What Is Included in Manufacturing Overhead?
Demystify manufacturing overhead. Learn to identify crucial indirect production costs and distinguish them from non-manufacturing expenses for accurate costing.
Manufacturing overhead is a fundamental concept in cost accounting, representing all indirect costs associated with the production of goods. It encompasses those manufacturing expenses that cannot be directly traced to a specific product unit, distinguishing them from direct materials and direct labor. Understanding manufacturing overhead is essential for businesses to accurately determine the true cost of production, which in turn informs product pricing, profitability analysis, and strategic decision-making. Proper accounting for these costs ensures compliance with financial reporting standards and provides a clearer picture of operational efficiency within the manufacturing process.
Indirect Materials
Indirect materials are those production supplies that are necessary for the manufacturing process but do not become a significant, traceable part of the finished product. The cost of tracking these materials to individual units would often be impractical or too time-consuming. These items support the manufacturing process without being directly incorporated into the final good.
Examples of indirect materials include lubricants for machinery, cleaning supplies for the factory floor, and small components like glue, nails, or fasteners. These items are consumed during production but are not easily allocated on a per-unit basis, making them part of the overall manufacturing overhead. Their consistent availability is important for smooth operations, even though their individual cost per product might be minimal.
Indirect Labor
Indirect labor refers to the wages and salaries paid to personnel involved in the manufacturing process who do not directly work on the product itself. This category includes employees whose efforts support the production environment rather than physically transforming raw materials into finished goods. Their contribution is necessary for the overall functioning and efficiency of the factory.
Examples of indirect labor roles are factory supervisors who oversee production lines, maintenance staff who keep machinery running, and quality control inspectors who ensure product standards. Security personnel for the factory and janitorial staff cleaning the production facility also fall under this classification. Unlike direct labor, which is easily traced to specific units produced, indirect labor costs are accumulated as part of manufacturing overhead and then allocated across all manufactured products.
Other Indirect Manufacturing Costs
Beyond indirect materials and labor, manufacturing overhead includes a broad range of other costs essential for factory operations that cannot be directly attributed to specific products. These expenses are necessary to maintain the production environment and ensure that manufacturing activities can occur. They represent the indirect support structure for the entire production process.
Such costs include:
- Rent or mortgage payments for the factory building
- Utilities such as electricity, gas, and water used in the production facility
- Depreciation of factory equipment and buildings
- Factory insurance
- Property taxes on the manufacturing facility
- Costs associated with repairing and maintaining production equipment
- Equipment rental costs for production machinery
- Small tools expense not classified as indirect materials
- General office supplies used within the factory
Costs Not Classified as Manufacturing Overhead
It is important to distinguish manufacturing overhead from other business expenses that, while necessary for a company’s operation, are not directly tied to the production of goods. They are generally treated as period costs, expensed in the period they are incurred.
Selling expenses are costs incurred to promote, market, and sell products to customers. These include sales commissions, advertising costs, and shipping expenses for delivering finished goods to customers. Administrative expenses cover the general management and oversight of the company, not directly linked to manufacturing or selling. Examples include executive salaries, general office rent, legal fees, and the costs of the accounting department.