What is Manufacturing Overhead?

Manufacturing overhead is all indirect costs incurred during the production process. This overhead is applied to the units produced within a reporting period, so that the cost of these units are fully burdened with all manufacturing costs. These costs are then charged to the cost of goods sold as the units are sold over time.

Characteristics of Manufacturing Overhead

The characteristics of manufacturing overhead are as follows:

Indirect nature. Manufacturing overhead includes costs that cannot be directly traced to specific products, such as factory utilities, maintenance, and depreciation.
Supports production. Manufacturing overhead costs are essential for the production process but are not directly involved in the transformation of raw materials into finished goods.
Generally fixed nature. Most manufacturing costs remain constant regardless of production volume, such as rent or salaries for supervisors. However, some can vary with production levels, such as utility expenses or indirect materials usage.
Allocated to products. Overhead is allocated to products using predetermined rates based on cost drivers such as machine hours, labor hours, or units produced.
Impacts inventory valuation. Under absorption costing, manufacturing overhead is included in the valuation of inventory, impacting financial statements.
Can be controlled. Effective management of energy usage, maintenance schedules, and indirect labor can reduce manufacturing overhead.

Manufacturing overhead is an essential component of product costing and profitability analysis and requires careful management and allocation to ensure accurate financial reporting and operational efficiency.

Examples of Manufacturing Overhead

Examples of costs that are included in the manufacturing overhead category are as follows:

Depreciation on equipment used in the production process
Property taxes on the production facility
Rent on the factory building
Salaries of maintenance personnel
Salaries of manufacturing managers
Salaries of the materials management staff
Salaries of the quality control staff
Supplies not directly associated with products (such as manufacturing forms)
Utilities for the factory
Wages of building janitorial staff

Since direct materials and direct labor are usually considered to be the only costs that directly apply to a unit of production, manufacturing overhead is (by default) all of the indirect costs of a factory.

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What is Not Included in Manufacturing Overhead?

Manufacturing overhead does not include any of the selling or administrative functions of a business. Thus, the costs of such items as corporate salaries, audit and legal fees, and bad debts are not included in manufacturing overhead. These costs are instead charged to expense as incurred; they are considered to be period expenses, and so are associated with an accounting period, rather than a product.

Accounting for Manufacturing Overhead

When you create financial statements, both generally accepted accounting principles and international financial reporting standards require that you assign manufacturing overhead to the cost of products, both for reporting their cost of goods sold (as reported on the income statement), and their cost within the inventory asset account (as reported on the balance sheet). The method of cost allocation is up to the individual company - common allocation methods are based on the labor content of a product or the square footage used by production equipment. it is also possible to use multiple allocation methods. Whatever allocation method used should be employed on a consistent basis from period to period.