Overheads contribute to the cost of manufactured goods.
Manufacturing overhead costs – also called manufacturing overhead, factory overhead or manufacturing support costs – are items that do not go directly into the goods or services produced. A company requires these costs to run a production process as a whole, rather than producing a single item. Types of manufacturing overhead, for example, include rent, depreciation of plant or equipment, and maintenance, as well as building security, quality control, and small materials costs that go into the production of all goods. Management accountants must record these costs in an account and then allocate a portion of them to each item produced. In short, these costs represent an important group of total production costs.
Manufacturing facilities must pay for the maintenance and upkeep of the machines, a sort of overhead cost.
All companies have some sort of manufacturing overhead. In companies that do not manufacture physical goods, these indirect costs are called general, selling, and administrative expenses. Costs are not directly related to any company good or service. Instead, costs provide resources for all departments and individuals working in the company. Companies looking to reduce costs often look to these overhead costs to find areas where cutting costs will save money without reducing the quality of the company’s stock.
Whenever a factory is producing goods, it is incurring manufacturing overhead.
Manufacturing companies tend to record manufacturing overhead in a single account called manufacturing overhead. The balance in this account is never really zero; there are always some costs here as long as the company produces goods. When a batch of goods passes through the production system, management accountants calculate the amount of manufacturing overhead to allocate to these items. In some cases, a company may use a predetermined overhead rate to apply these costs. This rate represents the expected amount of factory overhead to be applied to manufactured products.
Manufacturing companies tend to classify all indirect costs as “manufacturing overheads”.
A predetermined overhead rate represents the standard amount of manufacturing overhead required to produce a single good. For example, management accountants review the estimated total value of manufacturing overhead required to produce a specified number of goods. Then a total cost driver – such as labor hours or machine hours – is needed to determine the cost per unit for factory overhead. Dividing the total manufacturing overhead by the expected total cost driver value results in the required predetermined overhead. Allocating this amount of cost per unit to all goods produced will move factory overhead from the manufacturing overhead account to the goods produced by the company.