is the amount of indirect costs
attributed to units of production that is not
directly incurred during the production process.
The over-application or under-application of
overhead is due to differences between the
estimated and actual overhead amounts.
When actual overhead is greater than estimated
overhead, the amount assigned to inventory
costs was under-applied.
If the actual overhead is less than the estimated
overhead, the amount assigned to inventory
costs was over-applied.
How to calculate over/under applied
overhead

Determine the estimated cost driver. it can

be estimated direct labor hours or machine
hours.
Calculate the overhead rate. The amount of
budgeted overhead costs can include items
such as indirect labor, indirect materials
and other indirect costs. The total budgeted
overhead costs are divided by the
estimated cost driver to arrive at the
overhead rate.
Determine the actual cost driver. The actual
cost driver is based on actual production
activity; it can be actual direct labor hours
worked or actual machine hours used in
production.
Apply and calculate the overhead by
multiplying the actual cost driver by the
overhead rate. The applied overhead is
compared to actual overhead costs to
determine if the amount is over-applied or
under-applied.
How to Calculate Overhead Cost
Per Unit

Define overhead costs and expenses. These are all

costs associated with direct labor and materials.
Determine average hourly wage. Each employee's
contribution should be classified as either direct or
indirect labor. Direct labor works directly with
product, whereas indirect labor supports direct labor
Estimate the number of workdays available in a
given calendar year. Subtract the average number
of days labor will not be working (holidays,
weekends, vacations, sick leave, etc.) from 365.
Multiply the number of workdays available for
labor by eight (for an eight-hour work day).
This gives you an estimate for the total
number of labor hours worked.
Multiply number of total labor hours by
average labor wage determined in Step 2.
Add all overhead expenses, as defined in Step
1, to the dollar amount in Step 5. This is your
total overhead cost.
Look up the average number of units sold per
month and multiply by 12.
Divide total overhead costs by average
number of units. This is your overhead cost
per unit.
Variance analysis

For the purpose of over or applied

factory overhead analysis two separate
variance are computed as follows:

Budget or spending variance

Volume or capacity variance
Budget or spending variance
Factory Overhead spending variance is the
difference between actual expenses incurred and
the budgeted allowance based on actual hours
worked.
The spending variance is the responsibility of the
department manager, who is expected to keep
actual expenses within the budget.
Formula of Spending Variance:
[Actual factory overhead Budgeted allowance
based on actual hours worked*]
*[Fixed expenses budgeted + Variable expenses
(actual hours worked variable overhead rate)]
Volume or capacity variance
It is the difference between the budgeted
overhead estimated for the capacity attained and
factory overhead during the period
Responsibility of this overhead is rest on the top
management because of the policy decisions
about the utilization of the plant and equipment.
Formula of Idle Capacity Variance:
[Budgeted allowance based on actual hours
worked* (Actual hours worked Standard
overhead rate)]
*Fixed expenses budgeted + Variable expenses
(actual hours worked variable overhead rate)
Example of variance analysis

Fixed factory overhead P 40,000

Variable factory overhead 60,000

Total factory overhead
1,00,000

Variable overhead rate = 60,000 = P 3 per

D. L
20,000 Hr.
Budget variance

Actual factory overhead P

80,000
(Factory overhead budgeted
for the capacity attained)
Fixed overhead 40,000
Variable overhead 51,000

(P 3 x 17000)
91,000 Budget variance
P 11,000
( cr. Or unfavorable)
Volume variance

Budgeted overhead allowance P

91,000
for the capacity attained
applied factory overhead
85,000
volume variance( dr. unfavorable) P
6,000