Manufacturing overhead costs encompass all indirect expenses associated with producing goods. These costs significantly impact the overall profitability and pricing of products, making accurate calculations essential. By accounting for all indirect factors like electricity usage or supervisor salaries, businesses can better allocate resources and optimise production costs for greater efficiency.
Understanding the scope of manufacturing overhead costs is vital in ensuring accurate product costing. Neglecting these overheads can lead to under-pricing or even profitability loss, which is why companies strive to analyse and control them effectively.
What is manufacturing overhead cost?
Manufacturing overhead cost refers to all indirect costs incurred in the production planning process but not directly traceable to the creation of a specific product. A strong understanding of manufacturing overhead costs allows manufacturers to price their products competitively while covering all operational expenses. By identifying these expenses, companies can allocate resources more strategically, ensuring sustainable operations.
Formula to calculate manufacturing overhead cost
The formula to calculate manufacturing overhead cost is:
- Manufacturing Overhead = Total Indirect Costs / Total Machine Hours or Labour Hours
This formula helps determine the overhead rate, allowing you to allocate these costs appropriately across products.
Let’s break down the key components of the formula.
Total indirect costs
This includes all costs that are not directly tied to production. Examples are rent, factory maintenance, insurance, and salaries for supervisors. These are essential expenses that ensure the factory can operate smoothly.
Total machine hours
Machine hours refer to the total time machines spend in production. Overheads allocated per machine hour help companies understand how efficiently their machinery contributes to the cost of production.
Total labour hours
Labour hours are the cumulative working hours of employees involved in an indirect capacity, such as maintenance teams or supervisors. By using labour hours, manufacturers can measure the overhead costs attributed to the workforce.
What is included in manufacturing overhead?
Manufacturing overhead includes all indirect costs which must be accounted for calculating the total cost of manufacturing. Below are the key elements included in manufacturing overhead:
Indirect labour costs
These refer to wages paid to staff who do not work directly on production lines but are essential for supporting the manufacturing process. Common examples in factories include site maintenance teams, machine supervisors, cleaning staff, and health and safety officers. With stringent workplace standards set by government such as the Health and Safety at Work Act 1974, having indirect labour in place ensures compliance and operational safety.
Utilities
From electricity for manufacturing equipment to gas for factory heating, utility costs form a significant part of manufacturing overhead. Given the rising energy costs across the country, many manufacturers are investing in energy-saving measures and renewable solutions to control overhead expenses while adhering to sustainability goals outlined in environmental initiatives.
Depreciation of assets
Depreciation accounts for the gradual loss of value in machinery and equipment over time. UK accounting standards, like those set by the Financial Reporting Council (FRC), require businesses to reflect these costs accurately. For example, a manufacturer might use reducing balance methods to allocate depreciation for factory equipment, ensuring this expense is evenly spread across the useful life of the asset.
Maintenance and repairs
Regular upkeep and unexpected repairs of manufacturing equipment are critical to avoiding downtime, especially in industries where production delays can lead to fines under supplier contracts. Scheduled servicing, often mandated by government safety regulations, and emergency repairs for machinery fall under this category.
Facility rent and property expenses
The cost of renting or owning a factory or production space is a major overhead. This includes business rates (a tax specific to commercial properties), property insurance, and any council-imposed fees. These costs are particularly important to consider for manufacturers in densely populated areas such as Manchester or Birmingham, where commercial rents can be high.
Indirect materials
Items such as cleaning chemicals for machinery, oil for lubrication, and spare parts for minor repairs are essential but cannot be traced to a single product. For manufacturers, these costs are generally bought in bulk and added to overhead expenses since they support overall production rather than specific product lines.
Administrative and clerical support costs
Clerical staff salaries and factory office expenses, such as purchasing pens and paper or computer equipment, fall under this category. Many businesses also account for regulatory compliance costs here, such as preparing documentation required for audits under the Companies Act 2006.
Security and safety expenses
To ensure compliance with property insurance requirements or local council regulations, many manufacturers invest in security measures like on-site personnel, CCTV systems, and access control equipment. Health and safety expenses, from maintaining fire extinguishers to providing proper PPE (Personal Protective Equipment), are also a key component of overheads due to strict workplace safety standards.
Miscellaneous factory expenses
Costs like waste management services, which must often comply with strict environmental regulations such as the UK’s Waste Regulations 2011, or canteen expenses for factory staff, are part of the overhead. Facilities ensuring employee well-being, such as break rooms or on-site amenities, are also included here, as they can indirectly impact productivity.
How to calculate manufacturing overhead cost?
Step 1: Identify total indirect costs
First, gather all the indirect costs over a specific period (e.g., one month). For this manufacturer, the recorded monthly overhead costs are:
- Factory electricity and gas (utilities): £2,000
- Equipment depreciation: £1,200
- Maintenance and repair expenses for machinery: £800
- Indirect wages (cleaners, supervisors): £3,000
- Rnt and business rates for the factory premises: £4,500
Total indirect costs = £2,000 + £1,200 + £800 + £3,000 + £4,500 = £11,500
Step 2: Choose a basis (labour hours or machine hours)
Next, select an appropriate basis for allocation. This business tracks labour hours as the most accurate representation of its process. During the month, the workers logged 5,750 labour hours.
Step 3: Divide indirect costs by total chosen hours
Now, calculate the overhead rate per hour using the formula:
Overhead rate = Total indirect costs ÷ Total labour hours
Overhead rate = £11,500 ÷ 5,750 hours = £2 per hour
This means £2 of overhead costs will be allocated for every labour hour used in production.
Step 4: Apply overhead rate
To determine the overhead cost for a specific product, multiply the overhead rate (£2/hour) by the labour hours required to produce one unit.
For example, producing a wooden dining table takes 10 labour hours. The overhead cost for one table is:
10 hours × £2/hour = £20 overhead cost per table
If the manufacturer produces 150 dining tables in that month, the total overhead attributed to these tables is:
150 tables × £20 overhead cost per table = £3,000
Tool to track and optimise manufacturing overhead
Leveraging technology to manage manufacturing overhead costs completely transforms how manufacturers handle indirect expenses. Real-time tracking ensures transparency and accuracy in cost allocation, while advanced reporting tools provide actionable insights for informed decision-making.
Innovative systems, such as OneAdvanced’s manufacturing software, not only streamlines overhead tracking but also monitors inventory levels, helping manufacturers maintain optimal stock without risking overinvestment or shortages. With live data visibility, businesses can proactively reduce costs, improve operational performance, and set precise product pricing. This ensures they stay competitive and agile in an industry driven by efficiency and precision.
FAQs
1. How to reduce manufacturing overhead cost?
To reduce overhead costs, businesses can adopt energy-saving measures like switching to renewable energy sources or installing efficient machinery. Improve productivity, outsourcing non-core tasks, and renegotiating supplier contracts can also help. Implementing comprehensive tracking systems to monitor expenses aids in identifying inefficiencies and cutting unnecessary costs.
2. What is manufacturing overhead cost per unit?
Manufacturing overhead cost per unit is the total indirect costs allocated to produce one unit of product. It’s calculated by dividing the total manufacturing overhead by the number of units produced. This metric helps businesses in the UK price their products competitively and maintain profitability.
