What Does Manufacturing Overhead Include?
Gain clarity on manufacturing overhead: understand its true components and how these indirect costs shape your product's total cost.
Manufacturing a product involves numerous costs, not all directly tied to the creation of a single item. Understanding these various expenses is important for businesses to accurately determine the true cost of their goods and make informed decisions. Among these costs, manufacturing overhead plays a significant role in the overall financial picture of a production process. Manufacturing overhead represents the sum of all indirect costs incurred during the production of goods. These costs are necessary for manufacturing but cannot be directly traced to specific products. Unlike direct materials, which are physically integrated into a product, or direct labor, which involves hands-on work on a product, manufacturing overhead comprises expenses that support the overall factory operations. Including these indirect costs is important for accurate product costing and inventory valuation.
Understanding the Components
Manufacturing overhead encompasses a range of indirect expenses crucial for factory operations. These costs are categorized to provide a clearer picture of all the expenditures beyond direct materials and direct labor. Properly accounting for these components helps in understanding the full financial outlay of production.
Indirect Materials
Indirect materials are goods consumed during manufacturing that do not become a physical part of the final product, or their cost is impractical to trace to individual units. Examples include lubricants, cleaning supplies, and small tools. While these items are essential for production efficiency and maintaining a safe working environment, they are used across many products or in insignificant quantities, making direct tracing difficult.
Indirect Labor
Indirect labor refers to wages and benefits paid to employees who support manufacturing but are not directly involved in converting raw materials into finished goods. This includes factory supervisors, maintenance staff, quality control personnel, and janitors. These individuals ensure the production environment runs smoothly and efficiently, even though their work is not tied to a specific product. Their contributions are necessary for the factory to operate, but they do not directly handle or shape the product itself.
Other Manufacturing-Related Expenses
Other manufacturing-related expenses cover a broad category of costs essential to the factory’s operation that are not indirect materials or labor. This includes factory utilities such as electricity, water, and natural gas. Factory rent or the depreciation of the factory building and equipment are also included, as these costs are incurred regardless of production volume. Property taxes and insurance premiums on the factory also fall under this category, representing fixed costs associated with owning and operating the production facility. Additionally, repair and maintenance costs for factory equipment are considered manufacturing overhead.
Distinguishing from Other Business Costs
Understanding manufacturing overhead also involves recognizing its distinction from direct and non-manufacturing costs. Clarifying these distinctions helps prevent misclassification of expenses.
Direct Costs
Direct costs, such as direct materials and direct labor, are expenses directly traced to a specific product. For example, the wood for a table or the carpenter’s wages are direct costs. Manufacturing overhead, conversely, comprises all indirect costs that support production but are not directly identifiable with a particular unit.
Non-Manufacturing Costs
Non-manufacturing costs, often called period costs, are expenses incurred outside the factory and not related to goods production. Selling expenses, like advertising, sales commissions, and delivery costs, are examples of non-manufacturing costs aimed at generating sales. Administrative expenses, such as executive salaries, office supplies, and corporate office rent, are also non-manufacturing costs that support the general operation of the business. These expenses are essential for running a business but do not contribute to the cost of creating a product.