Is Factory Overhead an Asset? The Answer Is Complicated
Is factory overhead an asset? This article clarifies its complex accounting classification, explaining how it integrates into inventory as an asset component.
Factory overhead is an accounting term often misunderstood regarding its classification. This article clarifies its nature, role in production, and financial reporting treatment.
What is Factory Overhead
Factory overhead, also known as manufacturing overhead, refers to all indirect costs associated with the production process that are not direct materials or direct labor. These costs are essential for manufacturing but cannot be directly linked to a specific product unit.
Examples of factory overhead include factory rent, utilities for the production facility, and depreciation of factory machinery. Indirect labor, such as salaries for factory supervisors, maintenance staff, and quality control personnel, also falls under factory overhead. Other costs include factory supplies, property taxes on the production facility, and insurance premiums for the factory building. These costs are necessary to operate the manufacturing environment but do not become a physical part of the finished product.
Understanding Assets
In accounting, an asset is a resource controlled by an entity from which future economic benefits are expected to flow. Assets represent something of value a company owns or controls. Key characteristics include measurable economic value and the potential to generate future economic benefits or positive cash inflows.
Assets are typically reported on a company’s balance sheet, a financial statement that provides a snapshot of financial health. Common examples of assets include cash, accounts receivable (money owed to the company), and inventory. Property, plant, and equipment (PPE), such as buildings and machinery, are also examples of assets that provide long-term utility.
Factory Overhead and Inventory Cost
Factory overhead costs, while incurred as expenses, are treated differently from period expenses in financial reporting. These costs are considered “product costs,” meaning they are directly tied to the creation of products. Unlike “period costs” (like administrative or selling expenses), product costs are not expensed immediately but are instead “capitalized.”
Capitalization means that factory overhead becomes a component of the cost of manufactured inventory. This process aligns with generally accepted accounting principles (GAAP), which require manufacturing overhead to be included in the cost of inventory on the balance sheet. The indirect costs are accumulated and then systematically allocated to the goods as they move through the production stages.
Specifically, factory overhead is assigned to Work-in-Process Inventory as goods are being manufactured. Once production is complete, these costs, along with direct materials and direct labor, transfer to Finished Goods Inventory. The factory overhead costs remain part of the inventory’s value (an asset) until the products are sold to customers. Only at the point of sale does the portion of factory overhead embedded in the product’s cost become an expense on the income statement, recognized as part of the Cost of Goods Sold. Therefore, factory overhead itself is not a standalone asset, but its cost is absorbed into the asset of inventory until the inventory is sold.